1.4 Statistics

It is difficult to know how much financial statement fraud exists. Probably the best measure of the amount of financial statement fraud is to look at SEC Accounting and Auditing Enforcement Releases (AAERs)Public documents released by the SEC when a company commits financial statement fraud or other perceived inappropriate activities.. One or more enforcement release is typically issued when financial statement fraud occurs at a company whose stock is publicly traded.

While several studies have examined AAERs, the most recent study was conducted by the Anti-Fraud Collaboration, which was formed by organizations that represent the largest independent auditing firms (e.g., the Big Four), financial executives such as CFOs, internal auditors, and corporate directors. This study examined 204 AAERs dated between January 2014 and June 2019. The study’s objective was to identify higher-risk areas and found that the most common fraud involved improper revenue recognition, which was the most prevalent fraud scheme in nearly every year of the study. Other common frauds included inadequate liability reserves, inventory misstatement, and impairment issues.

In addition to identifying common fraud schemes, the study noted that some industry sectors were more frequently charged by the SEC. Leading the pack were technology services companies, while finance, energy, manufacturing, and health care industries also were commonly charged with accounting and reporting issues. Additionally, the report noted that chief financial officers were most commonly charged with fraud, followed by chief executive officers. The cases involved companies of all sizes.1

Years prior to this study, a comprehensive study was commissioned by the Committee of Sponsoring Organizations (COSO)An organization made up of representatives from major accounting organizations that is concerned about internal controls and financial statement fraud. of the Treadway CommissionThe National Commission on Fraudulent Financial Reporting that made recommendations related to financial statement fraud and other matters in 1987.. In the study, all financial statement frauds from 1998 to 2007 were analyzed. The results of this study were published in early 2010. Although this study is dated, it documented results that are similar to those of the most recent study, including that the most common technique used to manipulate financial statements was improper revenue recognition.

Another similar finding is that in the majority (89%) of the cases, the CEO and/or CFO was named in the AAER for some level of involvement in the fraud. Additionally, within two years of the completion of the investigation, 20% of the CEOs/CFOs were indicted, and over 60% of those indicted had been convicted.

This study also looked at the consequences of fraud for the company that committed it and found that once the news of an alleged fraud reached the press, company stock declined, on average, 16.7%. Furthermore, news of an SEC or Department of Justice investigation resulted in a roughly 7.3% abnormal stock price decline. Another severe consequence associated with financial statement fraud is that companies that engaged in fraud often experienced bankruptcyA legal process that either allows a debtor to work out an orderly plan to settle debts or liquidates a debtor’s assets and distributes them to creditors., delisting from stock exchanges, and/or material assets sales following the discoveryThe legal process by which each party’s attorneys try to find all information about the facts of a case and of the other side’s case before a trial begins. of the fraud.2

These findings are consistent with other similar reports such as the Report Pursuant to Section 704 of the Sarbanes-Oxley Act of 2002 prepared by the SEC. The study, like previous studies, found that the Commission brought the greatest number of actions in the area of improper revenue recognition, including the fraudulent reporting of fictitious sales, improper timing of revenue recognition, and improper valuation of revenue. There were also a relatively high number of enforcement matters that involved improper expense recognition.3 The specific types of financial statement fraud involving revenue and expense recognition that were found in the enforcement releases are shown in Table 1.1.

As mentioned earlier, a common thread in these studies is that the majority of the persons held responsible for the accounting violations were members of senior management, including board chairs, chief executive officers, presidents, and chief financial officers. In other words, top management are usually involved in financial statement fraud. For this reason, another name for financial statement fraud is management fraud.

Some of the cases that occurred between 1997 and 2002 included Enron, WorldCom, Cendant, Qwest, Xerox, Sunbeam, and Waste Management. Many of these frauds led to huge bankruptcies, the loss of investor confidence, and the loss of trillions of dollars in market value. In fact, three of the ten largest bankruptcies in history included WorldCom, Enron, and Conseco, which all involved large-scale financial statement frauds. Table 1.2 shows the ten largest bankruptcies since 1980.