Accounting fraud is a white-collar (business) crime. This type of fraud occurs when a company falsifies or manipulates the information in its accounting books or financial statements. The goal of the falsifications is to commit some kind of fraud against an unwitting person.
For example, an accountant within a company may make false entries in the company’s financial statements to give the appearance the company is worth more than it is. An investor, relying on the false information, might then purchase the company’s stock.
When the accurate value of the company is revealed, the investor has been defrauded. To be defrauded means to lose money in reliance on someone else’s fraudulent representation. Accounting fraud is punishable by time in jail or prison, monetary fines, or both.
How is Accounting Fraud Committed?
Accounting fraud can be committed in a variety of ways. These include:
- Deliberately (intentionally) overstating company profits.
- Deliberately not recording expenses. When a company intentionally does not record expenses of doing business, such as payments of rent, salaries, or taxes, the company presents its income as being higher than it actually is.
- Misstating company assets. Assets include equipment, inventory, business supplies, and investments. Overstatement of assets gives the impression that the company is making more profit than it really is.
- Misstating liabilities. Liabilities are a company’s financial debts or obligations. Debts include money owed to banks and other creditors. When the amount of company debt exceeds the amount of company assets, the company is referred to as “asset-deficient.”
- An asset-deficient company is prone to bankruptcy because its assets are insufficient to cover liabilities. Misrepresenting debts as smaller than they are gives the misleading impression that a company is generating money, when in fact it is not.
- Reporting a transaction as “completed” when in fact the transaction is still pending. A common example of this activity occurs with respect to sales or transactions. When a company reports a favorable sales deal that is in progress as being completed, it misrepresents its profitability.
How Do You Prove Accounting Fraud?
Investors who suffer financial losses due to accounting fraud may file a complaint with the federal Securities and Exchange Commission (SEC). The SEC will investigate the complaint and, if the complaint is valid, the SEC may file a civil or administrative proceeding against the company.
To prove accounting fraud, a victim must demonstrate the company deliberately falsified financial records. “Deliberate” means intentional, or on purpose. The victim must show the misrepresentation misled them. The victim must show that as a result of the misleading misrepresentation, the victim lost money.
For example, a company wants to convince investors to invest in their company. They falsified their financial records to show that they are making a profit and have no outstanding debts. The victim believed that the company was a wise investment, but after investing they discovered that the company is going under and used their investment as a way to avoid creditors. Now the victim has lost all of their investment.
Proving intent, or a “guilty mind,” can be difficult. To demonstrate intent, one must prove an employee or accountant knew the correct facts of financial statements, and chose to misrepresent those facts.
Many times, to prove intent, a victim relies on the knowledge of a so-called “whistleblower.” A whistleblower is an individual who informs on a company engaged in fraudulent activity. In 2002, a federal law known as the Sarbanes-Oxley Act was passed. This law prevents whistleblowers from being retaliated against for reporting accounting fraud.
What are the Penalties for Accounting Fraud?
Accountants must follow what are known as Generally Accepted Accounting Principles (GAAP) when preparing financial statements. GAAP consists of a set of accounting principles that the law considers the authoritative, or proper, way to conduct accounting.
Federal law requires that companies that are publicly traded, and that release financial statements to the public, follow GAAP guidelines. The purpose of GAAP is to create standards of accounting and reporting that are consistent. This allows investors to make a proper evaluation of a company’s financial worth.
Accounting fraud is a crime under state law and federal law. If the accountant, employee, or officer who committed the fraud is found guilty, then this person can be subject to prison time, in an action brought by the federal Department of Justice.
In addition, the SEC can sue companies whose accounting fraud violates federal securities laws. The SEC can sue in federal court or before a federal administrative law judge. If the SEC prevails, the SEC can obtain remedies, including civil money penalties, disgorgement (payment to individuals who have been defrauded), and monetary fines.
When accounting fraud violates state (as opposed to federal) law, a victim may report the fraud to their state’s SEC equivalent, or that state’s Attorney General. The Attorney General may file a lawsuit against the company on a victim’s (or multiple victim’s) behalf.
Do I Need the Help of a Lawyer if I Suspect Accounting Fraud?
If you believe you have been a victim of accounting fraud, or you work for a company where you believe such fraud is taking place, then you should contact the SEC or the local government organization that is in charge of regulating issues like this.
If you have been charged with accounting fraud or know you will be, then you will also want to contact a criminal lawyer. Accounting fraud is a serious crime, and like most crimes it is best to be forthcoming immediately. The more you cooperate with the local authorities then the easier the process will be.