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Corporate Frauds as Criminal Business Models: An Exploratory Study

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Corporate Frauds as Criminal Business Models: An Exploratory Study
C A S E S T UDY
51
Corporate Frauds as
Criminal Business
Models: An Exploratory
Study
By
Thomaz Wood Jr.
Ana Paula Paulino da Costa
In this article, we report on the findings of an exploratory, interpretive study of a notorious corporate
fraud that occurred in Brazil from 1989 to 2005. We examine the process by which this scheme was
created as well as how it was maintained for all those years. Our analysis covers both the substantive aspects (the actions fraud agents effectively perform) and the symbolic aspects (the resources
of impression management that they use). We suggest that under certain circumstances, corporate
frauds may be understood as the result of implementation of a criminal business model that focuses
on a niche market of risk takers or greed investors, uses aggressive commercial practices and offers
exclusivity, promotes the organization’s image and personality cult of the entrepreneur, operates a
management model that combines centralized control with fragmented systems, and uses complex
fraudulent practices. This perspective allows us to understand the phenomenon of corporate fraud
from a systemic point of view. We also suggest directions for future research and theory development
on corporate frauds. © 2014 Wiley Periodicals, Inc.
Introduction
C
orporate frauds are traumatic events that affect
investors, customers, and other stakeholders.
Over the past two decades, scandals involving
corporate frauds have become a prominent subject in
the media. The biggest and most widely discussed cases
have occurred in North American companies like Enron,
Global Crossing, WorldCom, and Bernard L. Madoff
Investment Securities. However, major corporate frauds
have also occurred in other countries, for example, the
Anglo Irish Bank in the Republic of Ireland, Nortel
in Canada, and Parmalat in Italy. Brazil, an emerging
country in which we carried out our research, has also
Correspondence to: Ana Paula Paulino da Costa, Economic Research Institute Foundation (FIPE), São Paulo, Brazil, [email protected]
Published online in Wiley Online Library (wileyonlinelibrary.com)
© 2014 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21676
52 CASE STUDY
recorded a significant number of corporate frauds,
prominent among which are the cases of the agribusiness
company Boi Gordo, the luxury-goods retailer Daslu, the
construction company Encol, and the banks Econômico
and PanAmericano.
The persistence and impact of corporate fraud, specifically, and corruption, in general, have led to an increase
in interest in the phenomenon among researchers (see
Ashforth, Gioia, Robinson, & Treviño, 2008; Brown &
Cloque, 2011). In the field of organization studies, fraud
research has focused on the question of why fraud occurs
(e.g., Hill, Kelley, Agle, Hitt, & Hoskisson, 1992; Schnatterly, 2003). However, there are still few studies that deal
with the question of how fraud occurs (Ashforth et al.,
2008). To address this latter question, it is necessary to
analyze corporate fraud from a systemic perspective, viewing it as the result of coordinated actions.
The purpose of this study is to contribute to the
understanding of the phenomenon of corporate fraud.
We seek to understand how fraud is committed within
an inherently (and intentionally) criminal enterprise.
In doing so, we intentionally give emphasis to internal
issues, albeit recognizing that external variables, such
as lack of effective control by government agencies, also
allow fraud agents to implement and maintain their
scams. We argue that corporate frauds may be, under
certain circumstances, understood as the result of implementation of a criminal business model.
We intentionally give
emphasis to internal issues,
albeit recognizing that
external variables, such as
lack of effective control by
government agencies, also
allow fraud agents to implement and maintain their
scams.
We carried out an exploratory, interpretive study of
a corporate fraud case that occurred in Brazil between
1989 and 2005: the Banco Santos case. This case was
chosen because of its notoriety, its duration, its impact on
customers, and its widely available legal and journalistic
documentation.
The rest of the article is organized in the following
way: First, we present the theoretical fundamentals of our
study. Second, we describe our methods of information
collection and analysis. Third, we present the case and
comment on it. Fourth, we explain the criminal business
model and illustrate it with the Banco Santos case, as well
as two other notorious cases: Madoff and Enron. Finally,
we offer suggestions for future research.
Theory
Definition of Corporate Fraud
Fraud, generally speaking, is any cunning act in bad faith,
with the intention of deceiving another. Jamal, Johnson,
and Berryman (1995) observed that corporate fraud
occurs when the fraud agents identify an opportunity,
make successive decisions with the aim of obtaining illicit
advantages, and manage the mise-en-scène (the symbolic
actions carried out to make fraud feasible) to conceal
such decisions and their effects.
We find some common characteristics in the literature on fraud that help define the phenomenon: (1) the
motivation of the fraudsters, which may be associated
with a predisposition (see, e.g., Baucus, 1994); (2) the
presence of available targets (see, e.g., Moura, 2007); (3)
the nonexistence or insufficiency of internal or external
controls (see, e.g., Cohen & Felson, 1979); and (4) social
disorganization or the loss of social and moral values (see,
e.g., Belkaoui & Picur, 2000; Schnatterly, 2003). It is worth
noticing that some definitions of corporate fraud include
those against the company, committed by employees.
However, this kind of fraud is not the focus of our study.
Based on these definitions and common characteristics found in the literature, we define corporate fraud as:
A series of illicit acts carried out in a conscious way by
members of the top management of an organization,
who use the processes and systems of the organization
and of management in a deceptive way with the aim
of serving their own interests and prejudicing third
parties.
The Evolution of Literature on Corporate Fraud
An important milestone in the development of literature
on corporate fraud was the work of Baucus (1994), who
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
DOI: 10.1002/tie
Corporate Frauds as Criminal Business Models: An Exploratory Study
53
identified three groups of situational factors that precede
fraud: pressure, opportunity, and predisposition to fraud.
Pressure is the result of the industry, the legal and regulatory environment, and the organizational characteristics.
Opportunity comes from the competitive environment,
the legal and regulatory environment, and the organizational characteristics. Predisposition is the result of the
characteristics of the environment and, once again, of
the organization. Despite its usefulness in systematizing
the factors that lead to fraud, this theoretical formulation
appears to us to be insufficient for helping address the
process by which fraud occurs. In fact, the Baucus model
deals only with the antecedents of fraud, making it suitable for use only in determining why fraud occurs.
The work of MacLean (2008), based on a fraud
investigation into the sales of a life insurance company,
further developed the model of Baucus (1994). MacLean
observed that the premise of the “model of corporate
illegality” is that individuals, when faced with the variables of pressure, opportunity, and a predisposition to
fraud, make a decision to commit or not to commit fraud.
But, MacLean pointed out, the influence of individuals’ cognitive interpretive frames was missing from the
Baucus model. MacLean therefore introduced a moderating variable that is related to the culture of the organization. In doing so, he endowed his model with the logic
of symbolic interactionism, in which deviating behavior
is socially constructed and rooted deep in the organizational culture, or more precisely, in the frames shared
by the professionals within a particular organizational
environment. Although this refinement did advance our
understanding of the phenomenon of fraud, it still leaves
the scientific formulation insufficient to explain how
fraud occurs.
We then looked to the work of Misangyi, Weaver, and
Elms (2008), which sought to explain the systemic corruption logic that occurred in Bosnia-Herzegovina. This
objective demanded an understanding of the substantive
and symbolic resources used in both the virtuous and the
vicious logic. The study concluded that such resources were
similar. What differentiated one logic from another was
the way in which meanings were attributed to substantive
resources. By detailing the question of cognitive processes
and shared schemas, Misangyi et al. (2008) went further
along the investigational trail that had been initially laid by
MacLean (2008). Their focus was still the same as that of
previous authors: to explain why fraud occurs. However, in
exploring the symbolic dimension, they carved a promising trail for explaining how fraud occurs.
We can view the work of Baucus (1994), MacLean
(2008), and of Misangyi et al. (2008) as contributions
to the same evolutive line. The first model provides
an understanding of the origins of fraud by emphasizing the factors that precede it. The two later models
help with an understanding of how meanings (symbolic resources) for fraudulent practices (substantive
resources) are created.
Starting from a procedural point of view, we propose
that corporate fraud occurs because of certain preceding
conditions (which have already been explored in literature) coupled with the actions of fraud agents, which follow three stages. The first stage is the conception of the
fraud, which comprises identifying an opportunity for
illicit gain and identifying the substantive and symbolic
resources needed for carrying out the intended fraud.
The second stage is the introduction of the fraudulent
scheme, which consists of mobilizing substantive and
symbolic resources and neutralizing control systems.
The third stage is the maintenance of the fraudulent
scheme, which involves administering it and managing
both impression and image, the latter a process directed
at both internal and external publics (see Alvesson, 1990;
Boorstin, 1962; Giacalone & Rosenfeld, 1991).
In corporate frauds, the managers who constitute
the fraud agents have more information about their
companies and their business practices than do the victims of the illicit processes; they are therefore able to
DOI: 10.1002/tie
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
In corporate frauds, the
managers who constitute
the fraud agents have more
information about their
companies and their business
practices than do the victims of the illicit processes;
they are therefore able to
take advantage of these
circumstances.
54 CASE STUDY
take advantage of these circumstances (Hsien & Tsai,
2005). In order for the scheme to function, the victims,
specifically, and interest groups (e.g., the media, control
bodies, suppliers), generally, have to be unaware of the
asymmetry of information that exists between the parties.
The victims need to believe they have all the information
necessary for a correct assessment of the business, so
the asymmetry must be camouflaged by the image projected by the company through impression management
(Westphal & Graebner, 2010).
Methods
In the previous section, we presented a definition of
corporate fraud and briefly reported the evolution of the
literature dealing with the theme. In this section we present our investigation approach, the criteria adopted for
choosing the case, and the methods used for collecting
and analyzing the information.
Investigational Approach and Choice of Case
This work is an exploratory, interpretive case study based
on an extensive analysis of documents. More specifically, we may classify this as an “instrumental case study”
(Stake, 1994, p. 237), since, through the case, we hope to
provide insight into the issue of corporate fraud. According to Glaser and Strauss (1979), a case study can generate general conceptual categories or properties. George
and Bennett (2005) name “configurative idiographic
cases” those that may be used in subsequent studies for
theory development, even if, by themselves, they do not
contribute directly to theory. In sum, in this article we
do not aim to develop a theory of corporate fraud, since
we cannot generalize after a single case, but we intend to
present ideas to be tested more systematically in future
studies.
In research based on case studies, the choice of case
is a fundamental issue. In this work, we adopt the criteria suggested by Eisenhardt (1989) and Phillips and Di
Domenico (2009). We chose the Banco Santos case for
the following reasons: (1) because of its notoriety, size,
and impact; (2) to meet the requirements of our theoretical definition of fraud; (3) to involve the use of substantive and symbolic actions, which constituted part of the
focus of our investigation; and (4) because a vast amount
of information and a large number of documents relating
to the case are available for analysis.
Furthermore, the company was commented upon in
the media both before the fraud was discovered (when
it was presented as a success story) and after (when it
was presented as a corporate scandal). As a result, our
investigation had access to a comprehensive list of documents. The document base we analyzed comprised 24
documents from the judicial branch; 1 document from
the Securities and Exchange Commission; 4 pieces of
legislation; 222 articles from newspapers, magazines, and
electronic media; 1 dissertation; and 9 publicity videos.
The data collection process was based on a constant
comparison procedure wherein the next group of data
and sources were determined by the analysis of the last
group. Important documents accessed by key terms
emerged from this process. At first, the key terms “Banco
Santos” and “Edemar Cid Ferreira” gave access to relevant
legal documents, some less important pieces of legislation, and many media materials, including institutional
videos. Then the use of the term “Alsace Lorraine,”—a
company in the Banco Santos group found in media
material—gave access to the bankruptcy sentence and the
prosecution document, which was fundamental to understanding the case and chronologically organizing all the
material. The main events and actions were organized in
order to display the sequence of facts and the substantive
symbolic resources used by fraudsters.
We also followed the principles of “theoretical saturation” (Glaser & Strauss, 1979). The data collection
stopped when there was enough consistent material to
ensure the trustworthiness of data, and new data did not
provide any substantial different knowledge and just confirmed the previous analysis. The constant comparison
of data from different sources allowed structuring a story
more consistently. As this story was taking form, it was
possible to separate substantive resources and symbolic
ones. Some of them were present during the entire process, while some were modified along the way.
From this analysis, the process of fraud emerged with
its phases and components, and then symbolic issues
were organized to explain how each identified symbolic
resource was used, for what purpose, and what each was
hiding. The emerged fraud process revealed how context
was prepared for fraud, internally and externally. Some
information was not considered if it did not add comprehension to the process or if there was not strong evidence
of its existence from other materials or sources.
Information Collection
Information Interpretation
The case chosen was widely investigated by the relevant
supervisory bodies and was the target of many lawsuits.
Analysis procedures and data treatment were adapted
from Strauss and Corbin (2008). Interpretation was
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
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Corporate Frauds as Criminal Business Models: An Exploratory Study
We described how internal
and external context were
prepared for fraud and
identified elements used in
impression management.
based on two methods: document analysis (Bardin, 1977)
and discourse analysis (Phillips & Di Domenico, 2009).
Document analyses were conducted to reorganize information in order to describe facts and resources used in
the fraud. We identified symbolic resources (e.g., rationalization and socialization processes) and substantive
ones (e.g., product and incentive systems). Discourse
analysis identified how meanings were modified through
theses resources. We described how internal and external
context were prepared for fraud and identified elements
used in impression management. Substantive actions
were identified mainly from legal documents. Symbolic
actions were identified mainly from the texts produced
by media.
55
founder of Banco Santos himself and by his secretary,
family members, friends, and other illegal “straw persons,” used only as a front.
In 1998, Banco Santos also started operating investment funds. By 2004 it had 82 such funds (Comissão de
Valores Mobiliários, 2008). It also became an important
intermediary for funds coming from the Brazilian Development Bank (BNDES), the state economic and social
development bank.
Banco Santos gave loans at lower cost than did its
competitors, and it offered special financing conditions to companies that were experiencing financial
difficulties. It also promised its clients a return that was
above the usual levels in the market (Consultor Jurídico,
2005). As a result the bank attracted investors with
greater risk propensity.
Commercial Strategy and Impression Management
Banco Santos was founded in 1989. Formally, the company was part of the financial arm of organizations
belonging to entrepreneur Edemar Cid Ferreira. The 19
companies in this business group were placed in two controlling holding companies, one of which was a financial
holding company (Procid Participações) and the other
a nonfinancial holding company (Procid Investimentos)
(Comissão de Valores Mobiliários, 2008).
From 1998 onward, other companies were created
that were directly or indirectly related to Banco Santos,
resulting in a system that, according to federal police
investigations, comprised 225 companies (Prestes, 2009).
This system was created and maintained to facilitate the
deflection of funds and was formally headed up by the
To enter and grow in a competitive market, Banco Santos
adopted a niche strategy, seeking to serve companies and
private individuals with high purchasing power. To do
so it developed personalized and sophisticated services
in addition to the extraordinary business conditions it
offered for investments and loans. It also sought to create
and consolidate an image of competence and seriousness. Within this niche, Banco Santos started attracting
particularly those companies that were in financial difficulty and that would find it hard to raise funds in other
banks.
Central to this effort was the figure of Edemar Cid
Ferreira himself, who used public relations to systematically promote his image as a sophisticated businessman
and patron of the arts. Banco Santos was a great patron
of the arts, and Cid Ferreira presided over the São Paulo
Art Biennial, the most important art exhibition in Brazil,
from 1992 to 1997 (Cypriano, 2004). When Banco Santos
was operating, the entrepreneur acquired a notable personal collection of paintings and sculptures.
One of Cid Ferreira’s companies, BrasilConnects,
which was created to organize cultural events, had a
collection of 12,000 works of art and a team of specialists for each type of work (Carvalho, 2004a). Over the
four-year period it was operational, the company held 49
exhibitions in 12 countries, with the support of 80 Brazilian and international sponsors. Such initiatives reached
an audience of 80 million people in Brazil and abroad
and provided impressive spontaneous media coverage
(Ferreira, 2004). BrasilConnects also produced extraordinary events, such as exhibitions in the Forbidden City
in China and in the Vatican (Carvalho, 2004c; Trevisan,
2004).
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Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
Case Study
In this section, we present and comment on the corporate fraud that occurred at Banco Santos. We describe the
company, its history, and the fraudulent scheme.
The Company and Its Strategy
56 CASE STUDY
Such initiatives helped establish an image of sophistication, refinement, and boldness for the entrepreneur
and the company. At the same time as the international
exhibitions, Cid Ferreira opened an office in China and
made approaches to India and Russia as he sought to
develop business in all BRIC group countries—Brazil,
Russia, India, and China (Barros, 2004a, 2004b, 2004c).
It is relevant to note that before founding Banco
Santos, Edemar Cid Ferreira was involved in cases relating
to the bankruptcy of companies and deflection of public
moneys, and he was denounced by the press for his relations with corrupt politicians in the federal government
(see Carvalho, 2004b). However, he was never punished
and, as a well-known Brazilian journalist declared, “after
he became a patron of the arts, sommelier, a celebrity in
the social columns, everything was swept under the carpet” (Nassif, 2004, p. B3).
Organizational Model and Impression Management
Internally, Edemar Cid Ferreira introduced a management system that supported his criminal business model
while at the same time creating the illusion, for most of
his employees, of a legitimate, competent, and innovative
organization. The management system was both centralized and fragmented. Only a small group of executives
had a complete view of the operations. Managers had
no autonomy to make decisions or change procedures.
Banco Santos had a code of ethics and a compliance
department, but its operations and internal controls were
segmented (Comissão de Valores Mobiliários, 2008),
which prevented employees from perceiving the frauds.
The fraudulent scheme used the usual processes and
systems of a financial institution, perverted in such a way
as to allow the frauds and to conceal them. One of the
“creative” resources used by the organization was to buy
securities based on the risk classification supplied by rating agencies, which evaluated a portfolio as a whole and
not its securities individually. Thus, its fund company
used to buy securities of Banco Santos based on bank’s
portfolio evaluation. As a result, Banco Santos obtained
the legitimization it desired, thus concealing the real
condition of its portfolio.
To attract highly qualified staff, Banco Santos had an
aggressive remuneration policy, which paid salaries and
gave prizes that were higher than those of the market. As
a result, it attracted talent and strengthened its image as
a strong and aggressive institution (Banco Santos, 2008;
Comissão de Valores Mobiliários, 2008). Exceptional
prizes, including luxury cars, were given to employees
who closed reciprocity deals when relending BNDES
funds (Carvalho, 2005). These deals involved inducing
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
One of the “creative”
resources used by the organization was to buy securities
based on the risk classification supplied by rating
agencies, which evaluated a
portfolio as a whole and not
its securities individually.
customers to borrow a greater amount than they needed
from the state development bank and to invest the difference in Banco Santos (or related companies) securities.
In fact, the remuneration system encouraged not only
these deals, which were used to back the bank’s yield, but
also those that allowed the frauds to occur, thus promoting a socialization process by co-optation (Ashforth &
Anand, 2003). Internally, all operations were considered
legitimate, the reciprocity operation being viewed as a
tacit agreement between the client and the bank.
The Frauds in Banco Santos
The main fraud committed by Banco Santos consisted
of deflecting investor funds to companies controlled
by the institution itself, with some of those companies
being merely a front, known as paper companies. Such
deflections led to a lack of cover in the bank, and this
was concealed through illicit accounting procedures
that simulated the existence of the necessary guarantee (Comissão de Valores Mobiliários, 2008; Consultor
Jurídico, 2005).
The scheme functioned like a pyramid or Ponzi
scheme, with withdrawals being covered by funds from new
fundraising sources. At the same time, the bank’s offshore
companies were laundering money by facilitating the illegal transfer of funds abroad. These companies, located in
tax havens, were not obliged to reveal information about
their shareholders, their partnerships, or their finances
(De Sanctis, 2009). The operation of the fraudulent system
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Corporate Frauds as Criminal Business Models: An Exploratory Study
included two groups of companies: one group deflected
money and transferred currency abroad illegally, and the
other repatriated and laundered the money.
Moreover, when granting loans, the bank demanded
“reciprocity”: part of the money received by the client had
to be invested in the bonds of group companies (most
of them just paper companies) and in investment funds
managed by the group’s stockbroker. This condition was
normally accepted by the client companies, especially
those that were unable to obtain loans from other banks
because of their weak financial situation. Moreover, this
procedure was presented and accepted as part of doing
business with Banco Santos.
Bankruptcy
In December 2003, after analyzing Banco Santos’s portfolio and evaluating its risk profile, Fitch Ratings lowered
the bank’s rating (Comissão de Valores Mobiliários,
2008). In 2004, the Brazilian Central Bank and Trevisan,
an audit company, indicated problems with the credit risk
rating, and in the same year the BNDES reduced its loans
for relending.
In parallel, the Sao Paulo Civil Police found information incriminating Banco Santos for laundering and
evading money. This information was forwarded to the
Brazilian Federal Police. When the Brazilian Federal Police
started investigating the Banco Santos group, the Brazilian Central Bank, which had accepted unusual operations
without questions until that moment, started to ask Banco
Santos for some changes in operation and command.
In response to this situation, which made it difficult to raise new capital and threatened the fraudulent scheme, the bank intensified its illegal operations,
attempting to generate cash where it was needed to cover
the gaps created by the deflection of funds. The objective was to avoid an asset deterioration that would justify
intervention. During that same period, which preceded
the bankruptcy, Edemar Cid Ferreira also stepped up his
art buying and built a huge mansion in an upscale neighborhood of the city of São Paulo.
In the second half of 2004, the local press treated
the problems being faced by the bank in a discreet way,
always emphasizing the bank’s positive image (e.g.,
Beraba, 2004; Gradilone, 2004). At the end of 2004, the
bank announced drastic changes in its business strategy,
indicating that it was opening a retail bank and creating
another investment fund. Both initiatives were aimed at
customers with incomes considerably lower than those of
the bank’s traditional customer base. In fact, the objective
was to keep the fraudulent system operating by feeding it
with new funds.
DOI: 10.1002/tie
57
The bankruptcy of Banco Santos in September 2005
generated a loss of R$3.4 billion (approximately US$2.4
billion in 2013 values) for some 2,000 direct creditors,
including 54 pension funds, 15 foreign banks, 97 city
administrations, and the BNDES (Comissão de Valores
Mobiliários, 2008; Consultor Jurídico, 2005). The case
was investigated by the Central Bank, the Securities and
Exchange Commission (Comissão de Valores Mobiliários, 2008), the Federal Revenue Service, the Ministry
of Finance, the São Paulo Civil Police, the Federal Police
(Tavares, 2010), and the Courts (Banco Santos, 2005a,
2005b, 2008; Consultor Jurídico, 2005; JusBrasil, 2009)
in various lawsuits. Edemar Cid Ferreira was found guilty
of crimes against the financial system, money laundering, organized crime, fraudulent management, and conspiracy (“Ex-banqueiro,” 2006; “STF Concede Habeas
Corpus,” 2006).
Criminal Business Model
In the previous section, we presented the case of
corporate fraud at Banco Santos. In this section, we
propose an analytical model to better understand it.
Complementarily, we discuss the licit and illicit cycles
of activities carried out at Banco Santos, and show how
symbolic actions were put into practice to hide fraudulent practices.
The image of Cid Ferreira
as a sophisticated person
and benefactor of the arts
helped attract wealthy clients for Banco Santos. By
the same token, the management model adopted at
Banco Santos hid its fraudulent practices.
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
58 CASE STUDY
Understanding the Fraud as a Criminal Business
Model
Figure 1 is a diagram of the criminal business model of
Banco Santos. The five central components—focus on
market niche, image of organization and entrepreneur,
management model, fraudulent practices, and aggressive
commercial practices—reinforce each other, forming a
coherent and cohesive whole that was capable of maintaining the fraudulent scheme for a long period of time.
For instance, the image of Cid Ferreira as a sophisticated person and benefactor of the arts helped attract
wealthy clients for Banco Santos. By the same token,
the management model adopted at Banco Santos hid its
fraudulent practices. Clustered around these five central
components, we identified 17 secondary elements. These
secondary elements are activities, processes, and characteristics designed to support the five central components.
The criminal business model at Banco Santos can
be seen as a refined scam, developed and implemented
over the years. Its complexity, sophistication, and internal
coherence help understand why it was possible for Cid
Ferreira to sustain the fraud for so many years.
In the following discussion of the five central components of the criminal business model, in addition to
Banco Santos we mention two other notorious corporate
FIGURE
fraud cases: Enron and Madoff. Like the Banco Santos
case, these were cases of corporate fraud that lasted for
many years, deceiving investors, media, regulatory agencies, the US Securities and Exchange Commission (SEC),
and the Internal Revenue Service.
1.
2.
Identification of and focus on a market niche of risk takers
or greed clients. At Banco Santos, this niche was made
up of high-income clients and companies, including
those with financial problems that were not being
served by other banks. At Madoff, Bernard Madoff
created a separate investment advisory business that
targeted a select group of rich and invited investors
(Gregoriou & Lhabitant, 2009). Enron focused on an
audience looking for exceptional performance in an
unknown and deregulated market (see Boje, Rosile,
Durant, & Luhman, 2004).
Use of aggressive commercial practices and offer of exclusivity.
Banco Santos offered exceptional conditions for both
investors and borrowers and access to BNDES funds
through political connections. It also offered additional sophisticated services for wealthy clients. Madoff
promised returns that were exceptional, totally safe
(see Gregoriou & Lhabitant, 2009; US SEC, 2009),
and steady for a long time despite market volatility
(Markopolos, 2010). Enron made “creative” use of
1 Criminal Business Model
Exceptional
conditions for
granting loans
High-income
clients and
companies
Serving clients
with financial
problems
Exceptional
conditions for
remunerating
investments
Doing business
with major
clients
Sponsorship of
exhibitions
and cultural
events
FOCUS ON
MARKET NICHE
IMAGE OF
ORGANIZATION
AND
ENTREPRENEUR
AGGRESSIVE
COMMERCIAL
PRACTICES
Promotion of
international
business
Access to
BNDES funds
Centralization
of decision-making
process
Reciprocity
operations
FRAUDULENT
PRACTICES
Money
laundering and
illegal transfers
abroad
Use of third
parties as
executives in
paper
Illicit
operations
with offshore
companies
MANAGEMENT
MODEL
Accounting
frauds
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
Fragmentation
of systems and
working
processes
Use of cuttingedge technology
with
partnerships
Aggressive
remuneration
package to
attract talent
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Corporate Frauds as Criminal Business Models: An Exploratory Study
special purpose entities (SPEs) to cover its fraudulent
operations.
3.
Building of the organization’s image and personality cult
of the entrepreneur. At Banco Santos this occurred
mainly through sponsorship of cultural events and
art exhibitions, promotion of international business, and business dealings with major companies.
Madoff’s strategy to attract clients included projecting an image of himself as an expert, genius, and
sophisticated gentleman with good relationships that
should give him privileged knowledge about market
functioning and trends. Enron promoted its executives as “the smartest guys,” able to innovate and gain
fortunes.
4.
A management model that combined centralized control with
fragmented systems. Banco Santos centralized all major
decisions at the top, while keeping fragmented systems and processes in its different companies so that
its own middle-level managers could not figure out
what was going on. Madoff did not execute any transactions at all for his clients; therefore, he did not need
a team but a few people, mainly relatives, who centralized communications and forged false documents.
Working processes were decentralized as he operated
by many feeder funds, refusing to give detailed information about his portfolio and strategy (Gregoriou
& Lhabitant, 2009; Markopolos, 2010). Similarly, at
Enron the major decisions were centralized in the top
management and processes were fragmented in many
companies (Boje et al., 2004).
5.
Use of various complex fraudulent practices. At Banco
Santos these practices included deflection of clients’
money, accounting fraud, illegal transfer of currency abroad, money laundering, and various other
illicit operations. At Madoff these practices included
false registration and extraction of trades, accounting
fraud, illegal activity of investment advisory, and false
testimony (US SEC, 2009). Enron falsified pricing,
simulated operations and trades among its companies
to legitimate business and volume of trades, produced mise-en-scène of trading operations in order
to impress the media, and corrupted ratings agencies
(Boje et al., 2004).
Evidently, Figure 1, as presented here, cannot be
completely applied to other cases, as it seeks to represent
solely Banco Santos’s case. However, similarities with
other corporate fraud cases, such as those mentioned
above, may be more than coincidence. The development
of the criminal business model, in order to make it generalizable, must be the object of future research.
DOI: 10.1002/tie
59
Licit and Illicit Cycles
The fraud at Banco Santos was characterized by coexistence within the organization of both licit and illicit
cycles. The licit cycle consisted of winning over and
serving companies and high-income clients that were
attracted by the strong and sophisticated image of Banco
Santos and Edemar Cid Ferreira, and by the exceptional
investment returns and loan conditions offered. Operations with the BNDES, high-profile clients, and partnerships with major information technology companies cast
the organization as respectable and reliable.
The illicit cycle consisted of using countless fraudulent practices, conceived and executed by the chief executive himself and a small group of top managers. Such
practices were concealed by the complexity of the organization and by the combination of a centralized decisionmaking process with fragmented systems and procedures.
Until the first events shook the credibility of Banco
Santos and led to its bankruptcy, the licit cycle, which
was reinforced by the use of impression management
techniques directed toward both internal and external
publics, masked the illicit cycle. Some doubtful and
risky internal practices were seen as “business-as-usual”
for a strategically aggressive, competent, and innovative
organization.
Until the first events shook
the credibility of Banco
Santos and led to its bankruptcy, the licit cycle, which
was reinforced by the use
of impression management
techniques directed toward
both internal and external
publics, masked the illicit
cycle.
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
60 CASE STUDY
Substantive and Symbolic Actions
The fraud at Banco Santos occurred right from the
conception of the company and continued until its
bankruptcy. It even intensified toward the end. Its success for so long can be attributed to a synthesis between
substantive actions and symbolic actions, a situation
that was well orchestrated by the company’s top executive. The image of the bold and visionary entrepreneur,
allied with that of a strong, legitimate, and profitable
business, attracted investors and neutralized any critical
views of the company’s activities. Table 1 summarizes
the substantive and symbolic actions carried out by
Banco Santos.
Conclusion
Brazil, like the United States and other countries, has
witnessed a number of high-profile corporate fraud
cases in the past 20 years. Several of the most notorious
Brazilian cases occurred in the financial sector (with
the banks Econômico, Nacional, Noroeste, Santos, and
PanAmericano) and in the agribusiness sector (Gallus,
Boi Gordo, and Avestruz Master). One may hypothesize
that these two economic sectors were, for some time,
more vulnerable to frauds. However, vulnerability was
not directly related to these sectors themselves, but to the
lack of regulation and control of financial investments
in its business environment. In all these cases, fraudsters
implemented their scams in a business environment that
was complex and insufficiently controlled. They knew
how to deceive clients and regulators, building customers’ confidence through the use of symbolic resources
and impression management techniques that highlighted
extraordinary competences and exclusivity. In the past
five years, improvements in the Brazilian regulatory and
control systems made frauds like those mentioned above
less frequent.
TABLE
However, cases like the one reported in this article
may bring lessons for firms willing to enter the Brazilian
market. There is a saying that “Brazil is not for beginners”
(see Wood & Caldas, 2002). Foreign firms entering Brazil
must pay attention to the complex set of rules and inefficient punishment system for corporate frauds. Foreign
firms must also be aware of local competitors, who have
expertise on how to take advantage of their understanding of the peculiarities of the local business environment,
including those companies that take advantage of political connections with the government and those that use
unethical or fraudulent business practices.
We carried out this case study with the objective
of contributing to an understanding of the phenomenon of corporate fraud. We analyzed both the substantive and the symbolic aspects of the case and suggested
that under certain circumstances, corporate frauds may
be understood as the result of a criminal business
model—that is, a rational scheme that defines how the
organization captures, creates, and distributes wealth (see
Baden-Fuller & Morgan, 2010).
As case researchers, we do not claim that our findings are applicable to other fraud cases (George & Bennett, 2005). However, we expect that this article provides
insights into the issue of corporate fraud, to be tested in
future studies.
In terms of theory development, we believe that
future research, involving multiple cases, should address
two main questions. The first question is, what makes
a criminal business model sustainable? One could, for
instance, assume time as a dependent variable and conduct multiple case studies to better understand how different independent variables affect it, such as image and
reputation, centralization of decision making, fragmentation of systems and processes, and organizational culture
(greed, ambition, and aggressiveness). The second question is, what makes a criminal business model difficult
1 Fraudulent Actions and Impression Management
Fraudulent Actions
Impression Management
• Simulation of profitable operations by means of transfers between
associated companies
• Simulation of loans, with deflection of funds and illegal transfers of
currency to offshore companies
• Deflection of funds by buying securities from a paper company
• Use of relending funds from the BNDES for “reciprocity” operations
• Accounting frauds, with improper risk classification, improper registration of companies, and settlement of doubtful credits with funds
from offshore companies
• Use of third parties as the front executives of paper companies
• Construction of the businessman’s image as a visionary, sophisticated,
and competent achiever
• Construction of the bank’s image as strong, imposing, and agile
• Construction of the image of employees as a special, sophisticated, and
reliable group
• Use of cutting-edge technology to provide an air of sophistication and
agility to the business
• Construction of “partnerships” with major global companies, such as Dell
and Microsoft
• Celebration of a client portfolio with 300 of the 500 biggest companies
operating in Brazil
Thunderbird International Business Review Vol. 57, No. 1 January/February 2015
DOI: 10.1002/tie
Corporate Frauds as Criminal Business Models: An Exploratory Study
to detect? One could, for instance, study the effect of
multiple variables, such as opacity of information, complexity of the scam, image and reputation, and the use of
symbolic resources.
In terms of contribution to the practice, we believe
that future research should address the question
of how to prevent the implementation of criminal
business models. One could, for instance, seek better
understanding of fraudulent practices used by fraud
agents, such as those we observed at Banco Santos,
Madoff, and Enron. One could also seek information
on how different countries establish and implement
guidelines and policies regarding fraud and how effective they prove to be. For instance, it is well known that
the financial industry in Brazil is subject to a regulatory
61
system that is more rigid than that in the United States.
In both cases, however, fraud agents were capable of
identifying gaps and operating for long periods at
the very boundaries of the law. In the United States,
despite receiving various complaints about Madoff, the
SEC was not capable of uncovering the fraud. Similarly, in Brazil, despite investigating Banco Santos for
several years, the Central Bank was unable to identify
any irregularities.
We hope that this exploratory study may serve
as encouragement for other researchers interested in
exploring the gaps in knowledge of the subject, help
develop better theories on corporate fraud, and improve
prevention and control systems in such a way as to
restrain the actions of fraud agents.
Thomaz Wood Jr. is a full professor at FGV-EAESP. His research interests include business transformation and
organizational change. Further research focuses on the development of the creative industries in Brazil.
Ana Paula Paulino da Costa is a lecturer at BSP Business School Sao Paulo and researcher at FIPE - Fundação
Instituto de Pesquisas Econômicas. Her research interest is mainly on corporate fraud. Other interests include
strategic performance measurement and financial statements, including public accounting.
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