In the Name of Profit: The Reality of Corporate Fraud

The penalty imposed by the market on corporate fraud causes lasting reputational losses

‍Corporate fraud has become an increasingly prominent issue in today's business world. It is estimated corporate fraud costs investors $330 billion dollars annually.  Companies that are willing to put profits before ethical considerations are often willing to go to great lengths to conceal illegal activities, even if it means engaging in fraud. Unfortunately, this type of behavior has become increasingly common, and the consequences for companies caught engaging in it can be severe. Corporate fraud can take many forms, from accounting fraud and false statements to bribery and money laundering. It can have devastating effects on the companies involved and the people affected by their actions. In this article, we will explore the reality of corporate fraud, how it is committed, and how it can be prevented. By understanding the dark side of profits, companies can better protect themselves and their stakeholders from the devastating effects of corporate fraud and exploitation.

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Types of corporate fraud

The risk of corporate fraud to an investor is viewed as a systematic risk

• Accounting fraud - This type of fraud involves manipulating financial records, usually by overstating company earnings or understating expenses. Accounting fraud is a common way for companies to inflate their stock price or hide financial difficulties.

• Financial statement fraud - This type of fraud involves misreporting a company's assets and liabilities on its balance sheet. Financial statement fraud is particularly dangerous because it can take years to be discovered and can have far-reaching consequences for the company's shareholders. Fraudulent financial reporting often results in a company's stock being delisted from exchanges or being delisted altogether.

 

• Asset misappropriation - This occurs when a company's assets are illegally converted for personal gain. An example would be an employee who uses his position of employment to cause a payment for some inappropriate purpose

 

• False statements - This type of fraud occurs when a company deliberately misrepresents an event or a material fact. False statements often involve senior corporate executives reporting that a company is in better financial health than it is. False statements can result in hefty fines, settlements, and even criminal charges. An example of false statements occurred in 2001, when auditors at Arthur Andersen falsely assured investors that Enron was a healthy company. Later, auditors discovered that Enron had been inflating its stock price by hiding debt and falsely reporting healthy earnings.

 

• Bribery - This type of fraud involves offering or accepting items of value (e.g. cash, gifts, stocks, etc.) in exchange for a business advantage. Bribery can be difficult to uncover because it can be easy to hide if there is no paper trail. Bribery does not have to be related to obtaining contracts or gaining an unfair advantage during the bidding process. An example of bribery occurred in the 1990s when executives at Pacific Gas and Electric Company (PG&E) offered bribes to the California State Legislature in exchange for the ability to increase electricity rates. PG&E's actions allowed it to generate $100 million in additional profits, but they also resulted in several deaths due to wildfires caused by insufficiently maintained electrical grids.

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• Money laundering - This type of fraud involves disguising the source of illegally obtained funds by passing them through legitimate channels. Money laundering can be difficult to discover because it usually involves transactions between unrelated parties. Money laundering is often related to drug trafficking and other forms of organized crime. An example of money laundering occurred in 1996 when the Bank of New England was caught disguising cash from Colombian drug cartels as loans to a Caribbean casino. To avoid detection, the bank moved the money through an account linked to a Massachusetts insurance company. Another example of money laundering occurred in the early 2000s when the Russian government used banks in Cyprus and Latvia to launder billions of dollars in stolen funds. The government was eventually caught when it was discovered that the Russian Central Bank was printing massive quantities of high-denomination bank notes. A final example of money laundering occurred in 2012, when HSBC was discovered laundering billions of dollars in drug trafficking proceeds for Mexican and Colombian cartels. The bank avoided detection by setting a minimum dollar requirement for money transfers, neglecting to monitor large cash deposits, and failing to report suspicious activity.

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Causes of Corporate Fraud

Corporate fraud can occur when companies prioritize profits over ethics and are willing to take unethical or illegal actions to increase their bottom line. Some of the key factors contributing to corporate fraud include:

• Competition - In a competitive business environment, companies often feel pressured to achieve high profits to stay in business. If managers believe that unethical practices are necessary to achieve these profits, they may engage in fraudulent activities.

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• Pressure to perform - Managers and other employees who are under pressure to meet certain goals or produce certain results may be more likely to engage in fraudulent activities. While managers may not be directly responsible for meeting specific goals, they are often held responsible for achieving results. This puts managers under pressure to meet company expectations, even if doing so means engaging in fraudulent activities.

• Eroding ethical standards - As time passes, managers may come to view certain activities as normal or acceptable. Several decades ago, it was unlikely that companies would engage in practices such as accounting fraud. As time passes, ethical standards tend to erode, making it easier for managers to justify fraudulent activities.

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Impact of Corporate Fraud

​When companies engage in fraudulent activities, they can cause significant damage to their stakeholders. Shareholders often end up paying the price for fraud committed by company executives, particularly when the fraud involves the falsification of financial records. Customers can also be defrauded by a company, leading to a loss of money, time, and peace of mind. In some cases, customers may even be put in danger. Employees can also be negatively impacted by corporate fraud, particularly if fraud is committed by higher-ranking employees. Fraud also damages a company’s reputation, making it more difficult to attract new customers and raise capital.

Prevalence of Corporate Fraud

​Corporate fraud is unsurprisingly common, particularly among large companies with significant assets and connections. A study published in the Journal of Financial Crime found that 54% of companies had committed fraud during the previous year. The most common types of fraud included false or misleading financial reporting, accounting fraud, embezzlement, and misappropriation of funds.

More than half of the companies surveyed also reported a major fraud incident during the previous year. Another study found that a full 80% of management teams had engaged in ethical wrongdoing at some point. The most common types of ethical wrongdoing included: - Falsifying financial records - 65% - Hiding illegal activities - 63% - Stealing company funds - 62% - Misreporting production - 59% - Falsifying safety records - 54% - Hiding relationships - 52%.

Prevention of Corporate Fraud

​Given the prevalence of fraud in the business world, companies need to implement effective fraud prevention programs. Fraud prevention programs should include both reactive and proactive measures. Reactive measures are designed to detect fraudulent practices after they have occurred, while proactive methods focus on preventing fraud from occurring in the first place.

Conclusion

​If you are a shareholder and you believe you have been the victim of corporate fraud, contact securities fraud attorney Timothy L. Miles today for a free case evaluation. 

Timothy L. Miles, Esq.

Timothy L. Miles is a nationally recognized shareholder rights attorney raised in Nashville, Tennessee. Mr. Miles was recently selected by Martindale-Hubbell® and ALM as a 2022 Top Ranked Lawyer, 2022 Top Rated Litigator. and a 2022 Elite Lawyer of the South. Mr. Miles also maintains the AV Preeminent Rating by Martindale-Hubbell®, their highest rating for both legal ability and ethics. Mr. Miles is a member of the prestigious Top 100 Civil Plaintiff Trial Lawyers: The National Trial Lawyers Association, a superb rated attorney by Avvo, a recipient of the Lifetime Achievement Award by Premier Lawyers of America (2019) and recognized as a Distinguished Lawyer, Recognizing Excellence in Securities Law, by Lawyers of Distinction (2019). Mr. Miles has published over sixty articles on various issues of the law, including class actions, whistleblower cases, products liability, and more.  Please visit our website.