Financial fraud, deception
and manipulation

Red herrings swimming near your wallet

Financial deception is the attractive but false presentation of
financial transactions with the intention to pocket the victims'
money.

The so called subprime crisis was a massive example.
Even states can be involved as seen in the sovereign debt
bubble / crisis.

Stock markets and other financial markets are rather prone
to such manipulations and frauds

Definition (deception)

Caveat emptor (buyer, beware!), caveat investor!


Financial deception (or financial scam / financial fraud) is the
incentive attractive but false presentation of financial assets,
transactions or schemes, by manipulators whose real aim is to
poach pocket those investor's savings.

Such deceit can go as far as ruining the investors who get seduced by
such miraculous appearances or sexy looks.


Modern asset markets and financial institutions are assumed to be well
regulated and monitored.

But there is some illusion in that belief as:
  • Those entities are made of human beings, not  heavenly spirits
and whenbanksafe  money is at stake, the temptation
to fraud is high
.
instead of addressing the real issues.
  • As for the watchdogs, they might not be really watching,
because of neglect, mimicry or even collusion.
Elementary survival lesson not to forget:

An exceptionally
high financial luck return

is linked to an exceptionally
high
risk risk.

danger Remember it when you are proposed such returns!

A recent large scale scam : subprime loans

A massive example was the 2007-2009 US "subprime loan crisis"
via credit-related "structured investment vehicles" and credit-related
options.
The main causes were:
  • A massive money creation
under a lax monetary and credit policy by US monetary
authorities,
  • Combined with the neglect to monitor fast evolutions
in financial techniques and practices.

Those practices,
fog obscure in their sophistication and helped
by cheap (= borrowed with low interests) money and general
lever sous over-leverage, created moral hazards leading to a
massive (several trillion dollars) form of pyramidal scheme, a global
financial crisis and a near systemic collapse.

Another recent large scale rigging :
the Libor / Euribor scandal


The Libor (London interbank offered rate) of a specific currency (dollar,
euro, pound...) is an interest rate index published once a day in London
under the indications of a panel of big banks in which each one should
communicate at what rate the other banks are ready to make its short
term loans in that currency.
There is a Libor for each maturity.


In Summer 2012, after an investigation on the Barclay's bank, it was
found that some banks
often declared a rate that was under-
or over-valued
compared to their borrowing capacities or the
effective transactions.

A similar index, the Euribor, that covers  Euro-zone banks, has also
been manipulated.


It was therefore common practice to rig the index

The problem is that it is used as the reference rate of multiple contracts
and
operations of credit, infoinfo investment and financial derivative..

The variety and volume of those deals, and the fact that the rigging lasted
for many
years, make it probably impossible to determine all the entities
that got a gain or suffered a loss.


The total incidence could amount to tens, even hundreds, of billion US
dollars.

Some of the banks that were involved had to pay heavy penalties, going
from hundred of million euros to billions off US dollar.

A better controled system, based on real transactions, in the hand of
a major financial market (Euronext) is in preparation.


And now the Forex

A similar scandal was detected recently in the forex
(foreign
exchange market), in the way currencies are quoted and in which some
international banks have a dominant positions and manipulates the
rates used as public reference by the other banks and ...the ordinary
 customers.
Some of these banks have already been condemned to pay
heavy fines.

Typical cases: stock market deceptions

Motives, means, opportunities,
as TV series detectives say.


To describe the main aspects of deceptions,
let us take the cases of stock market frauds:

1) Who are the (potential) felons?

Some people with the means to do it can
be found among:

1)
Top executives of listed firms,

2) Also their accountants / auditors / rating agencies,

3) Market / finance professionals
      (bankers, brokers, analysts, consultants, fund managers),

4) Large shareholders (big hands),

5) Financial (and other) media,

6) Even public institution officials,
      directly, or at least by turning a blind eye.
      How many financial scandals, in History and up to now,
      were produced
by sovereign states?

7) Of course creators of bogus investment outfits
      (a case that is not specific to stocks, any financial instrument,
      or scheme,
even imaginary ones, might be used)
2) Why do they do it?

Their purpose can be:
1) To raise or to lower investors' expectations.
     
It creates the hope that stock prices will rise, for the
      manipulators t
o sell high, or fall, for them to buy cheap.

2)
Or, for the same purpose, to sustain those expectations.
     
The trick is to boost, or not to discourage - by using means
      explained below - the already existing bullish or bearish
      trends.


3)
Or to hide financial problems.
     
When people are desperate, or just greedy, they might be
      tempted to disguise
the truth  or to play funny games.
3) How do they do it?

How do they mislead investors?
Gullible ones, and even some smart ones?
They fool them for example by:
1) Lying, plainly.
Or more elaborately, building a good story that looks like a
truth.
And repeating such falsities, until they become familiar and
seem true and relevant.

2) Hiding the truth (lying by omitting some crucial points).
Or insisting on some sensational news so as to leave in
the shadow more important ones (weak signals...).

3) Building false impressions, showing red herrings
and creating smoke screens, directing people to the wrong
path.
Financial manipulators play on investor's cognitive
and
emotional
behavioral biases (for example "framing").

4) Or baiting with an adapted rhetoric made of
  • Cognitive tricks:
logical fallacies, framing, red herrings, storytelling,
catchwords,
  • Emotional tricks:
pictures or other reductive representations that play
on greed or fear / pain or pleasure...
In financial markets, the most usual deception tools are:
1) Cooked accounts or statistics.

2) False news, misleading signals, highly above average results
and promises.

3) Over-complex operations that people, and even gullible
professionals who follow the herd, cannot understand fully.

4) Selective information and smoke screens (hermetic wording,
call for secrecy) to hide the truth.

5) Spin (heavy information bombing) from analysts or media.

6) Direct market price manipulation.

7) Also off-market fraudulent schemes
(as detailed below in the "manipulation" section).
4) When do they use their tricks?

Some "hot" periods
are more prone to market excesses than others.
They give more opportunity to manipulate, bait and deceive.

For example, when market are
sillymad exuberant:

* investors look always for new meat to chew.
* also controls and rules start to relax, because of a contamination
  
by the general euphoria (or to collusion).

In those
buying crazes, the "gullibility index" reaches its top
and raises the temptation to promote any lame duck.

Are there also financial deceits by States?

We will not insist here on financial and monetary deceits by States,
Those institutions easily think they have all the rights.

The list of sovereign swindles is long and fascinating
.
You might find interesting to get it though your favorite Historians.


A word anyway about the present mess and how what I would
call the
"Keynesian trap" contributed to it.
Under an abusive use of Keynes theories, some politicians spread
the  belief that
economic growth can be obtained by
parachuting more and more
free money fueled by excessive
budget deficit and borrowing, and by lax
monetary creation.

But the invoice for the free lunches comes one day through the
mail.

We see now the nefarious results in the sovereign debt
turmoil and the world monetary system troubles.

Strangely some famous economists, yes, Nobel price stuff,
recommend more of the poison to solve the present crisis

Definitions and effects (manipulation)

Please, take your hand off my brain!

Definition (general)
To manip manipulate people is to present things in a pernicious way
that induces them to think and/or behave according to the manipulator's
agenda.

About everybody, starting from infancy, tries to manipulate everybody.


Definition:
financial market manipulation
It is the practice to influence asset prices and bring unfair market gains
to
the manipulator. In its "hard" form, it uses deceptive methods such as
lies and false appearances.


In financial market, the illusion is created (see below) by r
igging
information
and/o
r prices to entice investors to buy or to sell as
fits the manipulators' interests.

Effects on investors, markets, the economy...
Riches diverted to wrong pockets.
Market manipulation has two negative effects:
  • Harms to investors, as seen in the "deception" section,
They might overpay a manipulated asset which price  was
boosted artificially,
or sell one at an artificially depressed price.
  • Economic inefficiency in the allocation of resources.
Money might be "burnt" in assets with few economic potential
while starving other more useful projects and activities.

Manipulation and its effects can become massive,
as shown above for the subprime crises in the "deception" section.

Techniques that market manipulators use?

Three sets of techniques are usually used by marker manipulators

1) Rigging the info information
       
(spin, disinformation, framing...) in order to influence investor behavior.

As seen in the above "deception" section, they give false information,
repeat
those falsities, omit truths, stress only the sensational
news to use them as red herrings...


Various information channels
are used: traditional media,
newsletters, internet spam, advisers, buzz and word of mouth
("viral communication")


2) R
igging directly the market
priceprices / trends / signals

     by
launching artificial buy or sell transactions.

3)
Using poachfraudulent schemes:
  • The most primitive one, but still "popular"
is to make believe they found a martingale and to ask suckers
to give them money with the promise that they will
multiply it
.
Here we have the traditional Ponzi / pyramidal schemes,
or the Madoff scam to take a recent and huge example.
  • A more sophisticated bait,
shown as "modernity" and "financial engineering", but which
can pervade (and pervert) the whole system, is to create over-
complex and non-transparent
financial instruments
with
poor fundamental value behind
(the case of the
subprime-based securities and derivatives) 

Is financial engineering an issue?

Chef's stew


Financial engineering, which combines, and even creates synthetic
financial
instruments is not to be demonized in itself.
It allows financial institutions to:
  • Offer quite legit customized investment cocktails
that mix diverse financial tools and assets  so as to match
closely specific investors' needs
(liquidity, profitability,
safety, time horizon, legal and tax aspects...).

=>
Conversely, to use a pyramid of obscure products,
       under pretence of financial sophistication, a technical cover
       to hide the low value of the underlying assets, is of course
       a fraud.
  • Contribute to well balanced economic projects, either public or private,
by assembling and optimizing financial resources and
their use, and by anticipating and covering risks
.

=>
It can be wished anyway that the project initiators have
       some 
financial literacy to dialogue with finance professionals
       and not be tricked by them.

       Like in any area, the deciders, more than the experts, should
       stay the deciders.

What are the manipulators'
preferred targets and timing?

1) Some market targets make things easier for manipulators:

It is rather easy to manipulate the prices of small cap stocks, by using
"pump and dump" or other baits,

On the other hand, to manipulate
a large and highly liquid market,
somebody dishonest needs either important clout or means o
r to
belong to a powerful group (collusion).


But an entire
group crowd might self-manipulate.
This has been seen when most leading financial institutions, that
were supposed
to be nests of finance wizards, accepted as bona fide
financial instruments based on subprime loans.

2) Also timing, as finding the "psychological moment"
      when "minds are ripe", is part of the tactics.


As seen for "deceptions" in general (see above), a manipulation works
"better" when
it fits common beliefs and expectations, current emotions
and cognitive flaws
(behavioral biases)

Reference and further readings

Several articles detailing those topics (manipulation,
deception... )appear in the Behavioral finance glossary

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M.a.j. / updated : 21 Sept. 2015
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