adds value beyond that of the debentures if expectations are that the market price for shares will exceed the
conversion price during the option period.
HF earned its fees based on the dollar value of
assets under management (AUM): the higher the AUM,
the higher the fees, creating an incentive for HF to report
its assets at the highest possible values.
The loan markets tightened severely in 2007. Interest
rates on collateralized debt obligations, repackaged
bonds and loans, including subprime mortgage debt,
rose sharply in December 2006 and January 2007. On
July 10, Standard & Poor’s slashed ratings on approximately $12 billion of subprime debt, and on August
9, the European Central Bank and the U.S. Federal
Reserve injected $90 billion into the financial markets.
All the companies that owed money to HF were
in a desperate condition throughout 2007. HF was a
subprime lender when loan financing was drying up, the
global economy was shrinking and the stocks of HF’s
borrowers were trading for cents and even fractions of
a cent. The conversion options became worthless,
while the values of the debentures declined sharply.
Nevertheless, during its year-end reporting, these
market indicators were not taken into account in HF’s
marks, most of which were reported at a gain, or in the
worst cases, at cost.
Ultimately, the Securities and Exchange Commission
brought an enforcement action against HF’s founder, who
received a significant financial penalty for his actions.
Overstated Intangible Assets
Logitech International is a Swiss company with substantial operations in the U.S., operating in the personal
peripherals and video conferencing sectors. The mouse
in your hand may bear the Logitech brand. In November
2009, Logitech acquired LifeSize Communications of
Austin, TX, a company in the high-definition video
In April 2016, the SEC issued a cease-and-desist
proceeding against Logitech after discovering “recur-
Bernie Madoff didn’t do anything but take the investors’ money. Everyone understands that. But that’s not a complete picture of the fraud he committed. Madoff’s 17th floor employees painstakingly constructed false books, records and statements that were sent
to investors, showing their investment value growing steadily. Madoff’s
visible business was handled on the 18th and 19th floors. People didn’t
visit the 17th floor, where the false records were stashed.
Most people have trouble picturing financial statement fraud. Not
many people go to jail for committing it, and often the perpetrators
don’t even profit from it. In fact, many of the individuals involved in
financial statement fraud consider their actions to be beneficial to the
company that employs them.
According to the Association of Certified Fraud Examiners, financial statement fraud is a “scheme in which an employee intentionally
causes a misstatement or omission of material information in the organization’s financial reports.”
1 While instances of financial statement
fraud are much lower than other types of fraud, such as embezzlement
or corruption, the losses are much higher.
In this article, I present five examples of financial statement fraud:
overvalued complex financial instruments, overstated intangible
assets, understated liabilities, inflated revenue and institutionalized
misreporting. For those frauds not fully within the public domain, I
have used fictitious names to preserve the privacy of those involved.
Overvalued Complex Financial Instruments
HF, a hedge fund, provided liquidity to companies in the form of
convertible debentures. These loans included an option to convert the
debentures into shares of the company’s stock based on a contractually
stated conversion value per share. The conversion feature potentially
1 Association of Certified Fraud Examiners. Report to the Nations on Occupational Fraud and
Abuse: 2016 Global Fraud Study, Glossary of Terminology, pg. 90.
2 Ibid., pg. 12.
How Financial Statement Fraud is Committed:
Five Mini Case Studies
BY ANNE EBERHARDT
Financial statement fraud is not as prevalent or publicized as embezzlement, but as certified fraud
examiner Anne Eberhardt points out, the losses are much higher. She offers five mini case studies of
fraud, including some perpetuated by well-known companies, as a cautionary tale. If something seems
too good to be true, it usually is.
Senior Director, Valuation
and Litigation Services,
Most people have trouble picturing financial statement fraud. Not many
people go to jail for committing it, and often the perpetrators don’t even profit
from it. In fact, many of the individuals involved in financial statement fraud
consider their actions to be beneficial to the company that employs them.