You can fool some of the people all of the time, which is enough to make a very good living…

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You can fool some of the people all of the time, which is enough to make a very good living…

In order for fraud to be successful, you need two co-operating parties, the fraudster and the willing victim. This was again brought to our attention recently when we were called regarding money lost in an investment group. The amount lost was what we define as substantial, and the investment was conservative. While it is not impossible to lose a lot of money with conservative investments – ask anyone who owned Lucent – it certainly should be harder, and always merits a close look when it happens.

The manager running the investment said he was outraged at the loss, and insisted that he would oversee recovering the missing funds. This is nice, but, as a rule of thumb, it is inappropriate to have someone who might reasonably be suspected of causing the loss to be allowed to conduct the investigation. If the potential suspect is a bad guy it gives him a better chance of covering his tracks and getting away with it. If he is innocent and the money is not recovered, it unnecessarily leaves a suspicion that he might have been involved. Like Caesar’s wife, those investigating a possible criminal matter should be above reproach, which is why, in the September e- Journal, we recommended that new CEOs taking over a company where there was a suspicion of fraud turn the investigation over to some outside, unaffiliated, entity or professional.

In this case, the manager hired a recovery agent to help with his investigation. Unfortunately, this still left control of the investigation in the hands of the manager, who was one of the most likely suspects. Worse still, the agent hired was one about whom there had been newspaper articles alleging participation in widespread financial fraud in many countries. These allegations might or might not be true: We have no certain knowledge one way or the other, and our opinion is not particularly germane to the focus of this article. What is germane is that the situation presents four disquieting possibilities, each of which should leave the investors with an uncomfortable feeling.

1. The worst-case possibility is that the manager is a fraudster and that the agent hired to help is a co-conspirator. (In this case the investors can kiss their money good-bye.)

2.  The manager is honest and the recovery agent is crooked. (In this case the recovery agent will make recovery difficult or impossible.)

3. The manager is crooked and the recovery agent is honest. (In this case the manager will make recovery difficult or impossible.)

4. The final possibility is that the manager has bad judgment but is honest, and that the recovery agent is honest. (Here we are left with the appearance of impropriety, but no direct and active impediment from the combined (manager/recovery agent) recovery team to the determination of whether the funds had been lost or misappropriated, or to the possible subsequent recovery of funds.)

No matter which possibility turns out to be the reality, we do know, beyond the shadow of a doubt, is that when sums of money equivalent to the GNP of a small country have disappeared, the appearance of propriety is vitally important (particularly if the money is never recovered). This seems sufficiently obvious that one must ask why a group of investors able to collectively cough up this large an amount of money would let someone who should be considered a suspect manage the recovery of their missing funds.

The best explanation for this anomalous behavior turns out to be cognitive dissonance theory, which says that when there is a conflict between your beliefs and your actions it is easier to change your beliefs than your actions. We frequently see cognitive dissonance theory at work when dealing with spousal abuse. It is psychologically easier for the abused spouse to say the abuse is ok because they love the abuser (They must love them. Why else would they put up with the abuse?) than it is for them to admit that they might be victims, and make the appropriate changes to their behavior.

In the case of the missing investment money, it is psychologically easier for the investors to say the manager’s conducting the investigation is ok because they trust the manager (They must trust him. Why else would they put up with the obvious impropriety?) than it is for them to admit that they might be victims, and make the appropriate changes to their behavior.

Obviously, in any group there will be some people who will want to eliminate all doubt, and ensure that not only the reality but also the appearance of propriety is maintained. Whether or not an actual fraud has been committed, those who have become exemplars of cognitive dissonance theory in action typically outnumber this group, and the voices of the rational minority will be swiftly and firmly quashed.

The result is that, in cases of actual fraud, through manipulation of the majority to take advantage of their cognitive dissonance (Who among us wants to admit we were fooled?) the fraudster is likely to escape unscathed, and with profits intact.

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