Financial Crimes And Scandals: Lessons From Past Failures And Progress Towards Investor Protection

Lessons from past failures

Financial crimes and scandals have been a very important part of the financial environment across the world for a good period of time over the past decade. There have been numerous instances of many kinds of financial crimes, scandals and similar kind of incidents in the past decade, which have rocked the world economy and the global financial system. Generally such incidence have a deep underlying cause, which largely remains the subversion of overall interests in front of individual interests of the various individuals, who were involved in these incidents and crimes. The most important and vital impact such kind of incidents, has is on the investors and the general public at large.

It is their faith which is shaken from the repeated occurrences of such kind of financial scandals and intolerable crimes. They form one of the most important aspects of one’s business. The investors, general public and the various other stakeholders who have their stakes in the business are the ones, who are mostly affected by these deplorable actions of the businesses.

            For the last decade, more regulators have found the importance of strengthening the global financial framework, creation and harmonisation of the international accounting standards along with the various other accounting standards and the importance of the involvement of the corporate social responsibilities in the day to day functioning of these businesses.

With the growing incidents of financial crimes and scandals, the importance of these issues and their addressing has come to the public limelight. In this report, all these aspects have been addressed, along with the different lessons which have been learnt from the past financial and business collapse and the improvements which can be made in response with the growing incidents of financial crimes and scandals, with a view in protecting the interests of the investors of the businesses.

Lessons from past failures:

            In the past few years, particularly in the past decade, there have been various instances of financial crimes, scandals and business failures which had altered the course of the global economy for years to come. In the present times, when the incidence of such kind of business failures and scandals are but growing, it is has become the need of the hour to understand the causes and the lessons from these past incidents of financial scandals and failures of businesses. Some of the famous and important financial scandals and business failures, occurring the past decades have been provided below:

• The case of the Lehman Brothers’: This is a famous financial business failure, which laid the foundations of the recession of the 2008 period. One of the most important causes of this was the independence which was achieved by the company in the subprime mortgage market. Here, two blunders were performed by the management and the executives of the company; firstly, the company was unable to make accurate forecasts into the nearest future and failed to create counter strategies, against changing market conditions. Secondly, the executives might have known most of the changes taking place in the mortgage market, but were reluctant to implement new strategies to counter their impact, as they had remained busy in maximising the shareholders returns and in the process of enriching themselves by payment of huge bonuses (Adu-Gyamfi 2016).
• The Enron case: The Enron scandal took place in the October of 2001. Here the primary case involved blatant abuse of power and privileges, along with manipulation of information, placing personal interests over the interests of the stakeholders and the public, which led to the collapse of one of the most successful energy companies of America. Truthfulness was completely ignored and missed by the management of Enron, about the financial health of the company, lack of oversight of the management conflicts and clash of interests, deliberate abuse of power took place by Chairmen CEO (Hosseini and Mahesh 2016).. Some very important lessons crops up from this case, as to why the importance of implementing ethical principles, understanding, respecting the needs of the stakeholders is essential and the importance of leadership by example is so important in the corporate world (Hosseini and Mahesh 2016). As in the case of the Lehmann Brothers, depending on the audit reports and the financial statements only for investing is not sufficient enough.
• The collapse of Carillion:The collapse of construction giant Carillion has created an uncertain future for the thousands of workers, who have been under Carillion’s contract for a long period of time. The company had become overstretched, highly leveraged and had become highly exposed to adversarial kind of outcomes in case of small construction companies. The case of Carillion highlights the flaws in the UK’s corporate governance systems, which requires the importance of highlighting the interests of the shareholders over the interests of the stakeholders (Loxley 2018). The investors were paid dividends; the executives were paid bonuses, when the company was going towards disasters (Loxley 2018). There was a friction in the relation between the company executives and the labour unions. In this respect, action was needed to ensure that the strained relations between the unions and the management are resolved through meaningful dialogue and mutual respect and understanding the demands of each other. Timely decision making and respecting the audit reports is very important for the management of the company. In the annual report of the company for the year 2016, there was no mention of any kind of financial stability in the auditor’s report, which was not heeded by the management of the company (com 2018).
• Harmonisation of the International Financial Reporting Standards (IFRS):

            Harmonization is particularly important for the purpose of reducing any kind of differences in the various processes of financial reporting around the globe. The most important aspect of the process of initiation of the comparability of the different financial statements, across various companies, between different countries (Ifrs.com. 2018). When the reconciliation and eventual harmonization occurs, the difficulties of the companies in comparing each other’s financial statements becomes less cumbersome and smooth as a result of which the interpretation of the comparison and analysis also becomes fairly easy and relevant (Zehri and Chouaibi 2013). This has been the main idea behind the idea of harmonisation of the financial statements. 

Harmonization of accounting standards

There have been various calls from across the financial and economic spectrum from around the world, for a call of harmonization of the accounting standards specially the international financial accounting standards. There have been widespread confusion behind the standardisation and the process of harmonization of the financial standards. Harmonization is very different from the process of standardisation. In the former, the emphasis is placed on the creation of a similar kind or set of processes by setting up of specific boundaries as to how much can these can differ internationally (Ramanna 2013). On the other hand, the process of standardisation deals with the act of unifying the reporting standards for the purpose of making them on and the same.

This is almost an impossible and daunting task, which is very difficult to bring about, as a result of which the process of harmonization has been identified as the only viable solution to this problem. Here it has been stated that harmonization would pave the way of successful comparison of the performance of the multinational corporations, who all this while operated internationally using unique set of accounting and reporting standards. With the increasing instances of the businesses going global, growth in .

the cross-country mergers, takeovers, acquisitions, market entry, the need for a robust accounting standards, which is helpful in bringing in a certain kind of uniformity is becoming the need of the hour (Wang 2014).  Moreover, the new accounting procedures which have been implemented through the harmonization of the international accounting standards, would be much more investor centric.

Investor protection through IFRS:

The International Financial Reporting Standards have been issued by the IFRS foundation and the International Accounting Board for providing a common language of accounting across the world. Providing a common platform and a proper medium of communication for conducting and reporting the business affairs of the business organisations across the globe has been an important factor behind its creation and introduction in the financial system of the world. IFRS generally contain rules which are expected to be followed by the accountants all over the globe for the easy understanding, interpretation and comparability of the financial statements.

At the helm of all these activities, the major objective of protecting the investors from making scrupulous investments or investing money in any fraudulent business ventures has been the driving force. The IFRS has been created with several rules and provisions regarding the treatments of various financial assets, liabilities, expenses and other items with utmost diligence, keeping in mind the protection of the investors. It has taken the following steps and objectives for protecting the investor’s interests.

• In accordance with Para 15 of standard IAS 1,it ensures fair presentation of the accounting data, events and transaction, in accordance with the recognition criteria’s and definitions of assets, liabilities, incomes and expenses, within the framework of IFRS.
• For ensuring the protection of investors interests by providing correct information, IFRS has entitled its users to make way for accrual basis of accounting, in accordance with Para 28 of standard IAS 1.
• Materiality is another area, which is ignored by the accountants for fooling the investors. IFRS has ensured a tough crackdown on this, by making it a compulsion of presenting each and every aspect of materiality, whether it is big or small. Even dissimilar items need to be shown separately.
• IFRS has ensured that businesses remain healthy and periodic information about their going concern must be presented in the annual reports or through any other medium. This would provide safety to the investors in the long run. It has stressed on the importance of ensuring that investors receive adequate information about the liquidity and overall financial health of the firm.

The progress in various countries:

• Australia: The Australian Accounting Standards Board (AASB), have introduced the Australian equivalents to the IFRS, the (A-IFRS), which have replaced the previous Australian generally accepted accounting principles. It helps in accommodating newly established and revised accounting standards introduced by the IFRS in the Australian economy. It regularly reviews the changes and implements them in Australia. They have been at the forefront with the entire process of harmonization of the accounting standards and principles.
• Russia: Here the government has played a pivotal role in ensuring the initiation of the process of harmonization of the accounting standards of international nature. It had introduced a programme, aimed at harmonizing the national accounting standards of its country with the international accounting standards since the year 1998. Since then the Government of Russia has been at the forefront of introducing the principles of harmonizing the international standards of accounting. Since 2004, it has strictly been advised to all the commercial banks to prepare their financial statements both in the Russian accounting principles and also the IFRS (Ghio and Verona 2015). Although, full transition into the IFRS has been delayed, but after the year 2012, some new modifications have been introduced by Russian authorities. Since then the process of bringing in a standardised way of reporting financial statements has been in full swing.
• South Africa: It has been explicitly instructed to all the companies which are listed in the Johannesburg Stock Exchange are required to comply with each and every requirements of the international financial accounting standards since the 1st of January from the year 2005 (Ames 2013). It has been ensured that all the statements of the South African GAAP is in sync with the International financial accounting standards.
• India: The largest democracy in the world has also been working tirelessly for the implementation of the International financial accounting standards. The Institute of Chartered Accountants of India, has been at the helm of implementing the harmonization of the international financial standards of accounting. As a result of which, the ICAI had announced that complying with IFRS would be mandatory from the year 2012 (Dhankar and Gupta 2014). However, this plan fell through, and as a result of which still now, Indian companies have been following the old Indian GAAP. There has not been any kind of indication about the date of the adoption of the IFRS.
• Other countries: In case of some other countries, various examples crop up, which have been in the quest for the introduction of the policies for the harmonization of the international financial accounting standards. Uruguayan companies have adopted the IFRS concepts from the 31^st of July of 2007 and the complete introduction of the IFRS had started from the year 2008. New Zealand have introduced some accounting standards which have been described as IFRS equivalents. Malaysia had also planned in implementing the standards from the year 2012, and have successfully done so and are marching towards the harmonization of the international accounting standards. Similarly Taiwan has also been pressing for the introduction of IFRS in their accounting scenario (Zehri and Chouaibi 2013). The Taiwanese companies are now required to prepare financial statements in accordance with the Taiwan-IFRS, which was started from the year 2013.
• Importance of Corporate Social Responsibility in terms of investors and market protection:

            The relevance of corporate social responsibility has been growing at a faster rate in the past couple of years, with the increasing importance of shouldering the responsibilities towards the different stakeholders of the business entity. Presently CSR has been producing important results for the businesses across the globe. It has helped the investors of many companies in a variety of ways.

Investor protection through IFRS

In this way, the investors have realised the importance of CSR. Today CSR has become an integrated part of the way a business operates as these businesses need to demonstrate that apart from their profitability benefits, their business are also concerned about their employees , customers and the society at large. Members of investors committee of various business organisations have concluded that CSR has now gone beyond the legal and compliance obligations of good governance, thereby putting the interest of the stakeholders specially the investors and the social and environmental concerns at the very top (Kyriakou, 2018).

Various developments have occurred in the past few years in the sector Corporate Social Responsibility. It has been increasingly adopted by various internally reputed firms across the globe, such as Google. Google had introduced programmes like ‘Google Green’ as a part of its CSR activities, where the focus was on using resources efficiently and supporting renewable power. Just by recycling and turning off the lights helped Google in reducing its cost. These savings were redirected by the investors for investment purposes in other ventures, thereby protecting their interests. In April, 2016.

the Securities and Exchange Commission (SEC) had issued a request for public comment regarding the modernisation of certain business and financial disclosure requirements, under the Regulation S-K as part of its currently ongoing disclosure effectiveness initiatives. It is because of this that quiet a large number of business organisations have also accepted the significance of investor demand for human rights related disclosures by voluntarily reporting on human rights policies, practices, and risks associated with the businesses.

As of today, there exist a wide number of voluntary human rights reporting frameworks, including the  All these frameworks and regulations have acquired noteworthy investor and business organisation support. For instance, six global business organisations and more than eighty investors indicative of more than $4.25 trillion dollars in the assets UNGP Reporting Framework, and 78% of the coverage companies under this scheme make GRI’s G4 standards for their reporting of corporate responsibility (Morgan McKinley Ireland, 2018).

The investors feel protected by the introduction of the various ways through which the company can provide insights into the ways through which it operates by preparing and publishing a sustainability report. This ensures widespread transparency in the operations of the companies, thereby assuring the investors of being associated with a law abiding and responsible business entity.

            It has been seen that the companies or the business organisations which have introduced CSR in their financial reporting have seen a high audit quality standard as compared to companies which haven’t done so. It helps in enhancing the company’s reputation in the market and provides a host of other benefits. It helps in improving the financial stance of the company, risks become less and earnings also increase. On the other hand, business entities which do not adopt CSR into their financial reports tend to experience low auditing quality standards and increased financial risks (Bonsón and Bednárová 2015). 

Companies filing CSR reports prevent internal financial reporting weaknesses and tend to experience a higher return on their assets and they also tend to experience the support of the big four auditing firms. Companies which have adopted CSR have been compelled to reveal more information in their annual financial statements and annual reports, concerning matters related to environmental and social activities. This led to the serious discussion especially after the emergence of various financial scandals, especially with the fall of Wall Street, the collapse of Enron in 2001 and the economic recession of 2008.

The advent similar kind of financial scandals and bankruptcy of business powerhouses had compelled the government, industry experts and other experts to look for viable solutions to address such situations in the future (Tschopp and Nastanski 2014). This led to the creation of the corporate social responsibility and its subsequent adoption in the financial reports of various leading businesses. All these had increased the importance of the involvement of the different aspects of corporate social responsibility in case of financial reporting

Functions of Corporate Social Responsibility:

            Corporate social responsibility is the practice of compilation of the social and environmental objectives and responsibilities of any business organisation into its particular business operations. Rather than focusing only on the profits and the shareholders’ interests, business organisations which utilize the notion of corporate social responsibility observe how their business operations and practices influence their employees, suppliers, customers, local communities, government and the environment on a big scale (Belal and Owen 2007). Thus, in this all pervading concept, the functions performed by it are also very significant. Some of them are very important in ensuring proper financial reporting and maintaining the overall professionalism of the business organisations in terms of the execution of their business operations.

1. Responsible sourcing of materials and supplies is one of the most important functions of corporate social responsibility. Due to the regular publication of the sustainability and annual reports, the businesses would like to take up far more effective and efficient steps for ensuring zero wastage of resources, supplies and raw materials (Ioannou and Serafeim 2015.). If the company is unable to manage itself, how the community at large can would look up to it.
2. Greater relationship with the key stakeholders such as the employees, vendors, customers and the general community at large. The adoption of the policies and principles in relation to the corporate social practices, the business entity caters to look after the needs and requirements of each of them (Ioannou and Serafeim 2015). This helps in easing the relationship between the business and its stakeholders.
3. In implementing the corporate social responsible practices the adoption and the execution of the different functions related to the same by the CSR unit of the organisation is of paramount importance. It is the initiator and the insurer of the CSR practices by the business. Ingraining socially and environmentally responsible practices within the business is an important function (Crane, Matten and Spence 2013). Promotion of community investments such as monetary donations towards civil societies, schools, orphanages are some of the most effective and important functions of the CSR.
4. Respecting the laws of the land, ensuring timely payment of the taxes, promoting backward districts of the economy, practicing functions of social inclusion are another set of important functions advocated by the CSR practices (Bucur 2013). These practices have a special significance in the eyes of the government and the community at large. Emphasising these goals, practices is very important for ensuring the growth of the companies and other organisations.
5. Improvements for investor’s protection:

            For ensuring the protection of the interests of the investors and the amount of money invested by them, it is very important to take some concrete steps in ensuring such issues are addressed at the grass root levels. A number of steps have been provided below:

• External audits and surprise audits: In the present circumstances where there has been an excessive rise in the incidences of financial crimes, it has become very important to ensure proper auditing of the financial statements. In such scenarios relying on internal audits solely is not a welcoming move; rather it becomes very important to get the help of external audits in these cases. Arranging surprise audits is also a welcoming move (Steffensmeier, Schwartz and Roche 2013). This helps in keeping in checking the real scenario of business manipulation, if such cases exist.
• Modesty in CSR promotion: It has been seen that the companies and the business organisations which have been modest in their promotion of the different types of CSR activities undertaken by them has not been well received by the general public, treating them as mere gimmicks. Leading brands such as Citibank, 3M and GE value discrete ways of promoting their CSR related activities, which adds a layer of genuineness to the CSR activities.
• Improvements in IFRS regulations: Bringing bout major improvements in the regulations and framework of IFRS with the objective of promoting and protecting the interests of the investors is a good step. Mainly elimination of conceptual inconsistencies with the IASs in case of major financial terms and their treatment, need for additional guidance and disclosure, drafting improvements addressing the issues of relevancy and transparency is also one of the most important ways of initiating such changes. Making improvements in the reporting structure as well as the overall structure of the various provisions of IFRS would also go a long way in protecting the interests of the investors as well as ensuring the normalcy in the market.

Conclusion:

            The importance of corporate social responsibility and harmonisation of the accounting standards has become very important in the view of the recent crimes and incidences of financial scandals. In this report, lot of insights had been drawn into the past incidences of financial crimes, such as the Enron case, the fall of the Lehmann Brothers’, or the great economic recession of the 2008. Each of these events had taught a great lesson with regards to the financial crimes, corporate governance practices and other such similar practices. Through this report, the different aspects of the functions of the corporate social responsibility had been discussed;.

where it became evident the importance of CSR in financial reporting is very significant for ensuring the prevention of any kind of business related crimes or financial scandals. It has been explained through this report, that the harmonisation of the international accounting standards is pivotal in the arena of preventing any kind of financial crime. As has been seen in the report many nations have already adopted it and many are working towards it. This is really important for preventing such crimes in the future. Along with the entire harmonisation thing, the introduction of CSR practices  in the normal course of business through their financial reporting is very important and has been stressed upon in here.

References:

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• References:
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