Number One Reason For Financial Fraud: Lack Of Morals

Martin Woods, a London police detective turned corporate whistleblower says more money is being laundered in London every day than in Panama. And warns of more revelations to come.

And the reason for this is that more and more individuals and business managers around the world and in India are skirting the law or outright abusing it.

“There are these 10 addresses in the UK with 50,000 companies in each address, some of them even residential. You can tell which ones they are by the amount of letters the postman carries to these addresses,” he told me in an onstage conversation at the Thomson Reuters South Asia Risk Summit in Mumbai last week.

Woods became a celebrity when he blew the whistle on Wachovia Bank’s dealings with Mexican drug cartels in which billions of dollars of transactions were conducted, in gross violation of anti money laundering and know your customer (KYC) norms.

Most of Woods’ revelations emerged around the time of the global financial crisis in 2007-08. Wachovia first tried to dissuade and then discredit him, but without success. The bank subsequently went bust and was bought over by Wells Fargo.

Woods worked with the London Metropolitan Police’s drug squad and then as a fraud expert with the National Crime Squad, equivalent to the US’ Federal Bureau of Investigation or FBI before joining the corporate sector. In his current job, he is Head of Financial Crime at Thomson Reuters.

So why is this happening ? Is the world becoming a seedier place ?

The problem, Woods points out, is we just don’t live in an honest world anymore. And increasing amounts of data are proving it.

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1. Some 32% of respondents in Ernst & Young’s 14th Global Fraud Survey (2016) said they had personal concerns when asked about bribery and corruption in their workplace. Which means they were witness to, directly or indirectly wrongdoing in their organisations.
2. An amazing 42% of 2,825 executives surveyed by EY said that they could justify unethical behaviour to meet financial targets. Moreover, executives were willing to make cash payments to win or retain businesses, backdate contracts while others were willing to misstate financial performance.
3. More specifically, members of the finance team, according to the EY survey, were willing to change assumptions determining valuations and reserves, extend the monthly reporting period and book revenues earlier than they should. All specific examples of stretching the boundaries.[/ordered_list]

But why do banks and companies take so much risk ?

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1. In one word, the answer is `shame’ or lack of it. People just don’t feel it, says Woods. In the absence of shame, the system has to have strong deterrent in the form of punishments. But these deterrents don’t really exist, particularly in the world of high finance.
2. Insecure males. Amazingly, the insecure male, generalised as that may sound, is a big problem. This is because he has difficulty in telling his colleagues he does not know or did not understand and carries on despite lacking the knowledge. He lacks the courage to confront or seek answers.
3. Need for speed. Wachovia Bank and Halifax Bank of Scotland were some of the fastest growing banks in the world pre-2008. The banks do not exist today, says Woods, because their risk aspirations did not match the commercial aspirations of the bank. Company or country (fast growing economy like India) - this is a lesson for everyone.
4. Bonus system. A system of bonuses and commissions can incentivize people to do the wrong thing. “Do you want to get paid more and do the right thing or would you like a bonus system ?” he asks. The answer however is most people would like a bonus system. Woods says he is different but acknowledges he is in a minority.
5. “If you are not cheating, then you are not trying,” said one email that emerged from a recent bank forex rate fixing investigation in London. The exchange was between two traders. Not surprisingly, "The top 5 British banks have paid 60% of their profits in penalties and restitutions in the last 5 years,” says Woods.

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Can things change ?

It depends. The publishing of the Panama Papers shows that more and more people are alert to financial malfeasance. Citizens across countries are asking tougher questions of those who avoid taxes or spirit away illegally gained wealth. The Prime Minister of Iceland resigned after names of family members emerged in the Panama Papers.

India has seen some 500 names of individuals and companies emerge, including Bollywood actors and Income Tax authorities claim they are going after most of them.

But there is a legacy we have to deal with too.

In India, a moribund tax system (that in 1973-74 hit a maximum rate of 97.5% !!) ensured that many individuals spent more time and effort avoiding taxes than earning the income that led to it. But the culture of confrontation was laid down. And a feeling that the state was taking away more than it was giving.

From avoidance and jugglery we moved seamlessly to an era of corruption created by artificial shortages. The early shortages were in licenses and citizen services, the more recent (major) ones were in extractive industries, spectrum and mineral resources.

And then, simultanously, came extreme prosperity, reckless ambition and hyper-competition. The Satyam Computer debacle reflected this phenomenon. Kingfisher Airlines too was a case of recklessness and failure of all risk controls if not fraud. There are many more examples. Some are known, more will emerge, including in the venture capital fuelled space.

The excesses of the last decade are still not out yet. India’s banking system is reeling under a Rs 13 lakh crore non performing asset (NPA) or $195 billion problem, a fifth of all bank loans. In many ways this is a failure of risk systems, within the companies that ran up these debts and the banks for having failed to spot them in time.

Better systems, process and technology will surely reduce the prospects of a recurrence. But at the end of the day, it’s people who commit fraud, not machines.

And those without shame.