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The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

Creativity is central to the human condition and gives rise to innovation and entrepreneurship in a range of domains and activities. Human beings are also deeply territorial – constantly creating and deconstructing homelands in a Phoenix-like dance through time. In Anthony Powell’s masterly opus on what it is to be English, A Dance to the Music of Time, the participants tread and re-tread over the same spaces as they attempt to make sense of their existence. In the Star Trek world of ‘boldly going’ it was claimed that space was the final frontier, but in its geographical and temporal senses, space is the first frontier we attempt to account for and create around, however unwittingly. In our dance to the current mood music, creative accounting and how we manage, operate and occupy our work spaces are pertinent. The frontiers of what is efficacious in the two areas appear to be cyclical and not particularly structural. Enron became synonymous with everything that is destructive about accounting, and the de-humanising environment of call centres with the zeitgeist of work organisation.

The Enron sign.
Picture © STANANDLOU, used under Creative Commons licence.

Accounting is a framework for evaluating resource allocation and management in organisations. It is not objective reality, whose methodologies and methods lead to optimal and efficient outcomes. This would only be the case if we lived in a world of efficient markets in which all prices equated to values. This world would correspond to the Arrow-Debreu Theorem, named after the two Nobel prize-winning economists, in which all market exchanges are matched by underlying contingent commodities within a general equilibrium framework. Differences in time and place, and thus transaction costs, are not a consideration within this framework, so the accounting profession is stuck between the Charybdis of efficiently measuring values of organisational assets and the Scylla of differences in the time and place in the transactions of these values through market exchange.

Some siren voices may claim that the profession deserves everything it gets given scandals like Enron and the recent financial crisis, as well as the tax avoidance schemes which reached their zenith in the UK in the 1970s. However, accounting isn’t the agency of these outcomes, it’s the result of unintended consequences and perverse outcomes of the structure of regulation and regulatory changes. The ingenuity of ways in which regulations can be bypassed and turned into market opportunities is manifold and legion, but you cannot regulate away creativity and innovation, unless one starts to distinguish between good and bad parts of this human condition. So, what is the distinction between good and bad creative accounting? The length of a piece of string or when the ‘perps’ get caught? As for tax avoidance schemes, well we could ‘eat the rich’, and then send the accountants and other ‘creatives’ like management consultants and advertising agencies to another galaxy on the pretext of the earth exploding, but then financial products would be created on the transactions in human flesh and ‘marked to market’ at, say, Smithfield, the meat market in London. Getting rid of one form of accounting and its creative variants would then just generate others. The creative frontiers for accounting are set by the statute and international standards. These frontiers are really thresholds, the negotiation of which can lead to deviant behaviour – which is perhaps also one of the properties of the human condition.

The question of organisational deviancy is one that arises from why firms appear to spend so much time, energy and resources in managing property. The fundamental reason is that land is both a fixed and variable form of capital and gives rise to a set of uses and values, and most of our net worth is tied to property. At the philosophical level, John Locke developed the genesis of the idea of property rights as the foundation of the modern liberty. In the hands of the Peruvian economist Hernando de Soto, these rights are the basis of sustainable economic development. So property matters.

There is also the issue of power and prestige concerning property. The management of a mutual society may look down in pride on their provincial locale as they survey it from the heights of their new building. No self-respecting bank in 1980s London was complete without occupying a building with an atrium and an internal galleria. The question of architecture has external and internal dimensions. Externally, the need for signature architecture with a Gehry, Foster or Pei designed building seems central to corporate image. Internally the complex socio-psychological relationships of workers to their spaces cuts across the human resource management, finance and estate management functions. For the latter, maximising personnel in minimum space is rational, but the ebb and flow of movement and work patterns means that open plan or Dilbert-like booths are not optimal solutions. The way in which workers seek to humanise their work spaces suggest that the deep territoriality in all of us isn’t restricted to the home, but the challenge is to manage the challenge that status being often linked to a spatial hierarchy. Many firms claim that employees are their most valuable asset, but if they don’t creatively account for and put their spatial resources where their mouth is, this claim will not stand scrutiny. If you want to stifle workers’ creativity and innovation in solving business problems, then housing them as automatons in a single open space will suffice and no amount of virtual working will change this. There are creative solutions, but these are not cheap as the frontiers between private and public spaces in the workplace are constantly crossed and re-crossed.

At the banal level, accounting for the creative frontiers of managing financial and work space resources is a question of races and riders. The bottom or winning line, however, will only reached when it is recognised that these organisational imperatives are part of complex systems in which creative spaces develop and thrive.

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About the author

Leslie Budd is Reader in social enterprise at The Open University Business School. He is an economist and has written extensively on the relationship between regional and urban economics, and international financial markets.

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Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

Recent years have seen the emergence of a new term in the dictionary of financial markets jargon - ‘boiler rooms’.

The term relates to the aggressive selling of worthless investments to private investors by unauthorised overseas firms – mainly based in Spain, the United States or Switzerland.

Although the exact nature of the investments being sold varies from scheme to scheme it usually involves illiquid and valueless shares in obscure overseas companies. Aggressive selling encourages the targeted investors to buy these shares on promises that their price will rise sharply. Some schemes have also involved false share deals to make the investments appear valuable. Once the boiler room has secured money from investors it may disappear and then later reappear under a different name. As for the shares they’ve sold - their price then plummets and the hapless investors can only watch helplessly as the losses mount. In fact with no ready market for the shares, they’re left holding their investments that may become completely worthless.

"hapless investors can only watch as losses mount"

A recent tactic used by boiler rooms has involved conning both investors and small businesses out of their money. A typical scheme involves a boiler room approaching a company and offering to raise capital by selling the company’s shares to investors. These shares are then sold to private investors at anything up to 100% above the price agreed with the company. Once the shares are sold the boiler room takes a fee from the company for organising the share sale – sometimes as much as 90% of the money raised - and then disappears. The company is then left with the prospect that the investors will then demand from it a refund through the repurchase of the shares issued - even though the company only received a percentage of the funds actually raised.

The typical investors targeted by boiler room selling are middle-aged professional men, many with considerable investment experience – a profile deemed to maximize the chances of extracting money via investment scams. A recent Financial Services Authority (FSA) survey found that 81% of boiler room victims were men and 64% of victims were aged over 50. Members of this socio-economic group are more likely than others to have funds available for investment and, perhaps, a belief in their investment prowess and an appetite for the riskier shares that apparently offer the prospect of high returns. Victims of the scams lose on average £20,000 - although losses of over £100,000 have been reported.

The FSA - which regulates the selling of investments within the UK - has detected well over 100 unauthorised investment firms selling into this country. The problem for the FSA is that the companies involved in these boiler room sales are based overseas and are therefore outside the FSA’s jurisdiction. However the FSA has had some success in tackling some UK companies that have been involved in supporting boiler rooms by, for example, approving the promotion of their schemes.

Guidance has been provided by the FSA on the survey above, and certainly if you’re a potential investor you should check to confirm that the companies you are dealing with are authorised by the FSA.

But the key point to note is that if you’re phoned ‘out of the blue’ from overseas by a boiler room, do not to be drawn into any transaction.

If you’re contacted about an investment opportunity, consider the following:

• Is the company authorised by the FSA?
• Is the company calling from the UK?
• Have you solicited the enquiry?

If the answer to these questions is ‘no’ then you may well be dealing with a boiler room.

Remember if an investment sounds like it is too good to be true, it probably is too unsafe to be purchased!

Weblinks

• Your and your money - don't let your money be the boss of you, get help from our interactive
• The psychology of deception - how can rational people fall for scams?
• Join the discussion - should victims of boiler room scams know better?
• Moneymadeclear  - guides and advice from the Financial Services Authority

Course

• You and your money: personal finance in context

About the author

Martin Upton is lecturer in finance at the OU Business School. Previously he spent 20 years in treasury management, including 12 years as Treasurer of Nationwide Building Society. Martin's particular interests are financial services, the housing market, financial markets and risk management.

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Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

The Great Phone Call Con looks at the problems of phone-line fraud and unsolicited telephone marketing. This made me wonder, why has there been an explosion of this sort of fraud, and why do they seem to find it so easy to fool us? The answers to both questions may lie in the nature of human psychology.

Why the massive surge in telephone fraud?

Fraud requires a supply of victims, weak safeguards and motivated crooks. Changes in technology have increased access to potential victims. It’s relatively cheap and easy to set up machines to communicate with people. It’s also possible to obscure the trail back to the fraudster. The widespread use of electronic money exchange (online banking, credit card use, etc) also makes it easier – by making it easy for us to part with our cash. Safeguards are poor; law enforcement has struggled to keep up with these new forms of fraud.

However, I don’t think the availability of new means of fraud, alone, is sufficient to explain why there is so much fraud going on. An important aspect of the recent surge in telephone and internet crime seems to be the seemingly endless supply of fraudsters.

Successful fraud requires both a set of skills and a willingness to deliberately target and deceive others. The most successful fraudsters have a capacity to look us in the eye, to engage our trust and then betray it without a qualm. This capacity is actually quite rare and often associated with personality disorder (or perhaps politicians?!).

Typically, those committing fraud use psychological strategies to distance themselves from any sense of guilt. Criminologists refer to this as ‘neutralisation’. A common form of neutralisation is to view the victim as in some way to blame – “He had it coming; I couldn’t have taken him in if he wasn’t so greedy”. Another is to depersonalise or belittle the victim – for example the recently prosecuted perpetrators of a series of frauds on Ebay, referred to their 3,000 victims as ‘the idiots’. However, for most people, such attitudes are difficult to maintain in the face of personal contact with an intended victim.

By contrast, telephone or internet fraud guarantees a psychological distance between fraudster and victim. The technology already provides a significant amount of depersonalisation: a ready-made neutralisation strategy. Thus, people who would find the emotional costs of face-to-face fraud too high are much more able and willing to engage in remote fraud.

Why are we so easy to fool?

When we fall victim to fraud, or the more legal but related forms of advertising and marketing manipulation, we often assist in our own deception. Effective fraudsters don’t try to fill out all the gaps in a story. Like professional magicians, they know that manipulating us to reach a conclusion for ourselves is more powerful than making a direct statement. We’ll fill in the gaps in story for ourselves given the right motivation; and they know that greed and fear are both powerful motivators that they can easily manipulate.

If we believe someone can enrich us, or we think they can prevent something we dread, we want to believe them and will often explain away any holes in their story for ourselves.

Once we have become victims of deception, another factor comes into play. Fraud is often under-reported. For most of us, self-esteem is important; and we, often quite unconsciously, look for ways to protect it. For this reason, we tend to pay more attention to information that builds our own self-esteem than information that threatens it. So, many of us are quite reluctant to accept that we are victims and are even more reluctant to tell others.

Intelligence and education are not a protection here. Indeed, there is some evidence that highly educated people are easier to fool, because they don’t expect to be fooled.

There are important parallels between the traits that make many of us easily deceived by fraud and those that make traders in financial markets easily deceived by market movements. In my own research on the behaviour of traders in investment banks, I found these well educated, intelligent and highly trained professionals to be often prone to illusions about the extent to which they were in control and able to make unbiased financial judgements.

Fear, greed and the need to maintain self-esteem may make many of us more easily trapped by a telephone scam, but they also account for some major mishaps in financial markets.

Protecting yourself from fraud

So if the world is full of fraud and human psychology disposes us to be dupes, how can we protect ourselves? There is no foolproof solution, but some simple rules may help: 

• If it seems too good to be true, it probably is.
• If a person, or organisation, starts to play on your fears it may be that person or organisation that you should fear.
• If you are fooled, it does not mean you are an idiot. You are in good company. Do take the time to report the scam.

Further reading

• The psychology of decision making – the same thinking processes that help you cope with everyday life prejudice your judgements in other areas
• The Psychology of Fraud by Grace Duffield and Peter Grabosky, pubilshed by the Australian Institute of Criminology
• Introduction: Traders, markets and social science by M P Fenton-O'Creevy, N Nicholson, E Soane and P William, published by Oxford University Press
• Trio jailed for £300,000 fraud on eBay 'idiots' by Audrey Gillan and Bobbie Johnson in The Guardian (29 October 05)
• 'The Psychology of Deception' by R Hyman in Annual Review of Psychology
• The American Confidence Man by R Hyman and Charles C Thomas

About the author

Mark Fenton-O'Creevy is Professor of Organisational Behaviour at the OU Business School. His research includes investigations into the performance of traders in financial markets, and the problems that occur when management practices are transferred from one country to another.

He is also a National Teaching Fellow, and Principal of the Centre for Practice-Based Professional Learning.

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