Control Fraud

James Galbraith mentions in a comment the very useful concept of “control fraud” introduced by William K. Black, see e.g. When Fragile becomes Friable: Endemic Control Fraud as a Cause of Economic Stagnation and Collapse (pdf),

Individual “control frauds” cause greater losses than all other forms of property crime combined. They are financial super-predators. Control frauds are crimes led by the head of state or CEO that use the nation or company as a fraud vehicle. Waves of “control fraud” can cause economic collapses, damage and discredit key institutions vital to good political governance, and erode trust…

Economic theory about fraud is underdeveloped, core neo-classical theories imply that major frauds are trivial, economists are not taught about fraud and fraud mechanisms, and neo-classical economists minimize the incidence and importance of fraud for reasons of self-interest, class and ideology.

Neo-classical economics’ understanding of fraud is so weak that its policy prescriptions, if adopted wholly, produce strongly criminogenic environments that cause waves of control fraud. Neo-classical policies simultaneously make control fraud easier and more lucrative, dramatically reduce the risk of detection and prosecution by maximizing “systems capacity” problems, and encourage crime by making it easier for fraudsters to “neutralize” the social and psychological constraints against deceit and fraud. Thus the paradox: neo-classical economic triumphs produce tragedy…

William K. Black is also the author of the book The Best Way to Rob a Bank Is to Own One.

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7 thoughts on “Control Fraud

  1. Environmental “Control Frauds”

    “Control fraud” has specific implications useful to the study of conservation finance. Both public control frauds (“kleptocracies”) and some private control frauds pose special dangers to the environment. Kleptocrats loot “their” nation. The direct effects of kleptocracy on the environment are severe. The head of state (and often his cronies) will approve developments that enrich him regardless of the harm to the environment. The government he controls will help the cronies evade any domestic or international laws designed to protect the environment, e.g., by issuing false certificates of the origin/nature of products. Kleptocrats are also autocrats, so the leader will use the state to suppress environmental protests.

    The indirect effects of kleptocracy also harm the environment. Kleptocrats’ policies lead to widespread poverty, endemic corruption among lower-level government officials and reduced social trust and cohesion. Indeed, kleptocrats often follow the old colonial practice of “divide and conquer” — favoring one ethnicity or region over others. This can produce chronic armed conflicts that harm the environment. Even if there is no armed conflict the indirect effects mean that there is no effective environmental protection and increased pressure by poor citizens to exploit resources even when doing so overwhelms resources that could have been renewable.

    Private control frauds often target the environment. Whenever a company can gain a competitive advantage by acting in an unlawful manner, e.g., by disposing of toxic wastes in a river instead of in the appropriate (but far more expensive) toxic waste disposal center a “Gresham’s law” style dynamic arises. (Gresham’s law: “bad money drives good money out of circulation” during hyperinflation. Note: George Akerlof used this metaphor appropriately in his seminal explanation of “lemon’s markets.” Note that examples he gives in that article are all variants of another type of control fraud — those that target the consumer.) Thus, environmental control frauds have two victims — the public and honest competitors. Unless the government effectively detects and punishes environmental control frauds the dynamic can ultimately lead to environmental control fraud becoming endemic. In the case of international disposal of toxic wastes, companies search for nations with weak regulation (or kleptocrats). National and international regulatory/enforcement efforts are essential to reduce this perverse economic incentive to engage in environmental control fraud.

    William K. Black
    Executive Director, Institute for Fraud Prevention
    Associate Professor of Economics and Law, UMKC

    • How is it that when corporations – legal persons, by law – cannot be stopped from committing these crimes by merely applying the same law as applies to all other forms of ‘persons’ ? By this, of course, I mean to have them declared by competent experts as “criminally insane”, “sociopathic”, etc. in a court of law. A corporation so labelled would, I imagine, be curtailed from its activities until (if and when) it acts according to what the same legal experts deem appropriate and within the norms and expectations of social and legal framework(s). Is it asking too much that the law applies equally to all legal ‘persons’ ?

  2. The next big control fraud exposure is actuarial fraud within the insurance industry – an industry that works closely with state bankers and capital markets to influence share prices and loot pension funds.

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