Corporate Crime

Study: Most corporate fraud goes undetected

Corporate fraud is more widespread than most people are aware.
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· 4 min read

A steady, constant undercurrent of fraud and dubious accounting tricks seem to run through the corporate world, possibly destroying $830 billion of equity value a year, according to a new academic study.

The problem appears to run deep; according to the study, 41% of companies allegedly “misrepresent their financial reports,” 10% of “large, publicly traded companies” are allegedly committing securities fraud, and two-thirds of corporate fraud goes undetected. If that’s right, there are a whole lot more Elizabeth Holmeses and Trevor Miltons out there.

“The problem is bigger than you perceive it,” said Alexander Dyck, professor of finance at the Rotman School of Management at the University of Toronto and a co-author of the study. “[At] 10% of firms that you’re looking at today, there’s an ongoing fraud.”

Finding out what you don’t know. Saying that fraud is undetected can be like proving a negative: How do you find out how much you’re not finding out? Dyck and his fellow researchers came up with a novel way to answer that question, based on the infamous Enron case of the early 2000s.

In 2002, giant accounting firm Arthur Andersen collapsed after its auditors failed to catch the depth of deceit at Enron, leaving questions about their auditing work.

In the wake of Andersen’s implosion, new auditors and investors reexamined the firm’s former clients, taking a much more critical look at its auditing work, the report suggests. According to the researchers calculations, that gap between what Andersen found and what the new auditors found- the undetected fraud- is consistent and can be used to estimate how much undetected fraud there is.

The researchers also looked at a series of measures that can be indicative of fraud, including SEC enforcement actions, class action lawsuits, and financial restatements. The authors also “loosely” defined fraud, an expansiveness some have taken issue with.

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“The authors themselves concede that they use the word ‘fraud’ ‘loosely’ and for ‘simplicity,’” Joseph Grundfest, professor at Stanford Law School, former SEC commissioner, and creator of a database that tracks federal securities fraud cases, told the New York Times. “But events they call fraudulent include alleged frauds that weren’t frauds, honest mistakes, and differences of opinion about accounting treatment.”

But Dyck defends the study’s definitions of fraud as relevant for investors and companies alike.

“I think these are material; they matter for investors and, therefore, they should matter for us because they affect our ability to raise capital at reasonable costs and to funnel money into the best investment opportunities,” he told CFO Brew. “We should all care about that.”

Serious business. Regulators appear to agree. In September 2022, the Justice Department unveiled a series of initiatives to deter corporate fraud, including incentivizing corporate cooperation and self-reporting of corporate crime.

SEC chair Gary Gensler has prioritized transparency and accountability, especially the implementation of long-delayed rules mandated by Dodd-Frank. The SEC also finalized clawback rules last November that would seize pay of executives found responsible for financial misrepresentations and errors.

Even without government interventions, understanding the scope and pervasiveness of fraud enables businesses to make clearer decisions and allocate resources more effectively.

“Even if you don’t want any more regulation because you think regulation is in trouble, I still think you want to know the scope of the problem to think about how many internal resources you want to devote,” Dyck told CFO Brew. “It’s good to bring frauds to light more quickly, good to address [them] more quickly, rather than letting them fester.”—DA

News built for finance pros

CFO Brew helps finance pros navigate their roles with insights into risk management, compliance, and strategy through our newsletter, virtual events, and digital guides.