Ideas with Impact
UNB Faculty of Management

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If you’re like most people, probably a week does not go by without you being contacted at least once or twice by some form of consumer scammer. We hear about these scams in the media all the time: credit or debit card frauds, identity-theft schemes, lottery frauds, ponzi schemes are just a few. While many people think they’re savvy enough to recognize consumer scams, a surprising number of us fall victim to them. Dr. Jeff Frooman, a professor with the Faculty of Business Administration who teaches finance and business ethics, has recently completed some research on scamming with a co-author, Dr. Sareh Pouryousefi.  The research looks at consumer scams through the lens of “agency theory” to understand how rational people are duped by scammers.

“People can’t do everything for themselves, so they hire others, agents, to help them,” explains Frooman. Agency theory studies the business relationships between principals and agents and the conflicts of interest that can arise between the two. In business transactions, principals hire the agents to represent them and expect them to act on behalf of their (the principals’) interests, not out of self-interest. Sadly, not all agents do this.

In his study, Frooman looks at how consumer scammers manipulate the principal-agent relationship by capitalizing on an asymmetry of information between the two parties, where the imbalance favours the agent. He identifies three classic types of scams that stem from problems in judgement and/or observation resulting from an asymmetry of information in agent-principal relationships. These three categories are 1) wardship, a problem of both observation and judgment; 2) homoious hemin (a phrase borrowed from Plato for lack of an established term), a judgement problem; and 3) blind spot, an observation problem.

“The wardship relationship, where the principal is not able to observe what the agent is doing and not able to make any kind of judgement, is the worst kind,” says Frooman. “The victim is really vulnerable.” Perpetrators invest a lot of time designing these kinds of scams, creating well engineered narratives and thinking of all kinds of scenarios to produce a believable story line.

A well-known example of the wardship problem is the Bre-X scam that took place in the 1990s when the Canadian gold exploration company Bre-X Minerals Ltd. convinced people to purchase shares in the Indonesian Busang Mine, which they claimed held close to 71 million ounces of gold. Bre-X Minerals started selling on the New York Stock Exchange, thousands of investors put money into the venture, and share prices rose. “What investors didn’t know, because the mine was in another country in a remote area, is that there was no gold. They weren’t able to observe the operations, and because of their ignorance regarding hard-rock mining operations they lacked the ability to make sound judgements regarding what information they were being given. In only a few days, investors lost close to $5 billion.

The homoious hemin relationship occurs with the victim can observe but is not in a position to judge. The sale of fake gemstones by con man Jack Hasson in West Palm Beach, Florida, in the late 1990s, is a famous example. “Hasson looked for wealthy clients on golf courses, who were interested in purchasing precious jewels usually both as an expensive gift and as an investment,” explains Frooman. “The gemstones Hasson sold were very high-quality replicas, good enough to fool anyone but a professional appraiser, but worth only about 10% of their quoted value.”

Along with the sale of these fake gems, Hasson even provided certificates of authenticity which he claimed were from Bvlgari, Cartier, Tiffany and other high-end jewelers. In actual fact, these certificates were products of his own printer. The professional golfers Jack Nicklaus and Greg Norman were two of Hasson’s victims, and each spent $500,000 on fake gemstones worth less that $10,000. Hasson’s victims were able to observe the gem stones, literally hold them in the palms of their hands, but did not have the expertise to make a good judgement. The fraud was uncovered when Nicklaus’ property was appraised by his insurance company.

Frooman cites dating scams as a classic example of the blindspot relationship, one in which the perpetrator takes advantage of the victim’s inability to observe.  In a typical scenario, the victim meets someone through an online dating site. This perpetrator has a compelling and convincing narrative. The victim develops an attachment to the perpetrator and trust soon follows. After a while, the perpetrator fabricates a crisis and asks for a small amount of money to help them out.

In a real-life example Frooman describes in his article, how a victim—a woman around 50 years of age--started getting suspicious when bigger crises started coming, and larger amounts of money were requested. She had a lot of previous experience dating and considered herself to be a good judge of character, something her friends corroborated. However, she now found herself in a relationship where she was not able to directly observe the other person she was “dating,” since they only corresponded by email and by phone. In other words, while she may have been a good judge of character she couldn’t observe this character in person. To her credit, she got out of the relationship quite quickly.  “In total, she lost only about $1,500, but the average loss for victims of this type of scam is about $17,500."

In his paper, Frooman notes that “… in 2015 alone, 1.2 million individuals fell victim to scams in the U.S., accounting for an estimated loss of $765 million.” The “best” scams are ones in which the victim willingly participates, and which are carefully designed to take advantage of an asymmetry of information in the principal-agent relationship, with the imbalance favouring the agent. “The perpetrator knows what you don’t know and takes advantage of this,” says Frooman.  

So how can we prevent ourselves from being duped? One strategy, suggests Frooman, is to take control of the contract when we enter into a relationship with someone who is supposed to act in our best interests. Having a contract that provides the agent with a “take it or leave it” scenario, is a good first step.

Frooman joined the Faculty of Business Administration at the University of New Brunswick in 2007. His article, “The Consumer Scam: An Agency-Theoretic Approach” was published in the Journal of Business Ethics. This is one of four papers Frooman has recently published in a journal included the Financial Times Top 50 list of journals, the list of journals that the Financial Times uses to rank the research productivity of business schools worldwide.

Photo: Dr. Jeff Frooman recently completed a project on consumer scams which is published in the Journal of Business Ethics.

For more information, contact Liz Lemon-Mitchell.

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