Can corporate cheaters be caught before they ruin the

lives of their investors?

Introduction
Is there a way to catch corporate cheaters before they can cash out and ride off into the sunset,
leaving a swathe of broken and battered stockholders and employees in their wake? New
accounting procedures and a more secure system of checks and balances would be necessary, as
well as closer attention being paid to tell-tale signs like sudden massive gains in stock price.
In the corporate world money is king and whoever has the most, wins. The business world is the
very definition of competitive and this Darwinian environment spawns some of the cruelest
examples of Survival of the Fittest. People start from humble beginnings, building a company
from the ground up. They spend the prime years of their lives working to build a successful
business, only to watch it crumble when times get hard. Not everyone is willing to simply sit idly
by and see their empire fall apart because of a bad year, so they cheat. A little here and there,
some missed liability, some missing debt, and it starts to add up. Soon enough they find
themselves in too deep and they start cheating more to cover up the old errors. Eventually, like
the proverbial house of cards, it all falls down. Then of course there are the people who are just
plain greedy. There is no noble save the business at all costs mentality, no save those poor
peoples jobs ideology involved. They just want more money to finance their selfish greedy
lives, to pay for their spoiled families and to keep on top of the pack. They usually get caught in
the end. Guys like Bernie Madoff, the Ponzi scheme mastermind that stole 65 billion dollars
from investors got caught because he did the unthinkable, he confessed to his family. A guy with
the strength of character to destroy the lives and lifesavings of that many people should have
known not to trust his offspring. Others like Jeffrey Skilling and Kenneth Lay, the executives in
charge of the Enron energy company scandal, get caught because they let the con go on too long.
The company was nearing collapse and they cashed out to make the biggest profit they could
right before it happened. Doing that is like shooting up a flare over the SEC (Securities and
Exchange Commission) building that writes Im cheating, come get me in smoke, with your
name at the bottom. Sickeningly enough, despite catching a whopping 14 years of prison time
and a nasty 50 million dollar fine Jeffrey Skilling will still have 60-100 million dollars left to live
out his life in luxury after he gets out in 2019. Thats money that he stole from stockholders.

(Marketskeptics.com)

This is a simplified diagram

showing how Bernie Madoff defrauded investors.

The Bernie Madoff Ponzi Scheme

Madoff took money from investors promising huge returns, then used the money they gave him
from the initial investment to pay them their returns. Word of mouth got out that he was a gold
mine and investors swarmed him with capital, none of which he actually invested for them, he
simply kept it and kept them believing they were profiting because he just gave them fractions of
their initial investment at a time. When enough people had invested he had billions of dollars
worth of investment money, and no intention of giving it back. This was called a Ponzi Scheme.
How could people have kept him from doing this? The first line of defense is always knowledge.
Informed investors know what to look for and require proof that their investments are going
where they are supposed to be going. Unfortunately this type of thing will happen again because
investors are like gambling addicts, when they win they are suddenly blinded with arrogance and
greed and nothing else matters.

(docstock.com) This is a simplified

diagram of the Enron Accounting scandal timeline.

The Enron Energy Company Accounting Fraud

The Enron Accounting Scandal is another huge greed scheme that rocked the business world
when it broke. According to Ken Silverstein at Forbes.com Enron, once a sleepy natural gas
pipeline company, grew to become the nations seventh largest publicly-held corporation. But its
shoddy business practices, aided by bankers and advisors feeding from the gravy train, brought
down the company in December 2001. (Silverstein) If you look up the Enron Scandal on
Wikipedia (Wikipedia) you will notice this case was especially ugly. According to Wikipedia
Kenneth Lay, the chairman of the company, had executive compensation shares in the company
worth around 659 million dollars. When he was finally indicted he was released on bond and
went skiing in Colorado. He was convicted of fraud and other nasty criminal misdeeds and then
died of heart failure on vacation. His conviction was vacated because he died before he could
exhaust his appeals and no compensation could be sought for the victims of his crimes. Imagine
that for a moment: Someone steals hundreds of millions of dollars from you and your friends and
thousands of other people, and because of a legal loophole their family gets to keep it all.
Wikipedia also describes the wild spending spree the executives at Enron went on during the
height of their scheme. Executives were paid sometimes as much as double what executives in
other energy giants were paid, and the company stock increased at an unheard of rate of 750%
per year for the years leading up to the final collapse. Nobody saw it coming when it finally
came, but lets be honest here, how many legitimate companies have a stock growth of 750% per
year and sustain it year after year? Not one accounting professional raised an eyebrow? Not one
single investor got curious as to how this was possible in a sector where the actual money being
made is fairly straight forward? You generate energy and distribute it, offset the profit with the
cost of generating the energy and expand. There is no magic bullet to pure profit, with two
notable exceptions: Microsoft and Facebook. Even though those two companies took off and
never looked back the key to their success is that they created a product with inelastic demand,
computer operating systems and support and a social media outlet that connects friends and
families, and they did it with little to no overhead. The energy sector has ridiculous overhead.
Electricity generation and Oil refinement take very expensive machines, both to purchase and to
service and maintain. There is also the cost of transport and then the cost of corporate income tax
which can reach 40% or more, with double taxation coming into play when the dividends on
stock holdings are paid to company employees who have to report those dividends on their
income tax returns as taxable income. There is no massive revenue without massive overhead
like in a software giant or online company that sells intellectual rights.

(Moise) This graph shows the competitive edge Microsoft held

over Apple (its biggest rival) over the years.

A deeper look at Fraud on the surface

The graph above illustrates why companies like Microsoft and Facebook are above suspicion
when their stock price skyrockets in their early years. Until the advent of the Ipad and Ipods
Apple was mostly in direct competition with Microsoft in the PC/Mac wars, and was losing
badly. Even in 2004, the high point where Microsoft sold nearly 60x as many PCs as Apple sold
Macs, Apple was still Microsofts biggest rival. With almost no overhead, no real physical assets
on its balance sheet and by contrast no real liabilities, Microsoft was head and shoulders above
the competition. From an economic and accounting perspective this makes sense. What
happened at Enron did not. They were not more competitive or profitable than their competitors,
at least not noticeably so, but they were posting gains that were ludicrous, and nobody asked any
questions until it was too late.
The reasons for not finding these cheaters out early enough to avoid massive losses are
numerous, and even extend to corrupt accounting firms, as is evidenced by the downfall of
Arthur Andersen, at the time in the top 5 accounting firms in the world by profit and size. Arthur
Andersen was taking more than 25 million dollars a year from Enron to audit their books, which
of course created a conflict of interest that spiralled out of control. Anyone with eyes has to be
able to see that when you have a company paying the auditor absurd amounts of compensation to
police their accounting nothing good will result. The end result was dissolution of a massive
accounting firm. The firm was a partnership, which in corporate law makes the partners of a firm
responsible for the mistakes of the other partners. Honest, innocent people lost their retirement,
pension, and savings and had to go back to work as regular paid employees as a result of one
partners inability to remain neutral and avoid the proverbial tainted apple.
In conclusion there are many ways to catch cheaters. The first step is to avoid being blinded by
their wealth and power. Most reasonable people will assume that when a company is supremely
profitable and being audited by an independent accounting firm that they are simply smarter
than the rest of us. This is an assumption that needs to go out the window. The next step is to
provide government regulation for the rate structure involved in accounting audits and

independent oversight by the government when a company exceeds a certain profitability

threshhold. Finally there needs to be a better effort made by individual companies to educate
investors about the risks they are taking by investing their money. This is a hard one because
companies dont like to spook investors with possible bad news, thats why they try so hard to
keep massive debts and liabilities off of the balance sheet with capitalization expense fraud other
ways of hiding what they actually owe. Investors should always be aware that companies will do
everything in their power to make it look like they are profitable, and it may not always be the
case.