Accounting Fraud vs Criminal Securities Fraud: A Comparison

Accounting Fraud vs Criminal Securities Fraud: A Comparison

Accounting fraud and criminal securities fraud are both types of white collar crime that involve manipulating financial information. However, there are some key differences between these two types of financial crimes.

What is Accounting Fraud?

Accounting fraud refers to the intentional manipulation of a company’s financial statements and records to conceal assets, liabilities, or other information relevant to assessing a company’s financial health [1]. This type of fraud is typically committed by a company’s management and often involves overstating revenue, understating expenses, overvaluing assets, or underreporting liabilities in order to make the company appear more profitable than it really is.

Some common methods of accounting fraud include:

• Recording fictitious revenues
• Improperly accelerating or deferring revenues and expenses to other periods
• Concealing liabilities or expenses
• Improperly writing up the value of assets
• Incorrectly applying accounting principles

The main goal of accounting fraud is usually to mislead investors, creditors, and others about the financial performance and health of a company. Perpetrators may commit accounting fraud to meet earnings targets, get better rates from lenders, inflate stock prices, or hide losses from investors.

Some infamous examples of accounting fraud include cases like Enron, WorldCom, Tyco, and HealthSouth. In many major accounting scandals, corporate executives at the highest levels were involved in systematically falsifying and fabricating financial information over an extended period.

What is Criminal Securities Fraud?

Securities fraud refers to deceptive practices in connection with the trading of securities such as stocks and bonds [4]. This type of fraud often involves providing false or misleading information related to investments in order to induce investors to make investment decisions they otherwise would not have made.

Some examples of criminal securities fraud include:

• Insider trading – Buying or selling securities based on material non-public information
• Accounting fraud – Falsifying financial information to mislead investors (see above)
• Microcap fraud – Manipulating the share price of small or “microcap” companies
• Ponzi schemes – Using money from new investors to pay earlier investors high returns rather than investing the money as claimed.
• High-yield investment fraud – Luring investors with false promises of high returns and low risk
• Late-day trading – Illegally trading shares after the market has closed at 4pm EST

While accounting fraud is one method, criminal securities fraud encompasses a wider range of fraudulent investment schemes intended to trick investors. The common thread is the use of deception and manipulation related to the buying and selling of investments.

Key Differences

While accounting fraud and securities fraud overlap in some areas, there are several key differences between these two types of financial crimes:

Scope

Accounting fraud is focused specifically on manipulating a company’s financial statements and records. Securities fraud covers a much broader range of fraudulent investment schemes, not just falsified financial statements.

Perpetrators

Accounting fraud is most often committed by a company’s executives, directors, or accountants. Securities fraud can be committed by a wider range of actors including executives, stockbrokers, financial advisors, and anyone else involved in investment transactions.

Goals

The goal of accounting fraud is usually to make a company appear more profitable and financially healthy than it really is. Securities fraud may aim to achieve a wider variety of goals like artificially inflating stock prices, generating phony returns, or driving up the price of microcap stocks.

Victims

While both types of fraud harm investors, accounting fraud more directly impacts shareholders of the company manipulating its financials. Securities fraud victims can include any type of investor tricked into fraudulent investments.

Regulations

Accounting fraud mainly violates SEC rules and regulations around financial reporting. Securities fraud violates a broader range of SEC rules and regulations around buying, selling and transparency in securities transactions.

Criminal Penalties

Both accounting fraud and securities fraud can lead to severe criminal penalties. However, securities fraud laws tend to be broader and impose harsher sentences.

For accounting fraud, the main criminal statute is the Sarbanes-Oxley Act. Those convicted of knowingly violating accounting rules and falsifying financials face fines up to $5 million and prison sentences up to 20 years [2].

Securities fraud penalties are outlined in the Securities Exchange Act. Violators can receive fines up to $5 million and prison sentences up to 20 years. Those who profit from illegal insider trading schemes can be fined up to three times their profits. Many securities fraud statutes impose even stiffer penalties of up to $25 million in fines and 25 years in prison.

Sentences for both types of financial crimes can be increased based on the scope of the fraud, number of victims, and other aggravating factors. However, securities fraud laws tend to be more far-reaching and impose harsher maximum sentences.

Recent Trends and Notable Cases

Both accounting fraud and securities fraud remain serious issues despite increased regulation and enforcement in recent decades. However, the nature of these financial crimes continues to shift in response to new laws and technologies.

In accounting fraud, there has been a shift towards more subtle manipulation that pushes the boundaries of accounting rules as opposed to completely fabricating transactions. Revenue recognition fraud around things like channel stuffing and bill-and-hold transactions has become more common [2].

Securities fraud has increasingly moved online with the rise of crypto-assets and forex trading platforms. New technologies like AI and social media have also created opportunities for innovative scams and market manipulation techniques.

Some notable recent cases include:

• Theranos – Blood testing startup Theranos and founder Elizabeth Holmes used various accounting tricks to inflate financial performance and attract investments at a $9 billion valuation. Holmes was convicted of fraud in 2018 .
• Bernie Madoff – Financier Bernie Madoff ran a massive Ponzi scheme that defrauded thousands of investors out of $64 billion over decades. He was sentenced to 150 years in prison in 2009 .
• Enron – The massive Enron accounting scandal in 2001 involved elaborate schemes to hide billions in debt and losses. Executives Kenneth Lay and Jeffrey Skilling were convicted of securities and wire fraud .

Regulators continue to pursue both types of financial crimes aggressively. However, new technologies and more subtle techniques present ongoing challenges when it comes to detection and enforcement.

Corporate Responsibility vs Individual Culpability

A philosophical debate around accounting and securities fraud is whether corporate entities or individuals within them should bear responsibility.

Prosecutions for both accounting and securities fraud most often target individuals – corporate executives, accountants, stockbrokers, and others directly involved in misconduct. However, some argue that corporate culture and incentive structures promote unethical behavior [3].

Critics of corporate liability say that penalizing entire companies hurts innocent employees and shareholders. But others argue that only by holding corporations accountable can systemic issues be addressed.

Debates around individual vs collective responsibility continue as regulators balance punishing wrongdoers with creating systemic deterrence.

Key Takeaways

• Accounting fraud involves manipulating a company’s financial statements, while securities fraud covers a broader range of investment schemes.
• Accounting fraud is committed primarily by corporate executives, while securities fraud can be perpetrated by a wider range of actors.
• Penalties for securities fraud tend to be more severe and expansive than for accounting fraud.
• Both crimes continue evolving in response to new regulations, technologies and enforcement approaches.
• There are ongoing debates around whether individuals or organizations bear greater responsibility.

Understanding the nuances between accounting fraud and securities fraud is important for regulators seeking to detect and deter financial crimes. While these types of fraud overlap, awareness of the unique aspects of each is critical when developing enforcement strategies and policies.