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How to Detect Business Fraud

economist.com

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Re: How to Detect Business Fraud

#31

Post by cwmma »

advisedwang wrote: post #14

Good investigative reporting into shady business practices good for this world. However short selling companies before dropping your investigation is a massive conflict of interest. Muddy waters is incentivized to produce a scandalous hit piece, rather than necessarily do fair or accurate reporting. They will make money regardless. The damage their reporting does may make a self-fulfilling prophecy, ensuring they don…

You are correct, but really only about the first couple of times he does it, subsequent times people know his M.O. and he either gets a reputation for overblown bullshit, or a reputation for finding actual fraud.

Re: How to Detect Business Fraud

#32

Post by mierle »

For those who are interested in the accounting side, I highly recommend Financial Shenanigans by Howard Schilit [1]. If you don't have an accounting background, all you need to get value out of this book is a basic understanding of the double entry accounting method, and understand the four financial statements: balance sheets, income statements, cash flow statements, and statements of shareholders equity.

After reading this book, I found myself digging through earnings reports to look for signs of shenanigans, and have found cases that raise my armchair-accountant eyebrows.

[1] https://www.amazon.com/Financial-Shenanigans-Fourth-Accounti...

Re: How to Detect Business Fraud

#33

Post by alexpotato »

clairity wrote: post #23
camjohnson26 wrote: post #19

Earlier quoted context omitted.

The problem is getting anyone to care while the fraud is still making money

that's the point of combining it with lawyers--you find clients, possibly grouped into class actions, to sue the fraudsters (and make money that way).

So an interesting fact about class action lawsuits:

There were initially created to combat civil rights cases. For a long time, minorities who were seeking legal relief against large companies could not afford to mount legal battles.

The class action lawsuit was created as way for plaintiffs to pool resources and incentivize lawyers to take these kinds of cases. Only later on was the class action lawsuit applied to regular civil cases.

Re: How to Detect Business Fraud

#34

Post by refurb »

mierle wrote: post #32

For those who are interested in the accounting side, I highly recommend Financial Shenanigans by Howard Schilit [1]. If you don't have an accounting background, all you need to get value out of this book is a basic understanding of the double entry accounting method, and understand the four financial statements: balance sheets, income statements, cash flow statements, and statements of shareholders equity. After read…

I took a class specifically on this - how company manipulate their financial statements to make things look better.

It's really fascinating. If you're willing to dig into the financial statements (and ones from the past), you can learn a ton about how a company defines "performance" and whether or not it's reasonable.

Despite GAAP accounting rules, there is enough gray area for companies to hide a lot of bad information.

Re: How to Detect Business Fraud

#35

Post by mjcohen »

Kalium wrote: post #29
clairity wrote: post #15

it would be interesting to codify the known heuristics of forensic accounting into a software package (maybe even AI all the things!), then create a company out of it in partnership with prosecutors and regulators to root out fraud like this through both technological and legal means. i'm sure there have been some efforts to that end, though not commonly known. it would help rebalance the legal system toward the serv…

If you can reliably determine what companies and securities are fraudulent more accurately than the rest of the market and faster than government entities, then you can use this to make rather a lot of money as a short-seller.

You may have problems when the fraudsters run the government.

Re: How to Detect Business Fraud

#37

Post by WalterBright »

camjohnson26 wrote: post #18
nodesocket wrote: post #16

Earlier quoted context omitted.

Absolutely. Just look at Pershing Square‘s Bill Ackman. He goes on CNBC essential calling for the end of the world, turns out he had credit protection on bonds and tuned a huge profit[1]. [1] https://markets.businessinsider.com/news/stocks/bill-ackman-...

And a thousand other hedge fund managers talk about how bright the future is after investing in stocks. Maybe we shouldn’t rely on hedge fund managers for our opinion of the economy.

I believe them about as much as I believe the promoters of "Get Rich Through Real Estate" seminars. If their methods worked, they'd be getting much richer doing real estate than pushing seminars.

I recorded one once on TV, and carefully went through the spiel. It was fairly complex, and I was suspicious it was hiding something. Turns out, it relied on tricking the other party into accepting a bond with a maturation value of $10,000 instead of $10,000 now. The money was made on the difference.

Re: How to Detect Business Fraud

#38

Post by jerzyt »

RandomWorker wrote: post #30

I think one of the most interesting methods of business fraud detection is Benford's law. It has been found that natural transactions do abide by this law. https://en.wikipedia.org/wiki/Benford%27s_law

In real financial data you'll often see departures from the Benford's law. For example, if a company has $50 expense limit for dinner, you'll find a lot of invoices for $49.99. Same goes with approval limits at different management level. Not as useful in practice as in theory.

Re: How to Detect Business Fraud

#39

Post by pdonis »

WalterBright wrote: post #37
camjohnson26 wrote: post #18

Earlier quoted context omitted.

And a thousand other hedge fund managers talk about how bright the future is after investing in stocks. Maybe we shouldn’t rely on hedge fund managers for our opinion of the economy.

I believe them about as much as I believe the promoters of "Get Rich Through Real Estate" seminars. If their methods worked, they'd be getting much richer doing real estate than pushing seminars. I recorded one once on TV, and carefully went through the spiel. It was fairly complex, and I was suspicious it was hiding something. Turns out, it relied on tricking the other party into accepting a bond with a maturation v…

> If their methods worked, they'd be getting much richer doing real estate than pushing seminars.

More generally, one should be suspicious of anyone whose business model is not "get rich doing X" but rather "get rich by selling the secret of how to get rich doing X".

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