My Experience with Ariely's Modified Shredder: A Followup

 

I mentioned in a prior FraudBytes post that I have some suspicions about a set of experiments that Professor Ariely claimed he ran using a shredder that he said was modified so it looked like it was shredding but really wasn't (see this link for more details). After purchasing several shredders in an attempt to modify them so we could do what he claimed he did, we emailed Professor Ariely to ask him how he did it. He provided a voicemail response where he stated that it was "quite simple" to convert a shredder by breaking the teeth in the middle with a screwdriver but that he doesn't use that method any longer. (You can listen to Dr. Ariely's explanation at this link.)

As I said in the earlier post, we were unable to break any teeth on the shredders we purchased but ended up finding a way to remove some of the teeth in the center by taking the shredder apart. Unfortunately, when we did this the papers would no longer go through the shredder without getting turned to one side or another and they inevitably got stuck because the shredder no longer had enough teeth to pull them straight through. 

We concluded that it was impossible to modify any of the shredders we bought and I put an asterisk next to Dan Ariely's name as someone who made a claim regarding his research that seems very suspicious.

Since I posted about this almost two weeks ago, I did an extensive literature search (involving several others who helped out) looking for the research that he claims was done with the modified shredder. The end result is that I can't find any published paper that discusses using a modified shredder. I even called one of his co-authors and asked him if the experiment that they ran together used a modified shredder. He said the shredder in their study was not modified.

I did find a few papers that used a regular shredder but did not mention any modifications. I also found several statements (including this one and the one linked above) where he claims to use this mysterious modified shredder. Overall then, here's where we are with the shredder:

1. Dr. Ariely has made numerous claims to use a modified shredder in his matrix experiments.

2. I am unable to find any published papers by Dr. Ariely that use a modified shredder.

3. Modifying a shredder to do what he has claimed appears to be very unlikely.

So why would Dan Ariely make this claim? Perhaps he got confused about how his studies involving shredders were conducted. Or perhaps he never conducted the studies with a modified shredder. 

Unfortunately, the more I dig into things, the more I find instances where Dr. Ariely has made statements that suggest a lack of integrity on his part. For example, this NPR interview about dentists is troubling to me. He also has a paper that was recently given an "Expression of Concern" by the journal that published it (see this for details). I hope Duke University gets to the bottom of these black marks on Ariely's work and if other published studies are based on fabricated data that they get retracted like the 2012 paper. 

Unfortunately, at this point, I'm not sure what to think of the research he claims to have conducted on the psychology of dishonesty...I certainly will hesitate to cite any of his papers in my research.

Analysis Argues Ariely Retraction was a Sloppy Fraud

An analysis by Jonatan Pallesen shows that the Ariely fabrication that I posted about a few days ago was extremely sloppy. The post concludes that "This is a case of fraud that is completely bungled by ineptitude." Well, let's not mince words here....

The original analysis on the Data Colada blog identified several inconsistencies in the data that showed it was fabricated data. For example, the data is a uniform distribution that goes from 0-50,000 and stops. This new analysis, raises additional questions about the data and asserts that the analysis shows how the fraudster was able to manipulate the data to support the hypotheses tested in the paper. 

I recommend reading this analysis and deciding whether the author makes a compelling argument to support his claims. His ultimate claim is that the fraud had to be perpetrated by Ariely himself. He says: "Is it possible that someone at the car insurance company faked the data, and Dan Ariely simply received this fake data? I would say that it is not."

Bold claims require bold evidence. See what you think.

Top Honesty Researcher, Dan Ariely, Has Paper Retracted Due to Fraudulent Data

Today, truth is on my mind after I read the following quote:

"(T)ruth is not what you want it to be; it is what it is, and you must bend to its power or live a lie."–Miyamoto Musashi

This reminded me of this, my favorite, quote about truth: 

“When truth is buried underground it grows, it chokes, it gathers such an explosive force that on the day it bursts out, it blows up everything with it.”–Emile Zola

Over the years, I've found the latter quote to be very descriptive of the events that follow after the initial revelations that a fraud has taken place. For example, the explosion of truth that happened after Lance Armstrong was first accused by his former teammate, Floyd Landis, of doping. A few years later and Lance had been stripped of all his yellow jerseys and all sorts of revelations came out that exposed truth that was buried deep in the ground in hopes that it would never be revealed (this link chronicles about 150 blog posts about Lance's fraud coming to light).

Similarly, in accounting research, we had a researcher who, by many accounts, was considered accounting's most prolific academic, Jim Hunton, have a paper (ironically on auditor's detection of fraud) retracted in November 2012. Many of Professor Hunton's papers contained what he claimed was proprietary data that was obtained from confidential sources. A few years later, 37 of Jim Hunton's papers had been retracted (technically, 36.5 since one paper was partially retracted). He is currently listed as #14 on the RetractionWatch leaderboard (see this link for more information).

Over the past few days, a 2012 paper coauthored by someone who is arguably the most prolific psychology researcher on (ironically) honesty, Dan Ariely, was identified as containing fraudulent data and is being retracted (see this link for details on the investigation that led to the retraction; see this Twitter thread saying it is being retracted and giving other interesting context from one of the coauthors). Unfortunately, like Jim Hunton, Professor Ariely was in charge of the data and claims to have obtained it from a proprietary source. While it is too early to tell, this begs the question of what the future holds. Is this the early rumblings of the truth trying to free itself from its casket buried deep in the earth?

Sadly, I have had some suspicions about some experiments that Professor Ariely ran using a shredder that was modified so it looked like it was shredding but really wasn't (see this link for more details). After purchasing several shredders in an attempt to modify them so we could do what he claimed he did and even getting a BYU engineering student who was the lead TA in the Mechanical Engineering lab involved in the effort, we emailed Professor Ariely to ask him how he did it. He provided a voicemail response that was not satisfactory. He claimed it was "quite simple" to convert a shredder by breaking the teeth in the middle with a screwdriver but that he doesn't use that method any longer. (My TA found the file with Dr. Ariely's explanation; click this link if you want to hear it.)

(The photo on the left is one of the shredders we tried to modify. I'm confident that those teeth could not be broken with a screwdriver.) 

We were unable to break any teeth on the shredders we purchased but ended up finding a way to remove some of the teeth in the center by taking the shredder apart. Unfortunately, when we did this the papers would no longer go through the shredder without getting turned to one side or another and they inevitably got stuck because the shredder no longer had enough teeth to pull them through. We concluded that it was impossible to modify any of the shredders we bought and I filed the entire experience in my mind by putting an asterisk next to Dan Ariely's name as someone who made a claim regarding his research that seems potentially suspicious.

Time will tell whether this retraction is the rumblings of a massive explosion or not. If there are other implications, I hope the truth comes out because, I believe, the world is always a better place when fraud has been exposed.

Finance Professor Exposes "Deeds of Darkness"

A recent article in Bloomberg Businessweek highlighted the work of UT-Austin finance professor John Griffin, and his work in exposing the Bitcoin—Tether cryptocurrency connection. He found that when “Bitcoin fell to certain levels, purchases using Tether would flood in to stabilize prices” and this “fit a pattern consistent with someone, or a group of people, trying to manipulate Bitcoin prices.” Griffin also published a paper last year alleging a favorite benchmark of volatility in the finance industry, the XIV, was rigged. His work has drawn an “eager readership” among watchdogs, including the Department of Justice and the Commodity Futures Trading Commission.

Chinese Spies Infiltrate almost 30 U.S. Companies

On October 4^th, Bloomberg published an article detailing how Chinese spies placed microchips on motherboards produced for Super Micro Computer Inc., one of the biggest supplies of motherboards in the world.  Supermicro products are used by large tech companies such as Amazon and Apple. These microchips allow the servers they have been inserted into to be accessed remotely by those that put them there, and gather all the information they want. According to the article, "one government official says China’s goal was long-term access to high-value corporate secrets and sensitive government networks. No consumer data is known to have been stolen.”   A link to the full article is provided below.

China infiltrated U.S. tech companies

NY Times Investigation digs into possible President Trump tax fraud

On October 2^nd, the New York Times published a recent investigation into the President's taxes in the 1990s. The investigation states that "President Trump participated in dubious tax schemes during the 1990s, including instances of outright fraud, that greatly increased the fortune he received from his parents..." The investigation also concludes that, contrary to the President's claim that he is a "self-made billionaire," Trump owes his fortune to his father, who repeatedly bailed his son out of failed businesses. The article alleges that the President and his family engaged in tax fraud to avoid inheritance taxes as the father of the president passed his fortune on to his posterity. 

Links to a summary article and the full investigation are included below.

11 Key Takeaways from Trump Investigation

Full Investigation

Auditors and Fraud: Interview with Going Concern

Mark was recently interviewed by Going Concern about auditors' responsibilities to detect fraud. Here are a few highlights:

Moral Hypocrisy: The KPMG / PCAOB Scandal

Auditors aren't that great at detecting fraud and sometimes claim their audits aren't designed to detect it. It looks like they may not be that great at committing it, either (though not for lack of effort).

Is Bitcoin a Scam?

First, let's consider what bitcoin isn't.

PWC Held Responsible for Not Detecting Fraud

The Wall Street Journal published an article explaining that PricewaterhouseCoopers (PWC) was held responsible for failing to detect fraud in their independent audits of Colonial Bank. Colonial Bank collapsed in 2009 and, according to the Tampa Bay Times, was the sixth largest bank failure in history. The articles estimate that PWC may be responsible for damages totaling hundreds of millions of dollars.

This is an interesting case because the audit firm has had some individuals claim, in court, that auditors are not responsible to detect fraud. The court rejected this claim and said auditors who don't design audits to detect fraud are not following their own auditing standards. Here are some details from the FDIC order related to the case:

“While there are numerous auditing standards that are implicated in this case,...the overarching standard that governed the PWC audits is that: “[t]he auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud.” AU § 110.02; AU § 316. PCAOB Auditing Standard No. 2 states that “[a]lthough not absolute assurance, reasonable assurance is nevertheless a high level of assurance.” Id. at ¶ 17. To that end, a PCAOB 2007 release clarified that “[t]he auditor should, therefore, assess risks and apply procedures directed specifically to the detection of a material, fraudulent misstatement of the financial statements." (emphasis added). The Engagement Letters between PWC and CBG acknowledged this responsibility by stating that PWC would “design [the] audits to obtain reasonable, but not absolute, assurance of detecting errors or fraud.” See, e.g., A4 at 3. Indeed, Mr. Westbrook, one of the PWC audit partners, testified at trial that PWC had a duty to design audit procedures to detect fraud. Tr. 817:25-818:7 (Westbrook). He further testified that if PWC failed to design its audit procedures to detect fraud, it would be a violation of PCAOB standards. Tr. 822: 19-22 (Westbrook). 

However, PWC voiced a very different tune just a few years ago with respect to another lawsuit that stemmed from this fraud. TBW’s bankruptcy trustee also filed suit against PWC, alleging that PWC breached its duties when it failed to detect the fraud. That lawsuit proceeded to trial in August 2016 before it settled mid-trial. As part of that lawsuit, many of the same PWC engagement partners, audit managers, and audit staff who are involved in this case gave deposition testimony under oath in the TBW trustee’s case. During that testimony, these individuals repeatedly admitted that PWC did not design its audits to detect fraud. For instance, Mr. Westbrook testified that PWC “audits are not designed to detect fraud.” Tr. 358:6-7 (Westbrook) (quoting Westbrook TBW Dep. at 23:7-12). Likewise, Mr. Jackson, the PWC engagement partner, testified that “I would point out that our audit procedures were not designed to detect fraud.” Tr. 1027:1-10 (TBW Dep. at 31:17-20). Similarly, Wes Kelly, PWC’s audit manager for the 2003-2005 and 2008 CBG audits, testified that PWC “did not design audit procedures to detect fraud.” W. Kelly TBW Dep. 45:608 (Ex. P3120). Finally, Mr. Rivers, a PWC audit associate assigned to the CBG audit, testified that PWC had no obligation to look for fraud. Rivers TBW Dep. at 66:17-23. 

At trial, PWC attempted to explain away this testimony by arguing that these individuals simply meant that PWC was not a guarantor against the possibility of material fraud because the auditing standards recognize that “even a properly planned and performed audit may not detect a material misstatement resulting from fraud.” Ex. A400 at 7-8 (AU § 316.12); Tr. 821:25-822:24 (Westbrook stating that in order to provide a guarantee against fraud, auditors would “need a lot more tools like lie detector tests and subpoena power and guns and badges and all those kinds of things.”). This Court does not find this explanation credible, nor is it consistent with the previous testimony from the TBW trustee’s lawsuit. This Court heard Mr. Westbrook and Mr. Rivers testify for hours and is convinced that these gentlemen are more than capable of saying what they mean. If they had intended to say that PWC audits were not a guarantee against the possibility of material fraud, they would have testified accordingly. However, that was not their testimony. Instead, they clearly stated that PWC had no duty to detect fraud and did not design its audits to detect fraud. The Court concludes that PWC did not design its audits to detect fraud and PWC’s failure to do so constitutes a violation of the auditing standards. 

What I find interesting is that practicing auditors admitted that they don’t design their audits to detect fraud even though auditing standards clearly say that auditors are responsible to provide reasonable assurance that there are no material misstatements due to (error or) fraud. Over the past decade, including as recently as 2016, I’ve asked several audiences of auditors to answer the following true-false question: “Auditors have the responsibility to provide reasonable assurance that there are no material misstatements due to fraud.” These auditors range from staff to partners and, on average, about 50% incorrectly answer false. This is pretty disheartening to me...

Unfortunately, my experience suggests that most auditors don’t put in a lot of effort to detect material fraud. Fraud may be discussed briefly in the required brainstorming session but then quickly forgotten as the audit team gets focused on ticking and tying and trying to get some sleep during busy season. 

There are many things that auditors could do but, unfortunately, it's rare to find an auditor who is thinking beyond what they did last year. If I were king for a day, I would require auditors to do interviews with lower level people in an organization with the goal of discovering aggressive accounting or business practices. Combining interviews with strategic reasoning would potentially help auditors provide the reasonable assurance they are responsible for. For example, if strategic reasoning leads the auditors to believe revenue recognition and shipping cutoff is ripe for financial reporting fraud, auditors trained in interviewing could meet with shipping / warehouse personnel about the end of the year. Well designed questions could reveal information that could help identify control weaknesses and potential fraud. 

In any case, this case and other experiences with auditors reminds me of the 1980s when auditors put it in their engagement letters that they weren’t responsible for providing assurance for fraud. Back then, and now, the courts don’t appear to share that view. In the end, both the auditing profession and audit users end up suffering when auditors are weak in fulfilling this responsibility.

Wells Fargo Incentives Lead to Fraud

Wells Fargo, one of the largest banks in America, was fined $185 million for the company’s fraudulent selling practices. A Wall Street Journal article¹ reports, “Federal regulators announced that Wells Fargo opened as many as two million deposit and credit-card accounts without customers’ knowledge.” Many former employees of the bank attribute the widespread fraud to the incentive structure and the pressure received from managers to reach the company’s ambitious sales targets.

Wells Fargo has been envied by its competitors for its high return on equity, with greater relative profits than other leading financial institutions such as J.P. Morgan. This success is a result of the focus on cross-selling more products (i.e. different financial services) per customer, a strategy it has faithfully followed since 1999.

However, some managers’ fierce dedication to this strategy led many lower level employees to create dummy accounts. Sales progress was closely monitored, requiring updated reports several times a day. Not meeting your targets was not something to be taken lightly, as many lower and mid-level managers lost their jobs due to their inability to consistently achieve their goals.

The account representatives and account managers also felt immense personal pressure to achieve sales goals due to the monetary incentives attached to their targets. With low base salaries those bonuses became very significant and highly desirable. A Harvard Business Review article³ explains how this type of incentive structure entices employees to make minor ethical compromises which then escalate and spread from there. The article reads:

“Consider the following sequence: A bank account manager, under pressure to make a sales goal to receive his bonus, pushes a customer to add a credit card, even though the account manager knows it’s not in the customer’s interest. Still short of the goal, the account manager asks his friends and family to open accounts. (The accounts are to be closed shortly thereafter.) With the goal still not achieved, the account manager opens accounts without asking customers and transfers a small amount of money. (The accounts are closed shortly thereafter and the money is transferred back.) As soon as the account manager gets away with the first unethical act, it’s not a big step to the fraudulent ones. The justification moves from ‘it’s legal’ to ‘no one is harmed’ to ‘no one will notice.’ When such practices are tolerated, they escalate in severity and spread throughout the organization.”

Wells Fargo’s CEO, John Stumpf, accepted full responsibility in his congressional hearing last week.² Over the past five years the bank has fired 5,300 employees for their involvement in fraudulent practices and has hired consultants from PriceWaterhouseCoopers and Accenture as well as several law firms to investigate the situation. However, it seems as though all that effort was too little, too late. 

Mr. Stumpf has received a lot of heat for this scandal, including requests for his resignation and calls for top executive’s compensation to be paid back to those negatively affected. Some have even questioned his competency as the CEO of such a large bank. The WSJ article¹ previously mentioned goes on to state, “In the 2010 annual report, Mr. Stumpf said he often was asked why Wells Fargo had set a cross-selling goal of eight retail banking products per customer. “The answer is, it rhymed with ‘great,’ he wrote. ‘Perhaps our new cheer should be: ‘Let’s go again, for ten!’” 

The bank said it will “scrap all product-based sales goals in its retail branches starting January 1.”¹  It is unclear why they are waiting until next year to implement this change aimed to alleviate the pressure experienced by employees that led them to these illegal practices.  Hopefully this scandal will help other companies see more clearly that extreme commitments to aggressive goals can potentially lead to fraud.

1.     http://www.wsj.com/articles/how-wells-fargos-high-pressure-sales-culture-spiraled-out-of-control-1474053044

2.   http://www.wsj.com/articles/wells-fargo-ceo-stumpf-i-accept-full-responsibility-for-unethical-sales-practices-1474326173

3.   https://hbr.org/2016/09/wells-fargo-and-the-slippery-slope-of-sales-incentives

Combating Cheating in the Classroom

Online resources students may use for cheating

Have you ever heard of websites such as Course Hero, Quizlet, or Koofers? If you have, you may know that while these websites can provide some advantages for honest students, they also provide an opportunity for some students to cheat. A recent presentation by a professor at Brigham Young University (BYU) highlighted several concerns about these study websites. After searching the websites, thousands of assignments, quizzes, and exams were discovered posted on the various sites. While it may be okay to post student notes, flash cards, or even class slides depending on professors’ instructions, posting assignments, quizzes, and exams is likely a violation of copyright laws.

Whose Job is it Anyway? Are Auditors Expected to Detect Fraud?

A recent article in The Wall Street Journal details what could be one of the only legal cases from the great recession to actually go to trial. Taylor Bean & Whitaker Mortgage Corp. is suing PriceWaterhouseCoopers LLP (PWC) for $5.5 billion dollars claiming that PWC was negligent in auditing one of their clients. While PWC didn’t audit Taylor Bean, they did audit a bank with which Taylor Bean did frequent business--Colonial Bank (Colonial). Taylor Bean overdrew its accounts with Colonial for several years to cover cash shortfalls, then sold fake pools of mortgages to Colonial in order to cover up the fraud. Taylor Bean claims PWC was negligent in auditing Colonial, and that the collapse of Colonial led to them losing billions of dollars. The real question is how liable should auditors be for detecting fraud?

HSBC Holdings Receives Nothing More Than a Slap on the Wrist

A recent article in The Wall Street Journal talks about the Justice Department’s decision to not pursue charges against HSBC for allegations made in 2012. HSBC is a major bank in the UK that admitted to neglecting to spot proceeds from drug trafficking in Mexico and also did not flag transactions by countries under economic sanctions. Rather than being prosecuted, the bank was allowed to admit guilt, improve its controls, and make a few other minor changes. Both Republican and Democrat lawmakers view the decision as a slap in the wrist for a company that admitted to engaging in extreme illegal activity. While former Attorney General Eric Holder says his remarks were misinterpreted (see below), the fact that HSBC is no longer being prosecuted lends credence to the idea that the government seems incapable of handling corruption within some of the world’s largest corporations.

See this previous post for a further discussion on companies being too big to fail.

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