Is corporate fraud common?
Finance expert’s study points to ‘how widespread’ problem may be at public companies
On a recent visit to Salt Lake City, Alexander Dyck ordered Chinese takeout and received a branded fortune cookie wishing him wealth and promoting FTX, presumably packaged before the crypto empire’s epic collapse.
“I should have saved it,” he said regretfully.
Dyck is a professor of finance at the University of Toronto, who just published a study on the pervasiveness of corporate fraud. The study has been passed around in the world of academia in recent weeks and has become a fascination among general counsels, corporate leaders and investors.
It suggests only about one-third of frauds in public companies actually come to light and that fraud is disturbingly common.
Dyck and his co-authors estimate that about 40% of companies are committing accounting violations and that 10% are committing what is considered securities fraud, destroying 1.6% of equity value each year — about $830 billion in 2021.
“What people don’t get is how widespread the problem of corporate fraud is,” Dyck said about his study, published in the Review of Accounting Studies this month.
Last year, Trevor Milton, founder of electric-vehicle maker Nikola, and Elizabeth Holmes, founder of blood-testing company Theranos, were both found guilty of fraud. Holmes’ sentencing coincided with the swift fall of FTX, founded by Sam Bankman-Fried.
But the amount of fraud perpetrated at any given time stays pretty steady, Dyck said. He and his colleagues wanted to scratch the surface of misconduct in public companies to figure out how much of it goes undiscovered normally. To do this, they first examined a period of unique scrutiny in accounting history, the 2001 demise of auditing firm Arthur Andersen after the collapse of Enron.
At that time, the firm’s former clients were in the spotlight and new auditors were far more motivated to uncover wrongdoing, given the suspicions looming over companies that had worked with Arthur Andersen. That should make the rate of fraud they found more accurate than other measures.
But the probes didn’t uncover more wrongdoing among Arthur Andersen’s clients than at other businesses reliant on other auditors. The same ratio of fraud appeared in a set of comparisons with other research, which led them to conclude it is consistent. They used this rate of fraud to conclude that about one-third of corporate fraud goes unnoticed.
Given how common fraud is at audited public companies, Dyck said, misconduct is probably even more pervasive in privately held businesses.
Still, it’s difficult to prove misconduct and target everyone involved in wrongdoing, said Allison Herren Lee, a former commissioner and interim chair at the Securities and Exchange Commission. People involved often feel they are just testing boundaries rather than violating the law and such schemes can be sprawling in major corporations.
“To prosecute fraud you have to show intent,” she said. “In big public companies that’s tough, because it takes a village to commit fraud.”
Corporate crime fighters agree that fraud is a major problem.
But some are critical of the new study’s expansive take on the term.
Some note the research relied on studies with varying definitions that applied to a range of kinds of misconduct, including settled cases arising from accusations of accounting violations that were never ultimately proven by the prosecution.