Study investigates business fraud

Ever since Enron concealed $1.2 billion in debt and caused shareholders' and loan companies' to lose mass amounts of money,fraud has been an ongoing concern throughout the business world. \nWorried by this and other potential scandals, Randall Heron, an associate professor of finance at Kelley School of Business Indianapolis and Erik Lie of the University of Iowa investigated investor fraud in nearly 8,000 companies over the past 10 years. Due to their research, nearly 50 companies are currently being investigated in hopes of preventing additional business fraud. \nHeron and Lie had noticed an ongoing trend where stock prices seemed to dramatically increase as soon as company executives received stock grants allowing them to cash in on large sums of profit. Heron said they attributed this pattern to one of two possible reasons -- either the managers were manipulating the data in the financial statements or they were choosing the dates in which to make the stock grants, which is known as "backdating." Heron found that there was a significant decline in stock price, about 3 to 4 percent, leading up to executive stock grants and then a sharp increase in stock price of about 5 to 7 percent after the grant had been made. \nHeron said he suggested that the decline in stock price was due to "holding back good information before the grant was received and only letting out the bad news which beats down the stock price." Then to raise the stock prices and create profit after they received the grant, the executives would release the beneficial information about the company to the public. \nIn order to prevent instances of "backdating" the Sarbanes-Oxley Act was created in 2002, which changed the lag time in which options grants to executives had to be reported, from 45 days to two days. This new act lead to an 80 percent decrease in "backdating" and strengthened the evidence that manipulation of data was not the problem. While this improved the problem, 20 percent of companies were still filing information after the deadline and were not abiding by the act. \nAs a result of "backdating" stock grants, companies can protect corporate income from taxation and ultimately lower their tax bills. \n"Stock options are supposed to provide incentives for executives to work to improve the firm's future performance," Heron said. "However, backdating stock options so that they are already in-the-money and disguising the practice can be compared to letting executives bet on a game where they already know the final score." \nSince these companies were not following typical accounting procedures and the U.S. Securities and Exchange Commission views such instances as financial fraud, the SEC is going to make these organizations redo their financial statements and restate their earnings. There are also potential penalties that can be charged to these companies depending on the situation. In order to prevent future dilemmas new filing procedures will be created.\nHeron said they found that smaller companies and technical companies were more often at fault however it is also occurring in larger companies.