An Oversight: The Path to Fraud

By Clementine Yockey

The economy depends on consumer confidence. This fundamental function of financial markets has recently been shaken by three corporations; Evergrande, a real estate company in China; Wirecard, a German payment processing system; and Theranos, a health technology company. These companies have damaged shareholders and investors’ confidence. After the Enron scandal in 2001, it is difficult to believe that strict regulations have not been adopted to avoid further scandals.  

Investor confidence is one of the foundations of a productive economy. The Consumer Confidence Index (CCI) can be used as a measure to indicate what shape an economy is in. The index measures the confidence of income stability in consumers – providing an insight into consumers’ confidence in a future economic situation by analyzing their expected financial situation, their sentiment about the general economic situation, and unemployment and capability of their savings. A high CCI indicates an expanding market; whereas, lower consumer confidence suggests a contraction in the economy where a decrease in spending and manufacturing activity occurs.  

It is surprising that twenty years after Enron, regulatory oversights are still taking place. Enron was an American energy, commodities, and services company that claimed revenues of $100 billion in 2000. However, it was revealed that Enron’s reported financial condition was sustained by institutionalized and creatively planned accounting fraud. The deregulation of natural gas allowed them to trade energy derivative contracts. Soon, the company emphasized trading commodities of oil and other commodities like coal, paper, and steel. The gas company started to use mark-to-market accounting, allowing Enron to input its ‘fair’ rather than ‘actual value.’ When Blockbuster joined Enron Broadband Services, and Enron faced more competition from its trading sector, the company started logging expected earnings based on projected growth, which was highly inflated. As a result, when the dot-com bubble burst because of overvalued technology stocks and companies like went bankrupt, Enron crumbled as they did not have the cash flow they claimed. 

Elizabeth Holmes of Theranos, at one point, was considered the next Steve Jobs. Now, she is on trial for fraud. Holmes dropped out of Stanford in 2003 to develop a portable patch that could self-adjust the drug delivery dosage and directly notifies doctors of their patients’ blood level. Despite contracts with Safeway and Walgreens, the technology was not effective. The Wall Street Journal even reported that Theranos was using customary blood testing machines and the company’s technology was not innovative. Finally, in 2016, Theranos was under criminal investigation by the SEC and federal prosecutors. Fraud on this scale creates a ripple of uncertainty. The Guardian wrote about the effect Theranos’ fall has on the medical startup industry in Silicon Valley and the growing scepticism in the industry. Theranos employed almost 800 people, and most of them were laid off because of the company’s mismanagement and fraud. The extent of the scandal would inevitably cause a break in confidence for workers and the security they feel. 

A similar case occurred last year with the insolvent payment processor and financial service provider, Wirecard. Wirecard’s creative accounting “misplaced” €1.9 billion. In early 2016 the “Zatarra Report” surfaced, claiming Wirecard was involved in fraud and money laundering, but it was not until 2020 that a criminal investigation would occur. The company finally declared bankruptcy in June 2020, owing creditors close to four billion dollars. At its peak, the company was trading at 193.55 euros with 5800 employees, this fell to trading at .17 euros with 570 employees as of August 2020, and the company is since insolvent. The public nature of the Wirecard fraud in the Financial Times spread across the world and brought the lacking regulations to the forefront of peoples’ minds. There were laid-off employees uncertain of their financial situation and customers of Wirecard whose accounts were frozen. The insecurity of the financial system was again exposed to market participants, and this shook consumer confidence. 

The most recent scandal, Evergrande, is seeing the demise of the second-largest real estate company in China. Evergrande initially started in 1996 and profited from China’s property boom and the extensive urbanization of the country. The company is currently in debt by three hundred billion dollars with angry suppliers who have shut down construction sites and hundreds of unfinished residential buildings, leaving 1.6 billion people, according to Barclays, waiting to move into the homes. Creditors and suppliers have declared hundreds of billions of dollars in outstanding bills. Evergrande’s borrowing supported sprawling projects from excess apartment construction to its soccer team to its electric car company. Most wonder if Evergrande is ‘too big to fail’ and whether the government will bail them out. The multibillion-dollar projects did not seem to be heavily unmonitored. 

Although these cases represent different problems in the system – fraud in Theranos and Wirecard and overextending with Evergrande – these issues need to be addressed. Similar regulations to those established after the 2008 crash could have prevented the Evergrande collapse. However, in the wake of the Lehman Brother’s bankruptcy, new regulation focused on the banking industry instead of the financial system as a whole because it was the hardest hit. Not allowing Evergrande to overextend themselves and have a minimum required reserve to pay back lenders would have eased the financial chaos that resulted from their mismanagement. Simply having more oversight of companies like Theranos and Wirecard could have caught the fraud earlier and avoided the system’s abuse scale.  

It is evident there is a need for securitization with corporations to avoid huge meltdowns in the economy. If people lose confidence in the institutions they are supposed to trust, market stagnation will stagnate, where the output will decline or flatten. It can take years to build up, but ultimately, investors might think it is too risky to invest if there is no more oversight and transparency. Low confidence brings less business which means lower revenue and smaller periods of economic growth. Wirecard, Theranos and Evergrande are companies worldwide that were left unchecked and resulted in massive blowups leaving thousands indebted. The Central Bank could be forced to intervene if companies continue to make unethical decisions. China is currently examining the extent of the Evergrande crisis to determine whether they should bail them out. There are regulations in place. However, they are targeted towards specific industries. For example, strict limitations have been placed on the banking and investment community to prevent huge fallouts while the hedge fund and venture capital world remain primarily unmonitored. Financial institutions should be managed more closely so fraud can be caught early on and maybe even prevented. The market will slowly destabilize if there is a lack of response. It has yet to happen, but if occurrences like these continue, people will lose faith in the system, and a crash will inevitably occur.  

The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.

Photo: Markets Photo

One Comment Add yours

  1. Mike Swan (Sam) says:

    Brilliant! there is much potential. The U.S faces and inevitable struggle. How are mutual funds closely monitored and taxed, and yet hedge funds and private equity groups are not. There is plain lawlessness within American markets, if there will be any change in market regulation is must begin in the U.S. Europe needs assurance that the American government will commit to change. This article is a commentary on what is on the top of the minds of many financial experts.


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