What are the 5 major domains covered in corporate fraud studies?
1) Fraud Detection Models (statistical), 2) Accounting Manipulation Schemes, 3) Banking & Securitization Fraud, 4) Rogue Trading, 5) Root Causes & Prevention
What are the three fundamental statistics about corporate fraud pervasiveness and impact?
1) ~10% of large publicly traded firms commit securities fraud yearly, 2) Only 1/3 of corporate frauds are detected in normal times, 3) Corporate fraud destroys 1.6% of equity value annually ($830 billion in 2021)
For accounting restatements (2003-2022): what are the top 5 sources and their percentages?
1) Debt/Equity (27%, 4,709 cases), 2) Revenue Recognition (13%, 2,195), 3) Expenses (12%, 2,068), 4) Cash Flow (12%, 2,041), 5) Liabilities (11%, 1,957)
What are the three key timeline and impact statistics for accounting restatements (2008-2020)?
1) Average length ~520 days, 2) 30% disclose impact on net income, 3) Average negative income impact was -$50.3 million per restatement in 2020
===FRAUD DETECTION MODELS: What are the 3 main quantitative tools for detecting financial manipulation?===
1) Altman Z-Score (bankruptcy/distress prediction), 2) Beneish M-Score (earnings manipulation detection), 3) Montier C-Score (accounting fraud red flags)
Altman Z-Score: What’s the complete formula and what do the three zones indicate?
Z = 1.2(Working Capital/Total Assets) + 1.4(Retained Earnings/Total Assets) + 3.3(EBIT/Total Assets) + 0.6(Market Value Equity/Total Liabilities) + 1.0(Sales/Total Assets). Zones: <1.81 = distress, 1.81-2.99 = caution, >3.0 = safe
Beneish M-Score: List all 8 components, the formula structure, and the manipulation threshold.
Components: DSRI (Days Sales Receivables Index), GMI (Gross Margin Index), AQI (Asset Quality Index), SGI (Sales Growth Index), DEPI (Depreciation), SGAI (SG&A Expenses), LVGI (Leverage Index), TATA (Total Accruals to Total Assets). Formula: -4.84 + 0.92DSRI + 0.528GMI + 0.404AQI + 0.892SGI + 0.115DEPI - 0.172SGAI + 4.679TATA - 0.327LVGI. Score > -2.22 indicates likely profit manipulation
What’s the logic behind the Beneish M-Score? Match the 4 fraud incentive triggers to their manipulative reactions.
1) High sales growth → Accelerating sales recognition, 2) Deteriorating gross margins → Increasing cost deferrals, 3) Rising operating expenses → Raising accruals, 4) Rising leverage → Reducing depreciation
How effective is the Beneish M-Score? Cite the 3 detection success rates from different studies.
76% of earnings manipulating firms subject to SEC enforcement, 71% of prominent US financial reporting scandals pre-announcement, 82% (14 of 17) Malaysian listed companies charged with fraudulent reporting
Montier C-Score: List all 6 red flag components and what score signals potential fraud.
1) Growing divergence between net income and cash flow, 2) Increasing receivable days, 3) Increasing inventory days, 4) Increasing other current assets, 5) Declines in depreciation relative to gross fixed assets, 6) Total asset growth >10%. Score of 5 or 6 = potential fraud sign
What was the score distribution when Montier C-Score was tested on 3,000 Asian companies (2011-2015)?
Score 0: 3%, Score 1: 11%, Scores 2-4: 75% (23%, 29%, 23%), Score 5: 10%, Score 6: 1%
Who are activist short-sellers, and how does their business model work? Name 3 prominent firms.
Firms: Hindenburg Research, Quintessential Capital Management, Argonaut. Model: Identify companies with accounting fraud via financial analysis → Take short positions → Publish detailed reports exposing fraud → Profit when stock prices collapse
What were 5 of QCM’s most devastating fraud campaign results with their price impacts?
Akazoo (NASDAQ, 100% loss, liquidation, SEC sued), Bio-on (Italy AIM, 100% loss, liquidation, management arrested), Aphria (Canada NYSE, 43% loss, conflicted acquisitions), Folli Follie (Greece Athens, 100% loss, management arrested), Globo (Greece London AIM, 100% ceased as commercial entity)
===ACCOUNTING MANIPULATION SCHEMES: Real-World Cases===
Super Micro case (SEC 2020): What were the 3 revenue recognition tricks used?
Improperly recognized revenue by: 1) Recognizing revenue on goods sent to warehouses not yet delivered to customers, 2) Shipping goods prior to customer authorization, 3) Misusing marketing program to improperly reduce liabilities accrued
Capital Round Tripping: Describe both types and how they work.
Type 1: Bank gives customer favorable loan requiring portion be used to finance bank’s capital increase (90% loan, 10% capital). Type 2: Bank finances asset manager with customer deposits, who then uses them to finance bank capital increase. Value of capital guaranteed through complex structure
What are the 4 types of fraud committed in capital round tripping schemes?
1) Market abuse (shares kept off exchanges, manipulated valuations), 2) Mis-selling (clients misled about investing vs conduit role), 3) Breach of prudential norms (loans tied to equity purchases violated credit/capital rules), 4) Artificial capitalization (regulatory capital inflated)
PMC Bank scandal: Key statistics and the fraud mechanisms used.
108-year-old institution, >600 branches, 12 overseas offices. Frauds: >70% assets were loans to shareholders/associated companies, ~22,000 fake current accounts created to conceal info, NPA figures manipulated, shareholder account IT info restricted to few colluded employees. Detected by whistle-blower credit department employees
How do you investigate round tripping? List the 8 steps (6 off-site, 2 on-site).
Off-site: 1) Trigger (e.g., unclear own shares deduction), 2) Shareholders/Bondholders ID, 3) Fund mandate analysis (liquidity), 4) Jurisdictions analysis, 5) Management connections analysis, 6) Insider movements analysis. On-site: 7) Cross interviews, 8) Onsite supervision investigation
===BANKING & SECURITIZATION FRAUD: Lehman and the 2008 Crisis===
Repo 105/Tobashi Scheme: Explain the accounting treatment vs. the reality and what Lehman achieved.
Accounting: Treated as sale at price 105 (off-balance sheet). Reality: Costly repo to cut leverage at end of month, unwind at price 100. Lehman used this to temporarily reduce reported leverage each quarter-end without disclosure to investors/regulators/rating agencies despite being technically enabled by legal loopholes
Lehman’s asset growth 2003-2008: Show total assets, leverage growth, and what drove the expansion.
Total assets: Q4’03: $312bn → Q1’08: $786bn (152% growth). Gross leverage: 23.7x → 31.7x (34% growth). Key growth areas: Mortgage/Asset-Backed Securities (175%), Derivatives (253%), Securities borrowed (208%). Financed primarily by repurchase agreements (repo market), particularly heavy reliance compared to other investment banks
Contrast the two banking models: Originate-to-Hold vs. Originate-to-Distribute.
Originate-to-Hold (EU/Asia): Bank collects deposits, makes loans, keeps loans on balance sheet, bears credit default risk directly. Originate-to-Distribute (US): Bank originates loans, transfers to SPV, SPV issues securities (CDOs/CMBS/RMBS) to investors, credit risk transferred off bank balance sheet
Level 3 assets: What are they, and what are the 9 AVA adjustments that should prevent manipulation?
Level 3: Assets valued using company’s own assumptions/internal models (no observable market prices). AVA adjustments: 1) Market Price Uncertainty, 2) Close-out cost, 3) Model risk, 4) Unearned credit spread, 5) Investing and funding cost, 6) Concentrated positions, 7) Early termination, 8) Future administrative costs, 9) Operational risk
