Wise Words Podcast Now available on all major podcast channels.


Lying for Money Book Summary – Dan Davies

What you will learn from reading Lying for Money:

– The many types of fraud, from small scale individual fraud to systemic large scale fraud.

– The elements that lead to fraudulent behaviour.

– How certain trade-offs and incentives can lead to illegal behaviour.

Lying for Money Book Summary:

Lying for money was an eye opening book. It is a deep dive into everything around Fraud. It explores fraud from the ground up, from petty small scale fraud to the bigger systemic fraud caused by shoddy incentives and lack of feedback. If you want an insight into how the world really works and how fraud is more rampant then you think, then this is the book for you!


Fraud 101:

It’s important to begin with the fact that fraud has grown up with the modern economy and helped shape it. Lots of our most important economic institutions are shaped the way they are because they had to deal with the frauds which tried to exploit them as they came into being. The history of commerce is also the history of commercial crime.

Fraud is possible to the extent that people are prepared to trust strangers, or to leave valuable objects out of their immediate control; the ancients had much less occasion to do this than we did. There was less to check up on.

As soon as the concept of a property right was invented, as soon as ownership got more complicated than simply the ability to control things by fighting anyone else who wanted them, there is a need for a social web of trust that the rights will be respected and not misused. And where there’s trust, there’s the opportunity for fraud.

This is a pattern that we can recognise in the modern era too; the controls and technologies of fraud prevention tend to move forward one disaster at a time. The normal state of the political economy of fraud is one of constant pressure toward laxity and deregulation, and this tends only to be reversed when things have got so bad that the whole system is under imminent threat of losing its legitimacy.


The Psychological barriers to Corporate Fraud:

The hierarchies, status distinctions and networks which make up a modern economy also create powerful psychological barriers against seeing fraud when it is happening. White-collar crime is partly defined by the kind of person who commits it: a person of high status in the community, the kind of person who is always given huge helpings of the benefit of the doubt.


Fraud takes place on the system of trust:

The way in which most white-collar crime works is by manipulating institutional psychology. That means creating something which looks as much as possible like a normal set of transactions. The drama comes later, when it all unwinds.

Fraudsters don’t play on moral weaknesses, greed or fear; they play on weaknesses in the system of checks and balances, the audit processes which are meant to supplement an overall environment of trust.


Fraud is based on an equilibrium quantity:

The way we might describe this is to say that fraud is an equilibrium phenomenon. We can’t check up on everything, and we can’t check up on nothing, so one of the key decisions that an economy has to make is how much effort to spend on checking. This choice will determine the amount of fraud.

Precautions are expensive, or inconvenient, or both, and trust is free. This means that people will substitute trust for precautions up until the point at which the ‘shadow cost of trust’ – the expected fraud loss – begins to exceed the direct cost of precautions.

Since this trade-off is likely to involve a mixture of both, there will always be trust and therefore there will always be scams.


Why Fraud Trials are different:

Most trials only have a couple of liars in the witness box, and the question is a simple one of whether the accused did it or not. In a fraud trial, rather than denying responsibility for the actions involved, the defendant is often insisting that no crime was committed at all, that there is an innocent interpretation for everything.

In order to promote this innocent explanation, a crooked businessman* might employ the services of crooked lawyers, crooked accountants, even crooked bankers. Crucial documents will turn out to be ambiguously worded or lost altogether. And the question of guilt may turn on having to judge what was in the businessman’s mind at the time – was this an unfortunate series of deals, or an attempt to steal?


The 4 different levels of Fraud:

A long firm makes you question whether you can trust anyone.

A counterfeit makes you question the evidence of your eyes.

A control fraud makes you question your trust  in the institutions of society.

A market crime makes you question society itself. Since it’s impossible to run a modern economy without all four levels of trust, fraud is an insidious crime.


Collateral as a replacement for trust:

Collateral is a substitute for trust. It relies, however,  on strong legal institutions to make sure you can actually ‘realise’ it by taking possession of it when a debtor defaults.

The activity of ‘perfecting an interest’, ‘establishing security’ and similar euphemism forms a large part of what lawyers send bills to bankers for, because the law on this is tricky.


Compound interest the enemy of Fraudsters:

One key difference between fraudsters and legitimate businesses is that compound interest, the driver of growth and returns for the honest firm, is the enemy of the fraud.

The reason for this is that unlike a genuine business, a fraud does not generate enough real returns to support itself, particularly as money is extracted by the criminal. Because of this, at every date when repayment is expected, the fraudster has to make the choice whether to shut the fraud down and try to make an escape, or to increase its size; more and more money has to be defrauded in order to keep the scheme going as time progresses.

This tends to catch out a lot of amateurs and first-time criminals. A shoplifter or robber can carry out one or two thefts and then take a break; avoiding capture for a blue-collar criminal is just a matter of trying not to be the person who is connected to the crime. An embezzler, though, or a rogue trader or a tax swindler, has to cover up the existence of the crime itself. That means that it’s very difficult to be a onetime-only embezzler. The original crime creates an ongoing need to commit a series of further crimes, usually growing in magnitude.


Areas that lack financial regulation are best for Fraudsters:

Later generations of crooks would follow Ponzi’s example in working with assets not covered by financial regulation, for two good reasons. First, there is less constraint on one’s marketing material, so one’s sales patter can be utterly shameless. And second, one is not exposed to the quite draconian and arbitrary powers usually exercised by securities regulators to shut down investment schemes for any one of dozens of technical breaches or audit failures.


Defrauding the certification systems:

The professional qualifications and memberships of lawyers, accountants and actuaries give them a special status in the business world. Certain kinds of documents are only valid with an accountant’s seal of approval, and once they have gained this seal of validity, they are taken as ‘audited accounts’ which are much less likely to be subjected to additional verification or checking.

Example with gold mines:

In the old days, what you used to do was to get a shotgun cartridge and remove all the shot. You then filled the cartridge with gold dust, took it down to the site of your mine, loaded it into a shotgun, pointed it at some rocks and pulled the trigger. Then you picked up the rocks you had shot at, and sent them off to be crushed and assayed. Lo and behold, the results would come back from the laboratory saying that the rock samples from mine were shot through with flecks of metallic gold. You then took this assay report (signed by a reputable mining chemist at a well-regarded lab) and went to investors to start the real process of getting rich. It was your known as ‘salting’ a mine.

The problem with certification systems is the weak link is nearly always there, unfortunately. The purpose of a certification system is to economise on time and effort spent in checking. This implies that the checking process itself is laborious and difficult. Ideally, you would want to have as few stages in the process as possible, and you would prefer to have all the checking carried out by the same person, or at least the same organisation. Sadly, this is often not possible.

Even in the process of handing out certifications which are meant to economise on trust, some trust is necessary in the process itself. It’s often a very good idea to make sure that one is absolutely clear about what a certification process is actually capable of certifying- the assay was able to establish that the core samples contained gold, but was not in a position to certify that this meant the rock in the ground did.

Even in cases of straightforward banknote forgery, the deep structure of the crime is an attack on the certification system the presentation of something as having had a particular provenance and origin when it was actually produced in some other, cheaper or less honest way.


Pharmaceuticals and fraud:

One of the parts of the economy which has taken the most time and trouble over issues of certification, monitoring and verification of claims of authenticity is the pharmaceutical and medical industry.

And because we know that fraud is an equilibrium phenomenon, we can guess that one reason why so much trouble has been taken to build a robust system of certification is that the industry has a lot of potential fraud. This turns out to be true.

In fact, one could say that there are two main kinds of medical fraud: frauds carried out against the medical industry, and frauds carried out by the medical industry. It is not obvious which is the more serious problem.

The incentive to commit the crime comes from the fact that all the value in the medicine industry is tied up in the certification system. The manufacturing of pharmaceutical products is difficult and competitive, and as a result profitability is always under pressure. The bit of the system where the money is made is right at the end of the journey from molecule to patient, where a large mark-up over the cost of manufacture can be made, either because there is a strong brand or patent protection.

The lesson of Vioxx is that the concept of a crime against the certification system – a counterfeit in the most generalised sense – is a breach of an overall of trust, not an isolated attack on a single victim like a long system firm.

The trust in question in the pharmaceutical industry is that prescription drugs are the output of a process which is managed and regulated on a clinical and scientific basis rather than a commercial one. The patients who took Vioxx were entitled to assume that the company would behave in such a way as to take an objective, rather than optimistic, view of the clinical risks, and that it would communicate with prescribing doctors in a similar manner.


Legitimacy = not intrinsically fraudulent:

People with a moralistic view of tax-driven structuring may question the use here of the word ‘legitimate’; all we mean to convey is ‘not intrinsically fraudulent’.


The Control Fraud:

It is at this stage that the ‘control’ element of a control fraud starts to become the key to the operation. The more things you control, the greater your ability to create fake evidence to justify the fake valuations which underpin the fake profits earned from your fake assets.

Control of the top of the organisation allows you to undermine all the controls and completely corrupt the infrastructure of trust and checking which is meant to protect the system against external attackers.

Now, consider this what would happen if, rather than organising the fraudulent inflation of the corporation yourself, you simply set up a system of incentives and (non-) checks and balances, such that other people were likely to inflate it for you? In other words, rather than committing crimes yourself to inflate the value, you just created a massively criminogenic environment in the firm, and let nature take its course?

One important aspect of a control fraud is that the method of extracting cash is usually not intrinsically criminal. You set up an organisation such that it will legitimately pay out a percentage of its value to you through dividends, bonuses and commercial transactions with other controlled entities, then blow the size of that entity to an absurd level by taking on a load of debt, and let the normal and legitimate mechanisms of the corporation transfer the fraudulent value into your pocket.


Systemic Fraud and lack of responsibility:

What if – stay with me here because there will be examples – what if there really was no intention to create a criminogenic scheme at all? If you were lucky enough to set up a company with bad incentives and internal controls by accident, then you would get nothing but positive reinforcement for your decision for quite a while – it would look like the company was profitable, it would grow at a snowballing rate, and in that sort of situation, what senior manager would question whether or not he deserved a big bonus? Hypothetically, it could be possible for a massive control fraud to take place purely by accident, without any criminal responsibility for the overall scheme at all.


Understanding how to commit fraud is understanding how to manage something:

Imagine you are managing something-part of a business, an academic department, a government agency or something.

Choose something you know a bit about. Now, imagine that you want to defraud someone else. In order to do that, you are going to need to tell some lies in order to gain something of value. What would you try to steal? What would you need to falsify? How would you do it? How would you keep the fraud going over time? How much money could you extract from the fraud?

In other words, to understand how to defraud something is to understand how to manage it.

Which is to say, if you were to write down a summary how you manage something, the things you look for and рay attention to, how you expect them to develop and what you check in order to make sure all is as it should be, then you would have the beginnings of a template to carry out a fraud on the same workplace.

This might suggest a pessimistic conclusion that anything which can be managed can be stolen from, and that precautions are useless because all manageable entities are equally vulnerable. That would be going too far.

The easier something is to manage – the more possible it is to take a comprehensive view of all that’s going on, and to check every transaction individually – the more difficult it is to defraud.

Vulnerability to crime, in other words, tends to scale with the cognitive demands placed on the management of a business. The more things a manager has to pay attention to, the easier it becomes to carry out a commercial fraud. It also gets easier with increasing uncertainty with regard to what a ‘normal’ or valid transaction looks like; that’s why so many big frauds occur in brand-new business lines where there has been no time to establish a baseline of common practice.


Management as an information processing job:

If you can’t measure something, you can’t manage it is something of a caricature of modern management science, but it expresses a deep truth; management is an information-processing job, and the development of large corporations has been made possible by the parallel development of reporting structures, quality and output measures and other tools for getting that information from the machines into the offices.

The underlying problem is that most of the time, we are trying to manage or administer things which are too complicated to be aware of every detail at every time, so we need to choose what we hope will be a representative subset of all the information that we have.


Control systems and complexity:

There are only two ways addressing a problem of insufficient variety in the control system.

One of them involves reducing the information set, which makes you vulnerable to fraud from the things you are not monitoring. And the other one involves introducing new people to trust, which makes you vulnerable to fraud if they turn out not to be trustworthy.

In other words, the problem of managing fraud is the problem of management itself. It’s all about the ways in which you cope with the regrettable tendency of the commercial world to be too big and complicated to deal with all at once.

If the system you are trying to control has more variety than your control system has ability to keep track of, then you have three choices: expand the variety of the controller, reduce the variety of the system being controlled, or give up on the attempt to control.

Most management measurement techniques can be seen, cybernetically, as variety attenuators. They’re methods of taming the detail and uncertainty of the underlying system, to reduce it to something which can be represented in the head of a responsible manager – to, literally, ‘make it manageable’.


Trade offs and incentives for illegal behaviour:

Even in industries where the problem isn’t so drastic, there is always a huge, unbearable tension between objectives of market share and profitability. It’s not really all that much of an exaggeration to say that managing the trade-off between these two objectives is at least half of the skill of strategic management.

And one of the clearest ways to ease the trade-off is by doing something which decreases the tendency for competition to reduce pricing. You can do this in numerous ways; the most productive and socially valuable one is to make an improvement to the product or get more efficient, allowing you to earn profits.

At the other end of the scale, it’s secret meetings and price-fixing. The point at which the line is drawn between legal and illegal behaviour – and the point at which a second line is drawn between merely prohibited behaviour and an actual crime is a political-economic decision, made in the perceived interests of the system as a whole.


Fraud is cancer on the system of trust:

In biological contexts, a part of the system which has escaped the normal self-regulatory mechanisms and begun to grow without constraint is called a cancer. Unless they are controlled, fraudulent business units tend to outcompete honest ones and drive them out of business. In doing so, they generate profits, and those profits can be redirected into financing the corruption of the whole system. Runaway corruption is something which does happen, and which can undermine entire societies.


The banking system and it’s rules:

The inability to conveniently use the modern banking and payments system is a huge disadvantage for criminals when compared to the legitimate economy. So the government’s ability to use the banking system and its records as a tool of law enforcement is an important part means of its overall power to enforce its laws.


Three elements of fraud:

A fraud happens when the following conditions are simultaneously met:





The Golden Rule:

That’s the basis of my proposal for a Golden Rule:

Anything which is growing unusually quickly needs to be checked out, and it needs to be checked out in a that it hasn’t been checked before. Nearly all of the frauds in this book could have been stopped a lot earlier if people had been a bit more cynical about growth.