White Collar Crime

Two out of three corporate frauds go undetected, research finds

Christopher.Sorensen — Fri, 17 Feb 2023 17:51:14 +0000

Two out of three corporate frauds go undetected, research finds

Christopher.Sorensen Fri, 02/17/2023 - 12:51

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The collapse of auditing firm Arthur Andersen in connection with the Enron scandal in the early 2000s gave researchers a glimpse of how much corporate fraud was detected during a period of heightened scrutiny (photo by Allan Tannenbaum/Getty Images)

Rotman Staff

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Breaking Research

Research & Innovation

Rotman School of Management

White Collar Crime

For the University of Toronto’s Alexander Dyck, corporate fraud is like an iceberg: a small number is visible, but much more lurks below the surface.

But how much more? And at what cost to investors?

Alexander Dyck

Dyck, a professor of finance and economic analysis and policy at the Rotman School of Management, and his team found that under typical surveillance, about three per cent of U.S. companies are found doing something funny with their books in any given year. They arrived at the number by examining financial misrepresentations exposed by auditors, enforcement releases by the U.S. Securities and Exchange Commission (SEC), financial restatements and full legal prosecutions by the SEC against insider trading – all between 1997 and 2005.

However, the freefall and unexpected collapse of auditing firm Arthur Andersen, starting in 2001, due to its involvement in the Enron accounting scandal, gave Dyck and his colleages the chance to see how much fraud was detected during a period of heightened scrutiny.

Arthur Anderson had been working with 20 per cent of all U.S. publicly traded companies. Forced to find new auditors, those companies found themselves under a microscope due to their previous association with the disgraced accounting firm – presenting a “huge opportunity,” Dyck says.

While those companies didn’t show a greater propensity to fraud in the runup to the scandal, it was a different story once the spotlight was turned on between Nov. 30, 2001 – the date when Andersen client Enron began filing for bankruptcy – until the end of 2003. During that period, the new auditors, as well as regulators, investors and news media, were all looking much more closely at the ex-Andersen companies.

“What we found was that there was three times as much detected fraud in the companies that were subjected to this special treatment, as a former Andersen firm, compared to those that weren’t,” says Dyck, who holds the Manulife Financial Chair in Financial Services and is the director of the Capital Markets Institute at the Rotman School.

The researchers, which included Adair Morse of the University of California, Berkeley and Luigi Zingales of the University of Chicago, used the findings to infer that the real number of companies involved in fraud is at least 10 per cent – about three times greater than their previous estimates. That squares with previous research that has pegged the true incidence of corporate fraud between 10 and 18 per cent. While the researchers were looking at U.S. companies, Dyck speculated that the ratio of undetected-to-detected fraud is not significantly different in Canada.

The findings were published in the Review of Accounting Studies. Dyck is scheduled to present his research during an event hosted by the Capital Markets Institute on Feb. 23.

The researchers estimate that fraud destroys about 1.6 percent of a company’s equity value – mostly due to diminished reputation among those in the know, representing about $830 billion in current U.S. dollars.

The figures also help to quantify the value of regulatory intervention, such as the Sarbanes-Oxley Act, or SOX, introduced in 2002 in response to Enron and other financial scandals. The study shows the legislation would satisfy a cost benefit analysis even if it only reduced corporate fraud by 10 per cent of its current level.

The results should capture the attention of anyone with responsibility for corporate oversight and research, Dyck says.

“I spend a lot of time running a program for directors of public corporations and I tout this evidence when I say, ‘Do I think you guys should be spending time worrying about these things? Yes. The problem is bigger than you might think.’”

OSC should re-examine its policy of no-contest settlements, U of T expert writes in the Globe and Mail

geoff.vendeville — Wed, 11 Jul 2018 15:10:43 +0000

OSC should re-examine its policy of no-contest settlements, U of T expert writes in the Globe and Mail

geoff.vendeville Wed, 07/11/2018 - 11:10

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Anita Anand is the J.R. Kimber Chair in Investor Protection and Corporate Governance in the University of Toronto's Faculty of Law (photo by Johnny Guatto)

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Under a no-contest settlement, companies or individuals can resolve a dispute with the Ontario Securities Commission without having to admit wrongdoing.

The policy is meant to help the regulator enforce the law expeditiously. But law professor Anita Anand, the J.R. Kimber Chair in Investor Protection and Corporate Governance in the Faculty of Law, says there's reason to question the deterrence value and efficiency of no-contest settlements.

The average time taken to reach such a settlement has increased, while the process also lacks transparency, she argues in The Globe and Mail.

“We should question whether the alleged benefits of no-contest settlements, including efficiency and deterrence, outweigh the weaknesses of this enforcement program,” she says.

U of T sociologist Nathan Innocente on mortgage fraud and identity theft

ullahnor — Mon, 23 Jan 2017 17:36:04 +0000

U of T sociologist Nathan Innocente on mortgage fraud and identity theft

ullahnor Mon, 01/23/2017 - 12:36

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Nathan Innocente: “They understand how the system works, and what to say. Within a week, they can pocket several hundred thousand dollars and disappear”

Blake Eligh

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Blake Eligh

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Imagine making monthly mortgage payments to the bank for years – decades, even – and then discovering that your property had been stolen on paper, without your knowledge.

Criminology expert Nathan Innocente with U of T Mississauga’s sociology department, studies how the very systems meant to support real estate deals can create new opportunities for mortgage fraud and identity theft.

In his research, Innocente investigates how different parties involved in a typical real estate deal interact with each other, following the transaction process from title insurance companies to mortgage brokers and lending institutions, and the lawyers who help to finalize a sale.

Transactions can be impacted by factors that include changes in the way the state handles land title information, shifts in technology, or even in the way various players communicate with each other as they provide loans, execute conveyancing or finalize a deal.

“I’m interested in how these changes impact security or create loopholes that outsiders can potentially exploit to perpetuate a crime,” Innocente says.

One such change is the introduction of electronic land title searches.

“About 20 years ago, Ontario became one of the first jurisdictions to switch to an electronic land registration system,” Innocente says. “All the files that had been on paper at a registry office became available electronically. Along with the introduction of title insurance, transactions suddenly became much faster.”

While the system is secure, Innocente notes that high volumes of transactions are the most profitable business model for lenders.

“People want to do things over the phone or through a broker because it’s more convenient and faster,” he says. “Banks now have the ability to do more business, but that expedited system creates anonymity. A transaction can become corrupt and never get caught.

“Unlike white collar crime, which might involve a corrupt broker or lawyer, identity fraud is committed by people from the outside of the system,” Innocente says. ”Someone who understands a little of the system and can sufficiently mask an identity can exploit that.”

A typical identity theft scam might feature people posing as renters. They pay advance rent in cash, obtain fake identification, pretend to be the owner and sell the house.

“They understand how the system works, and what to say. Within a week, they can pocket several hundred thousand dollars and disappear,” Innocente says.

“Other real estate-related crimes include forging financial statements to secure a loan or misrepresenting the value of a property to a potential buyer.

“They are fascinating crimes but are not widely known about because the companies who have the best data, like lenders or title insurers, don’t release the [data],” Innocente says. “We simply don’t know the exact numbers on how often this happens. There are very few claims to title insurance and lenders are reluctant to release this data because it impacts their institutional reputation.”

Innocente’s research reveals that changing the system to prevent fraud is equally tricky.

“There is no incentive to make the system better,” he says. “In the past if a fraud occurred, the home owner was on the hook for the lost money. But the advent of title insurance in the 1990s ensures that the homeowner recovers those financial losses.”

Other levels of insurance protect the lenders, title insurers and lawyers when a deal goes wrong.

“If you’re insured, what’s the loss? There’s a real disincentive to exercise tight diligence, which means these cases will go through the system because the checks and balances aren’t there, or because they are viewed as too difficult and impractical to implement.”

White Collar Crime

Two out of three corporate frauds go undetected, research finds

OSC should re-examine its policy of no-contest settlements, U of T expert writes in the Globe and Mail

Read more in the Globe and Mail

U of T sociologist Nathan Innocente on mortgage fraud and identity theft