Affinity fraud and trust within financial markets
| Pages | 186-202 |
| DOI | https://doi.org/10.1108/13590791311322364 |
| Date | 03 May 2013 |
| Published date | 03 May 2013 |
| Author | Keith Blois,Annmarie Ryan |
| Subject Matter | Accounting & finance |
Affinity fraud and trust within
financial markets
Keith Blois
Green Templeton College, University of Oxford, Oxford, UK, and
Annmarie Ryan
Kemmy Business School, University of Limerick, Limerick, Ireland
Abstract
Purpose – The purpose of this paper is to illustrate how a financial fraud which originates as an
affinity fraud can utilise the interpersonal trust, which is a central feature of an affinity fraud, to move the
fraud into situations such as organizational markets, where personal relationships are much less dominant.
Design/methodology/approach – Sources of information consisted of scholarly articles and
articles retrieved from the web.
Findings – The trust which develops naturally between members of a community with common
interests can be exploited by a fraudster who is, or purportsto be, a member of that community. This
trust can thenbe used as the basis of creating trust within other types of relationships – especiallywhere
some people are active in more than one relationship – where personal relationships play a minor role.
Practical implications – Both individuals and organizations when making investments should
regularly formally evaluate their relationship with the organization in whom they are investing;
constantly evaluate alternative relationship opportunities; and, calculate how divergent the partner’s
behaviour can be from the expected before dissolving the relationship.
Originality/value – This paper, by utilizing Fiske’s Relational Models Theory, argues that trust that
has been developed in a communal situation can be used to build up a momentum of trust. This enables
the perpetrator of a fraud to extend the fraud into situations where different types (and possibly
impersonal) relationships operate.
Keywords Trust, Finance,Relationships, Fraud, Affinity groups
Paper type Research paper
Introduction
The efficient operation of all types of markets but especially modern financial markets
is dependent on trust because markets are extremely complex and their products include
significant tacit and credence elements (Darby and Karni, 1973; Morrison and Wilhelm,
2010). These factors, which are those that cannot, when starting a relationship, during it
or after it, be specified in terms which are subject to objective evaluation, mean that
much has to be taken “on trust” (Blois, 1999). For example, setting the share price for an
Initial Public Offering (“more an art than a science” (The Economist, 2011b, p. 70)) is
particularly difficult if, assessing the company’s service quality is problematical or
forecasting market conditions is recognized as being exceptionally challenging, so
“parties that require this type of information therefore rely upon trusted intermediaries
to provide it” (Morrison and Wilhelm, 2010, p. 3). Indeed a complete lack of trust would
prevent a party from entering into any financial exchange because, without it, endless
safeguards would have to be sought.
The nature of financial markets renders these non-verifiable elements important.
Specifically,the multiplicity of financial instruments creates difficulties in understanding
The current issue and full text archive of this journal is available at
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Journal of Financial Crime
Vol. 20 No. 2, 2013
pp. 186-202
qEmerald Group Publishing Limited
1359-0790
DOI 10.1108/13590791311322364
JFC
20,2
186
how financial markets work[1]. Furthermore, tracing who owes what to whom is an
exercise often fraught with uncertainty. So even sophisticated professional investors
often haveto make assumptions about the security of investments theyare making and to
rely on the assessments and advice of others whose opinions they trust (Engel and
McCoy, 2011, pp. 59-61).
Within financial markets there are individuals whose reputations are so great that
they are recognized to be “stars”. The these “stars” reputations for making above
average returns on investments acts as a magnet to investors who demonstrate great
trust in them by either investing their money in the “stars” funds. Once an individual
establishes a reputation as a “star” then they can rapidly extend the range of their
activities for, “if a person has a good reputation, one will quickly develop trusting beliefs
about that individual, even without first-handknowledge” (McKnight et al., 2006, p. 123).
Indeed, even if a “star” has become less successful their reputation often remains
undamaged, because:
When many people perceive that an individual has a good reputation, it is harder for a
negative event to significantly reduce a high level of trusting beliefs in that individual
(McKnight et al., 2006, p. 131).
Both Horlick, who lost £21 million of her clients’ funds by investing them in a fund run
by Madoff (Sherwell and Armitstead, 2008) and Guy Hands who lost £1.75 billion on a
single investment (The Economist, 2011a) illustrate this as both of them still attract
clients (Spanner, 2012, p. 52).
Financial fraud, and affinity fraud schemesin particular, exploit these characteristics
of financial markets. Affinity frauds are “investment scams that prey upon members of
identifiable groups, such as racial, religious and ethnic communities, the elderly,
professional groups, or othertypes of identifiable groups” (Perri and Brody, 2012, p. 305).
The essence of such frauds is that “the perpetrators take advantage of the well-known
characteristicthat it is human nature for people to tend to trust someone who is a member
of their own group” (Lewis, 2012, p. 8).More often than not the fraudster is a member, or
pretends to be, a member of the group they exploit. Most frequentlyan affinity fraud is
based on what is known as a “Ponzi scheme”which is where returns are paid to investors
from the moneys paid in by later investors rather than from genuine profits. Ponzi
schemes “usually offer higher returns than any legitimate business activity could
plausibly sustain” (Carvajal et al., 2009, p. 4).
Affinity frauds are more common[2] than is often recognized for two reasons. First,
many such frauds, such as the $33 million fraud that a member of the Amish community
committed against his co-religionists (Adams, 2011), receive little media attention
because, although the losses for the individuals involved are often significant, in total
they involve relatively small amounts. The second reason is that ma ny of the victims do
not pursue or make their involvement public. Their reluctance to do so arising from:
a refusal to accept that they had been “conned”; embarrassment at their foolishness in
being “taken in” by the perpetrator; and/or a desire to defend the reputation of the
affinity group of which they are member (Titus et al., 1995; Trahan et al., 2005).
The exploitation of community based trust is central to the operation of affinity
fraud. However, this is an inadequate explanation of how these scams grow beyond the
community and Fiske’s (1992) categorization of relationships is used to explore the role
of trust between those operating within financial markets, especially between the
Affinity fraud
and trust
187
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