Corporate Misconduct: The Legal, Societal, and Management Issues

By Margaret P. Spencer; Ronald R. Sims | Go to book overview

If the securities analyst does suspect fraud on the part of a public company he should attempt to elicit additional information in order to verify or eliminate his concerns. If he continues to suspect fraud, he should temper his analysis accordingly. If, as a result of receiving material nonpublic information about the company, he learns that fraud is occurring he should notify his employer. If the fraud is sufficiently significant he should also inform the SEC.

A major lesson that the histories recounted in this chapter have for investors involves the importance of portfolio diversification. Diversification is a process that improves the investor's perceived risk-reward ratio. One way to protect against serious losses resulting from investing a potential fraud is to severely limit the proportion of the portfolio invested in the securities of any single issuer.

It was surely not an economist who originally opined, "Crime does not pay." Change breeds opportunity and not just lawful opportunity. The securities markets represent an enormous source of opportunity for profitable fraudulent behavior. Some frauds probably never come to light as such. Some undoubtedly never come to light in any form.

The NSMC, EFCA, and ZZZZ Best cases serve to remind us that the magnitude of a single case of securities fraud involving a publicly held company can be counted in the tens of millions of dollars. Investors and security analysts cannot assume that outside audits are a failsafe device that prevents such frauds from occurring.

The investor can protect himself to a major extent by diversifying his securities portfolio. But he should still approach corporate financial statements warily. A knowledge of the "red flags" identified in this chapter may aid the process of financial analysis.


NOTES
1.
An excellent description of the bootstrap game appears in R. A. Brealey and S. C. Myers , Principles of Corporate Finance, 4th ed. ( New York: McGraw-Hill, 1991).
2.
Perpetual growth through bootstrapping is impossible because at some point a firm runs out of low P/E companies to acquire. The game could continue for a while, in principle, through a program of divesting the most rapidly growing divisions of the company. In the limit the company would end up with a single division, and that one would have the lowest growth and the lowest P/E of the lot.
3.
"White and Case," New York Times, May 5, 1977, p. D10.
4.
There is no evidence that the nonmanagerial employees were aware that they were engaged in an unlawful activity.
5.
Dirks v. SEC, 463 U.S. 646 ( 1983).

-107-

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Corporate Misconduct: The Legal, Societal, and Management Issues
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Preface ix
  • Acknowledgments xiii
  • 1 - Understanding Corporate Misconduct: an Overview and Discussion 1
  • Notes 20
  • 2 - A Look at Corporate Crime 23
  • Notes 38
  • 3 - Corporate Criminal Liability 41
  • Notes 53
  • 4 - Corporate Sentencing Guidelines 57
  • Notes 69
  • 5 - The Regulator's Perspective on Corporate Fraud 71
  • Notes 93
  • 6 - Corporate Fraud and the Investor 95
  • Notes 107
  • 7 - Corporate Fraud: the Employee's Perspective 109
  • Notes 122
  • 8 - Hacking, Computer Viruses, and Software Piracy: the Implications of Modern Computer Fraud for Corporations 125
  • Notes 146
  • 9 - Corporate Fraud in Marketing: Business Practices and Advertising Content 149
  • Notes 161
  • 10 - Corporate Codes of Conduct 165
  • Notes 179
  • 11 - Countering Corporate Misconduct: the Role of Human Resource Management 183
  • Notes 207
  • Index 209
  • About the Contributors 213
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