Insights into Character Risk Assessment Written by Ian James
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Character Risk Assessment


Modern businesses are increasingly exposed to the risk of fraud. We all are!

Before the advent of the Internet, anyone wanting to finance a car had to take the car to the financier for a physical inspection. As communications became electronic, and as finance companies became depersonalised, risk assessment processes followed suit, leading to an environment in which it has become relatively easy to commit certain types of fraud.

Many readers will recall the King Brothers’ bus debacle. In October 2005 Peter and Anthony King were committed for trial on fraud charges. They both subsequently pleaded guilty and were sentenced to imprisonment. At the centre of the charges were 144 ‘phantom’ second-hand buses (which later became 300 buses), financed by the National Australia Bank. These buses simply did not exist -- the King Brothers had invented the vehicle identifier numbers supplied to the NAB. The loan to purchase the non-existent Mercedes Benz buses was approved in December 2000, and the bank had begun investigating the loan in April 2003, when problems surfaced regarding $132 million in leasing and loans to the brothers’ bus company and its related entities.

With all its skills, know-how, human intelligence, fraud protection and risk assessment techniques, how could fraud on this scale ensnare a successful financier like the National Australia Bank? Unfortunately, the fraud was surprisingly easily to perpetrate, because the NAB’s procedures were designed to look at perceived business risks - whether the company was financially viable and how good its operations looked on paper.

The greatest risk you will ever face in investing, and the one you are most likely to completely overlook, is the character of the people you are asking to look after your money.

Suppose that you identify key areas needed to ensure business or project success, such as commercial feasibility, market research, operational capability, and so forth. You then form an opinion based on your enquiries and, as all seems in order, you make an investment. However, the one major risk you haven’t assessed is simply this: were the promoters telling the truth; are they successful operators or are they liars? Uncorroborated claims are valueless.

None of the King Brothers’ ‘phantom’ buses ever existed, and had the NAB conducted better risk assessment they would have discovered that the vehicles had never been registered, and that records held by the Australian distributor of Mercedes Benz buses showed that none of the vehicle identifiers provided by the brothers matched any of the buses it had imported.

While a large bank can bury this sort of loss, how many individual investors could recover from a catastrophe of this magnitude?

Risk is unavoidable, and can be managed or ignored. No matter which approach you take, risk is constant. The most common method of carrying risk is to keep your fingers crossed and hope to be lucky. Another is to almost opt out and put your funds with a major bank, thereby forgoing the higher returns available on the open market. However, the best way to manage risk is to make a small investment in sound risk assessment at the beginning of the investment process, to help mitigate the possibility that mismanagement or fraud might put a much larger investment in danger in the future.

The investors in Westpoint Corporation, and the myriad of similar but unpublicised corporate failures, would never have taken such leave of their senses in other areas of their lives - they wouldn’t have booked and paid cash for a $50,000 round-the-world trip with a company they had never heard of, which had never run a tour before, which was not licensed, and that didn't have a physical operating office.

The same principle holds true when investigating individuals. For example, when examining a 30-year old promoter, you would expect that person to have a reasonably long credit history. If a search revealed no credit history, you could be pretty sure that the promoter is using a false name. The fact that there was no credit history in effect means that the person had not had a landline telephone, rented a property, applied for gas or electricity, obtained a car loan, or even requested a credit card in their purported name. In the real world most Australians have a credit history of some kind, so if it is missing then alarm bells should sound.

A strange psychological phenomenon occurs with investing - attractive returns promised by polished promoters create hot states and excitement; reason abandons people who would otherwise never take such risks with their money. Part of the mystique of investing involves investors feeling they are getting a 'special' deal which is not generally available to others. The psychopathology of many fraudsters enables them to appear charming while lying, and concerned and stable while sucking every last dollar out of their victims.

Risk management is the systematic process of identifying, analysing, evaluating, treating, monitoring and responding to project risk. It is the process of taking deliberate action to shift the odds in your favour, increasing the odds of good outcomes and reducing the odds of bad outcomes.  It includes maximising the probability and consequences of positive events and minimising the consequences of adverse events, to project objectives.

Crooked promoters have a head start on their prey - they have developed and executed their plan well before approaching you. A good operator is encouraged by healthy risk assessment - with nothing to hide, the more assessment the better, as their project will be shown to be sound.

So never fear that if you ask too many probing questions or demand too much evidence to back up a promoter’s claims, that a good opportunity will be lost - it won’t be. Good opportunities always stand the challenge of testing. A professional fraudster will become very edgy when you take control of the situation, and this can often be your greatest weapon in discovering their true colours.

Be sure to obtain independent valuations, by valuers chosen by you, not the promoter, independent legal advice from a lawyer chosen by you, in writing, and a report from a competent investigator to establish evidence and antecedents of the character of the promoters and operators.

The key element in identifying fraud is the use of logic and reason. Another important counterfoil to potential fraud is to avoid hot-state decisions. Whenever someone tells you ‘last chance, offer closing today’, walk away.

The major characteristics of fraud are:

  • Inconsistencies in documents and statements;
  • Exceptional quality in presentation;
  • Refusal by the promoters to properly answer questions;
  • Shifting ground by the promoters;
  • Lack of substantive credentials;
  • Implausible claims;
  • Woolly talk by the promoters about how good they are; and
  • Lack of verifiable hard evidence.

If you discover any one of the above characteristics, abandon the investment. Listen to your intuition; if you feel uncomfortable, even though you can’t put your finger on why, you should abandon the investment.

The number one risk will always be the integrity and character of the custodian of your money. Ignore that at your peril!

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