- Triplet 17 - Understanding fraud at work: Role-model for economic fraudsters

Triplet 17

Understanding fraud at work: Role-model for economic fraudsters

By Shiva Kant Jha

June 26, 2009

AN overview of the history from the 16 th century to date shows that the art and craft of fraud are deficient in inventiveness: they repeat the same script of their craft time and again. of course, with seemingly new trappings. Its plagiaristic repetitiveness goes most often unnoticed because human memory is proverbially short. This point was forcefully driven home to us by John Kenneth Galbraith in The Age of Uncertainty (1977) where he said:

“The man who is admired for the ingenuity of his larceny is almost always rediscovering some earlier form of fraud. The basic forms are all known, have all been practiced. The manners of capitalism improve. The morals may not.”

It is well said. Shakespeare borrowed all his plots in his plays, but he turned them into things of beauty ever new, hence never stale. In this leaf I intend to tell you something about the structure and strategy of fraud as explored and portrayed by Charles Mackay in his Extraordinary Popular Delusions and Madness (1841). Never is a name more connotative and suggestive than this book's. This book, especially its first three chapters [‘Money Mania.—The Mississippi Scheme'; ‘The South-Sea Bubble'; and ‘The Tulip mania'] deserve to be read by all who want to understand the technique of mega frauds illustrated in certain financial/money manias, now brought to perfection under the Pax Mercatus (the rule of market) established under the architecture of the present-day Economic Globalization. Michael Lewis considered Mackay an economist as high in stature as Adam Smith, Ricardo, and Keynes. The bubbles evidencing greedy financial manias pertain to the South Sea Company bubble of 1711–1720, the Mississippi Company bubble of 1719–1720, and the Dutch tulip mania of the seventeenth century. These show how the murk of greed helped produce a breed of financial fraudsters who succeeded in ingratiating the power-wielders and suborning even the watchers of public interest to turn them into a band of suppliant helpers and cheer-leaders of the greedy maniacs.

In this leaf it is not possible to provide even a synoptic view of the aforementioned three chapters. What I would attempt is a short summary of the common features only those points which must not go unnoticed by us if we really believe in the often repeated idea, as Edmund Burke put it, ‘ Eternal vigilance is the price of liberty'. But before I set out to draw such features I would quote D efoe who described the craft of greed with an amazing succinctness:

Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry 'em down;
Divide the empty nothing into shares,
And set the crowd together by the ears

How graphic are the words in the concluding two lines in the context of the computer generated money under the present-day rogue financial system. How accurate is the portrait of the creatures pullulating on the stock markets gathering roses which do not exist, and harvesting money no more than evanescent digital flickers through figures which yield unjust enrichment to some, befool many entrapped in the quest of a rainbow, and leave the society by and large morally depraved to suffer inequity and injustice.

On this short leaf I cannot even provide you a synopsis comprehensive enough motivate you to go through Mackay's book for light and delight. Here I would provide you some foretaste of what is the best in Mackay's.

In the ‘Mississippi Scheme', Charles Mackay draws an account of a powerful financial bubble which emerged from the collective pursuits of the bankers, speculators, economic adventurers and crooks. The artificial creation of credit, and the fecundity in the proliferation in paper currency, and a systematic maneuverings through monetary policy worked hand and glove with the wielders of political power in the degenerate ancien regime in France marching headlong to the Revolution (1789). The circulation of more money and the emergence of the extractive and exploitative gladiators created certain oasis of wealth in the aggrieved French society fostered the flame till the ancient regime turned into ashes. Consider the following brief extracts from Mackay's book which, it is hoped, would provide us a good perspective to understand the goings-on of our days:

(a) The French society had become philistine, corrupt, and callous to common people. It was a society where some were born to great delight whilst all others were born to gruesome night.

“The looms of the country worked with unusual activity, to supply rich laces, silks, broad-cloth, and velvets, which being paid for in abundant paper, increased in price four-fold. Provisions shared the general advance. Bread, meat, and vegetables were sold at prices greater than had ever before been known; while the wages of labour rose in exactly the same proportion. The artisan who formerly gained fifteen sous per diem now gained sixty. New houses were built in every direction; an illusory prosperity shone over the land, and so dazzled the eyes of the whole nation that none could see the dark cloud on the horizon announcing the storm that was too rapidly approaching….. It was remarked at this time that Paris had never before been so full of objects of elegance and luxury. Statues, pictures, and tapestries were imported in great quantities from foreign countries, and found a ready market. All those pretty trifles in the way of furniture and ornament which the French excel in manufacturing were no longer the exclusive play-things of the aristocracy, but were to be found in abundance in the houses of traders and the middle classes in general. Jewellery of the most costly description.”

(b) The stock-market induced madness.

“The story goes that a hunchbacked man who stood in the street gained considerable sums by lending his hump as a writing-desk to the eager speculators! The great concourse of persons who assembled to do business brought a still greater concourse of spectators. These again drew all the thieves and immoral characters of Paris to the spot, and constant riots and disturbances took place.”

(c) Emergence of paper money: the hiatus inter se appearance and reality.

“The warnings of the parliament, that too great a creation of paper money would, sooner or later, bring the country to bankruptcy, were disregarded. The regent, who knew nothing whatever of the philosophy of finance, thought that a system which had produced such good effects could never be carried to excess.”

(d) Autocratic monarchy of the ancient regime worked as participis criminis in contradiction to constitutional monarchy of England where public outcry and vigilance led the government to forge effective steps against the swindlers whether they were in the government of the day or outside.

“In a constitutional monarchy some surer means would have been found for the restoration of public credit. In England, at a subsequent period, when a similar delusion had brought on similar distress, how different were the measures taken to repair the evil; but in France, unfortunately, the remedy was left to the authors of the mischief.”

The South-Sea Company was incorporated under the Act of the British Parliament with a view to restoring public credit, which was in a bad plight. Reports and rumours were assiduously manufactured so that the masses could be turned into herds to be easily driven to the traps so dexterously made with an active assistance of many ministers, members of Parliament, high dignitaries and many others shaping public policies including the Chancellor of the Exchequer. The king's worry, expressed at the opening of the session of 1717, at the state of public credit was sought to be dealt with by setting up two great monetary corporations, the South-Sea Company and the Bank of England. The French bubble was treated as a model, but ‘wise in their own conceit' some modifications were effected to escape the follies which pricked them flat. But the prime mover was the same in both the countries. Mackay puts it thus: “Visions of boundless wealth floated before the fascinated eyes of the people in the two most celebrated countries of Europe.” Some of the gnawing features were thus captured by Mackay:

“Walpole warned against “the dangerous practice of stock-jobbing, and would divert the genius of the nation from trade and industry. It would hold out a dangerous lure to decoy the unwary to their ruin, by making them part with the earnings of their labour for a prospect of imaginary wealth.” “It seemed at that time as if the whole nation had turned stock-jobbers.” "Every fool aspired to be a knave."

“The great principle of the project was an evil of first-rate magnitude; it was to raise artificially the value of the stock, by exciting and keeping up a general infatuation, and by promising dividends out of funds which could never be adequate to the purpose." In a prophetic spirit he added, that if the plan succeeded, the directors would become masters of the government, form a new and absolute aristocracy in the kingdom, and control the resolutions of the legislature. If it failed, which he was convinced it would, the result would bring general discontent and ruin upon the country.”

(iii) Some of these schemes were plausible enough, and, had they been undertaken at a time when the public mind was unexcited, might have been pursued with advantage to all concerned. But they were established merely with the view of raising the shares in the market. The projectors took the first opportunity of a rise to sell out, and next morning the scheme was at an end. The shares of this company were rapidly subscribed for. But the most absurd and preposterous of all, and which showed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled "A company for carrying on an undertaking of great advantage, but nobody to know what it is."

(iv) “But it did not follow that all these people believed in the feasibility of the schemes to which they subscribed; it was enough for their purpose that their shares would, by stock-jobbing arts, be soon raised to a premium, when they got rid of them with all expedition to the really credulous.” “It would be needless and uninteresting to detail the various arts employed by the directors to keep up the price of stock. It will be sufficient to state that it finally rose to one thousand per cent. It was quoted at this price in the commencement of August. The bubble was then full-blown, and began to quiver and shake, preparatory to its bursting.”

(v) “Is there no warmth in the despair of a plundered people?—no life and animation in the picture which might be drawn of the woes of hundreds of impoverished and ruined families? of the wealthy of yesterday become the beggars of to-day? of the powerful and influential changed into exiles and outcasts, and the voice of self-reproach and imprecation resounding from every corner of the land? Is it a dull or uninstructive picture to see a whole people shaking suddenly off the trammels of reason, and running wild after a golden vision, refusing obstinately to believe that it is not real, till, like a deluded hind running after an ignis fatuus, they are plunged into a quagmire?”

In the ‘Tulipomania' Desire for tulips were created and made wide spread by adopting a strategy analogous to the strategy of the present-day commercial world bent to beget consumerism by creating and manipulating demands and desires. They procured intellectual hirelings to prove their points and to sell their wares. This mania overtook Western Europe in no time ‘Unmerited encomia lavished upon these fragile blossoms.' ‘In 1634, the rage among the Dutch to possess them was so great that the ordinary industry of the country was neglected, and the population, even to its lowest dregs, embarked in the tulip trade.' Prices went up and down, and the speculative profits were reaped. The ‘tulipomania' got transmuted through some magic wand into ‘finmania' (financial mania)! Falsehood and propaganda grew in crescendo, and public vigilance faded out. ‘The tulip-jobbers speculated in the rise and fall of the tulip stocks, and made large profits by buying when prices fell, and selling out when they rose.' And all this led to:

“The prices of the necessaries of life rose again by degrees: houses and lands, horses and carriages, and luxuries of every sort, rose in value with them, and for some months Holland seemed the very antechamber of Plutus.”

All this not only swindled common people, it ruined even the crème de la crème who dug their

grave to sleep insouciance. Mackay describes their plight thus:

‘Substantial merchants were reduced almost to beggary, and many a representative of a noble line saw the fortunes of his house ruined beyond redemption.”

The story of greed ended as it always ends: in disaster. Even the government of the day found itself helpless.


Judicial Abhorrence to Fraud

The effect of fraud is expressed with a masterly stroke by Lord Denning LJ in Lazarus Estates Limited v. Beasley 1956] 1 Q.B. 702:


“No judgment of court, no order of a Minister, can be allowed to stand if it has been obtained by fraud. Fraud unravels everything.”

Fraud, collusion, deceit or concealment is the product of the touch of Comus. Michael Levi likens fraudster to Milton's sorcerer, Comus. This comparison is so graphic and so suggestive that the Supreme Court of India referred to it in Shrisht Dhawan v. M/s Shaw Brothers AIR 1992 SC 1555. The main title to this chapter has a reference to Keats' famous poem Lamia . Keats tells how Lycius was deceived by a snake-woman. He enjoyed love with her. Order to make a return to society he invited his friends to a wedding party. Apollonius turned up though uninvited. He was a philosopher. When he cast his gaze on Lamia, the snake-woman, could not stand the penetrating critical gaze; and her morbid reality became manifest. It is the duty of the government to keep the foreign entities operating in our country under critical gaze so that laws are not wrecked or bent through clandestine operations; so that public interest is not jeopardized. If government fails to do its duty, it becomes the duty of the judiciary to play its constitutional duty to ensure that public authorities discharge their public duty.

In Smith v. East Elloe Rural District Council [1956] AC 736 the House of Lords was examining the effect of fraud on a compulsory purchase order. The House worked on the assumption that the effect of fraud “would normally be to vitiate any act or order.” [Wade & Forsyth, Administrative Law, 7th ed. p. 442].

In Owens Bank Ltd. v. Bracco [1992] 2 All ER 193 HL the House was examining a conflict of laws situation whereunder the issue was whether the judgment debtor could show a prime facie a case of fraud. The House dismissed the Bank's appeal. The effect of fraud was held to deny finality to foreign judgments if it could be shown that they had been obtained by fraud. The House of Lords examined comprehensively the effect of fraud. In Abouloff v. Oppenheimer & Co (1982) 10 QBD 295, [1881-5] All ER Rep 307 Lord Coleridge CJ observed [1881-5] All ER Rep 307 at 309:

‘… it is enough for me to say that the English courts do enforce obligations created by judgments, but that it has always been held in the courts of this county to be an answer to an action upon a judgment, that that judgment has been obtained by the fraud of the party seeking to enforce it..”

Lord Coleridge CJ concludes his judgment by saying (10 QBD 295 at 303, [1881-5] All ER 307 at 310):


‘I think, therefore, on the broad ground that no man can take advantage of his own wrong, and that it is a principle of law that no action can be maintained on the judgment of a court either in this country or in any other, which has been obtained by the fraud of the person seeking to enforce it, that the defence is good…'

The Court of Appeals, (Criminal Division) in R. v. Mavji (1987) 2 All ER. 758 (CA). dealt with the effect of fraud committed against the Revenue. In the course of the examination of the fraudulent conduct, depriving the Revenue of public resources, the Court examined the ingredients of the offence of cheating the Public Revenue. The appellant was the director of a company trading in gold which failed to make value added tax returns and was charged to tax on sales, which it failed to account. He was convicted of cheating the Public Revenue; he was sentenced to six years' imprisonment and was made criminally bankrupt.

In taking the above view the Court considered the distinction between the common law offence of cheating and the statutory offence of fraudulent evasion. The Court observed (1987) 2 All ER 758, p 761:

“The most helpful case of those to which this court was referred is, in our view, R. v Hudson, [1956] 1 All ER 814, [1956] 2 QB 252, not only for what it decides but also for the review of the older authorities which is to be found in the judgment of Lord Goddard CJ. The head note is as follows (40 Cr. App R 55):

“The offence of making a false statement tending to prejudice the Queen and the Public Revenue with intent to defraud the Queen is, and always has been, a common law misdemeanour, and includes the offence of causing to be delivered to an inspector of taxes accounts relating to the profits of a business which falsely and fraudulently state the profits to be less than they actually were.'

It was argued in R. v. Hudson that the making of a false statement to the Revenue did not disclose an offence known to the law. Lord Goddard CJ cited a passage from Hawkins's Pleas of the Crown (1 Hawk PC 322):‘…. all frauds affecting the Crown and public at large are indictable as cheats at common law….' (See [1956] 1 All ER 814 at 815, [1956] 2 QB 252 at 259)”.

In Shrisht Dhawan v. M|s Shaw Brothers , AIR 1992 SC 1555 the Supreme Court not only examined the concept of fraud, it perceptively drew distinction between the operation of fraud in the fields of Private Law and Public Law. The Court observed. This is a remarkable judgment which portrayes judicial attitudes to the different species of fraud (1992) 1 SCC 534 at pp. 553-554.

The courts have unfalterably assumed that fraud in all its sinister manifestations must not be allowed to flourish under any system. The maturity of a jural system and the degrees of the success of fraudulent activity are inversely related. From the aforementioned discussion the following main propositions emerge:

(i) The courts have recognized that “fraud and collusion vitiate even the most solemn proceedings in any civilized system of jurisprudence”.

(ii) Judicial abhorrence to fraud is so deep that the courts recognize the taint of fraud as a special defence against a foreign judgment.

(iii) Fraud “is an extrinsic” collateral act.

(iv) Fraud vitiates not only the acts done in course of judicial proceedings but also the acts done through the administrative process.

(v) It is fair and just that no one should take advantage of one's wrong.

(vi) It has been held that “all frauds affecting the Crown and public at large are indictable as cheats at common law.

(vii) Frauds in public law and in private law differ in effect and operation without ceasing to be species of the same genus.

Fraud and collusion negate these postulates.

The decision of the Supreme Court of India in Shrisht Dhawan v. M/s Shaw Brothers 1992) 1 SCC 534 is important as it discusses the nature and effect of fraud in public law and shows how it differs from fraud in private law. The discussion is remarkable for its compressed reasoning, and also for an apt reference to the views of Lord Bridge in Khawaja v Secretary of State for Home Deptt (1983) 1 All ER 765, HL.

There is a lot of discussion in the different branches of law how much of fraud invalidates a transaction. It is not relevant to advert to this topic as in the field of public law even an iota of fraud, having the effect of causing wrongful gain to the fraudster and wrongful loss to the innocent victim, is bound to receive judicial displeasure. In International News Service v. Associated Press 248 U.S. 215, 247 (1918). Justice Holmes remarked:

“The falsehood is a little more subtle, the injury a little more indirect, than in ordinary cases of unfair trade, and I think that the principle that condemn the one condemns the others. It is a question of how strong an infusion of fraud is necessary to turn a flavor into a poison.”


Anatomy of Fraud

As the first leaf portrays the archetypal protocol of ‘fraud at work', and as the second leaf deals with the judicial response to fraud, and as the two subsequent triplets would say something about the corporate fraud, and the fraud astir at the stock-market, in this third leaf I attempt in outlines an anatomy of fraud so that the readers get conceptual clarity to appreciate the issues raised. Do not expect me to examine this tricky concept with that thoroughness with which Robert Burton wrote The Anatomy of Melancholy. In view of the constraints of the leaf, this discussion is just a quickie.

In generic sense ‘fraud' is a misrepresentation of fact for the purpose of depriving someone of a valuable possession, or deriving some unfair gains for self or someone whose interest he serves or promotes. One can visualize a whole set containing two smaller sets, which on certain points may intersect. The whole set comes within the province of ‘fraud at law' which breaks into the domains of the law of crimes and the law of torts. Beyond these two subsets we can visualize two zones, one is of ‘honest fraud' and the other in the gray area wherefrom ingress or egress into the ‘fraud at law' is always a matter of legal policy and the sense of right which people of a given society possesses at a particular point of time.

First, the concept of ‘honest fraud' (an apparent oxymoron). John Kenneth Galbraith explains this through an illustration in his “Free Market Fraud”

“Most economists commit what I, in a professionally cautious way, call innocent fraud. It is innocent because most that employ it are without conscious guilt. It is fraud because it is quietly in the service of special interest.”

The history of imperialism, political or commercial, is replete with the instances of that craft to which Gloucester refers so tellingly in Shakespeare's Richard III :

And thus I clothe my naked villainy
With odd old ends stol'n forth of holy writ,
And seem a saint, when most I play the devil.

As to the grey-area situations it is high time that certain grosser misdemeanours by the public power-wielders be treated as an actionable wrongs, or clear crimes. The traditional law of crimes and torts must respond creatively to our new needs of a democratic polity. In this context it is worth mentioning that in the European jurisprudence the law tends to recognize an arc of culpable wrong wider than that under the common law. It is made to include not only the intentional wrongs but even the situations which are simply misunderstandings arising out of normal business transactions. But the province of the cognizable fraud is always a matter of legislative and judicial policy.

In law. ‘fraud' is “the deliberate misrepresentation of fact for the purpose of depriving someone of a valuable possession.” ‘Deliberate deception' is the crook's strategy, the ‘mark' or ‘target' is he against whom the evil design is crafted and implemented, and the objective is to cause wrongful gains to the author of fraud, and wrongful loss to the victim of the craft. Its prime mover is GREED; its objective is to acquire wrongful gains, or/and to cause wrongful loss to others; its strategy is a stratagem characterized by deliberate deception; and its facilitating factor is collusion having an entente cordiale with fraud in its various subtle manifestations. and cavil. When ‘fraud' is not itself an independent crime, it is often an in-built ingredient in other crimes, especially when a culpable state of the doer's mind is contemplated as an ingredient. Under the neo-liberal paradigm we witness not infrequently the confidence game which involves a misrepresentation and breach of trust. In the instances of treaty-shopping through tax havens, one sees an entente cordiale of fraud and collusion between the masqueraders shopping ill-deserved treaty benefits, and the government of that tax haven which is a party in a bilateral tax treaty. Besides, that government also plays the game of confidence with its other treaty partner. The abuse of the Agreements for Double Taxation of Income, in effect, promotes Collusion and Fraud through their congeneric operation through an opaque system led the depredation on our country's economic resources, and as a matter of natural consequence contributed to moral degradation and national insecurity. The plea was that, on analysis, a Treaty Shopping is a conjoint product of Collusion and Fraud inter se the vested interests in Mauritius and the residents of the third States. The strategy was crafted through a network of collusion. As Comus was an offspring of Bacchus and Circe, a Treaty Shopping is fathered by Collusion and Fraud in Darkness to help those who want to launder money generated by the most unscrupulous methods, through bribery, receipt of kick-backs, drug-trafficking, insider trading, embezzlement, computer fraud, under invoicing-over invoicing, and other tainted activities spawning numerous scams having deep lethal consequences. - Links on Shivakantjha - Links on Shivakantjha

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