Financial Statement Fraud: Lessons Learned from Selected Legal Cases in the Past Twenty Years

• In Event: Accounting in Context: Past, Present, and Future

Abstract

The researchers analyzed selected federal district and appellate court cases of financial statement fraud decided during the past twenty years. The study of those cases led to these conclusions: (1) financial statement fraud is defined as the deliberate misstatement or omission of amounts or disclosures of financial statements to deceive financial statement users, especially investors and creditors; (2) statutes and regulations used to prosecute financial statement fraudsters include the Securities Act of 1933, Securities and Exchange Act of 1934, SEC Rule 10b-5, Investment Advisers Act of 1940, Private Securities Litigation Reform Act, and the Sarbanes-Oxley Act; (3) the most significant financial statement fraud schemes during the past twenty years included use of unconsolidated special-purpose entities to conceal debt, improper immediate revenue recognition in leasing of bandwidth in the telecom industry, improper capitalization of operating expenses, improper accounting for goodwill in a merger, failure to write off a large amount of bad receivables, excessive recognition of revenue in bundled leases in the photocopier industry, improper use of loss contingency reserves to inflate current income, use of fictitious revenue to overstate earnings, and improperly and purposefully moving a project’s operating expenses to capital in order to hide cost overruns; (4) in order to be held legally liable for financial statement fraud, a corporate officer is required to have knowledge of the financial statement fraud; and (5) an employee discharged after reporting a case of financial statement fraud may sue under the whistleblowing provisions of the Sarbanes-Oxley Act by showing she engaged in protected activity, management knew of the protected activity, she suffered an unfavorable personnel action, and the protected activity was a contributing factor in the discharge.

Authors

• Stephen Blythe, Tarleton State University

• James Goodpasture, Tarleton State University