Worldwide: Looters Have a Foothold

CPAs are very aware of the rise in global securities fraud and are working hard to combat it. Terrorists and insurgents frequently use fraud to finance their operations and launder their funds. When fraud becomes endemic in a nation, it can produce radical political changes that bring to power leaders who are hostile to market economies and democracy and who often are strongly anti-American.

Executives who strip corporations of money for their own use (called “looting control frauds” in criminological circles) use accounting fraud as a weapon of choice to inflate income and net worth. They also use normal corporate mechanisms to convert corporate assets to their own personal benefit before the company collapses. Because of the vigilance of the American accounting profession and tough new regulations such as the Sarbanes-Oxley Act, the problem in the United States may pale in comparison to other corners of the world.

Looters are succeeding in various parts of the globe because of several factors. The expansion of privatization of state-owned enterprises (SOEs) over the last two decades has led to a dramatic global upsurge in commercial enterprises, which increases the potential for private-sector looting. The mishandling of privatization creates the incentives for looting. For example, many of the SOEs in the former Soviet Union were noncompetitive and likely to produce long-run losses. The plants were obsolete, environmental disasters. In China, SOEs received subsidies through bank “loans” from other SOEs. Of course, the state banks were insolvent, but they too were implicitly subsidized by the state. By virtually guaranteeing the noncompetitive SOEs would not be permitted to fail, the Communist Party created an incentive for the managers to loot “their” SOEs.

Regrettably, these waves of privatization were undertaken without providing regulations strong enough to make an advanced private-sector economy effective. The economists who designed the systems had no experience in fraud prevention and seem to have assumed that the necessary control mechanisms would develop spontaneously. Instead, without a rule of law, honest courts, real banks or effective secured transactions, the result too often was endemic fraud.

In Latin America, privatization should have been more successful because those nations often had moderately effective institutions. Corruption was rife in the process, which frequently meant government officials sold valuable SOEs to cronies at a fraction of their true market value. Unfortunately, political cronies rarely are selected for business acumen, and many of the privatization efforts failed.

As the world has seen, fraud and corruption can endanger our very lives:

• A Chechen suicide bomber used a tiny bribe to escape arrest and bypass airport security and thus he was able to bring down an airliner.

• The former governor of Illinois recently was convicted of corruption. One part of that scandal involved bribes that led to the fraudulent award of commercial trucking licenses to hundreds of unqualified drivers—and, ultimately, the bribes led to fatal accidents that killed innocent people.

• Terrorists willing to pay under-the-table money could very well penetrate our national security.

We cannot “win” a decisive battle against fraud. We need to be eternally vigilant against fraud and work cooperatively with other nations. The Institute for Fraud Prevention (IFP) can help build those alliances—and CPAs and lawyers are vital to the effort. CPAs ensure the reliable accounting essential to any well-functioning enterprise; lawyers have taken the lead in helping to create a rule of law in emerging states.

The time-tested virtues of independence, professional skepticism and competence have never been so important. We have to take control fraud (that is, fraud perpetrated by management) seriously—that means recording it when we detect it (the Justice Department does not keep statistics on control frauds) and conducting research to learn how to spot it before it causes catastrophic damage. The results of the IFP’s research will provide the guidance to expand the education of auditors, to improve the management of audits and to better regulate securities. The information gathered by the IFP will be a major factor in the global effort to detect and prevent fraud.  

William K. Black, PhD, JD, the executive director of the Institute for Fraud Prevention, is an associate professor of economics and law at the University of Missouri at Kansas City. He began his career as an attorney, became a regulator during the savings-and-loan debacle in the 1980s and, after obtaining a doctorate in criminology, joined the academic community at the LBJ School of Public Affairs at the University of Texas at Austin. Mr. Black is a highly regarded expert in the area of management fraud and corruption.