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Public Finance for Public Administration, Northwestern UniversityMay 27th, 2014

THE PSYCHOLOGY OF FRAUD

Daven Morrison MDMorrison Associates, Ltd.Asst. Clinical Professor of Psychiatry,Chicago Medical SchoolSubject Matter Expert,Institute of Fraud Prevention

What a tangled web we weave when first we practice to deceive.

Marmion an epic poem

Walter Scott, 1808

“As a fraudster, I succeeded for almost two decades because I understood how to exploit the psychological and emotional weaknesses of my victims. This book teaches auditors and antifraud professionals about fraud psychology, the “soft underbelly of fraud” —the emotional manipulation, big and small lies, and other behavioral cues that fraudsters employ to successfully execute their crimes. I call it the art of spinning, and the authors have described it as the predator-prey dance. Without such an understanding of the behavioral dynamics of fraud, victims will always be doomed to lose (lots of money) and fraudsters will always have the upper hand.”

—Sam E. AntarFormer Crazy Eddie CFO, former CPA,

and a convicted felon

+Alan Greenspan: What Went Wrong I've always considered myself more of a mathematician than a psychologist. It all fell apart, in the sense that not a single major forecaster of note or institution caught it.

The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works—and it missed it completely.

“What Went Wrong” Alexandra Wolfe WSJ, Oct 18, 2013

+DEFINING FUNDAMENTALS

White Collar Crime

Caveat Emptor

FRAUD

+Recent Cases of Fraud in the News NY Times: Fraud in

Army Recruiting Bonus Program May Cost Nearly $100 Million

Chicago Tribune: Republican Party wing creates 18 fake websites for Democrats

WSJ: Ex-SAC Trader Found Guilty

My inbox: Dewey-Leboef Law Firm

Chicago Drivers use old stubs to fake parking payments

Rita Crundwell

Jesse Jackson

Retailers’ Theft Interviews: Fraudulent confessions

LIBOR

Raj Rajaraptnam

+A. B. C. of Fraud

+Questions for Today

Advances are made by answering questions. Discoveries are made by questioning answers. Bernard Haisch; Director, Calphysics Institute

+

Questioning Answers

+ ABCs of Fraud:Book

+A.B.C.’s of Behavioral Forensics

I: When Fraud Is Committed Ch 1 Fraud Is Everywhere Ch 2 The Sins of Quantification Ch 3 Beyond the Fraud Triangle . . .

II: The Foundations: Ch 4 . . . into the Mind Ch 5 “Said the Spider to the Fly” Ch 6 The Accidental Fraudster Ch 7 The Bad Bushel and Beyond

III A Call to Action Ch 8 The Ecology of Fraud:

What You Can Do on Monday Morning

Ch 9 The Future of Behavioral Forensics

+A.B.C.s of Fraud: Other Resources

• Original Paper: http://theifp.org/research-grants/IFP-

Whitepaper-3.pdf

• Blog

+Fraud: Ideas from “A.B.C.” Text:

Highlights of Bringing Freud to Fraud

A Human Act Driven by emotions Natural Expensive Likely reflects a “change

of mind” A.B.C.’s of Behavioral Forensics

Mental Illness One size fits all Not a “shameless” act Easily profiled A “solo” act

IS IS NOT

+Recent Cases of Fraud in the News NY Times: Fraud in

Army Recruiting Bonus Program May Cost Nearly $100 Million

Chicago Tribune: Republican Party wing creates 18 fake websites for Democrats

WSJ: Ex-SAC Trader Found Guilty

My inbox: Dewey-Leboef Law Firm

Chicago Drivers use old stubs to fake parking payments

Rita Crundwell

Jesse Jackson

Retailers’ Theft Interviews: Fraudulent confessions

LIBOR

Raj Rajaraptnam

+Questioning Answer #2: Greed is the motivation

What is Happening in the Mind?

+

FRAUD

THE FRAUD TRIANGLE

Rationalize: Justify theft to self

Opportunity: Find a hole in accounting process

Pressure/Incentives: Knowingly commit fraud for a perceived need

+

FRAUD

THE FRAUD TRIANGLE IN MOTION

Step Three: Rationalize

Step One: Opportunity Find a hole in accounting/oversight process

Step Two: Pressure Knowingly commit fraud for a perceived need

The “unofficial”legal line

Fraud is expensive over time

$$$ $$$$$

+The Values of the 8 Motivational States

19

Serious

Rebellious

Other

Playful

ConformingMastery

Sympathy

ControlFitting In

Individualism

Caring

Achievement

Enjoyment

Collectivism

Freedom

Playful

Self

+

Fraud

How Honesty Reverses

Answer: YesQuestion: Do I keep the money?

STARTING Motivation:

Follow the rules

FINAL Motivation:

Disobey the rules

The “unofficial” legal line

? !

The Reversal

Fraud Perpetration requires repetition

+

Fraud

Reversal

START: Rules Matter

Sustaining Large Scale Fraud is

Sustaining the Reversal Motivations to sustain fraud

(rationalizations)•Self: They don’t care ‘bout me

•Other: I need $ for our medical bills

•Play: who can catch me?

•Mastery: Now they will know who’s boss!

•4 More possible motivations

$$$$$$$

Time remains the enemy . . . because the cost grows

Over time the fraudster’s believes: “the rules are not for me”

Fraud

Reversal

START: Rules Matter

Sustaining large frauds requires getting

others to Reverse Motivation Motivations to recruit others

(rationalizations)•Self: They don’t care ‘bout you!

•Other: You need $ for our medical bills

•Play: who can catch us?

•Mastery: Now they will know we ‘re in charge!

•4 More possible motivations

$$$$$$$

Time/Title is the enemy . . . As the cost grows

Over time the fraudster’s TEAM believes: “their rules are not for us”

+

Questions?

+ Mark Whitacre

Video example

+Questioning Answer #3 The answer to halting fraud is a: ProfileWhat is Happening in the Mind?

+Recent Banking Fraud ScenarioFriday Afternoon, Wire Transfer

+ Predatory Fraud is a Dance

Predator Nigerian Prince(ss) Spider Madoff

Prey Grandma Fly Madoff’s friends

+IMPORTANT TOPICS AND NEGATIVE

AFFECT

Trivial

Important

IMPORTANT

IMPORTANTTOPICS: IMPORTANT

IMPORTANTIMPORTANT

Important

Trivial

+The Progression, Examples I and II: We (I) Need Money 419

ExcitementEnjoymentFear

The A.B.C.s p. 236

ShameDistressExcitement

+INNATE AFFECTS

From TomkinsPositive 1. Interest—excitement2. Enjoyment—joy

Neutral 3. Surprise—startle

Negative 4. Fear—terror5. Distress—anguish6. Anger—rage7. Shame—humiliation8. Contempt (Dissmell)9. Disgust

+Context

+Our biology

+Our biology

+ Predatory Dynamic

+Affects as Data and the BrainThe A.B.C.s: Appendix B

Richard D. Lane and David A. S. Garfield, “Becoming Aware of Feelings: Integration of Cognitive-Developmental, Neuroscientific, and Psychoanalytic Perspectives,” Neuropsychoanalysis 7, no. 1 (2005): 5–30

+Recent Banking Fraud ScenarioFriday Afternoon, Wire Transfer

+Predator Tactics

Masking

Dazzling

Decoying

Mimicking

Repackaging

Double Play The A.B.C.’s p 182

+The Seduction of the Profile

Imagine how hard physics would be if particles could think.

Murray Gell-Man, Physics Nobel Laureate

+Summary

Two new ways of thinking means questioning answers:

Blaming “Greed” will limit your seeing the larger ecology/environment of fraud

Profiling Employees will make more anxiety and distance than you want and will provide a road map for those fraudsters motivated to read from the play book!

+

Affects are the tracer bullets flying on the battlefield of fraud

What level of the human brain is your team using?

GOOD LUCK!

+

Questions?

+Fraud: Ideas from “A.B.C.” Text:

Two New Models: Bringing Freud to Fraud

Who is (s)he? What about the victim? Is there a Bad Bushel or

Crop?

ABC’s of Behavioral Forensics

What is in the Headlines? What is most common? What do you need to

know about each of them?

The Bad Apple? Predatory vs Accidental

+Professional Competence

TIME on the JOB

KnowledgePercentage

0%

100%

Day One First Year

Professor Harry Kraemer, MBA

Technical Knowledge

Interpersonal Knowledge

Having the Answer vs Getting the Answer

+

Tone at the Top:Executive AssessmentStrengths and Weaknesses in Judgment

+ Effective Judgment

High

Need for structure

MinimalRelationships Task

Emotional Elements

Competitiveness

Trust

Emotional energy

Standards

Need for nurturance

Shame

Collect All Relevant Available Data

Boil Down To Essence

Act

Impulsive

Procrastinate

Predict interpersonal environment

Practical problem solving

Verbal Abstractions

Changing Conceptual Sets

Low HighTolerance of ambiguity

+Executive Judgment

Strong Perceptions in ambiguity

Strong intellect in abstractions, and practical problem solving

Work Ethic

Reality-based approach (pragmatic)

Narcissism

Poor Capacity to read Emotions and fit with Context (EQ)

Hyper-Competitiveness

Absent Self-Reflection

At risk of mid-life challenges

Strengths Vulnerabilities

+Prime Fraud Sources inFinancial Services ClientsVendorsEmployees

+Bad Bushels and Beyond: Leadership Tone

The Role of Psychopathy The A.B.C.s Ch 5

The Role of Narcissism The A.B.C.s Ch 7

The role of the Charismatic Leader The A.B.C.s Ch 7

The Challenge of the Entrepreneur

The critical answer to question

+Clients: When does your

organization say “no” to a client? Corporate

What are the clients sharing?

What is the tone of their leadership?

How self-reflective are they?

How do they make you feel? Is there Narcissism in

leaders? How charismatic are they?

Do the leaders understand and manage their executive presence?

Individuals Are they at risk of being

victim of an email scam? Distress? Excitement? Pride? Narcissism?

What of the family What is their tone? Is there potential for

fraud in the family?

+Employees

When do they get the message to “do the right thing” vs ask if it’s legal?

Do they have a reason to feel taken advantage of by the organization and want something in return?

Are they emotionally competent?

Can they be seduced by a predator?

How would a fraudster turn the culture to his advantage?

What are the subcultures that put the organization at risk?

Avoid Accidentals

Innoculate against Predators

+Vendors:

Who interfaces with them?

Service Providers to the organization

Providing Service to Clients

+Leadership

What is the tone of the leadership? Do the leaders understand their presence?

How well do they understand emotions? Are they competent? Are they creating a sense of belonging or alienation? Interpersonal Misfits are a breeding ground for risk/fraud? How competitive are they?

Are there Charismatic-Leader Follower Dynamics?

Do they understand their impact on culture?

+Op Risk Officers

Acts of Nature

Theft

Sabotage (non-IT)

Work Place Violence

Hackers: internal, external, contractors

Fraud

Navigate Regulators

Recruit and Retain Top Talent

Leverage Core Organizational Competencies

Asked early in the planning of new initiatives – is your perspective sought out? . .. Or avoided.

Managing Organizational Operational Risk

Running and growing the Organization

+To SELL: The challenge of convincing leadership to address fraud

1. Their attention

2. Their understanding

3. Their perspective

4. Their willingness to change

1. Your understanding of the business/strategy

2. Your willingness to change

3. Your efforts in executing the strategy

What you need What they need

+Required Dialogue on Risk

0% Low High100%

Safe Zone

Securities Traders

RegulatorsInternal Governance

H C A G E

F A D E BAffects are Data

+Fraud Defined

A generic term, embracing all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get advantage over another by false suggestions or by suppression of truth, and includes all surprise, trick, cunning, dissembling, and any unfair way by which another is cheated. . . .

Elements of a cause of action for “fraud” include false representation of a present or past fact made by defendant, action in reliance thereupon by plaintiff, and damage resulting to plaintiff from such misrepresentation.

Black’s Law Dictionary

+White Collar Crime

“Those classes of nonviolent illegal activities which principally involve traditional notions of deceit, deception, concealment, manipulation, breach of trust, subterfuge or illegal circumvention.”

Caveat Emptor

+ Op Risk NY CityFederal Reserve Bank of Chicago

Operational Risk Specialist

ABU Dhabi Investments Authority Deputy Director

Intact Financial Corporation Vice President

Freddie Mac VP Internal Controls

International Monetary Fund Accountant

US Securities and Exchange Commission Staff Accountant

National Bank of Canada Vice-President, Operational & Reputation Risks

ABU Dhabi Investment Authority Senior Manager

Santander Director of Technology & Operations

Banque Pictet & Cie SA

Banco Bradesco SA - Controller

Brazilian Development Bank – BNDES Operational Risk Manager

Banco de Mexico Deputy - Manager

IMF Accountant (2)

UniCredit Bank AG - Managing Director

Banco Bradesco S/A- Compliance Analyst Sr.

Zions Bancorporation Risk Management Administrator

Banco de la Republica - Deputy Manager

+A Psychiatrist’s PerspectiveGetting into the Mind of the FraudsterAn Exploration of your ChallengesActions to Consider: Convincing Leadership to take it Seriously

+Background: Focus on Private Industry Morrison Associates, Ltd.

Arthur Andersen Continental Bank Conseco Insurance Food Lion

Daven Morrison Psychiatric Resident and Chief Resident (1996) Morrison Associates since 1996 Consultation to Leadership Teams Anti-Fraud Efforts

Institute of Fraud Prevention Tomkins Institute of Emotion and Cognition Senior Editor and Author: The A.B.C.s of Behavioral

Forensics

+ Dixon Illinois

The Best Reason Ever to have Professional Management