Lessons from white-collar crimes

The billion-dollar question on everyone’s lips is both simple and perplexing: How, exactly, can one misplace $2 billion? That’s the mystery surrounding Wirecard, the erstwhile fintech darling of Europe. Established as a payments processor for adult and gambling websites, it morphed into a software developer for online transactions with a bevy of A-list clients like FedEx and IKEA. Obsessed by tech envy for America, Germans allowed themselves a flush of pride when the interloper elbowed 150-year-old Commerzbank out of Germany’s DAX stock index, rubbing shoulders with giants like Adidas, BMW, and SAP as its market value crossed €24bn.

But this June, its decade-old auditor said that it could not find €1.9 billion—a quarter of the firm’s balance sheet—meant to be held in escrow accounts in the Philippines. Markus Braun, the CEO since 2002, resigned and the company admitted that the €1.9 billion “probably does not exist”. Braun was later arrested for employing fraudulent accounting practices to inflate the balance sheet and revenue to make it rosier to investors and clients. He was released on bail for €5 million, only to be rearrested. The company has begun insolvency proceedings, the first DAX-listed company ever to do so.

Every time a celebrated corporate honcho unexpectedly descends into the netherworld of criminal activity, we are stunned into asking ‘Why? Why do they do it?’ While some attribute criminality to psychological aberration, others say over-confidence, stress, excessive greed, or ambition could be culprits. In 1939, the influential sociologist Edwin Sutherland said that deviance committed by “respected business and professional men” was simply overlooked because people of high socio-economic standing were not usually convicted in criminal courts. He coined a new term for this class of deviance: white-collar crime. Is white-collar crime a result of nature or nurture? Is it based on intuition or reasoning?

In the 1870s, Cesare Lombroso, an Italian criminologist and physician, was struck by an insight: that a person’s disposition could be assessed by examining his physical appearance. Legend has it that the great mathematician Pythagoras chose his friends and students based on their appearance, believing it depicted their true character. Aristotle extensively wrote on how disposition could be inferred from physical character. By the late 18^th century, the practice of evaluating a person’s character based on his physical likeness had become a full-fledged “science”: physiognomy. When the Swiss pastor Johann Lavater published his book on physiognomy, it became a global sensation with 150 editions in six languages. The book prophesied that a broad, square forehead is a clear indication of a good memory. If one’s eyebrows were situated unusually high on the forehead, he would lack a sense of reflection. The idea gained such popularity that it would be considered ill-advised to hire an employee until his features had been compared with the physiognomic manuals of the time.

While Lombroso’s findings would be largely dismissed as pseudoscience today, his basic premise that some are deeply and fundamentally flawed (‘born criminal’) continues to resonate. U.S. President George W. Bush responded “there are some bad apples” when pressed to explain the deviant executive behaviour after Enron’s collapse. Disgraced financier Bernie Madoff’s attorneys said they “represent a deeply flawed individual”. These explanations indicate that corporate criminality arises not from an act of mistaken judgement or some situational influence but from an innate deviant nature simply waiting to exploit the right opportunity.

With more sophisticated tools available, the quest moved from external body to the internal mind. In the Kerviel rogue trading case where Société Générale lost $5 billion, the judge explained that people with lower self-control have greater difficulty resisting temptation and restraining reckless behaviour which eventually leads to criminal conduct. Some studies concluded that low self-control was caused by poor parenting, while others blamed it on heredity. But whether self-control is driven by nature, nurture, or a mixture of both, once set, it remains largely stable for the rest of a person’s life.

Malfeasance could also be caused by temporary lapse of judgement. Stress and over-exertion can rapidly deplete self-control and inhibit restraint which make individuals temporarily more prone to lie and cheat. Media reported that the Wirecard boss constantly checked the company’s share price on his mobile. As if straight out of a 1960s Bond movie, instead of stroking a fluffy white cat, he preferred sipping peppermint tea to overcome stress. When the price dropped, managers received angry orders to “do something”. Glowering with rage at a townhall meeting on receiving a qualified audit report was a rare display of emotion at work for a person who had revealed shedding tears when overwhelmed by an opera performance.

Genes also contribute toward creating antisocial behaviour influencing regulatory biochemicals and bodily hormones, according to some. Studies show that executives with the most masculine facial features, indicative of higher testosterone levels, were twice as likely to manipulate their firm’s financial statements. Higher levels have long been hypothesized to trigger more aggressive and egoistic behaviour. Newspapers were abuzz with reports that Braun had even commissioned a study exploring the idea of buying Germany’s financial powerhouse, Deutsche Bank.

“All lies are false statements, but not all false statements are lies,” argued philosopher Thomas Carson. Executives often make exaggerated statements that are not viewed as lies. Wearing the black turtleneck uniform immortalised by Steve Jobs and Elizabeth Holmes, Braun’s public persona resembled that of a visionary tech billionaire. He vowed that Wirecard would lead a world where notes and coins were obsolete and will grow in a powerful, organic way. Such statements are nothing more than puffery, yet it’s not difficult to imagine how touting can transform from the merely promotional to the deceitful. As Francis Bacon put it four centuries ago, “It is not the lie that passeth through the mind, but the lie that sinketh in and settleth in it, that doth hurt.” Translation: It’s not the literal message but the impact that message has on decision-making that’s the issue. Braun had told investors that his firm used the latest AI technology to analyse data only for later investigations to find that staff were cobbling together spreadsheets.

Our ability as humans to empathize with others is directly related to their proximity to us. The click of a mouse or the stroke of a pen creates a distant and impersonal harm. Yet, the deleterious consequences can be equally devastating to those impacted. Due to ‘temporal gap’, financial crime lacks instantaneous feedback. The harmful effects of such a crime may follow years after the initial actions, so it’s easier for the perpetrator to be ignorant of the harm he caused.

Mythological stories show little angels and demons perched over our shoulders offering advice. The two entities offer conflicting advice; the angel is our inner conscience prodding us towards ethical behaviour, while the demon nudges us toward mischief. During decision making, executives find choices are often made in isolation or while they are surrounded by people with similar tendencies and incentives. Unlike the tussle between the angel and the demon, there is no genuine debate between opposing views. Many offenders don’t even identify the moral dilemma in the first place.

So, what is the solution? Frauds cannot be eliminated by solely relying on regulatory deterrence or enforcement efforts. Sanctions, even when incredibly severe, are often just too far removed and remote to become relevant to executives in their day-to-day decision making. Watchdogs can strive to make penalties seem more relevant by widely publicising cases of corporate misconduct and the resulting sanctions. Such efforts can inculcate better values and nudge behaviour toward improved legal compliance by making people better appreciate the detrimental nature of certain actions.

Unlike a Boeing or an Airbus trying to understand the failure of one of its planes, many corporate executives have little interest in understanding the causes of destructive behaviour within their own firms. Instead, it seems as though they would prefer to quietly pay fines (like the 1MDB settlement last month) and move on and carry on business as before. Companies that encourage better norms of conduct and whose employees avoid misdeeds ought to have some benefits relative to those that do not. One path to consider could be the firms’ ability to attract and recruit the best talent. If firms that are felons in the eyes of the law were not permitted to recruit on B-school campuses, it could instil an urgency to better address the roots of misconduct that might exceed even the largest fines. This would also motivate company boards to take greater accountability for the actions of all employees. Gaining the attention of students on campus would no longer be a preordained right but, rather, would represent a privilege that firms earn.

There’s a thin line between confidence and hubris. Some executives have bragged how they believe they are doing “God’s work”. Even if said in jest, this belief in the righteousness of their ambitions devoid of any sense of fallibility is precisely the sentiment held by many executives prior to faltering. During a senior leaders’ training programme at HBS, the CEOs are asked to rank a list of ten responsibilities from the item they feel most to least prepared to take on as they begin leading a multi-billion-dollar company. They often rank “setting the right moral tone” as the simplest one. Yet, it is precisely some of these leaders who subsequently appear in newspapers having engaged in the egregious conduct that they once vowed they would never do.

Most of us think that we are better and more moral than we actually are. It is this sense of infallibility that has led to the downfall of many leaders across multiple fields. It’s only after faltering that reality dawns and the executives ask themselves:” Why didn’t I see that coming?” Most of us insist we would have behaved differently if forced to step into the shoes of an executive engaging in misconduct. But this confidence is artificial. It’s only when we admit that our propensity to err is much greater than we often imagine that we’ll begin to take necessary steps to reform ourselves. Till then we will continue to see more cases like Wirecard, Luckin Coffee, 1MDB, PNB, Satyam et al.

Views are personal. The author is a Harvard alumnus and works for an investment bank in Mumbai. He is also a member of the Young Scholars Initiative at the Institute for New Economic Thinking, founded by George Soros et al.