When millions, and sometimes billions, of dollars are on the line, some individuals are willing to play dirty. In the past, financial scandals have wreaked havoc by shaking investor confidence and threatening the financial system’s stability. In the aftermath, governments and regulators often rush to enact reforms aimed at preventing such catastrophes in the future.
While it can be difficult to identify accounting fraud and misreporting, there are some telltale signs that should alert investors to potential problems. For example, a company that consistently misses earnings estimates and fails to disclose significant changes in the business may be committing fraud or misreporting. The personal and professional background of the responsible parties will also be carefully investigated, particularly if there is a documented pattern of criminal activity or involvement in other fraudulent schemes.
In the wake of the global financial crisis, we have seen a number of high-profile accounting scandals. One of the most prominent was the Bernie Madoff Ponzi scheme, which cost investors more than $170 billion. Another is the 2001 Enron bankruptcy, which involved the energy giant hiding massive debt through a series of off-the-book partnerships and accounting tricks. It was only when Sherron Watkins blew the whistle that investors began to realise the truth. More recently, Germany’s Wirecard was exposed for engaging in extensive accounting fraud over several years, and the EUR1.9 billion it claimed in accounts probably never existed. Similarly, Patisserie Valerie’s fraud was revealed after the Serious Fraud Office and FRC launched investigations into the firm’s finances.