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Are well-known companies more prone to financial statement fraud?

It’s logical to think that companies on the verge of bankruptcy or suffering severe financial stress might be tempted to fudge their financial statements. Yet a recent university study says that large prestigious public firms are even more prone to cooking the books. We look at why this might be the case and the need to delve into the psychology of individual perpetrators.

Last year the Financial Reporting Council, the U.K.’s financial watchdog, closed a multi-year investigation into financial statement fraud at retailer Tesco, putting an end to one of the country’s largest-ever accounting scandals.

In 2014, when the supermarket admitted to inflating profits in the first half of that year by 250 million pounds, the news sent Tesco’s stock tumbling and wiped billions of pounds off the company’s share value. Investors were naturally concerned.

After all, this was the U.K.’s biggest supermarket and a benchmark stock on the country’s FTSE 100 index — hardly a company where markets would expect to find these kinds of financial shenanigans. Renowned value investor Warren Buffett, who had a 4.1% stake in the retailer, said he’d made a “huge mistake” in placing Tesco stock in his portfolio. (See Warren Buffett: ‘Tesco was a huge mistake,’ by Julia Kollewe, The Guardian, Oct. 2, 2014.)

As the Tesco scandal attests, it isn’t necessarily corporates on the verge of bankruptcy that are most likely to cook their books, as some might think. Prestigious firms that are held in high regard are in fact the ones more prone to financial accounting fraud.

That at least is one of the conclusions academics at Washington State University (WSU), Pennsylvania State University and Miami University reached in a study released earlier this year. (See Financial Prominence and Financial Conditions: Risk Factors for 21st Century Corporate Financial Securities Fraud in the United States, by Jennifer Schwartz, Darrell Steffensmeier, William J. Moser and Lindsey Beltz, Jan. 9, 2021.)

“We thought it would be companies that were struggling financially, that were nearing bankruptcy, but it was quite the opposite,” Jennifer Schwartz, WSU sociologist and lead author on the study, was quoted saying on the WSU website earlier this year. (See Big name corporations more likely to commit fraud, WSU, Feb. 5, 2021.)

“It was the companies that thought they should be doing better than they were, the ones with strong growth imperatives — those were the firms that were most likely to cheat,” Schwartz says.
The Tesco case backs some of the survey’s findings and illustrates why blue-chip firms might resort to financial statement fraud, not to mention the legal difficulties in assigning blame in such cases. (See Proving intent proves to be tricky, by Gerry Zack, CFE, Fraud Magazine, March/April 2015.)

After the company had flagged the accounting problems, forensic accountants went on to discover the amount Tesco had inflated was closer to 263 million pounds and that financial misstatements went back to prior years. This further cut confidence in the once admired retailer. An investigation ensued.

The case was far from cut and dried, though. The three Tesco executives accused of fraud were acquitted after the U.K.’s Serious Fraud Office failed to prove that any of them knew of the crime — the “directing mind” threshold required by U.K. law to establish corporate criminal liability in fraud cases. Two were cleared of fraud charges in late 2018, and the third was acquitted in January the following year. (See Former Tesco executive acquitted over £250m accounting scandal, by Jane Croft, the Financial Times, Jan. 23, 2019 and Tesco trial failure is another setback for SFO, editorial board of the Financial Times, Dec. 9, 2018.)

And while that ruling acquitting the executives raised questions over why the company should submit to any sort of punishment, Tesco signed a three-year deferred prosecution agreement to avoid corporate prosecution and agreed to pay a 129 million pound fine. (See SFO confirms end of Deferred Prosecution Agreement with Tesco Stores Ltd, SFO, April 10, 2020.) 
The U.K. Financial Conduct Authority (FCA) also said that the company had committed market abuses and ordered Tesco PLC to pay about 85 million pounds to investors who’d bought its shares and bonds during the time of the misstatement. (See Tesco to pay redress for market abuse, FCA press release, last updated Aug. 23, 2017.)

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