Webs

Con Men and Fraudsters Set Them Up

President Ronald Reagan offered up wisdom on spiderwebs. He once compared government programs to intricate webs that eventually swallowed up the spider that spun them.

I don’t think he is incorrect.

President Reagan used the ''escape the spider's web of dependency'' when referring to government programs consistently and related it back to how they actually destroy families.

“We must revise or replace programs enacted in the name of compassion that degrade the moral worth of work, encourage family breakups and drive entire communities into a bleak and heartless dependency,''

''In the welfare culture the breakdown of the family, the most basic support system, has reached crisis proportions - in female and child poverty, child abandonment, horrible crimes and deteriorating schools.''

President Roosevelt, who initiated many toxic government welfare programs, said in his own State of the Union on Jan. 4, 1935, that welfare was ''a narcotic, a subtle destroyer of the human spirit.''

They weren’t wrong.

Fraudsters are the same. There is some pattern matching that can go on. When you look at large-scale fraud, like Enron, MF Global, FTX, Theranos, WeWork, and like Bernie Madoff, they each weaved huge intricate webs and then one cataclysmic event caused the entire thing to fall down upon itself.

What drives each of them?

Access to cheap easy money for one. The government just prints more of it and auctions off the debt. The government debt is a pledge against the future tax receipts of American citizens. Set up a new program like the $35 insulin cap that totally ignores economic principles and issue some debt to cover it. As existing government programs get bigger, yet do nothing to help the people they were designed to help, issue more debt to keep them going because eventually, they will work. Proponents rationalize them using all kinds of code words. They also use guilt and fear as motivators to keep the programs around.

A government program will work someday and Charlie Brown will kick the football too.

Fraudsters are similar.

They need access to cheap money. They can create that stream themselves or, they can be deceitful and get investors to back them.

Their promises are just realistic enough that everyone wants them to be true. Just like a government program.

• Wouldn’t it be great if one drop of blood could give vision to a whole host of medical problems?

• Wouldn’t it be great if I could get outsize market returns consistently?

• This new technology will change the world, and you will earn fantastic returns if you invest.

As an investor, if you are too cynical you will never take a risk or enough risk to really earn a return. You might as well invest in US Government bonds until the debt gets too large it collapses.

Hence, good investors will be amenable to a sales pitch from a fraudster. If you invest enough, you will have earned some outsize returns that allow you to see the possibilities of what the fraudster is selling.

They might even have credibility. They went to the right schools. They come from the right family. They joined the right country club. They wear the right clothes and drive the right car. When you go into their office, they have pictures of themselves with the right people.

The trick then is the diligence the investor engages in prior to making the investment. The Angel Capital Association has done numerous studies and it has been proven that doing due diligence in a thorough and timely manner creates a more fertile ground to make good investments. You cannot outsource diligence.

In the past few years, entrepreneurs were given term sheets with little or no diligence. I blogged in the past that this would wind up going badly for VCs and hurt returns. Investors in their fervor not to miss an opportunity, and to not bruise their reputation threw money quickly into deals.

I read with incredulity that Tiger Global pays Bain $100,000,000 per year to do due diligence for them! Wouldn’t it have been cheaper to hire a few newly minted MBA’s and a couple of CPA’s to do it? Bet the diligence would have been better. If I were an investor in Tiger, I’d get a new management team or pull my money out immediately.

Ray Charles could have seen FTX was set up incorrectly from the get-go.

Anyone with a modicum of knowledge about how exchanges were structured would have passed on FTX. Anyone that engaged in a modicum of due diligence with Theranos would have passed. Anyone that really looked at the numbers of WeWork would have passed after the initial valuations. Anyone that had any sense of financial markets knowing that you can’t always have winners would have passed on Madoff.

The shocking thing about frauds like MF Global was you didn’t see them coming. It took a person that was so unscrupulous and so devious that fraud was committed. Even to this day, people that commit fraud like Jon Corzine did blame someone else or are so self-unaware they don’t think they did anything wrong.

The ones that didn’t go to jail point to a highly politicized process that kept them out.

In Corzine’s case, the Department of Justice's head Eric Holder kept him out since he was one of them, and also one of the largest bundlers to the Obama campaign. Sam Bankman-Fried attempted to construct a protection web of his own by donating millions of dollars to politicians.

Will they help him now?

I hope they don’t but I am cynical enough to realize that Merrick Garland will spend his time looking for abortion clinic protestors at their homes instead of prosecuting a fraud where billions were stolen.

The other thing advocates of big government or fraudsters engage in is a big but seemingly certified deception. They run studies with the smartest people who have all the burnished credentials they need to head an important committee.

They then use phrases like

• “the planet will destruct if we don’t”

• “crime will increase if we don’t”

• “we must block out all racism in our time”

• “this is a plot by our enemies to undermine us”

Or any other amazing phrase that most people would nod their head at. Until they see the details about how this person plans to go about their business. They rely on you to either be not curious enough to investigate or to be compliant.

If you really delve into the math that they present you will find it doesn’t add up. Usually, when you want to delve into the math, they won’t show it to you. That’s a sign.

When discovered, there is the roar of the tidal wave that cascades over you to try and drown you. It’s really hard to stand up to. They will besmirch your reputation. They will cut you out of opportunities and they will socially isolate you. But if you stand up to it and stay strong, when the tide goes out you will see who is naked.

There is going to be a lot of ugly nakedness in the next two years in both government and in finance.