Theranos is just one of a long list of financial scandals that have made headlines in recent years. In addition, Wirecard, a German payments processor, and Abraaj, a Dubai-based private-equity firm, have been accused of various crypto-thefts, and a bonanza of misappropriation of government handouts for businesses during the Covid-19 pandemic. There are so many scams, and so many big ones, that a billion dollar theft is not guaranteed to become a global headline. Chances are you haven’t heard of Outcome Health, a Chicago-based health-tech firm whose former CEO and president was recently convicted of defrauding customers, lenders and investors, of roughly that amount.
Beneath the billion-dollar blockbuster frauds lies an alarmingly long tail of smaller financial scams. Taken together, these add up to a larger global problem. Crowe, a financial-advisory firm, and the University of Portsmouth in England, shows that fraud costs businesses and individuals around the world more than $5 trillion each year. This is about 60% of what the world spends on health care annually.
The drivers of fraud are many and complex. Sometimes it is due to pure greed. Sometimes it begins with a relatively innocuous attempt to paper a small financial crack, but spirals when the initial attempt fails; Some believe that this is how it got its start with Bernie Madoff’s massive Ponzi scheme. Market pressure and a desire to exceed analysts’ expectations may also play a role: after the global financial crisis of 2007–09, GE was fined $50m for artificially lowering its profits to keep investors sweet. The fine was imposed. Accounting tricks like this, which fall into a gray area, are more common than outright fraud. There’s even an established term among tech startups for manipulating numbers to buy you time to navigate the rocky road to financial respectability: “Fake it till you make it.”
Fraud is an evergreen pursuit. The economic boom helps fraudsters hide creative accounting, such as exaggerated revenues. Recessions expose some of these wrongdoings, but they also create new shenanigans. As funding dries up, some owners and managers fatten the books to stay in business. When survival is at stake, the line between what is acceptable and unacceptable can be blurred when disclosing information or booking a sale.
World events can also incite cheating. At the peak of the pandemic, an estimated $80bn of US taxpayer money given under the Paycheck Protection Program set up to aid struggling businesses was stolen by fraudsters. The Covid-induced increase in remote working has created new opportunities for miscreants. The 2022 KPMG Fraud Outlook concludes that the rise in working from home has reduced businesses’ ability to monitor employee behaviour. Geopolitics also affects cheating. NATO countries experienced four times as many email-phishing attacks from Russia in 2022 as they did in 2020. Cybercrimes such as ransomware attacks have already transferred a staggering amount of money to illegal actors. Costs to businesses range from stolen data, intellectual property and money to post-attack disruption, lost productivity and system upgrades.
It is wrong to think that fraud can be eliminated, but much more can be done to reduce it. Corporate boards and investors need to be asking more questions. Investors are often comforted by the presence of big names in the list of owners and directors. Some were apparently worn by Theranos’ star-studded board, whose members include two former US secretaries of state and the ex-boss of Wells Fargo, a big bank.
Regulators also need to be more skeptical. The US Securities and Exchange Commission rejected a detailed and damning analysis of Madoff’s business provided by Harry Markopolos, a concerned fund manager. Germany’s financial-markets regulator was similarly cracking down on short-sellers and journalists who called Wirecard.
The most effective change would be to do more to encourage whistleblowers. Incorrect financial statements must begin with someone who notices fraudulent acts. When fraud occurs, many people ask “Where were the auditors?” But the question should be “Where were the whistleblowers?”
As critical as skeptical investors, regulators and journalists may be, without someone from the inside to spill the beans, not much fraud will be detected. Research shows that over 40% of frauds are discovered by whistleblowers. The Wirecard scandal came to light largely because of the bravery of one of the company’s lawyers, Paav Gill, who went to the press with his concerns. The Theranos fraud was brought to the attention of authorities and the Wall Street Journal by whistleblowing employees (one of whom was the grandson of a former political veteran on the board).
Too often, companies try to silence whistleblowers, or portray them as crazy, bad, or both: Wirecard, for example, fought ferociously against Mr. Gill’s allegations and the journalists who investigated them. Organizations need to create safe spaces where employees can voice their concerns about wrongdoing. Internal reporting channels need to be robust, and employees educated on how to use them. It is important to create an environment where whistleblowers are respected, not stigmatised. Companies should worry more about those who can circumvent controls, such as senior leaders or star employees, than about those willing to raise concerns.
Governments could have done more. Protection for whistleblowers has been recognized as part of international law since the United Nations adopted the Convention Against Corruption in 2003, and has since been ratified by 137 countries. In reality, there are legal security patches. They are strongest in the US, offering rewards to whistleblowers who provide information that leads to fines or imprisonment. In most of Europe, and elsewhere, the law is still very soft on those who muzzle or retaliate against those who sound the alarm.
Fraud can be reduced. But first we must better understand who did it, educate people how to report it, and then make sure policies protect those who choose to come forward. Until we do, financial crime will remain a multi-trillion dollar scourge.
Kelly Richmond Pope is the Barry J. Epstein Endowed Professor of Forensic Accounting at DePaul University in Chicago, and author of “Fool Me Once: Scams, Stories, and Secrets from the Trillion-Dollar Fraud Industry.”
© 2023, The Economist Newspaper Limited. All rights reserved. From The Economist, published under license. Original content can be found at www.economist.com
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