In the last few years, massive frauds against shareholders seem to have unraveled almost on a daily basis. Although the general theme of fleecing the investor has remained constant, the methods employed by wrongdoers have become increasingly complex and difficult to parse. Schemes are to be bounded only by the extensive creativity of ingenious yet deceitful perpetrators. Some widely reported recent fraudulent strategies have included:
ACCOUNTING FRAUD
- Recognizing False Income: This is a favorite of fraudulent companies, constituting more than half of all accounting fraud. The deception consists of recognizing income prematurely and in some cases fabricating non-existent revenues. This artifice uses "fake trades" or "round tripping" whereby one company sells another some supposed asset, only to buy it back at the same price shortly thereafter--allowing both parties to the transaction to recognize revenues from the "sale."
- Improperly Booking Expenses: By secretly failing to recognize expenses, companies artificially inflate, and thus misrepresent, their income levels. Although simple in theory, without a vigilant auditor this ruse is frequently amazingly effective until the bottom falls out of a company.
- Special Purpose Entities: Enron made this method famous. By forming ostensibly "unrelated" shell companies in which to hide all of its decaying assets, Enron was able to hide mountains of its own debt. The deception also allowed for the gross over-statement of profits. In recent years, the discovery of these and other accounting tricks forced 330 publicly traded companies to "restate" their previously issued financial statements. The corporations involved in these restatements were not limited to smaller or start-up entities. Over half of such corrective filings were from corporations with annual revenues in excess of $100 million. Over a fourth came from companies with annual revenues of at least $1 billion.
CORPORATE DISHONESTY
Rampant accounting irregularities are not the only "growth area" for fraud. For example, corporate dishonesty has also cheated investors through the following methods:
- Subprime Mortgage and Related Assets: More recently, many Wall Street investment banks and other large financial institutions have been named in countless securities and related cases alleging wrongdoing in connection with subprime and related mortgages. Many of these cases allege that the financial institution improperly sold high-cost mortgages to borrowers knowing that the borrower would likely default. Other cases allege that these financial institutions packaged these subprime loans together, and then improperly sold to investors at inflated prices securities backed by these subprime assets.
- Bernard Madoff and other "Ponzi" Schemes: As now reported widely, Bernard L. Madoff has pleaded guilty to operating the largest Ponzi scheme in history. Madoff, a former chairman of the Board of Directors of NASDAQ, reportedly paid returns to early investors not based on trading profits, but instead with money raised from new investors. Stunningly, estimates of the damage to investors from the fraud frange from some $50 billion to $65 billion or more.
- Insider Loans: A shocking 75% of the largest 1,500 public companies have now disclosed the extension of loans to corporate insiders on egregiously favorable terms. Of an estimated $5 billion worth of such loans, about $1 billion will be "forgiven".
- Insider Trading: Crooked executives sometimes impermissibly sell personal shares of corporate stock with advance knowledge of undisclosed negative "inside" information about their company. Other investors, unaware of the impending adverse news, buy these shares at artificially inflated prices. In essence, the informed insider is stealing money from the unsuspecting public. It's illegal, but it happens and it happens in huge dollar amounts.
- IPO Spinning: Many Wall Street investment banks have obtained lucrative underwriting business from companies by offering executives the right to buy shares of other "hot" IPOs. These shares can be sold almost immediately for a huge, nearly risk-free profit. The practice essentially constitutes an illegal bribe to corporate leaders aimed at inducing them to spend vast sums of company money with the underwriter.
- Analyst's Conflicts of Interest: In order to win business for their firms, analysts have issued positive recommendations on stocks they knew to be poor performers. For example, the Attorney General of New York brought charges against many of the largest analyst firms for this practice, resulting in large settlements with multiple companies.
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