How do they get away with it?
In one of the largest frauds in history — though it certainly has competition from subsequent events — managers of Korea’s Daewoo Group used accounting maneuvers in the late 1990s to commit a $15.3 billion fraud, which included inflating the company’s equity by $32 billion. The scheme involved dozens of company officials, including several who went to prison and paid large fines.
The company’s founder and chairman was accused of a host of criminal charges, sentenced to 10 years in prison and directed to forfeit $22 billion, much of which he had sent out of the country.
As with most of the scandals covered in this Guide, journalists wrote about the events afterward, not in advance. The goal of media is to get out in front of a story like this by reporting on irregularities or suspicious claims before they erupt in a scandal. Is that possible?
“Anyone carefully studying Daewoo’s books could detect misconduct of that magnitude,” Lee Dong Gull, a former Korean presidential economic adviser, told BusinessWeek in 2001. (For tips on how to recognize certain accounting gimmicks, see charts on spotting “shenanigans,” Chapter 6.)
Lee added that those held responsible for such frauds should include “the accounting firms and regulatory officials who overlooked the fraud.’’
Stock exchanges and regulatory agencies are supposed to discover such manipulations, essentially by rigorously enforcing disclosure and filing requirements. Often, though, it does not work that way, for several reasons:
Many exchanges and enforcement agencies in emerging markets have lax rules, limited resources or are not skilled in handling complex laws and regulations
Enforcement is weak or non-existent
Managers and financial experts within companies become expert at hiding their dealings
Media are not diligent about reading and reporting on financial and other disclosures, or writing about companies that fail to file on time or omit critical information
Securities regulators are being pushed to toughen enforcement, and the pressure has had some impact. In 2011, Vietnam’s market regulator, the State Securities Commission (SSC), published the names of 14 listed companies that violated disclosure requirements, primarily by late filing of financial statements.
The SSC’s tougher stance was prompted by the revelation that Vien Dong Pharmaceutical (DVD), which was listed on the Ho Chi Minh Stock Exchange, concealed from share-holders and regulators that it was forced into involuntary bankruptcy by heavy debt. But critics argue that warnings, fines and trading suspensions are not strong enough to reform the market, and say that only by delisting offending companies can regulators improve transparency practices.
Perhaps the most dramatic example of a success story is Brazil’s Novo Mercado, a special market for companies that voluntarily observe good governance guidelines. The market, created in 2000 by Brazil’s stock exchange, Bovespa, is credited with raising the standards of corporate governance in Brazil and setting an example for exchanges in other emerging markets.
Before Novo Mercado was launched, both domestic and foreign investors were wary of Brazilian companies, and IPOs were rare. Although Novo Mercado got off to a slow start, it now has more than 100 listed companies and hosts frequent IPOs.
An executive of Brazil’s investor relations association even credited the governance improvements inspired by Novo Mercado with helping the country get through the worldwide financial crisis in 2008-2009.