Quantitative Value, + Web Site: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors

CHAPTER 3

Hornswoggled! Eliminating Earnings Manipulators and Outright Frauds

“[Accounting] shenanigans have a way of snowballing: Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require it to engage in further accounting maneuvers that must be even more “heroic.” These can turn fudging into fraud. (More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.)”

—Warren Buffett, Shareholder Letter,2000

In The Great Crash of 1929,1John Kenneth Galbraith referred to embezzlement as “the most interesting of crimes”:

Alone among the various forms of larceny it has a time parameter. Weeks, months, or even years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in—or more precisely, not in—the country's businesses and banks. This inventory—it should perhaps be called the bezzle—amounts at any moment to many millions of dollars. It also varies in size with the business cycle.

The “bezzle” is the sum of all undiscovered swindles, hornswoggles, chisels, and flimflammery perpetrated on the economy. According to Galbraith, it swells in good times, when money is plentiful, and shrinks in the depression as audits become more penetrating and meticulous. ...