Are some financial fraudsters psychopaths?

The short answer is that we don’t know for certain. Research on psychopaths has primarily been focused on violent criminals, and researchers say that it is difficult to conduct adequate research (which is quite invasive) on psychopathy in the workplace. The concept of the psychopath first became popularised in the 1940s, following important work done by Hervey M. Cleckley, an American psychiatrist who devoted much of his life to studying the condition. Cleckley published a book, The Mask of Sanity, in 1941, which is widely regarded as a seminal work in the field. Confusion with the unrelated concept of psychosis, along with waves of alarmism in the popular media, has led some to doubt that the idea of the psychopath is valid, but extensive research during the last two decades has greatly improved the clinical understanding of psychopathy and methods for its diagnosis.

The idea of the psychopath is a scientific construct, a modern term that has been invented to describe a syndrome (a personality disorder involving a specific cluster of different personality traits and behaviours). Diagnosing a psychopath involves the administration of elaborate tests; it is not, therefore, possible to diagnose a historical figure as a psychopath or to diagnose a major fraudster, such as Madoff or Stanford, on the basis of their media coverage.

Nevertheless, there are good grounds for suspecting that a disproportionately large percentage of financial fraudsters may be psychopaths. For example, some of the classic characteristics of psychopaths, such as recklessness, charm, deceitfulness and the absence of feelings of empathy or guilt seem, on the face of it, to match many of the fraudsters discussed in this book. Furthermore, it is established that psychopaths are drawn to occupations in which they can abuse positions of trust, and as the financial services industry offers many positions of trust it would appear to be attractive to such individuals.

It is sometimes claimed that 10% of financial services workers are psychopaths. This is not supported by scientific evidence; in fact, there has been very little research into psychopathy in finance or, more broadly, in the corporate world in general. Studies of corporate psychopathy have generally used samples that are too small to be representative. One such study found that 4% of the corporate executives in their sample were psychopathic. Although this cannot be generalised to the wider population of all corporate executives, it is suggestive, since 4% is substantially higher than the 1% estimated for psychopathy in the general population.

While pointing out that there has been insufficient research into psychopathy in finance to answer the question definitively, Robert Hare, a leading authority on psychopaths, argues that the percentage of psychopaths on Wall Street ‘may be even higher than 10%, on the assumption that psychopathic entrepreneurs and risk-takers tend to gravitate toward financial watering holes, particularly those that are enormously lucrative and poorly regulated. But, until the research has been conducted, we are left with anecdotal evidence and widespread speculation.’

So what are psychopaths really? Hare has memorably described them as ‘intraspecies predators’, in other words, animals that predate on their own kind. This predation can take numerous forms, not necessarily violent, and not all psychopaths commit crimes or end up in prison. The current understanding of the condition is that it is a matter of having less or more of certain qualities, rather than either having or not having these qualities. Diagnosis involves complex tests that measure scores in four ‘domains’ or areas of the personality. To meet the criteria for being a psychopath, you must score highly in these areas on the test, and these data must be cross-checked and supported by other information taken from, for example, medical and criminal records. In the well-known test, Psychopathy Checklist – Revised (PCL – R), an individual must score 30 out of 40 to be judged a psychopath.

The key features of the psychopathic personality are, according to Hare:

• glibness and superficiality
• egocentricity and grandiosity
• lack of remorse or guilt
• lack of empathy
• deceitfulness and manipulativeness
• shallow emotions.

These features lead to identifiable behaviours involving:

• impulsiveness
• poor behaviour controls
• a need for excitement
• a lack of responsibility
• antisocial behaviour.

Psychopaths are often superficially charming and extremely skilful at deception and manipulation. They choose their victims carefully, and have an uncanny ability to identify and exploit victims’ psychological weaknesses. They have no sense of empathy and are indifferent to others except as objects to be used – psychopaths appear to be unable to imagine what it is like to be another person, but ‘learn’ to disguise this. They do not feel guilty for any crime they commit, however heinous. They have big ideas about who they are and what they expect to achieve, and often feel themselves to be above the law. They have a strong sense of entitlement and have contempt, which they conceal, for social norms.

Although psychopaths are formidable adversaries and extremely dangerous for their victims, they are by no means superhuman. Their predatory qualities, described above, come with related features that can be seen as weaknesses. They are often hyper-sensitive to insults, and react violently to them. They are impulsive, and often do not consider the consequences of their actions. They like excitement, and enjoy doing risky things. They often do not have clear plans for achieving their grandiose goals.

Such features may help to explain why some fraudsters pursue schemes that are doomed to failure. Ponzi schemes, for example, can develop naturally from a legitimate business as the result of a few impulsive decisions, like making risky investments that lose money, and then covering up the losses and paying old investors with new investors’ money – once the fraudster has done this a few times, he is virtually trapped into a cycle of maintaining the fraud to avoid discovery, without any idea of how he is going to get out of it. A psychopath, it is thought, would feel more comfortable in such a trap than a ‘normal’ fraudster because of his lack of fear, an enjoyment of the risks, and a lack of thought about the likely eventual consequences.

Unfortunately, unless a fraudster is properly tested and the results published, we cannot say for sure if a given individual, such as Bernie Madoff, is actually a psychopath. The word gets bandied about too freely in the popular media, and Madoff has even discussed the question with an interviewer, claiming that a psychiatrist had told him, ‘You are absolutely not a sociopath’ (the term ‘sociopath’ is often used to refer to non-violent psychopaths). It would be typical of a psychopath to tell such a story, but this doesn’t help us; it really isn’t constructive for a non-expert to attempt a diagnosis. The best that can be said is there is a prima facie case for Madoff possibly being a psychopath, given his charm, deceitfulness, recklessness and the doubtful sincerity of the remorse he has expressed.

Investors, especially the kind of investor who assumes that finance professionals will always act rationally, should get to know something about psychopathy, because it refers to a type of person who not only would make a very convincing fraudster but is also capable of committing fraud in circumstances that a ‘normal’ fraudster would find too risky or too stressful. Many of the frauds discussed in this book were likely to be discovered eventually, so a ‘rational’ fraudster who wanted to avoid this would look elsewhere; the fact that the frauds were committed anyway should alert us to the fact that it is possible, perhaps even probable, fraudsters often ignore such calculations; some in this latter group may in fact be psychopaths.

Routine activity theory

Despairing of the possibility of penetrating the psychology of fraudsters, many researchers have turned to different kinds of analysis, such as examining the situations in which fraud occur. One such approach is routine activity theory, proposed by Cohen and Felson in the late 1970s. The theory assumes that perpetrators will act rationally, assess all the risks carefully, and only commit a crime if the benefits of doing so outweigh the risks and/or costs of getting caught. As mentioned above, it is clear that not all fraudsters do behave rationally in this way, but nevertheless it may be a large number of fraudsters do make such assessments. The theory proposes that there are three factors involved in crime:

1. the opportunity to commit a crime
2. the absence of effective guards
3. the motive to commit a crime.

According to Cohen and Felson, crime rates don’t go down in times of prosperity simply because there are more opportunities to commit crime. These opportunities become more apparent during routine, recurring activities, such as working in an office each day, when victims and victimisers are brought together repeatedly. If there are no strong guardians to protect the victims, the criminals will commit a crime. Thus, the theory attempts to predict the situations where crimes are likely to cluster.

In 1995, Nick Leeson, a futures trader based in Singapore, brought down his employer, the venerable merchant bank, Barings. Leeson had made a series of unauthorised and risky trades on behalf of the bank, apparently in pursuit of an increased bonus that would be forthcoming if he achieved increased trading profits. When he started to make losses, he disguised them and then tried to trade his way out of trouble, which created further losses and resulted in Baring’s’ collapse owing £827 million, twice the available trading capital of the bank. An analysis using routine activity theory would emphasise the absence of an effective system of control and supervision within Barings; it is alleged that senior executives did not appreciate the potential size of the liabilities created by derivatives trading, and the internal controls should have spotted Leeson’s activities before they got out of hand. The theory suggests analysing job roles may reveal weaknesses in the control system that indicate a conjunction between an opportunity for wrongdoing and the absence of adequate controls; and indeed, Leeson had sufficient autonomy in the Singapore office to be able to disguise his reckless trading from his superiors.

Routine activity theory has focused attention on the ‘guardian’ factor, with the rationale that there are likely to be more crimes in situations where there are weak guardians. This has some relevance to the investment world, because it is very striking that there are fashions in investment fraud, with one specific fraud type being in vogue for a few years before it gives way to another. This variation in the type of fraud may be linked to the waxing and waning of governance in specific areas. For example, the sub-prime mortgage crisis of 2007 was in large part due to a gradual, but drastic, relaxation of the regulation of the mortgage lending industry in the US. This reduced regulation allowed intermediaries to commit a range of frauds on a large scale that would never have been permitted under earlier regulatory regimes. Thus someone with intimate knowledge of the state of the industry’s regulation might have been able to foresee that there would be an increase in fraud.

This doesn’t help us much as individual investors, because we generally don’t have an intimate knowledge of all the regulatory authorities that are supposed to protect our investments! Perhaps we should. We certainly need to be aware of the basic protections, such as the details of compensation schemes for bank deposits. It may seem obvious, but it is important to appreciate that regulators and investor protection schemes in different countries work differently from one another. Deposit protection in Ruritania, say, will not be identical to deposit protection in the UK, and may well not be covered by UK schemes. The Icesave customers in the UK who lost money in 2008 received compensation from the UK government, but it was not obliged to give this money under any scheme; it stepped in when it emerged that the Icelandic government was not at that time willing to offer compensation to foreign savers. These little details really matter when you are deciding where to invest – some investor protection schemes are not worth the paper they are written on.

Nigerian scams – a different type of fraudster altogether?

Although the notorious Nigerian fraud gangs have not penetrated very deeply into the regular investment world, their creativity and talent for financial fraud suggests that they may eventually arrive there. In the meantime, it is worthwhile considering the unusual methods and structures of these gangs to see whether or not they offer any insight into fraudster psychology.

Since the 1980s Nigerian gangs have been operating internationally, duping victims across the world into handing over larger and larger sums of money. Although the UK has been a major target for these scams because of its historical connections with Nigeria, the gangs have penetrated very widely indeed; I once spent a week in Penang, Malaysia, watching a Nigerian group who had just been expelled from Thailand continue their activities from a local internet café.

The scams these gangs operate are diverse and often innovative; the main one is advance fee fraud, also known as the Spanish prisoner scam. This scam existed long before the Nigerians lighted upon it. In its traditional form, the victim is told that the fraudster needs to ransom or rescue a wealthy relative who is being held in Spain; if the victim will put up the money to secure the release of the relative, he will receive a huge reward. The classic Nigerian versions, known as ‘419 frauds’ because they fall under section 419 of Nigeria’s penal code, generally involve approaching a foreigner, often by email, to ask for help in a venture. Typically this will involve an elaborate story about a huge sum of money that is blocked or frozen; if the victim can stump up a few thousand to help free the money, he or she will receive millions in commission. Some victims are tricked into paying multiple sums over to the fraudsters on various pretexts before they realise it is a scam; some victims never do realise that they have been cheated. The stories told by the fraudsters range from the ridiculous (a share in Saddam Hussein’s private wealth) to the plausible (intercepting calls to Nigeria and telling the caller that the person they are calling has been in a traffic accident and needs money urgently). Emails and letters are sent out on a massive scale, and even the most unbelievable story seems to find a few takers. According to the FBI, 419 scams have netted more than a billion dollars in the US in total, while a Dutch firm estimates that the UK lost $520 million to the scammers in 2005 alone. Although the Nigerian authorities are attempting to crack down on these scams, Western governments have been less responsive. This is partly because much of the fraud is believed to go unreported, and also because there seems to be a general feeling that anyone greedy or foolish enough to fall for such a scheme deserves what they get. Often the emails and letters are full of obviously false statements and ridiculous mistakes. Frequently they invite the victim to participate in a crime, such as illegally diverting public funds from an African government. The victims get plenty of warning, in other words, that the fraudsters may not be who they say they are. Nigerians sometimes claim that victims are deceived because they are racist and assume that the fraudsters are asking for their help out of a child-like African naivety. This may be true in some cases, but in others it seems more likely that the victims themselves were simply very gullible.

Dismissing Nigerian fraud because it seems to prey only on the extremely gullible is a mistake. Beneath the surface, the gangs are becoming increasingly adventurous and sophisticated. For example, they are known to be active in ‘phishing’, trying to obtain account details and PINs from victims over the internet by, for example, sending them an email that appears to have come from their bank. They are also very active in international credit card fraud, often taking care only to make relatively small purchases, say under £1,000, to avoid attention from the authorities.

The gangs are said to be loosely structured and ‘flat’, without a rigid hierarchy. Groups may coalesce under one leader to carry out a particular scam, and then dissolve into other groups in which other members take the leadership role. Some informants claim, however, that there are ‘gangmasters’ who seek out computer-literate English-speaking youngsters to work as ‘foot soldiers’ for years before being allowed to conduct their own scams. Nigeria itself suffers from rampant endemic corruption and it is often difficult to tell where crime ends and the formal economy begins. Many policemen and office functionaries take bribes as a matter of course. In what has become a disastrously dysfunctional society, many people feel justified in participating in scams in order to survive. Corruption in the country also helps to make it a safe haven from which to operate, or to which to return with ill-gotten gains. Parcels sent via carriers from Nigeria to the UK are said to consist largely of forged documents, which are then used by other gang members for their various scams. This gives an indication of the industrial scale of the fraud: every day, thousands of documents, including identity documents, phoney cheques, and official letters, are produced for a huge number of ongoing scams. Much of the material going the other way, from the UK to Nigeria, consists of items purchased fraudulently, according to customs officials. The division of labour is well organised, with different people, often in different countries, specialising in particular tasks, such as writing letters, forging official documents, arranging travel, and holding meetings. Victims are often encouraged to visit Nigeria, where they are then vulnerable to all kinds of extortion even if they are unwilling to close the deal they are being offered.

Scamming in Nigeria, which has a population of 162 million, is so widespread that it is perhaps more helpful to view it as a social phenomenon than to attempt to analyse the fraudsters’ personalities. Reports suggest that common attitudes among the scammers include the views that they are not to blame for the victims’ greed, the victims are the descendants of exploitative imperialists, or the scam is payback for the slave trade. In other words, the victims deserve to be cheated. Such attitudes are common enough in the developing world; what makes the Nigerian scammers interesting is that they are adapting, very rapidly and very creatively, to the globalisation of world finance. They are resourceful, smart, and well- travelled. They have global networks, and they keep the money moving – it is claimed that proceeds from smaller scams (many 419 frauds are thought to net only a few thousand pounds a time) into bigger ventures, such as heroin smuggling, in which Nigerians have become very active. They are willing to try new scams, and some clearly have aspirations to get into the higher end of financial services. It would not be surprising if they succeed – watch out for Nigerian scammers at the riskier end of investment – such as commodities, financial derivatives and spread betting – in the years to come.

The problem with plausibility

Law enforcers use profiling with some success to identify types of individuals who are likely to commit specific crimes. The trouble with this approach, from the investor’s point of view, is that we don’t often have the opportunity to really assess the personalities of the people who handle our investments. Warren Buffett, the famous investor, emphasises the importance of good character in the executives who run the companies in which he invests, but, as one of the richest men in the world, he has unusually good access to these people.

Most of us have to make do with much more indirect evidence, such as the plausibility and internal consistency of the investment offers. What many of us fail to do, however, is to verify the facts. Plausibility is an important factor – who would want to invest in an implausible scheme? – but, as we have seen, there are personality types who are extremely skilled at creating spurious plausibility.

A charming, clever, witty, confidence-inspiring financial star may be genuine, but he or she may in fact be a psychopath recklessly exploiting investors in a scheme that is bound to end badly. Routine activity theory has highlighted the rather obvious, but nevertheless very important, point that there is likely to be more fraud in situations where controls and supervision are inadequate. A good rule of thumb for investors is that controls are likely to be more relaxed during bull markets: it is when things are going really well and everybody seems to be making money and it becomes a racing certainty there will be more fraud. And we should not forget that during bull markets the intermediaries tend to relax their standards, too. For example, during the dotcom bubble of the late 1990s I spent a day in Hong Kong with a stock analyst at a major US investment bank who painted an absurdly optimistic picture of how successful a number of dotcom companies were going to be. Within months, some of his favourites had collapsed. The analyst’s arguments were based on glowing estimates of future growth that a child could see through, but he showed no sign of embarrassment – he evidently thought that his ridiculous stories would be believed. Does this mean that he was some kind of fraudster? Probably not. It is more likely as a stock analyst on the ‘sell side’ (the departments in financial institutions that sell investment products and advice to the public) he was simply expected, as part of company policy, to talk up these stocks. So was the investment bank committing fraud? Not exactly – it is not necessarily fraudulent to make optimistic stock recommendations, although when the dotcom bubble finally popped a number of analysts were in fact found to have acted improperly. When everyone else thinks that a certain industry can only go up, it just isn’t very good business for an institution to be gloomy and suspicious – that’s the investor’s job! But we should not make the mistake of thinking that such advice is always impartial, or institutions see it as their duty to blow the whistle on possible crooks. As we have seen (Chapter 3), a number of institutions conducted a careful analysis of Madoff’s investment business and concluded that something was wrong. They chose to avoid Madoff, but did not denounce him.

Globalisation and the internet have given millions of people in developing countries access to the West. In the financial world this is seen as good for business, but globalisation brings new risks with it. We may be at the beginning of a new era of frauds emanating from developing countries. In addition to the Nigerian fraudsters discussed above, there has been a striking increase in telephone fraud coming from the call centre cities in India, such as Bangalore. Westerners are telephoned at home from a person claiming to work for a famous software company. The victim is told that there is a virus problem and is persuaded to switch on their computer and then follow instructions given by the caller. This results in the download of software to ‘fix’ the non-existent virus, and then a demand for money. It would not take an enormous effort of the imagination for a well-connected financial fraudster to devise a scam that exploited this valuable Indian resource: a low-cost sales force of internet-savvy English speakers well out of reach of the authorities in the target countries. Watch this space!