Everyone that desires to take a deep dive into financial history cannot abstain from analysing financial scandals. Indeed, the study of financial frauds and controversial incidents – sometimes more than regular or linear events – eases the understanding of even the most subtle and complex sides of the field. Moreover, getting to know the mechanisms behind financial scams or frauds can help prevent similar future happenings, as well as better understand financial perpetrators’ behaviours.
Notwithstanding that the common idea of financial scam is followed by concepts such as technological innovations, computers or even cyberattacks, our first story begins 300 years ago, in the early 1700s. The event that would have gone down in history as the “Mississippi Bubble” owes its occurring to the economist, mathematician and gambler John Law.
Being a close friend of the French regent, the Duke d’Orléans, Law convinced him to establish the Banque General in 1716; one year later, he acquired the Compagnie du Mississippi to transform it into the Compagnie d’Occident (later renamed Compagnie des Indes), and with it also the monopoly on North America colonies. It did not take long before Law gained the full control on France’s trades and financial system. Law had put a simple but effective “marketing” tactic in place: he convinced investors that the Compagnie was a gold mine, launching a speculative spiral on its shares, that peaked from less than 3,000 livres to more than 10,000 throughout 1719. This could not last long and, as easily foreseeable, the shares soon dropped to zero, in one of the heaviest speculative and economic crisis ever.
It was two centuries later, in the 1920s, that our next scam took place: despite being neither the greatest nor the first, the Ponzi Scheme will always have a substantial spot in financial tales, and has represented the very basis for several future similar events. The occurrence itself is characterised by an intrinsic simplicity: Charles Ponzi discovered that IRCs (international reply coupons, i.e., coupons that can be exchanged for postage stamps) could be bought abroad for paltry amounts and then sold in the U.S. at a much higher price. By promising investors outstanding profits in shorter time periods, he was able to create an exceptional vicious cycle, where he paid elder investors with the funds coming from the newer ones. Even though the socalled Ponzi scheme allowed its inventor to get rich soon, it eventually blew up, and Ponzi’s illicit micro-reign quickly collapsed.
They say that history always repeats itself: nevertheless, criminals – and financial perpetrators are not different – constantly devise the most creative and innovative ways to circumvent laws and deceive financial systems. It is the case, for instance, of ZZZZ Best Cleaners: founded in 1982 by the 16-year-old Barry Minkow, ZZZZ Best Cleaners was a carpet-cleaning company, whose core business only functioned as a facade for its several illicit activities. It was undoubtedly his young age that caused Minkow deep struggles in raising funds: unfortunately, he was brilliant enough to excogitate alternative ways to feed his business. Indeed, at its very beginning, ZZZZ Best Cleaners only survived thanks to credit-card thefts and little money stealings; shortly after, Minkow gathered the promising profits of the unlawful exploitation of the insurance restoration business, initiating an out-to-out Ponzi scheme.
Minkow and his partner Tom Padgett, who already worked in the insurance market, founded Interstate Appraisal Services, a fictitious insurance company that only produced fake documents declaring that ZZZZ Best Services was thriving and involved in restorations: this convinced banks to grant loans to the company, and eventually allowed it to go public in 1986. At the time, the core business of the company represented only the 14% of its actual incomes: the residual 86% came from insurance frauds and illicit financial activities, being almost 300 million dollars worth.
Evidently, Minkow’s fraudulent building was destined for failure: investors ended up discovering ZZZZ Best Cleaners’ hidden business, and Minkow and his lackeys were charged with 54 indictments, such as money laundering, insurance fraud and tax evasion.
A common course of the events that usually characterises the rise and fall of fraudulent companies is the following: the firm hides illicit revenues or inflates its profits, shareholders discover the scam, and the company eventually files for bankruptcy. This has more or less been WorldCom’s story, that shortly moved from being the second largest US telecommunication company to dramatically collapse in 2002, in an over 9-billion-dollars scandal.
WorldCom owed its troubled existence to its CEO, Bernie Ebbers, whose strategy was to overprice the company’s actions in order to gain more investors and thus finance the several acquisitions that would have led to the firm’s expansion. With a series of non-sophisticated accounting deceits, Ebbers was able to fake an extraordinary profitability: the cash flows inflation and the expenses capitalisation allowed the overstatement of more than 4 billion dollars, even reporting, in 2002, a 1.5 billion revenue over the actual loss.
Finally, investors suspected an illicit business behind the glowing company reports, and the SEC started an inquiry that rapidly revealed the swindle. WorldCom filed for bankruptcy, and Ebbers was charged with nine counts of financial frauds and convicted to 25 years of detention.
The last story worth to be told is what went down in history as the biggest Ponzi scheme ever, which entirely revolves around Bernard Madoff, founder of Bernard L. Madoff Investment Securities, and architect of a 65-billion-dollar scam. The cons king’s hedge fund was able to regularly hit a stunning 11% yearly gain, which he paid with the newest investors’ funds: as predictable, the scheme exploded when investors started reclaiming higher interests than the amount of the latest investments. Almost 40,000 people in 136 countries remained offended in this fraud, comprehending individuals, well-known characters and investment banks.
It was in 2008, aware of having reached the no return point, that Madoff confessed his fraud to his sons, who were the designed heirs of his criminal empire, and reported him to the authorities. Madoff, charged with eleven counts, was convicted to 150 years of imprisonment.