Fraudulent financial reporting by U.S. public companies often results in bankruptcy or business failure, according to a new study, and often results in significant immediate losses for shareholders and penalties for executives.
The study, by the Committee of Sponsoring Organizations of the Treadway Commission, also known as COSO, examined financial statement fraud allegations investigated by the U.S. Securities and Exchange Commission over a 10-year period. The study found that news of an alleged fraud resulted in an average 16.7 percent abnormal stock price decline in the two days surrounding the announcement.
Companies engaged in fraud often experienced bankruptcy, delisting from a stock exchange, or asset sale, and in nine out of 10 cases the SEC named the CEO or CFO for alleged involvement.
All parties involved in the financial reporting process need to continue to focus on ways to prevent, deter and detect fraudulent financial reporting, COSO chairman David Landsittel said in a statement. COSO plans to sponsor additional research on fraudulent financial reporting, as well as the development of further internal control-related guidance to assist those involved in the financial reporting process.
The study, Fraudulent Financial Reporting: 1998-2007, examines nearly 350 alleged accounting fraud cases investigated by the SEC. It shows that financial fraud affects companies of all sizes, with the median company having assets and revenues just under $100 million. The median fraud was $12.1 million. More than 30 of the fraud cases each involved misstatements or misappropriations of $500 million or more. The SEC named the CEO and/or CFO for involvement in 89 percent of the fraud cases. Within two years of the completion of the SEC investigation, about 20 percent of CEOs/CFOs had been indicted. Over 60 percent of those indicted were convicted.
Revenue frauds accounted for over 60 percent of the cases. Many of the commonly observed board of director and audit committee characteristics such as size, meeting frequency, composition, and experience do not differ meaningfully between fraud and no-fraud companies. Recent corporate governance regulatory efforts appear to have reduced variation in observable board-related governance characteristics.
Twenty-six percent of the firms engaged in fraud changed auditors during the period examined, compared to a 12 percent rate for no-fraud firms. Initial news in the press of an alleged fraud resulted in an average 16.7 percent abnormal stock price decline for the fraud company in the two days surrounding the announcement. News of an SEC or Justice Department investigation resulted in an average 7.3 percent abnormal stock price decline. Companies engaged in fraud often experienced bankruptcy, delisting from a stock exchange, or material asset sales at rates much higher than those experienced by no-fraud firms.
The full text of the study is available at www.coso.org.
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