Although we might be tempted to assume that fraud and anti-fraud investigations are a relatively new phenomena, that have emerged with the multinationals and the modern capitalist system, history teaches us that the risk of fraud is ubiquitous, existing since ancient times, whether we are talking about economic fraud or even the sale of an empire.
Discovering the major cases of fraud in history can help us better understand the mechanism of deception, how criminals operate and, perhaps most importantly, how anti-fraud investigation techniques can prevent damage of institutions.
- The Sale of the Roman Empire
Contrary to the name it has gone down in history – the sale of the Roman Empire -, the fraud in 193 AD did not involve the actual sale of the empire, but that of the title of emperor, which provided decision-making power over all aspects of the empire’s administration, from the laws’ adoption to road infrastructure, political appointments, army leadership etc.
The position of Roman Emperor could be won by merit or inherited. In both cases, the emperor was recognized and considered worthy of office by most Romans.
On the last night of 192 AD, Comodus, the son of Marcus Aurelius, was killed. In his place, the Praetorian Guard appointed Pertinax, the urban prefect of Rome, as emperor, the next day.
The Praetorian Guard (Latin, cohortes praetoriae) was an elite unit of the Roman Imperial Army, whose members served for almost 3 centuries as bodyguards and intelligence officers for the Roman leaders. The Praetorians were noted for their intrigue and interference in politics, leading to the fraudulent overthrow of emperors and the proclamation of their successors, as they did with Pertinax. From the emperor’s bodyguards, they had become the manipulative power behind the throne.
When Pertinax refused to reward them with money for his appointment and tried to make changes among the corrupt guards, the Praetorians killed him. Instead of simply appointing another emperor, the members of the Praetorian Guard organized a public auction on March 28, 193 AD, and the person who offered them the most money would be named emperor.
Pertinax’s father-in-law offered 5,000 drachmas for each soldier of the Guard, but the winner was Didius Julianus, a very rich senator, who offered them 6,250 drachmas each. Given that there were about 4,500 praetorians, the total amount of payment was 28,225,000 drachmas. It’s quite difficult to say how much an old drachma would be worth today, but historians estimate that it is between 50 million and 1 billion dollars paid to fraudulently win the Roman throne and the protection offered by the Praetorian Guard.
Why is this incident categorized as a fraud? Because, as in any other classic financial fraud, the guards sold something that did not belong to them. The Praetorians did not own the empire; what Didius Julianus actually bought, was their support for becoming emperor.
As for the new emperor, he was not appreciated at all for the way he obtained the throne, and even a civil war broke out between several factions trying to overthrow him. Two months later, abandoned by the praetorians and the Senate, he was executed by a soldier in his deserted palace.
The first step taken by his successor to the throne was to execute the praetorians who plotted the imperial fraud.
- The Original Ponzi Scheme
We wrote on our blog, in the past, about what a Ponzi scheme is, how it works, why is it illegal, how big is the damage and which are the legal repercussions when fraud emerges. This time, we will discover the most famous Ponzi scheme fraud, which, incidentally, gave the name of this illegal act.
This type of economic-financial fraud is named after Charles Ponzi, an Italian crook who also called himself Charles Ponci, Carlo or Charles P. Bianchi and who became known in 1920, in
following a scam he set up with the help of postage stamps.
There is much evidence to suggest that it was not the Italian who invented the fraudulent investment scheme, but the extent of the deception he devised led to the naming of this type of economic-financial fraud after him.
Postal services had developed in the early 1920s, coupon programs called IRC (International Reply Coupon) which involved a payment in advance fort the value of the postage stamps. The senders were introducing the coupon in the correspondence envelope, then, the recipients took it to the local post office and exchanged it for the postage stamps they needed in order to send a reply.
One day, Charles Ponzi received a letter from a Spanish company. The envelope contained an International Response Coupon (IRC), and the Italian realized that he could get proﬁt if he bought IRCs in one country and then exchanged them for more expensive stamps in another country. Also, he realizes that the profit – and obviously the fraud – would be even bigger if he sent money to collaborators in other countries, they would buy IRCs, ship them to the US, and then Ponzi would exchange them for stamps, which he would sell at a higher value than that he paid for them.
In economics and finance, the practice of winning from the price difference between two or more markets is called arbitrage and is perfectly legal. This was the argument with which Charles Ponzi, in search of even greater gains, persuaded other people to join him in the attempted fraud, as investors. He promised them huge profits, 50% in 45 days or even 100% in 90 days period.
Encouraged by the initial success, Ponzi decided to take his fraudulent business to the next level and, in January 1920, he founded the Securities Exchange Company. In the first month, he had 18 investors, who traded $ 1,800. The profits were paid promptly the following month – not from the gain, but from the money received from the new investors. Meanwhile, the Italian was looking for solutions to change IRCs into cash. Then, he quickly realized that it was almost impossible to succeed. For example, in order to exchange the $ 1,800 invested in the first month, 53,000 IRCs would have been needed to make the proceeds from the arbitration. He noted, however, that the promised interest could be paid to investors, thanks to funds from new investors.
Six months later, the level of investment through the Securities Exchange Company was about millions. As a result of the fraud, Ponzi became a very rich man – he would seem to earn over $ 250,000 a day. His rapid rise and extravagant lifestyle had begun to attract the attention of many.
The fraud set up by Ponzi began to falter when a reporter from The Boston Post investigated and then wrote about the financial engineering. At that point, the investors tried to withdraw their money.
The fraud today called the Original Ponzi Scheme, lasted for a year, and the estimated prejudices were over $ 20 million in 1920, the equivalent of about $ 196 million in 2019. We can only imagine, if Ponzi had been more cautious in displaying his fortune, he would not have become the subject of that press investigation and the fraud he devised could have probably continued unhindered.
Following the fraud investigation launched against him, Charles Ponzi was arrested in August 1920 and charged with 86 frauds by mail in 2 federal trials. He pleaded guilty and spent the next 14 years in prison. He died in Rio de Janeiro in January 1949, poor.
- The Enron Bankruptcy
The bankruptcy of the Enron energy company was called not only the biggest bankruptcy of a corporation in US history at that time, but also the biggest failure of a financial audit firm.
Enron, headquartered in Houston, Texas, was established in 1985 following the merger of Houston Natural Gas and InternNorth, two natural gas companies.
The founder, CEO and chairman of the board was Kenneth Lee Lay, who will play an important role in the company’s bankruptcy. He would hire Jeﬀrey Skilling a few years later, who was already working with Enron as a consultant and who was gradually advancing in the hierarchy of the Enron group of firms, becoming, in 1997, the number 2 in the company, after Kenneth Lay.
Under the leadership of the two, Enron becomes the largest wholesaler of gas and electricity, with over $ 27 billion traded in a single quarter and ranks 7th in Fortune magazine’s Top 500 American Companies; Fortune also awards the energy company the award for “Most Innovative Company” for 6 years in a row.
By 2000, the company had hired 21,000 people and grossed $ 111 billion. However, one year later, Enron’s share price began to fall from $ 90.75 in August 2000 to $ 0.26 on November 30, 2001.
As the company’s value continued to decline, CEO Kenneth Lay told his employees that Enron had recovered and encouraged them to buy as many shares as possible. At the same time, he sold a large part of his shares.
US authorities have launched an anti-fraud investigation and Enron’s main competitor, Dynegy, has offered to buy the company at a very low price. After the deal failed, Enron filed for bankruptcy on December 2, 2001.
The investigation performed by the Securities & Exchange Commission and the Department of Justice revealed that the bankruptcy was based on corporate fraud and corruption. Enron had artificially inflated its profit, hiding its subsidiaries’ debts and losses. The government has subsequently accused Kenneth Lee Lay and Jeﬀrey Skilling of conspiracy to cover the company’s financial vulnerabilities to investors.
The investigation into the fraud also revealed that Enron’s financial auditor, Arthur Andersen LLP, deliberately destroyed documents incriminating the energy company. Arthur Anderson was one of the top five financial auditing and consulting firms in the United States, along with PricewaterhouseCoopers, Deloitte, Ernst & Young and KPMG. In 2002, as a result of their involvement in the Enron scandal, they lost their practice license, and The Big Five remained and are still known today as The Big Four.
What did Enron’s collapse look like in numbers? $ 63.4 billion in assets, 5,600 jobs and more than $ 2.1 billion in pension funds; these figures led to this fraud leading to the largest bankruptcy of a corporation in US history at the time.
In July 2004, the process began. Several Enron executives were accused of fraud, and some were later sentenced to prison. Jeﬀrey Skilling had 35 charges – including fraud, conspiracy and insider trading – and Kenneth Lay, 11. Two years later, Skilling was convicted of 19 of the 35 charges, and Lay was found guilty of 10 allegations of fraud and conspiracy. Lay failed to serve his sentence because he died two months later due to heart problems. In October of the same year, Skilling was sentenced to 24 years in prison.
Following the Enron scandal, new regulations and legislative measures were adopted in the United States, aimed at combating fraud by increasing the accuracy of financial reporting for the listed companies. For example, the Sarbanes-Oxley Act, also known as the Law on the Reform of Accounting for Listed Companies and Investor Protection, or the Law on Corporate and Audit Responsibility, Accountability and Transparency, increased penalties for destroying, modifying or fabricating evidence from federal investigations or attempts to shareholder fraud. The law has also increased the responsibility of audit firms to remain impartial and independent of their clients.