Understanding the Risks of Financial Fraud

Peter McGahan

Monday 1st July, 2024.

FRAUD is a tale as old as time, but its guises evolve with the ages. Let's have a look into some of the most notable frauds and understand the psychological underpinnings that make them so effective.

The Nigerian Prince Story was pretty obvious right?

"Send me your bank details so I can send you money," said the elusive Nigerian prince. It sounds absurd, yet this scam has defrauded victims of a staggering $4.5 billion.

Bernie Madoff or ‘made off’ was another.

Promising high, consistent returns, Bernie Madoff's Ponzi scheme was a house of cards built on deceit. Instead of legitimate investments, Madoff used new investors' funds to pay returns to earlier ones. The cost? A devastating $65billion.

‘Pump and Dump Schemes’ manipulate the press and forums to inflate stock or crypto prices artificially. Once the stock price peaks, fraudsters sell off their shares, leaving duped investors with worthless stocks.

OneCoin was marketed as a revolutionary cryptocurrency, OneCoin leveraged multi-level marketing to attract investors, promising high returns. The result? A $4billion scam, leaving investors worldwide in financial ruin.

Initial Coin Offerings (ICOs) in the cryptocurrency frenzy gave rise to fraudulent ICOs, where projects promised massive returns but often failed due to lack of viability. Billions were lost as investors, driven by hype, overlooked the inherent risks.

Tulipmania is history's lesson on irrational exuberance. At its peak, a single tulip bulb sold for 10,000 guilders, the equivalent of a mansion on Amsterdam's Grand Canal. Eventually, the bubble burst, leaving a trail of financial devastation.

What happens in the mind to get caught by fraudsters?

It's like déjà vu all over again. Investors lose track of rational expectations, driven by psychological biases. A positive-feedback loop inflates asset prices until the inevitable collapse, bankrupting the majority.

Highly irrational and emotional decision-making lies at the heart of these frauds. Speaking with psychologists, it's clear that fulfilling our psychological needs healthily is crucial. If unmet, we turn to unhealthy substitutes like drugs, alcohol, gambling, or high-risk investments for a dopamine rush.

Dopamine, a neurotransmitter, plays a key role in pleasure, motivation, memory, and attention. It's heavily involved in addiction and risky behaviours, making the anticipation of rewards in gambling or crypto investments particularly alluring.

We must meet our psychological needs healthily, or risk seeking unhealthy alternatives. Just one unmet need can lead to paralysis, foggy heads, or staring blankly at screens.

Those needs are:

Security: A safe environment for full development.

Attention: Giving and receiving attention, a form of nutrition.

Autonomy and Control: Making responsible choices.

Emotional Connection: Friendships, intimate relationships, and acceptance.

Community: Feeling part of a wider community.

Privacy: Time and space to reflect and process experiences.

Status: Feeling valued within social groupings.

Competence and Achievement: Achieving goals.

Meaning and Purpose: Finding meaning and being stretched in what we do.

When stressed or ‘out of whack’, we're vulnerable. An Amygdala Hijack occurs when the brain's emotional centre responds to stress or intense emotions, bypassing rational thought. The result? Impaired thinking, heightened emotions, and susceptibility to fraud.

So how do I avoid the Amygdala Hijack?

The Bank of Ireland UK’s "STOP, THINK, CHECK" strategy aligns with the following steps to avoid falling victim to fraud:

Recognise signs of an Amygdala Hijack. Pause and acknowledge your emotional state. Practice deep breathing to activate the calming parasympathetic nervous system. Engage in mindfulness to stay present and reduce emotional intensity. Ask logical questions to engage your rational brain. If overwhelmed, delay important decisions and consult trusted individuals. Learn about common fraud tactics and warning signs. Build a support system and consult with a trusted network when faced with suspicious situations. Incorporate relaxation techniques and critical thinking into your daily routine and get your human givens into line.

Fraudsters exploit our psychological vulnerabilities, operating without empathy or care.

Remember, your bank or financial adviser might not give you a dopamine rush, but they care deeply about your financial well-being.

So, take a moment to STOP, THINK, and CHECK. And if you seek a thrill, perhaps try bingo instead.

Run anything by me or your bank, accountant, or solicitor. Together, we can outsmart the fraudsters and safeguard our financial future.

If you have a financial query, please call Peter on 01872 222422..

Peter McGahan is the Chief Executive Officer of Independent Financial Adviser Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.

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