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Operations Management Viewpoints

Freezing Out Fraud

by Nick Kochan


This article was first published in Quantum magazine.

Many financial institutions failed to notice the surge in fraud during the last boom. Nicholas Kochan examines how they can avoid making the same mistakes as the global economy starts to grow again.

The Growing Problem of Fraud

The seeds sown in the good times are being reaped in the bad times. When money was easily available, it was lent with ease, without enough thought given to its use or the return to the lender. Now money is tight, lenders are revisiting their old practices and clients. To their shock, practices, and documentation are found to be weak; clients are found to have disappeared or be bankrupt. In short, fraud—the use of deception to acquire a financial benefit—has grown at an alarming rate.

Evidence of this came to light in a recent report from KPMG (see Figure 1), which showed that fraud in the United Kingdom is currently at its highest level for the 22 years during which the accountancy firm has been covering the sector. KPMG blamed globalization and computerization for making fraud easier and quicker to commit, as well as a culture of carelessness associated with buoyant markets and cheap money.

This assessment was confirmed by one lawyer, who noted: “Now the boom is over, people are taking a closer look at what has happened and discovering more and more cases of fraud. The longer this period of analysis and inspection continues, the more incidents we are going to become aware of.”

The upsurge of fraud is universal, and the carelessness was never better on display than in what came to light as a result of the Bernie Madoff scandal, where wealthy individuals and funds had put their trust in an investment manager whose methods they did not understand and whose results looked too good to be true. Victims—including charities, individuals, and funds—lost some US$60 billion invested in Madoff’s vehicles.

Many more traditional hedge funds have obtained cash from investors by falsifying data about their returns or investment strategies. As with Madoff, the fraud only comes to light during straitened times, when investors seek the return of their capital only to find that it is invested in illiquid instruments or has simply been stolen by the managers.

Other victims of “good-time” fraud are the host of mortgage companies that lent to borrowers in the housing market. Mortgage fraud is today’s fastest-growing fraud in the United Kingdom—£77 million worth of fraudulent mortgages were exposed in 2009, compared with just £36 million the previous year.

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