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Fiduciary Duty to Cheat? Stock Market Super-Star Jim Chanos Reveals the Perverse New Mindset of Financial Fraudsters

American business has always had cheaters and crooks, but today they are escaping prosecution and are incentivized to cheat more.
 
 
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Editor's note: This article is the first in a new AlterNet series, "The Age of Fraud."

Hustlers. Cheaters. Crooks. American business has always had them, and sometimes they’ve been punished. But today, those who cheat and put the rest of us at risk are often getting off scot-free. The recent admission of Attorney General Eric Holder that systemically dangerous megabanks may escape prosecution because of their size has opened a new chapter in fraud history. If you know your company won’t be prosecuted, a perverse logic says that you should cheat and make as much money for shareholders as you can.

Jim Chanos is one of America’s best-known short-sellers, famed for his early detection of Enron’s fraudulent practices. In deciding which companies to short (short-sellers make their money when the price of a stock or security goes down), Chanos acts as a kind of financial detective, scrutinizing companies for signs of overvaluation and shady practices that fool outsiders into tlhinking that they are prospering when they may be on shaky financial footing. Chanos teaches a class at Yale on the history of financial fraud, instructing students in how to look for signs of cheating and criminal activity. I caught up with Chanos in his New York office to ask what’s driving the current era of rampant fraud, who is to blame, what can be done, and the ways in which fraud costs us financially and socially.

Lynn Parramore: You’re often characterized as a short-seller. How does fraud become a concern in that context?

Jim Chanos: One of things we like to say is that in virtually all cases of major financial market fraud over the past 20 years, the only people who really brought forth the fraud into the light were either internal whistleblowers, the press, and/or short-sellers. It was not the normal guardians of the marketplace – regulators, law enforcement, external auditors or people like that -- that did it. It was people who had an incentive to come forward either for personal reasons or for profit to point out what was going on at the Enrons and the Sunbeams and Worldcoms. Short-sellers played an important role in the marketplace not only in terms of capping, sometimes, irrational exuberance in terms of prices, but also in ferreting out wrongdoing.

LP: Researchers have created all kinds of tools, like software to detect speech patterns associated with lying, to try to detect fraud. What are some of the best tools for catching financial fraudsters?

JC: There’s no single tool that works all the time, and some of them are kind of interesting, like the voice detection, or Bedford’s law, which looks at numbers and repetition patterns in accounting. But we have seen some models that we work with and I teach in my class-- frameworks of fraud and fraud analysis – that have been helpful in looking down through the years where we’ve seen patterns continue. One is a wonderful checklist, the Seven Signs of Ethical Collapse in an organization. Some are clearly intuitive, such as a board full of one’s cronies or an obsession with making earnings forecasts. But some are not so obvious, for example, doing good to mask doing bad.

LP: Good deeds can be a sign of fraud?

JC: One of the more interesting observations in the world of fraud is that some of the most egregious frauds were some of the most philanthropic companies in their communities. In some ways, if you look at Bill Black’s theory of the corporation as both a weapon and shield (we teach a lot of Bill Black’s things in my class), you can begin to see that that would be one way in which the bad guys in corporate suites would basically use the corporation as a shield. They’d say, well, look at all the wonderful things we do in the community, how many people we employ. We give to hospitals, we give to the Little League team, and so on. Not all these things would be immediately obvious to the casual observer.