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When Fraud Bites Business: Lost Fortunes, Reputations and Lives

Credit card breaches, swindlers and even baby formula form a web of fraud that spans the globe

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In the late 1800s, swindlers like Reed C. Waddell and Charles and Fred Gondorf sold the Brooklyn Bridge — over and over again — to newly arrived immigrants for anywhere from $200 to $1,000. That’s as much as $28,000 in today’s money. So convincing was the con that police would have to eject the new “owners” for trying to erect toll barriers.

Cheated business fraud corporate fraudFraud has always been with us. It wouldn’t be surprising if archeologists one day discovered a scam to sell the pyramids.

But the scope of fraud is much larger today and the sums involved are certainly greater than 28 grand.

Fraud’s Financial Costs Pile Up in a Hurry

Counterfeit goods, which can range from jewelry to workout videos to guitars, account for 10% of global trade worth $500 billion a year, according to the World Customs Organization. The Department of Homeland Security alone seized products infringing on patents, trademarks and copyrights last year worth more than $1.7 billion at the manufacturer’s suggest retail price.

And the pain of fraud to the little guy can be intolerable. One accounting study puts the median loss from fraud at $105,000 for U.S. organizations. True, that won’t bankrupt Walmart (WMT) or Apple (AAPL), but it could easily sink a small-business owner.

For the most part, investors in listed securities don’t have to worry about fraud. There’s no need to discount the price-to-earnings ratio of a stock to account for the possibility that it’s all smoke and mirrors. The Securities Exchange Act of 1934 made it much harder for con artists to swindle investors — at least those investors who aren’t playing around with penny stocks.

True, the recent data breach at Target (TGT) cost the retailer tens of millions of dollars and hurt its share price, but investors didn’t lose everything. The same goes for Citigroup (C), which had to slash its outlook after discovering $400 million in fraudulent loans made by its Mexico subsidiary.

But fraud does extract a huge toll on industries and private citizens.

Take the insurance industry, for example. Excluding health insurance, the FBI estimated back in 2010 that insurance fraud comes to more than $40 billion a year.

Naturally, insurers pass the costs of fraud onto their policyholders — and the hit to their bank accounts is substantial. The FBI also said insurance fraud raises the premium payments for the average U.S. family from $400 to $700 a year.

White-collar fraud and corporate fraud probably get the most attention, if only because they often turn out to be massive scams involving well-known companies. Enron had a market cap in excess of $60 billion at one point. WorldCom’s market value peaked at three times that amount.

More recently, Bernie Madoff won the dubious award for perpetuating the greatest financial fraud in U.S. history, swindling his marks out of $17 billion.

When Losses to Fraud Go Beyond Dollars

However, the damage from an Enron imploding or a Ponzi scheme like Madoff’s tends to be limited to bondholders, shareholders, employees or investors. Moreover, it’s mostly monetary damage, much less physical.

That’s not the case with counterfeit goods, which can spread disease and even cause death.

The majority of counterfeit goods come out of China, but the Chinese often pay the steepest price. For instance, a decade ago, dozens of babies died as a direct result of fake baby formula sold in eastern China.

Counterfeit condoms are likewise a dangerous problem. In May 2013, authorities in China uncovered one of the largest counterfeit condom operations ever seen. Police seized more than 4.5 million condoms, branded with major names such as Durex, Contex and Jissbon. They confiscated another 1,100 pounds of unpackaged condoms, shutting down a scam that could fabricate 20,000 fake prophylactics a day.

Even more troubling is the global trade in counterfeit pharmaceuticals.

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Article printed from InvestorPlace Media,

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