From Greed to Guard: The History of Financial Fraud

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

Hollywood has been greatly enthralled with the mystery behind fraud, coupled with heists, cons, scams, and robberies. It has motivated the development of several films, documentaries, and TV shows exploring these ideas.

This obsession has brought to life tales of sophisticated deceptions and bold stealing, so reflecting the complex dynamics of offenders and the creative means used to outsmart 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) – Engaging in money laundering for a drug cartel, a financial planner negotiates a criminal underworld and legal difficulties to safeguard his family.
15. Paper Moon (1973) – Set in the Great Depression, it centers on a con artist and a young child who might be his daughter as they negotiate 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

From very simple schemes like the ancient insurance fraud carried out by Hegestratos, the technique of financial fraud has evolved over millennia from rather simple methods to intricate, multifarious operations using the nuances of contemporary financial systems. This development shows not only technological progress but also a better knowledge of human nature and the weaknesses in political systems. For example, the shift from Ponzi’s original plan to modern-day securities fraud shows how fraudsters have evolved to fit shifting economic environments and the increased understanding of investors and authorities.

The terrain of fraud has changed dramatically today; there are now over 41 acknowledged forms of fraud ranging:

• Identity fraud is the process by which someone else is impersonated in order to obtain financial benefit.
• 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 is related to malicious mobile applications.

These modern fraud techniques exploit both technology and human vulnerabilities, creating financial, operational, and reputational consequences for organizations and individuals. Businesses should pay particular attention to payment-related schemes involving phishing, impersonation, compromised accounts, and fraudulent payment instructions. Effective wire fraud prevention requires both technical safeguards and financial controls, including independent verification of payment changes, restricted authorization rights, employee awareness, and secondary approval for high-risk transactions.

Countermeasures: The Function of Audits

Particularly in the form of audits, the ongoing evolution of fraud has made increasingly complex countermeasures necessary. Audits used to be essentially straightforward checks and balances, but today they can incorporate sophisticated analytical tools, including artificial intelligence and data analytics, to identify anomalies and areas of elevated risk. Organizations can also use internal audit services to evaluate control effectiveness, identify process weaknesses, assess fraud risk, and strengthen monitoring before vulnerabilities result in significant losses.

Technological and Regulatory Development

Regulating systems and technology have advanced significantly parallel to the development of fraud and audits. Reacting to significant frauds, laws like the Sarbanes-Oxley Act in the United States were passed to improve company governance and financial reporting accuracy. Furthermore, the evolution of blockchain technology and its implementation in financial transactions reveal fresh chances for protecting financial transactions against fraud, therefore highlighting the possibility of technology to be both a tool for and a defense against fraud.

Cultural and Ethical Considerations

Fighting financial fraud requires more than technology and regulatory compliance. Reducing fraud also depends on developing an ethical business culture, establishing accountability, and creating effective oversight throughout the organization. Strong internal controls that prevent fraud can reduce opportunities for misconduct through practices such as segregation of duties, transaction approvals, reconciliations, management review, and active financial oversight. Internal audits can then help organizations determine whether those controls are appropriately designed and operating as intended.

Audits and Regulations in the Fight Against Fraud

The past of financial fraud and the necessity of audits demonstrate the continuous game between fraudsters and those assigned to protect the integrity of financial systems. As history has demonstrated, people will be trying to illegally obtain valuable assets if they exist.

Therefore, audits are crucial in preserving confidence and stability in the worldwide financial system together with strong regulatory systems and moral business conduct. The future battle against financial fraud will probably see more technological integration in audits, ongoing regulatory framework improvement, and a continual focus on ethical corporate behavior together.

How can LBMC help?

If your organization has experienced suspected fraud or is looking to strengthen its defenses before an incident occurs, LBMC can help evaluate risk, controls, and financial processes. Our audit and assurance services support organizations seeking stronger financial reporting, risk management, internal controls, and confidence in their broader financial environment.

For organizations focused specifically on fraud prevention and control effectiveness, our team can review the current control environment, perform a targeted risk assessment, and work with management to prioritize improvements designed to prevent or detect fraudulent activity.

Our method involves looking over your current control system and doing a thorough control analysis. Working with your management team, we provide suggestions on improving or creating controls meant for fraud prevention and detection. For certain companies, implementing these controls also offers a benefit in terms of possible simplification of year-end audit procedures and possible cost control.

If your organization wants to proactively reduce fraud risk, learn more about LBMC’s Internal Audit services and how our team can help evaluate controls, identify vulnerabilities, and prioritize improvements. If fraud is already suspected or an investigation is required, explore our Forensic Accounting services for specialized investigative support.