Can we eliminate fraud and other financial shenanigans?

• Author: Schilit, Howard M.
• Position: Corporate and banking scams

FINANCIAL shenanigans often can cause great harm to individuals, companies, and society. On a micro level, they hurt investors, lenders, employees, and vendors; on a macro level, they result in resources being allocated to the wrong companies--those that deceive the public with accounting tricks.

Something must be done to remedy this problem. Financial sleight of hand and other improprieties must be exposed for all to see. Scamsters can be stopped only if the public is educated better and continues learning new techniques for detecting their tricks. By studying and learning from yesterday's financial reporting failures, investors, lenders, and others can recognize early warning signs of accounting gimmicks and fraud and consequently avoid being hurt by tomorrow's scams.

In the realm of financial reporting, 1992 might be remembered as the "Year of the Scam." As it was unfolding, Americans learned details of the collapse of Cascade International and Maxwell Communications. By April, news of College Bound's financial shenanigans had been covered in the national press. By summer, the media reported about the massive inventory fraud at Phar-Mor. Just in time for Thanksgiving, the public learned that the top executives at Comptronix had falsified its financial records for at least three years. If that wasn't enough, two mega financial scams from previous years were settled in 1992--MiniScribe and Lincoln Savings & Loan. A then record $128,000,000 in damages was paid to settle numerous lawsuits against MiniScribe, only to be eclipsed by $400,000,000 to cover lawsuits related to Lincoln and several other S&Ls.

While 1992 was a particularly busy year for financial shenanigans, "creative accounting" and outright fraud have been around since the time of the pyramids, when the Pharaohs received misleading information from their builders about the number of stones and material used. More recently, the first half of the 20th century witnessed numerous instances of accounting manipulation in corporate annual reports, leading to grossly overvalued stock prices and contributing to the collapse of the U.S. stock market between 1929 and 1932. For example, International Power, Inc.'s stock dropped 78 points in a single day when it was reported that the company had falsified its financial records.

In addition to issuing misleading corporate financial reports, swindlers and con artists caused investors and bondholders to suffer great losses. Charles ("Get Rich Quick") Ponzi, perhaps the best-known con artist in history, duped investors with promises of incredibly high returns. He used the...