There is no rest for the wicked: The death & birth of fraud amidst crisis
During every financial crisis two simultaneous events occur. Old frauds are revealed and new frauds are created.
It's no coincidence that three of the largest Ponzi schemes in history - orchestrated by Bernie Madoff, Allen Stanford and Tom Peters - along with dozens of others, were discovered circa the Global Financial Crisis. Market collapse forced investors in need of liquidity to redeem approximately $7 billion from Madoff. Since he didn't have the assets he claimed to have and couldn't scramble to get $7 billion-worth of new investors, the gig was up.
There is nothing like a good crisis to make liquidity more scarce, financial scrutiny more intense, and help bring Ponzi schemes to their inevitable end.
In his book, John Kenneth Galbraith described a similar phenomenon after the most devastating market collapse in modern history, the crash of 1929. "At any given time, there exists an inventory of undiscovered embezzlement... In good times people are relaxed, trusting, and money is plentiful... Under these circumstances the rate of embezzlement grows, the rate of discovery falls off... In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved.” (The Great Crash of 1929, Chapter 8)
Before we celebrate this silver lining amidst market crisis, we must recall that during periods of stress people are also more likely to fall victim to fraud. In desperate times people pine for expedient "silver bullet" solutions to allay anxieties and pains. This is when charlatans and scammers appear on stage.
Today we are witnessing a torrent of fraudulent abuses in healthcare. There are countless cases with false promises of COVID-19 detection, prevention, or cures (exhibit A). Many others are offering counterfeit products (exhibit B), and phishing scams abound (exhibit C). In some cases, the frauds prey on our fears by claiming to sell bogus lists of those infected with the virus in our community. And in the most regrettable cases, there are phony charitable causes, preying on people's good will and generosity, at a time when our good will and generosity is more needed than ever before. All of these are shameful and unfortunate.
From an investment point of view, there is no shortage of opportunities being touted through various sites and social media. Whether they are some newfangled cryptocurrency, a freshly concocted coronavirus ETF, or the more the traditional "pump-and-dump" scams[1], where "hot" stocks of companies are aggressively promoted with misleading claims of discovered cures.
Ironically, the title of my most recent book, Selling Snake Oil, was based on the story of Clark Stanley. Stanley understood that swindlers' greatest edge is in unfamiliar markets or situations, where emotions run high, and where there's a profound information asymmetry between the buyer and seller. Stanley claimed that every ailment—from simple nausea to arthritis, skin disease and cancer —could be cured by his magical elixir, which was nothing more than mineral oil. Stanley knew that his buyers couldn't immediately determine the efficacy of his medicine but would pay for it due to both ignorance and wishful thinking.
Fear is among the most utilized methods employed by con artists. If fraudsters can unearth your anxiety, and immediately offer the remedy, there is a good chance you will bite. Many charlatans in the 20th century adopted Stanley’s fear-preying ways. Some, like John Brinkley, took it to a whole new level by deceptively claiming to treat male impotence via a goat testicles transplant. In the process, he hurt and robbed many vulnerable men with the false promise of a cure.
In a world that presents us with extraordinary uncertainty about the future, along with the heightened anxiety levels that accompany social, psychological or economic distress, it is imperative for investors to employ fraud detection best practices and vigilantly separating fact from fiction at every turn.
[1] Traditional "pump-and-dump" schemes involve luring investors into micro-cap stocks (which typically have little publicly available information) with deceptive claims through press releases, emails or social media. This in turn elevates the demand and pricing for the shares (i.e. the pump). At that point, the fraudsters behind the scam sell off their shares at a profit, leaving investors with worthless, or near-worthless, stock (the dump).
Mo Lidsky is the Chief Executive Officer at Prime Quadrant, Canada’s leading investment research and consulting firm. Mo is also the current Chairman of CAF Canada, the Prime Quadrant Foundation, and sits several the boards of several non-profit organizations including Hebrew University and Holland Bloorview Hospital. Mo has authored or co-authored four books, his most recent book being, Selling Snake Oil: Investment Lessons from the World’s Greatest Frauds. The others include, Partners in Preservation: How to Know Your Advisor Is Truly Protecting Your Wealth, In Search of the Prime Quadrant: The Quest for Better Investment Decisions, and The Philanthropic Mind: Surprising Discoveries from Canada’s Top Philanthropists. In recognition of Mo’s contributions to the community and leadership, Mo has been selected as the recipient of Canada’s Top 40 Under 40 Award. However, his greatest distinction continues to be his extraordinary wife and five adorable children.