Dividends and Corporate fraud is widespread – and largely undetected, study says

Over the years, we have seen many frauds some of them famous such as Madoff and Ponzi, some of them similar to Enron and Worldcom, but very few people have quantified how much fraud there is.

In an article by Alexander Dyck published in the New York Times, Professor Dyck believes 1 out of 10 public companies in the US is committing securities fraud, costing investors $830 billion a year, but most of it goes undetected.

Professor Dyck, who teaches finance at the University of Toronto used the real life situation – the collapse of accounting firm Arthur Anderson and the need for its clients to find a new auditor.

Before Enron, Arthur Anderson audited about 20% of public companies as clients as well as had consulting contracts with many of them. Mr. Dyck found that after the companies changed auditors, the rate of fraud detected was higher. Mr. Dyck believes when the auditors looked harder, they found a lot more stuff.

The issue is how much of it was material which meant the companies had to report to the public?

To measure fraud post-Anderson, the academics examined financial misrepresentations uncovered by auditors, as revealed by securities class action lawsuits; enforcement actions by the SEC; SEC securities fraud cases and restatements of financial results that did not involve clerical errors but related to judgement by management.

To arrive at the $830 billion annual cost of fraud, the authors used other published estimates and costs of disclosed and undisclosed frauds, applied the loss of 1.6% of the market value to the total capitalization of the US equity market.

Linking to dividend paying stocks, as investors we tend to believe the dividend paying stocks have less fraud because the profits tend to be manageable. Part of the reason is related to reporting earnings every quarter and management wants to look good, if the profits of the company are reasonably consistent which allows for profits to pay dividends, many people will be satisfied with the results. When there is a big change, more people will ask the questions why and how and management will have to answer.

There are more questions than answers, till the next time – to raising questions.


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