When Fraud Pays: Executive Self‐Dealing and the Failure of Self‐Restraint

• Date: 01 December 2007
• Published date: 01 December 2007
• DOI: http://doi.org/10.1111/j.1744-1714.2007.00046.x
• Author: Daniel T. Ostas

When Fraud Pays: Executive

Self-Dealing and the Failure of

Self-Restraint

Daniel T. Ostas

n

I. INTRODUCTION

Fraud is a generic term that encompasses the multifarious and often

ingenious means by which one individual can gain an advantage over

another through deliberate false suggestion, concealment, or misrepre-

sentation of the truth.

1

Fraudulent acts include the submitting of

false claims, tampering with scales and measures, false bookkeeping, tax

evasion, and intentionally lying in contractual negotiations. In ethical

terms, fraud combines deliberate falsehoods with a conscious willingness

to prey on the trusting nature and reliance needs of others; hence, fraud

carries strong moral disapprobation.

2

In law, fraud constitutes a defense to

a breach of contract action, an affirmative cause of action in tort, and a

crime.

r2007, Copyright the Author

Journal compilation r2007, Academy of Legal Studies in Business

571

American Business Law Journal

Volume 44, Issue 4, 571–601, Winter 2007

n

Professor of Legal Studies and Harlow Chair in Business Ethics, Michael F. Price College of

Business, University of Oklahoma; B.S., Purdue University; J.D., IndianaUniversity School of

Law; Ph.D. (Business Economics), Indiana University School of Business.

1

BLACK’SLAW DICTIONARY 685 (8th ed. 2004) (defining fraud as a ‘‘knowing misrepresentation

of the truth or the concealment of a material fact to induce another to act to his or her

detriment’’).

2

For a practical discussion of the ethical dimensions of fraud in a common law context, see

G. Richard Shell, When Is It Legal to Lie in Negotiations? 32 SLOAN MGMT.REV. 93, 99 (1991)

(noting that, if a negotiation seems unethical, it is likely to be illegal as well). See also Alan

Strudler & Eric W.Orts, Moral Principle in the L aw of Insider Trading,78T

EX.L.REV.375, 409–20

(1999) (offering an ethical analysis of insider trading as a guide to understanding several vagaries

incumbent in insider trading law).

Although difficult to measure, a significant amount of fraud see-

mingly touches every American industry and commercial endeavor.

3

The

Department of Justice estimates that fraud in the health care industry

aloneFincluding such practices as phantom billing, double billing, illegal

kickbacks, and the prescription of unneeded medical proceduresF

amounts to between three and ten percent of total public and private

health care expenditures, or as much as $210 billion annually.

4

The annual

cost of tax fraud tallies even higher. The Internal Revenue Service (IRS)

recently estimated that tax fraud for the year 2001 totaled $290 billion, or

more than 13% of all taxes owed.

5

Most of these frauds involved the

underreporting of self-employment income and the illegal use of offshore

tax shelters.

6

In addition, the recent Enron scandal brought the many

forms of ‘‘executive fraud,’’

7

including fraudulent self-dealing, falsification

of financial information, and illegal market manipulations, to the center

stage of public awareness. At Enron and elsewhere, corporate executives

3

See generally DAVID CALLAHAN,THE CHEATING CULTURE:WHY MORE AMERICANS ARE DOING

WRONG TO GET AHEAD (2004) (surveying and discussing fraudulent behavior in a wide variety

of settings). Callahan maintains a Web site, www.cheatingculture.com (last visited Feb. 23,

2007), providing information on cheating as an American cultural phenomenon.

4

See U.S. D.O.J. FEDERAL BUREAU OF INVESTIGATION (FBI), FINANCIAL CRIMES REPORT TO THE

PUBLIC, C-1 (2005) (noting that health care expenditures totaled more than $2.1 trillion in

2004 and estimating fraud at 10%); see also Blue Cross Blue Shield Association Anti Fraud

Report at www.bcbs.com/antifraud (last visited Feb.23, 2007) (estimating health care fraud at

about three to five percent of total expenditures).

5

See U.S. GOVT’SACCOUNTABILITY OFFICE, GAO-05-753, TAX COMPLIANCE:BETTER COMPLIANCE

DATA AND LONG-T ERM GOALS WOULD SUPPORT A MORE STRATEGIC IRS APPROACH TO REDUCING THE

TAX GAP 3 (2005), http://www.gao.gov/new.items/d05753.pdf. The IRS Report took several

years to complete and was released in July 2005. It was the first comprehensive government

assessment of tax fraud since 1988. See generally Robert E. Brown & Mark J. Mazur, IRS’s

Comprehensive Approach to Compliance Measurement 1 (June 2003), http://www.irs.gov/irs-soi/

mazur.pdf (discussing the methodology of the study).

6

See Richard Wolf, Some See Unpaid Taxes as $400B Deficit Miracle Cure, USA TODAY, Mar. 1,

2006, at A1.

7

As used herein, the term ‘‘executive fraud’’ is roughly synonymous with the term ‘‘corporate

fraud’’ as defined internally within the Department of Justice. These frauds include: (1)

falsification of financial information, (2) self-dealing by corporate insiders, (3) abusive trading

practices including market and transaction timing schemes, and (4) obstruction of justice with

regard to the first three categories. See Corp. Fraud Task Force Rep. No. 2, at 3.2 (2004).

Because these frauds are perpetrated by high-ranking corporatee xecutivesrather than by the

corporations themselves, with stockholders typically the victims, the term executive fraud

seems apt.

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