Posts Tagged ‘fraud’
“Things gained through fraud are never secure”*…
… Still, the damage done to the defrauded is too often too real. A unsettling report from the front lines of financial accounting…
The level of corporate earnings manipulation is similar to that of past pre-recessionary periods, according to research by professors at the University of Missouri and Indiana University.
Their finding is based on the M-Score, a screening model that catches fraud in corporate earnings reports. Messod Daniel Beneish, a professor at the Indiana University Kelley School of Business, created the M-Score in the 1990s. The “M” stands for manipulation, and the measure is also sometimes referred to as the Beneish M-Score.
Based on known examples of past financial misreporting, the M-Score combines eight ratios on a company’s balance sheet to assess its fraud risk. A higher M-Score means a company is more likely to be manipulating its earnings.
“It allows us to assess fraud risk in real time,” said Matt Glendening, an accounting professor at the University of Missouri. “The advantage of using a measure such as the M-Score is that if you use actual instances of accounting fraud, not all cases are caught, especially the less severe cases. And also, there is a delay between the misreporting period and the time at which the fraud is actually revealed.”
One notable M-Score success came in 1998, when a group of Cornell students used the M-Score to flag Enron as having an elevated fraud risk. This was three years before the public learned that the company was inflating its profits, resulting in what was then the largest corporate bankruptcy in history and several executives going to jail.
…
Corporate earnings are traditionally manipulated either by overstating revenues or understating expenses. How companies do this varies, but it could include recognizing sales revenues early or understating inventory.
“There are all sorts of capital market pressures on firms to maintain stock price, maintain earnings growth,” Glendening said. “There could also be some compensation incentives at play.”
In 2019, Beneish expanded the M-Score, creating a new measure that goes beyond individual companies to the economy as a whole. With the help of Glendening and two other co-authors, Beneish created the aggregate M-Score, which now compiles the M-Scores of 2,004 companies to measure the likelihood of earnings manipulation across the economy. Earlier in 2023, the aggregate M-Score was at its highest level in 40 years.
“Accounting manipulation matters for the economy at large,” Glendening said. Companies use other business’ earnings data to inform hiring, purchasing, and production decisions. “What we are finding is that the level of aggregate misreporting is very similar to what we’ve observed in pre-recessionary periods.”
Ask not for whom the bell tolls: “This little-known accounting measure is ringing an economic warning bell,” from Kai Ryssdal (@kairyssdal) and Andie Corban on @Marketplace.
See also: “Corporate Fraud” (source of the image above)
* Sophocles
###
As we look more closely, we might recall that it was on this date in 1974 that the House Judiciary Committee voted to recommend that America’s 37th president, Richard M. Nixon, be impeached and removed from office for a variety of offenses that arose from the Watergate Affair. Several days later (August 5), as the full house discussed the trial, the “Smoking Gun” tape was released, demonstrating that Nixon was in fact involved in the cover-up. His political capital destroyed, Nixon resigned– in a nationwide television address– on August 8, effective the next day.
“Long life is welcome, agreeable, pleasant, and hard to obtain in the world”*…
… maybe, as recent research from Saul Justin Newman explains, even harder than we thought…
The observation of individuals attaining remarkable ages, and their concentration into geographic sub-regions or ‘blue zones’, has generated considerable scientific interest. Proposed drivers of remarkable longevity include high vegetable intake, strong social connections, and genetic markers. Here, we reveal new predictors of remarkable longevity and ‘supercentenarian’ status. In the United States supercentenarian status is predicted by the absence of vital registration. In the UK, Italy, Japan, and France remarkable longevity is instead predicted by regional poverty, old-age poverty, material deprivation, low incomes, high crime rates, a remote region of birth, worse health, and fewer 90+ year old people. In addition, supercentenarian birthdates are concentrated on the first of the month and days divisible by five: patterns indicative of widespread fraud and error. As such, relative poverty and missing vital documents constitute unexpected predictors of centenarian and supercentenarian status, and support a primary role of fraud and error in generating remarkable human age records…
The paper in full: “Supercentenarian and remarkable age records exhibit patterns indicative of clerical errors and pension fraud,” at @biorxivpreprint.
(Image above: source)
* Buddha
###
As we long for longevity, we might send healthy birthday greetings to William H. Welch; he was born on this date in 1850. A physician, pathologist, bacteriologist, and medical educator, He was one of the “Big Four” founding professors at the Johns Hopkins Hospital, the first dean of the Johns Hopkins School of Medicine, and the founder of the Johns Hopkins School of Hygiene and Public Health, the first school of public health in the country.
Welch revolutionized American medicine by demanding of its students a rigorous study of physical sciences and an active involvement in clinical duties and laboratory work. His students included Walter Reed, James Carroll and Simon Flexner.
“For the sake of the science, it might be time for scientists to start trusting each other a little less”*…
We’ve looked at methodical problems in scientific and medical research before (see here, here, and here). Let us turn now to outright dishonesty. The rising number of retracted research papers suggests that either medical research fraud is on the rise or that efforts to spot it are getting better. Either way, it’s a problem …
… Partly or entirely fabricated papers are being found in ever-larger numbers, thanks to sleuths like Dr Mol. Retraction Watch, an online database, lists nearly 19,000 papers on biomedical-science topics that have been retracted (see chart 1). In 2022 there were about 2,600 retractions in this area—more than twice the number in 2018. Some were the results of honest mistakes, but misconduct of one sort or another is involved in the vast majority of them…
… Yet journals can take years to retract, if they ever do so. Going by these numbers, roughly one in 1,000 papers gets retracted. That does not sound too bad. However, Ivan Oransky, one of Retraction Watch’s founders, reckons, based on various studies of the matter and reports from sleuths, that something more like one in 50 papers has results which are unreliable because of fabrication, plagiarism or serious errors…
… It is often asserted that science is self-correcting. And it is true that, if a claimed result is important enough, an inability to replicate it or of subsequent work to conform to it will eventually be noticed. In the short term, though, it is easy to hide in the shadows. Even co-authors of a data-fabricating scientist—those, in other words, who are closest to him or her—may not notice what the culprit is up to. In complex studies of a particular disease, several types of researchers will be involved, who are, by definition, not experts in each other’s fields. As Dr Bishop observes, “You just tend to take on trust the bits of data that somebody else has given you.”…
In the end, however, keeping fakes out of the scientific record depends on the willingness of publishers to stump up more resources. Statistical checks of clinical-trial papers often involve laborious manual work, such as typing up specific data in spreadsheets. This would require journals to hire dedicated staff, cutting into profits.
Many academics who have spent years trying to get fabricated papers retracted are pessimistic that better ways to detect fraud will, alone, make a big difference. Dr Roberts and Dr Mol want journals to be regulated in the way that social media and the news business are in some countries, with standards on what they publish. Peter Wilmshurst, a British cardiologist who has raised the alarm about numerous cases of research misconduct in his field, thinks there should be criminal penalties for those who fabricate data. Dr Gunsalus wants universities to make public the reports from their research-fraud investigations. And everyone agrees that publish or perish is a recipe for disaster.
None of these solutions will be quick or straightforward. But it is now clear that choosing to look the other way is causing palpable harm to patients…
“There is a worrying amount of fraud in medical research- and a worrying unwillingness to do anything about it,” from @TheEconomist.
* Stuart Ritchie, Science Fictions
###
As we look harder, we might spare a thought for Alfred Habdank Skarbek Korzybski; he died on this date in 1950. Trained as an engineer, he developed a field called general semantics, which he viewed as both distinct from, and more encompassing than, the field of semantics. He argued that human knowledge of the world is limited both by the human nervous system and the languages humans have developed, and thus no one can have direct access to reality, given that the most we can know is that which is filtered through the brain’s responses to reality. (Korzybski assumed that the quest for knowledge was an authentic, honest one; that said, if “human nervous system” an be understood to extend to “human nature”…)
Korzybski was influential in fields across the sciences and humanities through the 1940s and 50s (perhaps most notably, gestalt therapists), and inspired science fiction writers (like Robery Heinlein and A.E. van Vogt) and philosophers like Alan Watts.
His best known dictum is “The map is not the territory.”
“Hard times arouse an instinctive desire for authenticity”*…
… but that authenticity can be hard to find…
In 2016, US retailer Target severed ties with textile manufacturer Welspun India after discovering that 750,000 sheets and pillowcases labelled Egyptian cotton were not 100% Egyptian after all.
Egypt has long been known for producing long- and extra-long-staple cotton, a variety of the crop with especially long threads that results in softer and more durable fabric – so products labelled Egyptian typically command a higher price. But the year after the Welspun incident, the Cotton Egypt Association estimated that 90% of global supplies of Egyptian cotton in 2016 were fake.
Egyptian cotton is not the only fabric that has fallen foul of mislabelling in recent years. In 2020, the Global Organic Textile Standard (Gots) said that 20,000 tonnes of Indian cotton had been incorrectly certified as organic – around a sixth of the country’s total production. In 2017, a Vietnamese silk brand admitted that half of its silk actually came from China. And in 2018, several British retailers had to withdraw “faux” fur products that turned out to be the real thing.
From choosing an organic cotton T-shirt to buying trainers made out of recycled plastic bottles, many of us opt to pay more in the hope that our purchase will be better quality, or help people or the planet. However, as the Welspun incident and others have shown, when it comes to textiles, we’re not always getting what we think we’ve paid for…
How can we tell if the clothes in our wardrobes really are what they claim to be? “Why fabric fraud is so easy to hide,” from @BBC_Future.
* Coco Chanel
###
As we root around for the real, we might recall that it was on this date in 1938 that Howard Hawks’ comedy Bringing Up Baby premiered at the Golden Gate Theater in San Francisco. Featuring Cary Grant, Katherine Hepburn, and a leopard, the film earned good reviews but suffered at the box office. Indeed, Hepburn’s career fell into a slump– she was one of a group of actors labeled as “box office poison” by the Independent Theatre Owners of America– that she broke with The Philadelphia Story (again with Grant) in 1940.
As for Bringing Up Baby, the film did well when re-released in the 1940s, and grew further in popularity when it began to be shown on television in the 1950s. Today it is recognized as the authentic screwball classic that it is; it sits at 94% on Rotten Tomatoes, and ranks among “Top 100” on lists from the American Film Institute and the National Society of Film Critics.
“The opposite of knowledge is not ignorance, but deceit and fraud”*…
In follow-on to our last look at corporate fraud, a provocative piece by Byrne Hobart…
This paper has been getting some attention lately for its eye-catching estimates: 11% of publicly traded companies are committing securities fraud every year, with an annual cost of over $700bn…
[There follows an illuminating discussion of lessons that can be drawn for the follow-on to Arthur Andersen’s collapse after the implosion of Enron, the rules/regulations developed then to prevent similar public company frauds, and a consideration of whether corporate fraud has waned– at least among publicly-traded companies– and is perhaps a little less wide-spread than the paper argues…]
But since fraud is a human problem, and not purely a matter of better accounting standards, it’s not likely to have just gone away. But if the rate of accounting problems among big publicly-traded companies is lower than the 11% number cited in the paper, the question isn’t “why did it disappear?” but rather “where did it go?” And we can take our list of trends against fraud and invert them:
• Sarbanes-Oxley does apply to private companies, but only on the penalty side, not the disclosure side. But accounting frauds in private companies are often less visible; many investments go to zero, anyway, and it’s less embarrassing for everyone involved not to say why.
• There are no short-sellers in private markets. There have been efforts here, but they don’t work out because the market doesn’t clear (“everyone wanted to short Theranos, Dropbox and WeWork”). The closest you can get to shorting is to pass on a round and then brag about it later. Big deal: I didn’t invest in FTX, either.
• There’s less data available on private companies, though the rise of alternative data tools means it’s easier to get decent proxies.
• Startups are not expected to return capital. It’s a bad sign if they do. They’re often valued either based on strategic considerations or starting with a multiple of sales—a dollar of sales is much easier to fake than a dollar of earnings or cash flow, so the incentive to do so is strong.
• The idea market in startups is liquid when it comes to successes, but it would be pretty tacky for a VC to write a long blog post explaining why they passed on a live deal. (That memo may exist internally, but to the extent that it’s shared it’s in the form of a quick summary over Twitter DM or Signal.)
JPMorgan Chase’s writedown of their fintech acquisition Frank is a great case study in all of these forces. The NYT has a good story digging into the details: Frank’s founder is a serial exaggerator whose self-promotion veered into fraud (once again, if the rate of continuous improvement in public perception to be maintained exceeds what the fundamentals can deliver, compound interest works its ruthless magic). The company was valued at a high multiple of what turned out to be a flexible metric, total email addresses captured. And there were alternative datasets that could have pointed to problems: given the likely number of student aid applicants in the US, Frank’s numbers implied that it had reached near-dominant market share in the category with little marketing. Meanwhile, its monthly site traffic was not enough to have acquired that sizable a customer list over Frank’s entire existence. So it could have been caught, if the buyer had been looking for fraud. But one paradox of frauds and cheats in general is that lying is less than half the work—most of the effort is in appearing not to need to lie. The more impressive a company looks, the more embarrassing the basic due diligence questions are.
A down market and a series of high-profile failures might give private markets the same kind of natural experiment that Arthur Andersen’s failure did for public markets. Due diligence checklists will get longer and more thorough, and new funding rounds will feel more like a cross-examination and less like a party. One reason for a high base rate of fraud is that at least some of it stems from inattention rather than malice—the Arthur Andersen study finds that most of the frauds were fairly minor, and could be more the result of poor internal metrics than of intent to mislead. But either way, standards will get higher, and private companies will need to step up their efforts accordingly…
Has the primary locus of corporate fraud moved from public to private companies? “Where Fraud Lives and Why,” from @ByrneHobart.
[Image above: source]
* Jean Baudrillard
###
As we do due diligence, we might recall that it was on this date in 2016 that the Centers for Medicare and Medicaid Services (CMS) sent a letter to Theranos after an inspection of its Newark, California, lab. The investigation, which took place in the fall of 2015, had found that the facility did not “comply with certificate requirements and performance standards” and caused “immediate jeopardy to patient health and safety.” This followed on three exposes on Theranos in the Wall Street Journal (in October [here and here] and December of 2015) and a critical FDA report. Things unraveled from there: in March, 2018, Thearnos, CEO Elizabeth Holmes, and President Sunny Balwani were charged by the FCC with fraud. Three month later, a federal grand jury indicted both Holmes and Balwani on two counts of conspiracy and nine counts of wire fraud, finding that the pair had “engaged in a multi-million dollar scheme to defraud investors, and a separate scheme to defraud doctors and patients.” Theranos closed in 2018. Holmes was convicted and sentenced to 11 years in prison for her crimes (a sentence she is appealing); Balwani, to 13 years.
Theranos was a private company, funded by investors including Henry Kissinger, Betsy DeVos, Carlos Slim, and Rupert Murdoch.
Elizabeth Holmes found guilty (source)
You must be logged in to post a comment.