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.
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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.
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