Tips on Spotting Financial Fraud

For those of you who never got around to taking ancient Greek in college, the word of the day is hubris.

Webster’s dictionary, 8th ed.: “Excessive pride or self-confidence, often entailing a loss of contact with reality and an overestimation of one’s own capabilities, especially on the part of those in positions of power.”

That pretty much sums up the psychology behind the ongoing debacle that is Peregrine Financial, whose founder and CEO, Russell Wasendorf, Sr., was indicted in Cedar Rapids, Iowa, on Monday on 31 counts of lying to U.S. financial regulators.

By his own admission, Wasendorf bilked investors out of nearly $100 million over the course of nearly two decades (just days before his arrest, the National Futures Association reported a deficit of more than $200 million in funds that Peregrine Financial had claimed to be on deposit at U.S. Bank). To hide the theft, he cooked up fake bank statements using Photoshop, Microsoft Excel, and high-quality printers. These he then handed over to Peregrine’s CFO, who appears to have adopted an “OK, you’re the boss” attitude after Wasendorf used what he called “blunt authority” to cow him into submission. Wasendorf seems to have taken special pride in his forger’s art, bragging of how adept he eventually became at falsifying not just hard copies, but online statements as well, none of which the financial regulators appear to have questioned.

Then, this summer, Peregrine hit the wall. Wasendorf couldn’t keep all the balls bouncing. On July 9, he tried to kill himself by inhaling fumes from a hose hooked up to his car’s tailpipe. Needless to say, the firm had been run into the ground. Wasendorf’s son was devastated at finding the company he was supposed to inherit was now a mound of useless paper—and that his father was a crook. Peregrine’s workers were out of a job. And of course, thousands of investors were left holding the bag.

Excessive self-confidence? Check. Grotesque overestimation of one’s abilities? Check. Loss of contact with reality? Check. (Sooner or later someone had to notice that there was no actual money in those U.S. Bank accounts.)

But the hubris didn’t stop there. It was also abundantly on display in Wasendorf’s suicide note, in which, far from showing any remorse, he actually seemed to thumb his nose at financial regulators. Evidently even his would-be last moments were ego-driven:

Where executives [like Wasendorf] have committed crimes, “it is not remorse that motivates” them to kill themselves, said Dr. Alan Berman, executive director of the American Association of Suicidology, a suicide education and prevention group. “Rather it’s a refusal to accept a changed public persona.”

As he prepared to take his life, Wasendorf confessed to massive fraud in a document whose tone often sounded more boastful than ashamed. He explained in detail how he had used “careful concealment and blunt authority” to steal hundreds of millions of dollars over two decades from clients of his brokerage firm. His scheme to falsify bank statements and balance sheets started 20 years ago, he wrote, because “my ego was too big to admit failure.”

In the cases of executive criminals, Berman said that “the suicide dies having preserved in his mind that the world’s view of him will remain that of before his death. Death is preferred to losing face, suffering media coverage of the felonious behavior, prison and other consequences.”

Incredible, an ego that massive. But seeing as how egotistical delusions are the enemies of realistic risk assessment pretty much 100% of the time, investors would do well to take a cold shower before forking over money to any proposal that appears too good to be true. Specifically, they should learn to recognize Ponzi schemes, of both the Waserdorf and the Bernie Madoff variety. These schemes have several tell-tale traits:

  • They promise minimum or steady returns;
  • They claim their opportunities are exclusive, available only to a select few;
  • Their means of making money is too complicated or secret to explain;
  • They make it difficult to withdraw your money, saying that funds have been frozen;
  • They issue statements that lack detail, or that frequently show discrepancies that cannot be explained;
  • They are frequently run by a single individual whose charm and charisma allow him maximum leverage over investors’ fears—and greed.

Con artists like Wasendorf prey upon the egotistical hopes and equally egotistical anxieties that come out in just about all of us whenever money is involved. Knowledge and financial realism are their enemies. That’s why, whenever you’re about to embark on a new financial venture, it pays to check your ego at the door.

Posted by on August 17th, 2012 at 7:50 am

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