We can't fight an enemy that we don't know. The Institute for Fraud Prevention, directed by Dr. William K. Black, is striving to build a statistical foundation that will increase the global body of knowledge and improve anti-fraud efforts.  

What do we actually know about the causes of fraud? Not much, says Bill Black. "We know too little about fraud and its causational factors and our ignorance greatly reduces our effectiveness," says Black, the director of the Institute for Fraud Prevention (IFP), a joint project of the ACFE and the American Institute of CPAs and other organizations, created by Joseph T. Wells, CFE, CPA, founder and Chairman of the ACFE. "[Governments] do not keep good statistics on the prevalence of major frauds, and we do not treat fraud as a serious crime. So the IFP's most valuable contribution might be to fund research on fraud and help develop statistics on fraud. We will urge governments to make anti-fraud efforts a far higher priority," Black said. [See "Institute for Fraud Seeking Partners" at the end of this article]

Black's many careers have prepared him well to be the director of the IFP. Previously, he was a lawyer in private practice, a senior regulator, and a lead investigator of the Savings & Loan scandal. Black has trained regulators, FBI agents, and Assistant U.S. Attorneys in detecting and prosecuting sophisticated financial frauds. He has also been general counsel and senior vice president for a major bank. In the mid-1990s, Black went back to school and earned his doctorate in criminology. He has taught microeconomics, public financial management, financial regulation, and a range of anti-fraud courses at the LBJ School of Public Affairs at the University of Texas at Austin and Santa Clara (Calif.) University.

Black spoke to Fraud Magazine from his office in Santa Clara shortly before he began his new position as associate professor of economics and law at the University of Missouri at Kansas City.

What are the origins of the Institute for Fraud Prevention and its purposes?
Joe Wells [ACFE founder and Chairman] had the vision to create the IFP. Joe, in turn, credits the great criminologist Donald Cressey with demonstrating how valuable it was to understand fraud and those that commit it. The IFP's primary goals are to engage in multidisciplinary research and education to reduce fraud and corruption worldwide.

Here's a three-parter: Why is this a good time to start the IFP? Why is it important that the IFP exist? And why does the anti-fraud profession need a proponent and depository of research?
Recent developments make the IFP particularly vital. A wave of fraud led by CEOs (I call it "control fraud") has caused greater financial losses in the U.S. than all other forms of property crime combined. Many of our most elite institutions and professionals have aided these frauds.

Fraud and corruption have now been shown empirically to be major barriers to economic development and effective government. Previously, too many economists asserted that corruption improved growth. Corruption and fraud kill. Illegal mines in China, kept open by bribes, kill thousands. Unsafe buildings in Turkey, made possible by bribing building inspectors, are death traps that kill tens of thousands in earthquakes.

Control fraud is not limited to the U.S. Privatization in the former Soviet states and Latin America has frequently been undermined by corruption and fraud.

Fraud has become increasingly international. Identity theft, for example, might involve theft via Ukrainian hackers, the sale of the stolen private information to a broker in Western Europe and the use of the stolen identity to defraud a merchant in California. Frauds take advantage of regulatory gaps in "nearly failed" states (nations that have ineffective governments but adequate telecommunications).

Fraud and corruption are vital to terrorism. Many terrorist organizations fund themselves primarily through fraud (for example, "false front charities"). International terrorists often use bribes to defeat security. Bribes obtain passports, IDs, and shipping approvals. Chechen terrorists bribe their way through roadblocks to launch attacks inside Russia and to escape arrest and commit suicide bombings on Russian planes. If terrorists use a nuclear weapon in the U.S. they will deliver it in a container on a vessel by bribing port inspectors not on an ICBM.

The IFP is needed to deal with two fundamental research problems. First, we know too little about fraud and its causational factors and our ignorance greatly reduces our effectiveness. There are three allied problems: the U.S. Department of Justice, other global justice departments, and foundations rarely finance research against fraud; they do not keep good statistics on the prevalence of major frauds; and they do not treat fraud as a serious crime. So the IFP's most valuable contribution might be to fund research on fraud and help develop statistics on fraud. We will urge governments to make anti-fraud efforts a far higher priority.

Second, because there is no academic body dedicated to fighting all forms of fraud (we consider corruption a form of fraud), there is no overall coordination or single source of information about fraud. So even where we have useful information on fraud techniques and ways to fight it, too few people know it.

In October of 2005, the IFP offered grants in three specific areas: identity theft, procurement fraud, and control overrides by management in financial statement fraud cases. Who received those grants and how is the research proceeding?
We were fortunate as a new entity to be able to attract world-class researchers in our first research effort. Robert Tillman is a prolific researcher who has published books and articles on a wide range of frauds. He is studying control overrides and has recently provided us with a preliminary report. Nikos Passas is internationally recognized as an expert on corruption and money laundering. He is studying procurement fraud in cooperation of the U.S. Office of Government Ethics and various agency inspector generals. William Kresse has partnered with the Chicago Police Department to study identity theft. Its database is allowing him to answer the empirical research question we posed - what are the most common means by which thieves steal identities?

The accounting firm, Grant Thornton, is a funding partner of the IFP. What other organizations have partnered with the ACFE and the AICPA in developing the IFP?
Japan's ACFE organization [managed by the firm, D-Quest Inc.] has joined the ACFE, the AICPA, and Grant Thornton in becoming ACFE's financial partners. We will be securing additional funding partners this year.

Intellectual partners include the U.S. Postal Inspection Service, the Government Accountability Office, the FBI, the National White-Collar Crime Center, and the Council for Better Business Bureaus.

What does the IFP need right now to thrive?
Our research needs to be successful, we need to create a top Web site that can spread the expertise we develop, and we need to do broaden public awareness of the IFP and how harmful fraud is.

What can fraud examiners do to support the IFP? Why is the IFP important to a fraud examiner who works not in academia but in the trenches?
IFP's purpose is to provide useful information to help prevent, detect, and prosecute fraud. The great criminologist Donald Cressey's suggestions led Joe Wells to create the ACFE. Few criminologists are ivory-tower types. The IFP, like the ACFE, will help anti-fraud professionals. We will develop and provide useful information on anti-fraud techniques, increase public understanding of how much damage fraud causes, and raise the status of anti-fraud specialists.

What other plans are in the works for the IFP? What are your dreams?
We are creating an international research consortium. The Australian National University and a university in Sofia, Bulgaria, have joined three U.S. universities as our initial members. My aspiration is that the IFP will become a respected source of advice that legislators and government officials will frequently consult.

Can you briefly describe your concept of "control fraud"?
A seemingly legitimate corporation can do vastly more damage when it operates as a fraud. The person that controls a corporation poses a unique danger because he can turn it into a fraud. He can also optimize the internal and external environment for fraud by defeating the internal and external controls, by causing the corporation to grow rapidly, and by using political and charitable contributions to create regulatory gaps and make it hard to take action against the corporation. An embezzler who takes $50 creates an easy prosecution. A CEO who uses accounting fraud to inflate the corporation's earnings can convert the corporation's wealth to his own benefit through normal corporate mechanisms such as dividends and stock appreciation. The combination of these factors means that control frauds can produce losses vastly greater than any lesser senior officer can cause.

What was the impetus for writing "The Best Way to Rob a Bank is to Own One," a book on the 1980s' Savings and Loan frauds?
I felt that we had learned the wrong lessons from the debacle and that this left us sitting ducks for the current, much larger wave of control fraud. The conventional economic wisdom about the debacle was that fraud played no material role and that in any event control fraud could not occur absent deposit insurance. Both conclusions were false. Their policy advice was that we should deregulate and minimize enforcement actions because the financial markets easily spotted and prevented serious securities fraud. This was the worst possible advice they could have given and it produced a disaster. I wanted to sweep away the myths and explain the key role of control fraud in producing the S&L debacle and other waves of fraud.

How do you use your experience as the former director of litigation for the Federal Home Loan Bank Board to analyze today's fraud? What are some of the common denominators between then and now?
Accounting was and is the weapon of choice for looting control frauds. Accounting fraud produces guaranteed record profit if the corporation grows rapidly. This makes the CEO that leads the fraud to become a hero and a rich man through seemingly legitimate corporate mechanisms that can make a successful prosecution very difficult. A control fraud's most valuable ally is an accommodating audit partner. We repeated the same mistakes in gutting the regulatory ranks in both crises.

In the aftermath of the Lay/Skilling trial, what have we learned, if anything, from this sad story?
Control frauds can fool the most sophisticated "experts." They do not simply exaggerate their earnings. They can report record profits while they become massively insolvent. Enron was voted the most innovative company by Fortune and Andy Fastow was named the nation's top CFO by CFO Magazine. Fastow was not even technically competent as a CFO. Yet it took a massive and skilled government effort to convict Enron's two leaders of one of the largest and most obvious control frauds in world history.

How do you see your control fraud concept working in the Enron debacle?
Enron was a classic looting control fraud. It created record "profits" through accounting fraud. One of the other myths that arose from the S&L debacle was that market value accounting would prevent fraud. Enron successfully sought permission from the SEC to use market value accounting in order to massively overstate asset values. It hid real losses through fictional "sales" to Fastow's fraudulent special purpose entities (SPEs). The most disturbing part of Enron is that the nation's most elite banks and professionals played critical roles in aiding the frauds.

Why does looting - a variant of control fraud - often end in catastrophic failure?
Looting control frauds produce losses because the CEO converts corporate assets to his personal benefit. They produce catastrophic losses because the way to optimize looting is to maximize accounting fraud and the way to do that is to deliberately make bad investments. This last aspect is the most difficult to comprehend for those who don't study fraud. In the debacle, the worst borrowers were willing to agree to pay the highest fees (and the agreement was sufficient to book the "income" even though it was self-funded). In Enron's case, the more insane the business concept the larger the fictional profit that Enron could book.

Looting control frauds target creditors and shareholders. Control frauds that target consumers and the public produce real, albeit unlawful profits. This is bad news, for it creates a destructive dynamic in which dishonest firms gain a competitive advantage. This can cause fraudulent firms to dominate entire industries.

You've written that "three of the nation's top financial experts took the worst corporation in the nation [Lincoln Savings]- and pronounced it superb. That is the measure of how successful control frauds are in deceiving experts who do not understand fraud mechanisms and assume that CEOs cannot be crooks." Since then, of course, we've seen a number of CEOs do the "perp walk" and the Sarbanes-Oxley Act is beginning to make a dent. Are financial experts truly wiser and more skeptical or are we doomed to eventually repeat the same regulatory mistakes?
One of the reasons we need the IFP is that we have not learned the critical lessons. The frauds are continuing. The CEOs of many of our top mutual funds engaged in "late trading," manipulation of options appears to be widespread, and the effort to roll back regulation is gathering force. See "SOX under attack." 

I understand that you recently helped the World Bank develop an anti-corruption initiative. Can you describe that and your participation?
The World Bank has recently come to understand how pervasive corruption has become and how seriously it has discredited the Bank and harmed its programs. The Bank also realized that corrupt contractors often used the same tactics and the same corrupt middlemen and government officials. We designed the Voluntary Disclosure Program (VDP) to create an incentive for contractors to come clean and obtain reduced sanctions if they identified the corrupt entities. Three test cases identified over 100 corrupt entities. The World Bank retained the IFP as a consultant to help design the VDP program. I drew on models of similar programs in the U.S., such as those in the Defense Department, and other nations.

At the end of the day, what motivates you to keep up "the good fight" against fraud?
The element that defines fraud is deceit. One first creates trust and then betrays it. All of us in the anti-fraud field are pursuing a worthy goal. It's a fulfilling task.

Dick Carozza is the editor of Fraud Magazine.

Institute for Fraud Seeking Partners

During a General Session at the recent 17th Annual ACFE Fraud Conference & Exhibition, Joseph T. Wells, CFE, CPA, founder and Chairman of the ACFE, asked for financial partners with the Institute for Fraud Prevention.  

"We're seeking additional financial partners to serve on our 12-member board, which now has five members," Wells said. Current financial partners include the ACFE; the AICPA; the Japanese consulting firm D-Quest Inc. (which manages the ACFE Japan Office); and the accounting firm, Grant Thornton.  

"If your organization is interested in serving on the board, you will help determine the research direction the IFP takes and be influential in future decisions," Wells said. Each IFP board applicant pledges $40,000 per year for a minimum of three years, he said. Individual ACFE members are also encouraged to financially support the IFP.