What The Biggest Financial Frauds Can Teach Us

What You Need to Know

Employees of fallen companies often compartmentalize and rationalize what is going on.
Much of what occurred at Enron had been signed off by accountants and lawyers.
At FTX, a number of big-money people were driven by a desire to keep up with their friends.

We’ve seen many major examples of financial fraud in recent years. Enron, Theranos and FTX are three high-profile examples.

At the recent Morningstar Investment Conference, held for the first time at Chicago’s Navy Pier, one session focused on financial fraud and its causes, fallout and regulators’ scrambles to keep up. 

The panel discussion, “How History Can Help Us Decode Deception: Learning From the 21st Century’s Greatest Financial Frauds,” was moderated by Todd Trubey, a senior manager research analyst at Morningstar Research Services.

Panelists included Bethany McLean, a contributing editor at Vanity Fair and co-author of “The Smartest Guys in the Room” on the Enron collapse; and Zeke Faux, an investigative reporter at Bloomberg Businessweek and the author of “Number Go Up” on cryptocurrency’s rise and fall.

Many employees of fallen companies compartmentalize and rationalize what is going on. This explains why there often aren’t a large number of whistleblowers even when the fraud is well known internally.

Here are some highlights from the session.

Legal Fraud

McLean pointed out that much of what occurred at Enron was legal: Accountants and lawyers had signed off on it. This is reflected in how difficult it was to prosecute company leaders Kenneth Lay and Jeffrey Skilling.

She noted how useful it was to view fraud from a legal lens, that just because it is legal doesn’t make it right. Faux applied this theme to crypto, saying that the digital currency has, in essence, democratized scamming, with an entire population of people looking to get in on the next bitcoin or ethereum. Startup costs are low, and there is a huge potential for fraudsters using this type of approach to get away with it.

The Environment for Fraud

When a degree of mania is already in place, McLean noted, it’s easier to pull off a fraud. Such fear of missing out leads to a situation in which many people who want to get in on the next big thing do so without asking too many questions.

The ability to tell a story helps promote a fraudster’s ideas as well, she said. Faux agreed that the impact of FOMO cannot be overstated, relating his own experience when a friend told him about their experience with crypto. A number of big-money people were driven by a desire to keep up with their friends, he said.

Off the Balance Sheet

When Trubey brought up the gray area of off-balance sheet entities. McLean offered that Enron facilitated its fraud in both a technical and a non-technical manner. The technical fraud included the use of off-balance sheet entities and earnings manipulations that were technically legal and in many cases signed off on by accountants and lawyers. Andy Fastow, the company’s chief financial officer, played a huge role in this part of the fraud, she said.

The other side of the fraud was the sheer complexity of everything that Enron was doing, McLean added. This had the result of instilling a fear of asking questions about what the firm was doing, because many experts were reluctant to inquire about basic information. One credit rating agency, she related, asked how Enron made money, ultimately deferring to what were labeled “the smartest guys in the room.”