There is no doubt that financial crime causes harm, but it is often thought that the harm done can only really affect those who are not well off financially and this is insignificant, Unfortunately, these are myths and should not be encouraged. Financial crime causes more than just financial harm, it causes physiological harm, causes the victim to lose trust in the financial systems, and in technology and it also causes a domino effect, because, it first affects the individual then, the organization, and in turn, affects the wider society.
In this essay, my intention is to talk about what financial crime is, and what fits into this category, then I will introduce and explain the cases of the Enron scandal and the Madoff scandal, I have chosen to use these cases in order to show the true effects of financial crime on the individual, organizations and the wider society. I will then enlighten us on why financial crime is very serious by highlighting the significant harm that is caused at each of the levels of the individual, organization, and the wider society. Additionally, I will expound on why financial crime should be a priority for law enforcement and regulators before bringing this essay to a conclusion.
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The problem with financial crime is that it is often hard to precisely describe what it is, it should be noted that “financial crime is a slippery concept, notably resistant to precise definition due to its blurring of activities and structures. So, over the years, there have been many definitions put forward by government agencies and other commentators” (Rider, 2015, p. 242). The problem with not having a clear definition often means that we are left with different definitions that conflict and create different accounts of its impact, this also means that what comes under the scope of financial crime changes depending on the definition used. It is important to consider, as Picard discusses, that “When we refer to financial crimes, we narrow down the scope of activities to only those that pertain to the financial market or the investment business. They relate to investment businesses, the stock market, insurance or accounting, i.e. any transaction that may have an impact, directly or indirectly, on an individual’s investment strategy” (Picard, 2008, p. 387). But in reality, financial crime is broader than this, and by giving it such a narrow scope we are setting a false limit to its effects. Thus, one would think to use the broader scope in order to really show its effects and consequences, as I initially planned to do in this essay, but unfortunately using the broader scope is impractical and this is due to the fact that it is a blurring of activities and structures, thus what would I do with the different aspects of financial crime that are bordering on other crimes, such as burglary, this would make my essay vague, imprecise and importantly the question would not be answered. Thus explaining why the narrow scope has been adopted.
According to the International Monetary Fund (IMF), “There is no internationally accepted definition of financial crime” and it interprets it as follows: “Financial crime can refer to any non-violent crime that generally results in a financial loss. It also includes a range of illegal activities such as money laundering and tax evasion” (IMF, 2001, p. 5). The Financial Conduct Authority (FCA) defines it as “any kind of criminal conduct relating to money or to financial services or markets, including any offense involving: fraud or dishonesty; or misconduct in, or misuse of information relating to, a financial market; or handling the proceeds of crime; or the financing of terrorism (FCA, 2015).” It is clear that these definitions are different in the sense that the IMF definition is very broad and thus will include more crimes than the FCA definition. But for the purposes of this essay, I will use the FCA definition, as it is precise and clear-cut, to show why financial crime is a serious problem, that causes significant harm to individuals, organizations, and wider society, and should be a priority for law enforcement and regulators.
For us to have a glimpse of the seriousness of financial crimes, I will use the tales of Enron and Madoff as real-life illustrations of the significant harm that can be caused to individuals, organizations, and wider society. However, before going further, I will briefly retell their tales, starting with Enron.
The Enron Corporation was the product of a merger between Houston Natural Gas Corporation and InterNorth in 1985, they were two well-established energy companies. InterNorth was the larger of the two companies and was the purchaser of Houston Natural Gas. Kenneth L. Lay, the head of Houston Natural Gas, emerged to head the combined firm (Markham, 2006). As you can see the start of Enron was legitimate. The company deserved the respect it gained for its early ventures into trading gas and electricity, and for its projects in the innovative financing of energy projects (Fox, 2003, p. 307). Initially, Enron was very successful in its ventures and this caused the company’s share price to rise which in turn brought about many investors, even Some of its own employees invested their livelihood into the company thinking that as the shares continued to rise they too would become very wealthy. Many investors and employees were making millions by investing in Enron until Enron started making risky transactions in order to increase their profits.
These risky business decisions weren’t supported by the deals’ economics and caused Enron to suffer losses rather than profit. The losses began to pile up, pressuring the company to be ‘creative’ about its finances. Enron then started to falsify financial reports and corporate filings (Baker & Faulkner, 2003, p. 1174). They made it seem that on paper they were making huge earnings and profits from their risky ventures whereas, in reality, the company was suffering financially.
When such reports are put out about huge earnings it attracts more investors and this, in turn, drives up the Enron share prices, with the share price so high and investors still investing, Enron was able to recuperate some of their losses and this made them continue to falsify reports in hope of restoring their losses. As Fox outlines, “Enron’s success continued, it bent the rules more and more, somehow staying within the loosely defined parameters of accounting. Eventually, it seemed like a small leap to make from bending the rules to breaking them. There was no single moment when Enron transgressed from rule bender to rule breaker: Rather, the transformation resulted from the gradual accretion of offenses, encouraged by a corporate culture that valued aggression” (Fox, 2003, p. 308). Eventually, Enron had gone too far past the line to turn back what was a little exploitation of loopholes in the books turned into a full modification and cooking of the books. When Enron’s activities became exposed, due to a number of happenings, the price of Enron’s stock, which had increased spectacularly from a low of about $7 to a high of $90 a share in mid-2000, declined to under $1 by year-end 2001. Many employees who had invested in Enron stock saw their assets go from hundreds of thousands and even millions of dollars to almost nothing. On December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. With assets of $63.4 billion, it was the largest US corporate bankruptcy in history at that time (Benston & Hartgraves, 2002, p. 106). Over 5,500 Enron employees were laid off upon the filing of the bankruptcy petition (Markham, 2006). Losing your life savings is bad enough but then imagine also losing your job, unfortunately, this was the reality for most of Enron’s employees. The Enron scandal had worldwide implications and consequences that impacted individuals, organizations, and the wider society, Picard explains it in a brilliant way when he says “Enron is to financial markets what the events of September 11, 2001, were to public safety and terrorism prevention activities” (Picard, 2008).
When Enron’s scandal is compared to that of Madoff’s scandal, it is much easier to explain although Madoff’s scandal went on for just as long, if not longer. Bernie Madoff was a trusted investment banker who accomplished the largest Ponzi scheme in history. In order to understand the Madoff scandal, you need to understand what a Ponzi scheme is.
Lewis describes this in the simplest way possible “A Ponzi scheme is a type of investment fraud in which returns are paid to investors either from their own money or out of money paid in by subsequent investors, rather than from profits generated by investment or any genuine business activity” (Lewis, 2012, p. 294). Such schemes have been around since 1920, when Charles Ponzi, whom the scam is named after, persuaded investors to invest into a strategy, which he called “a sure thing” and that generated returns of up to fifty percent. Instead, current investors were paid with the money from new investors—the trademark of a Ponzi scheme. Madoff also went down this route and claimed to generate huge, steady returns through an investing strategy called 'split-strike conversion,' which is an actual trading strategy, yet he basically deposited new funds into a single bank account that he used to pay existing clients who wanted to cash out, nonetheless he was unable to maintain this fraud when the market abruptly curved lower in the financial crisis of 2008, he soon admitted to his sons and the next day they informed the authorities (Floyd, 2018). He had defrauded thousands of investors out of approximately $65 billion over the course of at least 17 years, it is unknown exactly how long he ran the scheme.
Dearden detailed that “Despite the gravity behind the dreaded $65 billion, the cost of Bernie Madoff’s crimes could be much greater than anticipated. The financial figure is only based on accounting estimates of money trusted to his firm and returns promised by his company. The emotional and interpersonal damages extend far beyond $65 billion” (Dearden, 2016, p. 87). This then shows how serious financial crime is, not only was there a $65 billion dollars price to pay but beyond all that, there was emotional and psychological damage as well.
It is only getting worse as technology improves because, it means that these financial crimes can be well hidden behind complex and intricate strategies, which the normal person would not dare to question An example of this is the Enron scandal, it was an assortment of multiple white collar crimes, including securities fraud, wire fraud, making of false statements to auditors, insider trading, bank fraud and making of false statements to banks, the number of crimes being committed under one roof was outstanding, yet it was allowed to go on for many years because no one questioned them and they believed in the strategy even though they did not know what the strategy consists of.
In modern times it would have been easier for Enron to hide such activities as there are now software applications to help hide such, even from experienced accountants. I believe that technology will increase the frequency of financial crimes exponentially thus making them a serious threat that needs to be dealt with. Edelhertz proposes that the effect of financial crimes may be 'far more significant than mere dollar losses matter how great, because it goes to the very heart of the issue of integrity of our society and to that confidence in our private and public institutions that are essential to their usefulness and effectiveness in serving the public' (Edelhertz, 1983). With this in mind imagine if the frequency of these crimes increases, the outcome of such would be a worldwide economic disaster. The seriousness of these crimes should not be underestimated.
“Victims of white-collar crime understand that the harm extends beyond the immediate financial loss. Emotional harm adds dimensions of damage to hollow numeric assessments. One emotional aspect is the breakdown of trust” (Dearden, 2016, p. 87). Dearden assessment is a good place to start when assessing the significant harm that financial crime causes individuals. First of all, financial loss. Many of those who were affected by the Enron scandal were their own employees, These were not wealthy people or investment organizations that “could afford” to lose a couple of thousands but these were the working-class people who had worked hard for their money. Not only did these employees lose their retirement plans but also their jobs. The financial situation of these employees went from a disaster to Armageddon, the myth that financial crime victims only suffer financially is wrong, they also suffer emotionally as Dearden stated. This is significant harm that is often ignored. Shove conducted a study and it was found that “despite the passage of years, the loss of funds continues to take a heavy toll in worry, depression, and despondency among those who survived a white-collar crime” (Shover, et al., 1994, p. 86).
It is clear that even years after the crime the victims still suffer emotionally. The reason behind this emotional reaction is that the victims blame themselves for falling for the crime, they believe there is no one else to blame but themselves for allowing themselves to be taken advantage of. They become angry and resentful, which causes depression and dejection and in some serious cases suicide, An example of this is in the Madoff scandal where after the scam, numerous people committed suicide including Madoff’s own son Andrew, the founder of Access International Advisor René-Thierry Magon de la Villehuchet, who lost $3 billion of his and his client’s money and William Foxton who was a decorated combat veteran of the British army and had invested his life savings, over $1 million.
They then become angry and resentful at the financial services that were supposed to protect their investment, which often results in a lack of trust in the future for such organizations, and without trust, these organizations cannot exist.
These are often the harm suffered by the individuals directly affected by financial crime but unfortunately, there is another category of victims, and these are those that indirectly suffer the harm, They could be those who used to be hired by the direct victims but were laid off because of the financial situation, business partners that are now affected due to the financial situations and may have to carry the burden, family members that have to deal with the emotional break out of the victim or the suicide that might occur causing them to have their own emotional experience. Individuals don’t have to be directly involved in financial crime to become victims, this shows the significance and harm that financial crime causes to individuals.
The lack of trust that begins to emanate from the individuals who have been victims of financial crime causes significant harm to organizations. Dearden enlightens on why this is so “On an organizational level, trust is essential for organizations that we place our money in. In fact, the need for trust has grown because of globalization. Trust is necessary to function within our economic society, as interactions between individuals and organizations have increased through globalization” (Dearden, 2016, p. 88). Thus, there is a domino effect taking place anytime a financial crime is committed. When there is a lack of trust there is no reason for an individual to spend or invest their money, and without any investments, these companies will cease to exist because not only is it not profitable but also because there is no reason for them to exist as there is no demand for their services.
Understandably if it was only one affected individual who stopped demanding their services then there would be no need to panic, but that’s the thing about financial crime is that there is never just one affected individual, there could be millions. The Madoff scandal is a perfect example of what happens when millions lose trust in such financial organizations After the scandal was exposed the rate of investment in risky financial services located in New York took a heavy hit and almost all trade grounds to a halt, as assets were moved to low risks options. Umit confirms this by disclosing his evidence “Using events surrounding the Madoff scandal, we have presented evidence of the importance of trust in the investment advisory industry. We show that a shock to trust led investors to move money from risky to low-risk assets” (Umit, et al., 2018). Small investment businesses, along with wealth advisors, were forced to shut down as a consequence of the scandal. In the Enron scandal the biggest accounting firm at the time, Arthur Andersen, was forced to shut its doors, not because they suffered financial loss but because no one trusted the firm, and without trust, there was no business.
It is not only organizations in the financial sector that are affected, but the blowout caused by financial crimes also affects organizations that are not in the financial sector, and this is due to the fact that the financial sector is the backbone of an economy. If the financial sector is falling then automatically other sectors also fall. For example, entrepreneurs would not get the investment they need to start up businesses, and existing businesses would not be able to get a loan that they need because there is a shortage of money in the economy. Without People trusting in the financial sector, they will not part with their money and the effect of that is a shortage of money within the economy. Shove notes that “In the absence of trust, people would not delegate discretionary use of their funds to other entrepreneurs and capitalism would break down as funds were stuffed into mattresses, savings accounts, and solo business enterprises rather than invested in the business ventures of corporations” (Shover, et al., 1994). Evidently, this affects all organizations within the economy, this shows how financial crime causes significant harm to organizations directly and indirectly.
When organizations and the economy within a society begin to fail then there should be a concern for the wider society. With the economy in a downward spiral, cuts will have to be made in order to prevent the complete collapse of the economy, both by organizations and the government itself. Organizations will have to let workers go thus driving up the unemployment rate which has the effect of driving up homelessness and crime rates within society. The government will have to make cuts in sectors such as education, welfare, and healthcare, They may also increase taxes in order to increase public expenditure and thus inject more funds into the economy or they may opt to print out more money to inject into the economy which will then decrease the value of their currency and cause inflation problems.
Whichever way you look at it the government will have to make ugly decisions in order to try and bring the consequences to a halt. People will see this as the Government making bad decisions and costing them to part with their funds causing there to be a loss of confidence in the Government.
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