Working closely with various audit clients, including those in the manufacturing sector, has  highlighted that fraud is an omnipresent concern across all industries, regardless of the entity’s operational scale.

Most people have the misconception that fraud is something that did not occur on a regular basis until modern times. Contrary to popular belief, fraud is not mitigated by increased legislation, oversight, auditing standards, or technological progress. In fact, fraudulent methods have evolved alongside technological advancements, proving that fraud schemes remain pervasive.

Historical Instances of Fraud

Ancient Insurance Fraud: The Case of Hegestratos

Dating back to 300 B.C., the earliest recorded instance of financial fraud involves a type of insurance scam by a Greek sea merchant named Hegestratos. In the case of Hegestratos, he sought to insure his ship and its cargo, utilizing a loan mechanism known as bottomry. This arrangement allowed a merchant to borrow money against the cargo, with the understanding that the loan would be repaid with the proceeds from the cargo’s delivery upon reaching its destination.

However, Hegestratos had no intention of delivering the insured cargo, which was corn. His scheme involved setting sail without the corn, planning to sink his ship deliberately, retain the loan proceeds, and then sell the corn separately for additional profit. Unfortunately for him, his plan disastrously backfired. In the act of trying to sink his ship, he drowned, attempting to flee from his crew and passengers who had discovered his deceitful intentions.

Ulysses S. Grant and Investment Fraud

Further research reveals that Ulysses S. Grant, a distinguished Civil War hero and former President of the United States, aimed to support his son’s business endeavors but unfortunately fell victim to fraud. Grant invested personal funds and secured a personal loan from William Vanderbilt for his son’s business.

Tragically, his son’s business partner defrauded him, causing a loss of around $100,000. To settle his debt with Vanderbilt, Grant had to surrender his personal belongings, such as uniforms, swords, medals, and other war memorabilia. This financial misfortune led to Grant’s insolvency at the time of his death in 1885.

The Emergence of the Ponzi Scheme

In 1920, Charles Ponzi, originally from Italy, orchestrated what became known as the original Ponzi scheme, or snowball system, in both the United States and Canada. This scheme defrauded investors of up to $20 million in just an eight-month period. While there were a few Ponzi schemes documented before Ponzi’s operation, such as the “Ladies’ Deposit” initiated by Sarah Howe in the 1880s, none of them gained the notoriety or reached the financial magnitude of Ponzi’s scheme.

Fraud in Popular Culture

The intrigue surrounding fraud, along with heists, cons, scams, and robberies, has significantly captivated Hollywood. It has inspired the creation of numerous films, documentaries, and TV series that delve into these themes.

This fascination has brought to life stories of intricate deceptions and daring thefts, capturing the complex dynamics of perpetrators and the ingenious methods employed to outwit their targets. Some notable examples include:

  1. The Accountant (2016) – A freelance accountant works for dangerous organizations.
  2. All the Queen’s Horses (2017) – Based on the actual theft by a city comptroller from Dixon, IL.
  3. American Made (2017) – The real-life tale of Barry Seal, a pilot turned drug smuggler for the Medellín Cartel, who was later recruited by the DEA.
  4. Bad Education (2019) – The true story of the largest public school embezzlement in American history, centered on a Long Island school district’s superintendent.
  5. The Big Short (2015) – A dramatic recount of the 2007-2008 financial crisis, highlighting the foresight and profit of financial experts amidst the housing bubble.
  6. Catch Me if You Can (2002) – Based on the true story of a con artist’s escapades.
  7. Dirty Money (2018-2020 TV Series) – A series revealing fraud and corruption in business, from payday loans to corporate scandals.
  8. Enron: The Smartest Guys in the Room (2005) – Chronicles the biggest case of fraud in modern times.
  9. Inside Job (2010) – A documentary on the global financial meltdown of Fall 2008.
  10. The Laundromat (2019) – Dramatizes the Panama Papers scandal, delving into financial fraud and offshore tax evasion.
  11. McMillion$ (2020) – Documentary series about the McDonald’s Monopoly game scam.
  12. Operation Varsity Blues: The College Admissions Scandal (2021) – A documentary exploring the scandal of sneaking the children of the rich and famous into top U.S. universities through reenactments and interviews.
  13. The Other Guys (2010) – A forensic accountant investigates a permit violation, leading to the discovery of corporate fraud.
  14. Ozark (2017-2022 TV Series) – A financial planner engages in money laundering for a drug cartel, navigating a world of crime and legal challenges to protect his family.
  15. Paper Moon (1973) – Set in the Great Depression, it follows a con artist and a young girl who might be his daughter, scamming their way through the Midwest.
  16. The Producers (1967) – A failing Broadway producer and his accountant devise a scheme to produce the worst show ever, planning to scam their investors, but their plan falters when the show becomes a hit.
  17. The Sting (1973) – Two professional grifters who team up to pull off a massive con against a mob boss.
  18. Trading Places (1983) – Explores insider trading for personal gain.
  19. White Collar (2009-2014 TV Series) – A con artist works as a consultant for the FBI.
  20. The Wolf of Wall Street (2013) – Based on the true story of a stockbroker’s rise and fall.

Evolution of Fraud Techniques

Over centuries, the methodology of financial fraud has transitioned from relatively straightforward schemes, like the ancient insurance fraud committed by Hegestratos, to complex, multifaceted operations that exploit the intricacies of modern financial systems. This progression reflects not only advancements in technology but also a deeper understanding of human psychology and the vulnerabilities of regulatory frameworks. For instance, the transition from Ponzi’s original scheme to modern-day securities fraud illustrates how fraudsters have adapted to changing economic landscapes and the growing sophistication of investors and regulators.

Today, the landscape of fraud has evolved significantly, with over 41 recognized types of fraud including:

  • Identity fraud – where individuals impersonate someone else to gain financial advantage.
  • Phishing – involving deceptive emails or messages that trick recipients into revealing sensitive information.
  • Account takeover – which is the unauthorized access to someone else’s account.
  • APP fraud – related to malicious mobile applications.

These modern fraud techniques exploit both technology and human vulnerabilities, causing devastating effects on individuals’ economic and emotional well-being.

Countermeasures and the Role of Audits

The constant evolution of fraud has necessitated the development of increasingly sophisticated countermeasures, particularly in the form of audits. Initially, audits were relatively simple checks and balances, but today, they incorporate advanced analytical techniques, including data analytics and artificial intelligence, to identify anomalies indicative of fraudulent activity. This evolution underscores the audit’s transition from a mere financial verification process to a comprehensive assessment of an entity’s operational integrity.

Regulatory and Technological Advancements

Parallel to the evolution of fraud and audits, there have been significant advancements in regulatory frameworks and technology. Legislation such as the Sarbanes-Oxley Act in the United States was enacted in response to major frauds, aiming to enhance corporate governance and the accuracy of financial reporting. Moreover, the development of blockchain technology and its application in financial transactions present new opportunities for securing financial transactions against fraud, showcasing the potential for technology to serve as both a tool for and a defense against fraud.

Ethical and Cultural Considerations

The battle against financial fraud is not solely a technical or regulatory challenge; it also involves significant ethical and cultural dimensions. Cultivating an ethical corporate culture and fostering transparency and accountability within organizations are critical in preventing fraud. Audits play a vital role in this aspect by not only detecting fraud but also by deterring potential fraudsters through the mere presence of an oversight mechanism.

Audits and Regulations in the Fight Against Fraud

The history of financial fraud and the need for audits is a testament to the ongoing cat-and-mouse game between fraudsters and those tasked with safeguarding the integrity of financial systems. As history has shown, if there are assets of value, there will be individuals attempting to illicitly acquire them.

Thus, audits, coupled with strong regulatory frameworks and ethical business practices, are essential in maintaining trust and stability in the global financial system. The future of combating financial fraud will likely see further integration of technology in audits, continuous refinement of regulatory frameworks, and a sustained emphasis on ethical corporate behavior.

How can LBMC help?

Should your organization become a target of fraud or if you’re seeking proactive measures to prevent fraud, LBMC offers the expertise and resources necessary for support.

Our approach includes evaluating your existing control environment and conducting a comprehensive assessment of controls. We collaborate with your management team to offer recommendations on enhancing or establishing controls aimed at the prevention and detection of fraud. An added advantage for some organizations is that adopting these controls can potentially streamline year-end audit processes and may lead to a reduction in year-end audit costs.

Discover more about our Internal Audit and Forensic Accounting services and reach out to us for assistance in safeguarding your organization against fraud.