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Sat, Mar. 25th, 2017, 02:02 pm
Nonfiction: Fraud

Edward Balleisen, Fraud: Despite the title, really a history of antifraud regulation in America. The book focuses on fraud by businesses against consumers, where businesses find themselves with conflicts—wanting government regulation or other help against deceptive competitors, but resistant to too much regulation of their own operations. It identifies key types of frauds—social mimicry (where signals of quality are faked, including by counterfeiting), personalization amid bureaucratization (the special attention paid by the salesperson), and deflection (explanations for losses that absolve the fraudster). As he points out, many of these techniques can be difficult or impossible to distinguish from techniques used by legitimate businesses, especially in areas with a lot of innovation. In terms of “affinity fraud”—where fraudsters exploit ethnic/social ties to leverage trust—he suggests that its incidence and scope increased starting in the 1980s, in part in response to the “growing fragmentation of American society and the related sharpening of social identities.” But there’s still a history, including “Sarah Howe’s Ladies Deposit Savings Bank,” a Ponzi scheme that swindled many women out of their savings.

Quality regulation has a long history in the US, especially for export goods that depended on a good reputation with foreign buyers. States regularly required that sellers use standard dimensions and required that goods bear a mark from an official inspector. These systems didn’t depend on individual victims’ complaints, which was good because of the significant barriers in time and law, as well as injured self-image, to such complaints. The formal requirements of law made proving fraud all but impossible, including strict requirements of materiality, actual reliance, and the buyer’s own inability to check the truth of the claims/reasonable steps to verify the claims, consistent with the classic American individualist “shame on you” perspective towards fraud victims/respect for the moxie of the swindler. Only groups perceived as impaired or otherwise limited, such as widows and African-Americans, could sometimes get more favorable treatment. So too when victims were deceived by apparent experts or third-party assurances.

Most fraud victims, yesterday as well as today, didn’t take any action—the costs of suit were large and the chance of recovery small, even if one survived the rigorous legal standards applied, since it was easy for fraudsters to decamp for greener pastures where they were unknown; also, being duped was shameful (as it remains for many of us) and victims were loath to admit it in public. Fewer than 1% of arrests in Baltimore in the late 1860s involved fraud, and many of those were retailers against customers or insurance companies against policyholders. And all crimes were hard to prove—even African-Americans were found guilty only 2/3 of the time in South Carolina from 1819-1860, which is low given the barriers they faced, including inability to testify on their own behalf. For white defendants, the conviction rate for fraud-related offenses could go as low as 20%.

The main force constraining sellers, in this telling, was administrative regulation—specifically inspection regimes in states that had them. However, Jacksonians (and some non-Jacksonians) objected to inspections from the 1840s on, considering it costly and crony-filled. Instead of protecting the public, inspections gave a false sense of security, according to these critics. And inspectors were not only bribeable, they could change definitions to suit the circumstances: “In 1847, for instance, the combination of a poor catch and intense pressure from local fishermen led Massachusetts fish inspectors to expand their definition of No.1 pickled mackerel, much to the consternation of Philadelphia fish dealers.” And sellers could use passing state inspections as a defense against subsequent fraud suits. New York even banned the creation of public offices for inspecting articles of trade in 1846, allowing sellers to bypass inspections altogether.

The far-flung nature of American life, however, led to pressures to deal with fraud risks, for example by the invention of credit reporting and credit insurance, along with the development of recognizable brands (and trademark infringement lawsuits) and money-back guarantees. Some journalists and businesses appointed themselves guardians of the public interest and tried to warn the public about frauds. Journalistic outlets competed with each other for sensational accounts and for status as trustworthy. Established businesses also tried to combat frauds that siphoned off business.

The Civil War brought new anti-fraud measures, led by concern over fraud in military procurement. Illinois introduced compulsory grain inspection, taking over from private graders that enabled evasion and anticompetitive behavior by warehouses. The result, Balleisen suggests, was the restoration of Chicago’s reputation as a grain hub; Illinois standards were adopted by traders throughout the North Atlantic region. Still, there was persistent dissatisfaction with variability in the rankings (and in the inspectors), as well as worry about corruption.

The Post Office then took the lead in combating fraud in the new economy, in part because fraudsters would blame the Post Office for losing merchandise that in fact had never been sent. First by broadly interpreting its own powers, and later with more explicit support from Congress, the Postal Service interrupted schemes it deemed fraudulent—including, at an early point, the operations of the Sears Catalog. Madame C.J. Walker, among others, also encountered early problems with the Postal Service in the course of developing new business models; it wasn’t always clear where the line was drawn between puffing and fraud where there were real goods and services behind the promises. Sears had trouble because it offered prizes, such as prizes to the first group of customers who ordered merchandise from a particular state. Regulators thought these were little more than lotteries. Sears also used “Barnum-like come ons, such as an 1889 newspaper advertisement that offered, for a limited time, a sofa and pair of chairs for only ninety-five cents. Although the ad included the word ‘miniature’ in tiny print, there was no explanation that Sears meant only doll furniture.” Its ads also stated prices for items as if they were final, rather than down payments, or the pictured good would not be delivered and another, lower-quality version of the same product would be. These would today be considered very clearly deceptive. One version of the Sears story involves Sears toning down its claims as it moved from trying to expand to trying to retain customers, and the mail fraud case against it was a nudge in that direction.

But Balleisen argues that there were other factors at work, in a climate where nationalizing businesses and expanding technological innovation made many opportunities seem plausible, such as a fraudulent scheme to sell superior refrigerators, which played on the “gap between popular enthusiasm and technical comprehension.” Likewise, the competitive economic environment encouraged exaggerated claims to attract investors with many different options. This created a market for lemons problem in some fields, such as clothing retailing—it was difficult to avoid false advertising when everyone else was doing it. And in such a churning environment, it could be really difficult for anyone to tell the difference between optimism and fraud; the Chicago Tribune even warned people about Montgomery, Ward and how it must be a “swindling firm,” because no company could sell such a broad range of products at such low prices.

Balleisen then tracks the early twentieth century rise of the Better Business Bureau as an anti-fraud, anti-regulation, pro-established business group, with all the advantages and disadvantages of a private regime designed to prevent government from becoming more heavy-handed. The twentieth century saw ever more elaborate schemes to defraud people, sometimes in response to the rise of new measures like credit reporting. People created fake oil rigs and even a fake car factory complete with a few cars. Established businesses worried about consumer skepticism rising generally in response, and also worried that investment schemes would depress willingness to invest overall or even spur Bolshevism. In response, the business establishment touted public education, limited legal reforms, and nonprofit oversight of business activities. Businesses wanted targeted legal changes that would enable them to go after lying competitors and would allow criminal prosecution of the worst offenders, but not an active administrative agency. On the nonprofit side, these organizations developed administrative procedures that didn’t look very different from due process; at the same time, they were likely to target businesses run by immigrants and speak disparagingly of lower-class consumers.

New regulatory responses, however, triggered predictable backlash—both the government and the BBB were criticized for being heavy-handed and inconsistent, and for denying advertisers sufficient chances to establish their innocence. (One critic called the BBB the ‘Clue Cliques Clan.’) Anthony Comstock, for all that we remember him as a sex- and birth control-suppression fanatic, was part of a broader anti-fraud/consumer protection mission in the Post Office. To Balleisen, the resulting struggles over procedural protections foretold later more general reform in administrative law (the APA). But procedural protections inevitably made it harder to act fast against fraudsters—the classic dilemma. And the cycle continued with a wave of pro-consumer reforms in the 1960s and 1970s, moving towards caveat venditor (and then back towards caveat emptor thereafter). The 1962 amendments to the Food & Drug Act finally made premarket proof of efficacy a requirement for drugs; many states passed modern consumer protection laws; new federal laws, including the Truth in Lending Act, came into being. But the often sparsely funded new consumer protection agencies, as well as the old ones, couldn’t keep up with the flood of complaints. Employees often responded by focusing on cases that could be resolved quickly, usually with some form of refund. While this helped satisfy victims, it left fraudsters relatively free to strike again.

Then came the era of conservative assault on the FTC, decrying it as both an inefficient drag on competition and toothless in actually protecting consumers; so too with the SEC for investors. Disclosure, often the regulator’s preferred way of dealing with potentially deceptive claims, turned out not to work well. Meanwhile, the BBB was increasing its procedural protections; “rights consciousness was not only the province of civil rights acitivsts, women’s rights advocates, or postwar consumers.” And the BBB failed to forge deep links with the consumers’ rights movement; it was ultimately beholden to established businesses.

By the 1980s, the worst frauds no longer came from small players on the margins, but rather from the largest financial institutions. Balleisen suggests that the deregulatory agenda played a large role in this development. In a time when the party in power is trying to destroy the federal government, one has to wonder where the cycle is taking us next—faith in the market is the official word, but hatred for government seems more important. Balleisen chillingly points to the divergence between public and private rhetoric in Alan Greenspan’s statements—publicly, he said that the government’s only real role was to police against fraud; privately, he didn’t think it was the government’s responsibility. Caveat emptor with a bite.

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