THE PSYCHOLOGY OF FRAUD Daven Morrison MD Morrison

+ THE PSYCHOLOGY OF FRAUD Daven Morrison MD Morrison Associates, Ltd. Asst. Clinical Professor of Psychiatry, Chicago Medical School Subject Matter Expert, Institute of Fraud Prevention Public Finance for Public Administration, Northwestern University May 27 th, 2014

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. Antar Former Crazy Eddie CFO, former CPA, and a convicted felon

+ Alan Greenspan: What Went Wrong n 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. n 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. n “What Went Wrong” n Alexandra Wolfe n WSJ, Oct 18, 2013

+ DEFINING FUNDAMENTALS FRAUD White Collar Crime Caveat Emptor

+ Recent Cases of Fraud in the News n n 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 n Chicago Drivers use old stubs to fake parking payments n Rita Crundwell n Jesse Jackson n Retailers’ Theft Interviews: Fraudulent confessions n LIBOR n Rajaraptnam

+ A. B. C. of Fraud Bad Apple Bad Bushel Bad Crop

+ n 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 III A Call to Action I: When Fraud Is Committed n Ch 1 Fraud Is Everywhere n Ch 2 The Sins of Quantification n Ch 3 Beyond the Fraud Triangle. . . II: The Foundations: n Ch 4 . . . into the Mind n Ch 5 “Said the Spider to the Fly” n Ch 6 The Accidental Fraudster n Ch 7 The Bad Bushel and Beyond n Ch 8 The Ecology of Fraud: What You Can Do on Monday Morning n Ch 9 The Future of Behavioral Forensics

+ A. B. C. s of Fraud: Other Resources • Original Paper: http: //theifp. org/research-grants/IFPWhitepaper-3. pdf • Blog

+ Fraud: Ideas from “A. B. C. ” Text: Highlights of Bringing Freud to Fraud IS IS NOT n A Human Act n Mental Illness n Driven by emotions n One size fits all n Natural n Not a “shameless” act n Expensive n Easily profiled n Likely reflects a “change of mind” n A “solo” act n A. B. C. ’s of Behavioral Forensics

+ Recent Cases of Fraud in the News n n 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 n Chicago Drivers use old stubs to fake parking payments n Rita Crundwell n Jesse Jackson n Retailers’ Theft Interviews: Fraudulent confessions n LIBOR n Rajaraptnam

+ Questioning Answer #2: Greed is the motivation What is Happening in the Mind?

+ THE FRAUD TRIANGLE Opportunity: Find a hole in accounting process FRAU D Pressure/Incentives: Knowingly commit fraud for a perceived need Rationalize: Justify theft to self

THE + FRAUD TRIANGLE IN MOTION Step One: Opportunity Find a hole in accounting/oversight process The “unofficial”legal line FRAUD Step Two: Pressure Knowingly commit fraud for a perceived need Fraud is expensive over time $$$ Step Three: Rationalize $$$$$

+ The Values of the 8 Motivational States Serious Achievement Conforming Mastery Fitting In Self Control Individualism Collectivism Caring Freedom Sympathy Enjoyment Playful 19 Other Rebellious

+How Honesty Reverses STARTING Motivation: Follow the rules The “unofficial” legal line FINAL Motivation: Fraud ? Disobey the rules ! Question: Do I keep the money? Answer: Yes The Reversal Fraud Perpetration requires repetition

+Sustaining Large Scale Fraud is Sustaining the Reversal START: Rules Matter Motivations to sustain fraud (rationalizations) • Self: They don’t care ‘bout me • Other: I need $ for our medical bills • Play: who can catch me? Fraud Reversal • Mastery: Now they will know who’s boss! • 4 More possible motivations Over time the fraudster’s believes: “the rules are not for me” $$ $$$$$ Time remains the enemy. . . because the cost grows

Sustaining large frauds requires getting others to Reverse Motivation START: Rules Matter 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! Fraud • 4 More possible motivations Reversal Over time the fraudster’s TEAM believes: “their rules are not for us” $$ Time/Title is the enemy. . . $$$$$ As the cost grows

+ Questions?

+ Mark Whitacre Video example

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

+ Recent Banking Fraud Scenario Friday Afternoon, Wire Transfer

+ Predatory Fraud is a Dance n Prey n Predator n Grandma n Nigerian Prince(ss) n Fly n Spider n Madoff’s friends n Madoff

+ IMPORTANT TOPICS AND NEGATIVE AFFECT Trivial Important IMPORTANT TOPICS: IMPORTANT Important Trivial

+ The Progression, Examples I and II: We (I) Need Money 419 n. Excitement n. Shame n. Enjoyment n. Distress n. Fear n. Excitement n The A. B. C. s p. 236

+ INNATE AFFECTS From Tomkins Positive 1. Interest—excitement 2. Enjoyment—joy Neutral 3. Surprise—startle Negative 4. Fear—terror 5. Distress—anguish 6. Anger—rage 7. Shame—humiliation 8. Contempt (Dissmell) 9. Disgust

Context +

+ Our biology

+ Our biology

+ Predatory Dynamic

+ Affects as Data and the Brain The A. B. C. s: Appendix B Higher CPUs: n Blends of blends (Prefrontal Cortex) n Blends of emotion (Paralimbic) n Discrete emotions (Limbic) n Action tendencies (Diencephalon) 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 Scenario Friday Afternoon, Wire Transfer

+ Predator Tactics n Masking n Dazzling n Decoying n Mimicking n Repackaging n Double Play n The A. B. C. ’s p 182

+ The Seduction of the Profile Imagine how hard physics would be if particles could think. n Murray Gell-Man, Physics Nobel Laureate

+ Summary Two new ways of thinking means questioning answers: n. Blaming “Greed” will limit your seeing the larger ecology/environment of fraud n. 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!

+ What level of the human brain is your team using? GOOD LUCK! Affects are the tracer bullets flying on the battlefield of fraud

+ Questions?

+ Fraud: Ideas from “A. B. C. ” Text: Two New Models: Bringing Freud to Fraud The Bad Apple? Predatory vs Accidental n Who is (s)he? n What is in the Headlines? n What about the victim? n What is most common? n Is there a Bad Bushel or Crop? n What do you need to know about each of them? n ABC’s of Behavioral Forensics

+ Professional Competence Professor Harry Kraemer, MBA Having the Answer vs Getting the Answer 100% Interpersonal Knowledge Percentage Technical Knowledge 0% TIME on the JOB Day One First Year

+ Tone at the Top: Executive Assessment Strengths and Weaknesses in Judgment

Effective Judgment + Emotional Elements Shame Impulsive Act Emotional energy Procrastinate Changing Conceptual Sets Competitiveness Boil Down To Essence Predict interpersonal environment Practical problem solving Standards Verbal Abstractions Need for nurturance Trust Collect All Relevant Available Data Need for structure High Minimal Relationships Low Tolerance of ambiguity High Task

+ Executive Judgment Strengths Vulnerabilities n Strong Perceptions in ambiguity n Narcissism n Strong intellect in abstractions, and practical problem solving n Poor Capacity to read Emotions and fit with Context (EQ) n Work Ethic n Hyper-Competitiveness n Reality-based approach (pragmatic) n Absent Self-Reflection n At risk of mid-life challenges

+ Prime Fraud Sources in Financial Services Clients Vendors Employees

+ Bad Bushels and Beyond: Leadership Tone n The Role of Psychopathy n The A. B. C. s Ch 5 n The Role of Narcissism n The A. B. C. s Ch 7 n The role of the Charismatic Leader n The A. B. C. s Ch 7 n The Challenge of the Entrepreneur n The critical answer to question

+ Clients: When does your organization say “no” to a client? n Corporate n What are the clients sharing? n What is the tone of their leadership? n Individuals n Are they at risk of being victim of an email scam? n Distress? n How self-reflective are they? n Excitement? n How do they make you feel? n Pride? Narcissism? n Is there Narcissism in leaders? n How charismatic are they? n Do the leaders understand manage their executive presence? n What of the family n What is their tone? n Is there potential for fraud in the family?

+ Employees Avoid Accidentals n n 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? Innoculate against Predators n Are they emotionally competent? n Can they be seduced by a predator? n How would a fraudster turn the culture to his advantage? n What are the subcultures that put the organization at risk?

+ Vendors: Who interfaces with them? n Service Providers to the organization n Providing Service to Clients

+ Leadership n What is the tone of the leadership? n n Do the leaders understand their presence? How well do they understand emotions? n Are they competent? n Are they creating a sense of belonging or alienation? n Interpersonal Misfits are a breeding ground for risk/fraud? n How competitive are they? n Are there Charismatic-Leader Follower Dynamics? n Do they understand their impact on culture?

+ Op Risk Officers Running and growing the Organization Managing Organizational Operational Risk n n Acts of Nature Theft n Sabotage (non-IT) n Work Place Violence n Hackers: internal, external, contractors n Fraud n Navigate Regulators n Recruit and Retain Top Talent n Leverage Core Organizational Competencies n Asked early in the planning of new initiatives – is your perspective sought out? . . . Or avoided.

+ To SELL: The challenge of convincing leadership to address fraud What you need 1. Their attention 2. Their understanding 3. 4. What they need 1. Your understanding of the business/strategy 2. Your willingness to change 3. Your efforts in executing the strategy Their perspective Their willingness to change

+ Required Dialogue on Risk Regulators Internal Governance Securiti es Traders Safe Zone 0% Low High 100%

H F C A A D Affects are G E E Data B

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

+ Op Risk NY City Santander Director of Technology & Operations Federal Reserve Bank of Chicago n Operational Risk Specialist ABU Dhabi Investments Authority n Deputy Director Intact Financial Corporation n Vice President Freddie Mac n Banque Pictet & Cie SA Banco Bradesco SA - Controller Brazilian Development Bank – BNDES n Operational Risk Manager Banco de Mexico Deputy - Manager IMF Accountant (2) VP Internal Controls Uni. Credit Bank AG - Managing Director International Monetary Fund n Accountant Banco Bradesco S/A- Compliance Analyst Sr. US Securities and Exchange Commission Zions Bancorporation n Staff Accountant National Bank of Canada n Senior Manager Risk Management Administrator Banco de la Republica - Deputy Manager Vice-President, Operational & Reputation Risks ABU Dhabi Investment Authority n n

+ A Psychiatrist’s Perspective Getting into the Mind of the Fraudster An Exploration of your Challenges Actions to Consider: Convincing Leadership to take it Seriously

+ Background: Focus on Private Industry n Morrison Associates, Ltd. n n n Arthur Andersen Continental Bank Conseco Insurance Food Lion Daven Morrison n n Psychiatric Resident and Chief Resident (1996) Morrison Associates since 1996 Consultation to Leadership Teams Anti-Fraud Efforts n n n 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