Recent history has shown a major disconnect in the world of business, and it is between the ideals of profitability and ethics. Thus far into the 21st century, we have seen dozens of major corporations fall as a direct result of accounting and securities fraud. Some of the most infamous examples include the rise and fall of companies like Enron, WorldCom, and Tyco. The government has done its part in protecting innocent investors, as most notably seen with the enactment of the Sarbanes-Oxley Act of 2002, also known as SOX. In a nutshell, SOX forces top management of publicly traded companies to sign off, and thus, take responsibility for the accuracy of financial statements produced by the company, severely increases penalties for fraudulent practices for top management of these companies. Since the passing of SOX, major cases of fraud have been much less common throughout the financial services sector. However, there has been a slight rise in the return of accounting and securities fraud since 2008, including Lehman Brothers and Bernard L. Madoff Investment Securities among others, and this does not include the thousands of small accounts of fraud that happen each and everyday. The fraud game has changed in recent years, and as technology and human intellect grow at a rapid pace, so do the possibilities for these white-collar crimes. There are various ways to commit fraud, with crooks having a slew of previously used schemes. With that, there is also a large and ever-growing number ways to prevent and detect fraud, and these practices are being taught to financial sector workers across the country.
Fraud involves companies lying about their profits and cash flow on their financial statements.
Most examples of fraud generally start with a relatively simple notion: Our books are showing profit, and we are going to provide to you (the investor) a hefty return. This notion, of course, is usually not true for the fraudulent companies. The fraudster is usually lying about where they are getting their money from and/or how they are using it to best serve the investors. For the public to know the specifics about these companies' cash flow and profits/losses, they would look to those companies' various financial statements. The heads of these fraudulent companies must doctor their statements to show profit that is not there, and must lie about where the money is coming from. This has become much more difficult since SOX, with both the FBI and the Securities Exchange Commission (SEC) requiring strict accountability in financial reporting, as well as threatening with serious punishments for fraudulent statements.
Ponzi schemes are some of the most common fraud
schemes seen in today's financial services industry.
A common way for fraudsters to get away with providing false financial information is through a Ponzi scheme. As complex as the system is, there is a very general principle that is used to conduct a Ponzi scheme. Accounting Professor Gary Bulmash explains that a Ponzi scheme is simply paying investors with the money provided to them by other investors. It is a scheme that usually ends in collapse or whistle-blowing (someone on the inside going public with the illegal activities).
CEO's are more willing to accept the huge risk associated with committing fraud due to performance-based compensation.
This is an interesting prospect that many would wonder: why would someone be willing to risk being fined enough to make them bankrupt, and being sent to prison for the rest of their life? The answer is relatively complicated, in that there are a lot of unknown variables going into this type of decision-making. One of the most central factors, however, is the competition of the market. The economy has been a wreck for the most part of the last five years, and this has negatively impacted profits by even some of the top dog companies in the financial services sector. As a result of this, investors are asking for much more out of their dollar if they are willing to risk their hard-earned money.
Internal detection and prevention are the best ways to fight fraud.
What people have to realize is that not all cases of fraud involve these multi-billion dollar investment schemes. Reality suggests the contrary, for there are examples of accounting and securities fraud that occur each and everyday. This could range from accounting practices that involve double-counting revenues, or purposeful exclusion of certain expenses, to simply mixing personal and business funds to either better the company or better the fraudster personally. Regardless of the type of fraud being committed, it is imperative for the integrity and accountability of our financial institutions that fraud be stopped from the inside when possible. There are various specific ways to detect fraud in the workplace, Professor Bulmash explains.
It may not necessarily be the case that the CEO is an honest, ethical agent of the company, and in many of the previously named examples of fraud, it was indeed the CEO or some other top executive who was directly responsible for the fraudulent actions of their company. If this is the case, employees and investors need to know when the company head is committing a crime, and that they should report any curious activity to the government as soon as possible. It is very accessible for someone to report these crimes to the FBI and SEC, and it is being encouraged more and more as our financial services industry expands.
