Earnings management, in exchange listed companies, is not fraud but a case of caveat
emptor for investors
Introduction
Caveat emptor is a Latin word that means the buyer should be aware of what he is buying. The
buyer is the one to shoulder the burden of all the risks in case of any problems with the product
that he has purchased. The buyer is directly responsible for protecting himself against any
problems with the product and also for knowing his rights, ignorance is basically not an option
for defense in case of the buyer.
However after the 1929 Wall Street market crash, the US congress adopted several measures
that favored disclosures through the enactment of the Securities Exchange Act. This act was
passed with a view of controlling or limiting the effects of the caveat emptor notion in the
securities exchange market.
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Earnings management in the Securities market entails that the participants in the Securities
market allocate funds to investments that are considered risky in an effort to earn higher profits
for their clients while the governments roles in the whole industry is to provide an oversight
supervision to ensure that all investors are protected principally against all kinds of fraud and
mispresentation that may target the investors but their efforts are limited to that effect only they
cannot protect the investors from other business risks and ignorance of the stock market
operations. They are supposed to be aware of the operations of the securities market and the
risks involved i.e. the caveat emptor notion. (Weisburd, Wheeler, Warring and Bode, 1991). The
government cannot by any means remove the business risks from the participants investment
decisions, the buyer is expected to be aware of the risky nature of investments decisions that
the agents or the brokers of the stock exchange have to make. The onus to bear high risks falls
on the investors who also must understands that the very high returns are also associated with
even greater risks and the government regulation authority cannot be responsible for their
losses which may be occasioned by their investment decisions the same case also if they
benefit substantially from the same decisions the government’s regulation bodies cannot claim
any part of it. The rule of thumb for many investors require that they should not invest the
monies that they cannot afford to lose and that they should stay away from products that they
are not understandable. (Frank, 1998) To minimize risks the investors would rather opt for the
short term stocks provided by the government that’s government stock. Buying and holding is a
good strategy but they should diversify their investment and not limit their investment in one
type of investment. Caveat emptor strategies of this nature are safer and reliable than relying on
the government’s regulatory investor protection policies and measures. (Alexander and
Seymour, 1998)
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Corporate governance require that all company CEO’s and their senior financial advisers or
company officers to be fully responsible for the full, accurate, understandable and fair
disclosures in their annual or periodic reports that are normally filed by the Securities and
Exchange Commission in the US and the UK. Corporate governance also ensures that the CEO
and other senior company officials must promptly disclose any violation of the code of business
ethics and conduct to the regulatory government agencies or the Securities Audit Committee
concerning any employee’s conflict of interest which may be actual or incidental. Companies are
also required to remove any deficiencies in their internal controls that may adversely affect the
firm’s ability to process, summarize, record and report any information that result in fraud
whether its material or insignificant. The CEOs are also expected to report any violation of the
Securities laws or other guidelines that are applicable to the business firm.
The code of ethics and controls is applicable to business operations and the procedures
involved. These procedures guide the standards and principles of employee ethics in an
organization and define improper behavior by employees. Violation of the code of ethics by
employees may result in disciplinary action or even dismissal. Some of the guidelines involve
outlawing insider trading, measures to control and define conflicts of interests, confidentiality,
competition and fair dealing practices, corporate opportunities, gifts and gratuities payments to
employees. (Coker and Little, 1997)
The US PATRIOT Act of the year 2001, H.R. 3162, established the Electronic Crimes Task
Force (ECTFs) that mandated the US Secrete Services to prevent, detect, mitigate and
investigate all forms of financial crimes affecting the financial markets. The following are some
of the common financial crimes in the US.
Identity Crimes
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These crimes are mostly defined as the improper use or misuse of personal other personal
identifiers so as to gain financially or obtain something valuable or even to facilitate other
criminal activity. (Alexander, 1998) Identity crimes are the most common financial crimes and
also the fastest growing economic crimes in the US and UK. These crimes target financial
institutions and also individuals whose identifying details have been used illegally. Identity
includes; Credit Card and Access Device Fraud known as Skimming, Cheque frauds, False
identification, identity theft and Bank fraud. (Givens, 1999)
Counterfeits and other fraudulent identification documents are utilized to propagate fraudulent
activities through the internet by use of different and illegal software’s that produce similar forms
of identification that can be applied to obtain or withdraw funds illegally.(Ganzini, McFarland
and Bloom, 1990)
The Access Devise Fraud is regulated by section 1029, title 18 of the United States code and its
normally referred to as the Credit card statute and it seeks to control frauds related to the debit
cards, ATMs (Automatic Teller Machines), Credit cards, Subscribers Identity Module (SIM) and
long distance electronic access codes.( Bureau of Justice Statistics (BJS), 1999)
Computer fraud relate to unauthorized access to information stored on computer systems with
the sole aim of unlawful financial gain. (Zuckerman, 2000) Computer crimes have allowed the
cyber criminals to reach their victims in any part of the globe and it’s difficult to reign in all the
offenders due to the nature of the crimes involved. The ECSAP (Electronic Crimes Special
Agent Program) and the ECTF were enacted mostly to fight these financial cyber crimes.
(Walsh and Schram, 1980)
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Forgery results in financial loses to companies as well to the government. Criminals steal
cheques and bonds and often forge the victim’s signatures in an effort to steal or withdraw funds
from their accounts. (Wellford and Ingraham, 1994)
Money Laundering is also another form of financial crime that is referred to as specified unlawful
activities under section 1961 of the Racketeer and corrupt organizations Act of the US
constitution. The US secret service and the British Scotland yard monitor all the transfers of the
illegal money.(Coker and Little, 1997)
To conclude, the code of ethics and good governance conduct for most companies aim at
controlling white collar crimes and reducing the effect of fraud. Listed companies utilize the
internet for most of their transactions which involve the transfers of huge sums of moneys during
the sales and purchases of stock and other financial guarantees. The Internet Fraud Watch at
the National Consumer League indicated that the online auctions accounted for nearly 87% of
all the internet frauds. To counter these activities the US government formed the Computer
Crime and Intellectual Property Section (CCIPS) which is located at the justice department in
- It’s mostly mandated to advice federal prosecutors on the nature of all computer related
criminal activities in the US and also to coordinate extra efforts to tackle computer crime. In
March 15 to 16 the year 2000 the US treasury announced on the National Summit on Identity
the formation of a computer based educational training computer manual that targeted the law
enforcement agents in an effort to combat financial crimes. The summit also came up with other
methods to control bank frauds, credit frauds and also techniques of combating money
laundering.
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References
Alexander, E. (1998) Providing Services to Victims of Fraud: Resources for Victim/Witness
Coordinators. Washington, DC: Police Executive Research Forum.
Alexander, E., and Seymour, A. (1998) Roles, Rights and Responsibilities: A
Handbook for Fraud Victims Participating in the Federal Criminal Justice System
Washington, DC: Police Executive Research Forum.
Bureau of Justice Statistics (BJS) (1999) Source book of Criminal Justice Statistics, 1998.
Washington, DC: U.S. Department of Justice.
Coker, J., and Little, B. (1997) FBI Law Enforcement Bulletin
(December) Federal Bureau of Investigation (FBI). 8 May 2000. Press Release.
Frank, M. (1998) From Victim to Victor: A Step-By-Step Guide for Ending the
Nightmare of Identity Theft. Laguna Nigel, CA: Porpoise Press.
Ganzini, L., McFarland, B., and Bloom, J. (1990) “Victims of Fraud: Comparing
Victims of White Collar and Violent Crime.” Bulletin of the American Academy of
Psychiatric Law18 (1): 55-63.
Givens, B. (1999) Identity Theft: How it Happens, Its Impact on Victims,
and Legislative Solutions. Los Angeles CA: 25th Annual Conference, National
Organization for Victim Assistance. Internet Fraud Complaint Center (IFCC). 2000.
Walsh, M., and Schram, D. (1980) “The Victim of White Collar Crime: Accuser or
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Accused.” In G. Geis and E. Stotland, eds., White Collar Crime Beverly Hills,
CA: Sage Publications.
Weisburd, D., Wheeler, S., Warring, E., and Bode, N. (1991). Crimes of the Middle
Classes: White Collar Offenders in the Federal Courts. New Haven: Yale
University Press.
Wellford, C. and Ingraham, B. (1994) “White Collar Crime: Prevalence, Trends, and Costs.” In
Roberts, A. ed., Critical Issues in Crime and Justice
Zuckerman, M. (2000) “Criminals Hot on Money Trail to Cyberspace.”
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