Deloitte Study Sees Fraud Ties to Bankruptcy

Forensic Center researchers say companies should pay careful attention to their fraud controls as temptations to manipulate numbers appear to rise ...
Sarah JohnsonNovember 24, 2008

Companies that have filed for bankruptcy protection are three times more likely to face enforcement action by regulators, according to the results of a Deloitte Forensic Center study released today.

The study found that the Securities and Exchange Commission accused 9 percent of bankrupt companies with financial-statement fraud from 2000 to 2007, compared to only 3 percent of non-bankrupt companies that heard from SEC enforcers during the same time. The Deloitte researchers also said companies that the regulator accused of fraud were more than twice as likely to go into bankruptcy as those that did not file for protection.

Deloitte researchers tell that their review should act as a warning for CFOs to pay even more attention to their fraud controls during the down market — when, in a worst-case scenario, even well-meaning employees could cause problems later on in bankruptcy court. “It is a timely reminder that companies facing difficult economic conditions and are struggling to achieve targets and budgets that were set in better times need to be especially concerned about the risk of employees committing fraud to achieve those targets,” says Toby Bishop, director of the Deloitte Forensic Center.

To be sure, temptation for fraud at troubled companies may be high these days, as employee morale is down amid reduced workforces. With that in mind, Bishop recommends that companies increase their monitoring of fraud controls, test their effectiveness, and do what they can to strengthen them. At the same time, boards and management should communicate more about target numbers so that expected results are more realistic as the financial crisis continues to work itself out.

Deloitte defined fraudulent companies as those publicly traded firms that were the subject of accounting and auditing enforcement releases from the SEC between 2000 and 2007. The study reviewed 352 releases, and the filings of 519 bankrupt companies and 2,919 non-bankrupt publicly traded companies that had at least $100 million in revenue (as reported in pre-bankruptcy filings).

While the firm makes the correlation between fraud and bankruptcies, the researchers could not make any direct connections between whether these instances of fraud led to these firms’ failures or whether regulators were more likely to find fraud because they may be more likely to review filings made by bankrupt businesses. In addition, bankruptcy filings are like “an open kimono,” subject to many reviews, including the companies’ financial advisers, creditors, bankers, and others, notes Sheila Smith, national service line leader of Deloitte’s Reorganization Services. “It’s hard to disaggregate whether there is more fraud in bankruptcies or whether because there is so much transparency in bankruptcy filings, we are just seeing more fraud,” she told

What the researchers do note is the number of fraud enforcement actions by the SEC each year has stayed around 20 during the past seven years for companies with more than $100 million in revenue. And 48 of those 139 announcements were made against insolvent firms.

The firm found most instances of fraud occurred at consumer companies, such as retailers, followed by the technology, media, and telecommunications (TMT) sector. In fact, at 27 percent, TMT represented the largest pool of companies issued enforcement action by the SEC, and 11 percent of those went bankrupt in the seven-year period under review.

The most common types of fraud for both bankrupt and non-bankrupt companies were revenue recognition, manipulation of expense, and improper disclosures. Bankrupt companies were twice as likely as solvent firms to have more than 10 fraud schemes in their history. Deloitte also noted that bankrupt companies with more than $10 billion in revenue had 10.8 fraud schemes on average.