Unfortunately, periodic financial scandals and frauds are a fact of life in business and investing. Investors should be aware that unscrupulous businesses and individuals exist, and that financial scandals can swiftly render assets worthless.
The following financial scandals, which rank among the greatest in history, show how dishonest people can mislead investors in order to benefit themselves.
Charles Ponzi’s Ponzi Scheme
2008 Global Financial Crisis
Among the financial scandals involving Wall Street, the Enron scandal is arguably the most well-known. In the late 1990s, Enron was a high-flying energy services firm and a stock market favorite. Shareholders could have lost as much as $74 billion when it finally crashed. In order to inflate sales and conceal debts, the CEO, Jeff Skilling, and the CFO, Andrew Fastow, employed a variety of questionable accounting techniques. As a result, while having debt, the corporation gave off the impression of being the most profitable in history. Enron was able to readily secure additional funding to continue the ruse thanks to the impression of a sound balance sheet and significant revenues.
The majority of the fraud was carried out between 1998 and 2001, when the stock price reached a high of $90.56. CEO Ken Lay continued to give Skilling increasing amounts of power during this time, which Skilling then used to alter the company’s financial records. By switching an accounting methodology to use market-to-market prices, the corporation was able to inflate asset values and revenue. Then, these prices were deceived. Debt worth billions of dollars was also concealed through Cayman Islands shell firms and removed from the balance sheet. After Lay was replaced as CEO by Skilling, the fraud picked up speed.
When the deception ran its course in 2001, the business failed. They detained Ken Lay, Jeff Skilling, Andrew Fastow, among others. Fastow and Skilling were imprisoned for six and twelve years, respectively. Before being punished, Ken Lay passed away. In addition to Enron’s destruction, the controversy also contributed to the death of Enron’s auditor, Arthur Andersen. The auditor contributed to the cover-up and failed to notice the financial malfeasance. One of the biggest accounting scandals in the United States to this day was caused by Arthur Andersen’s involvement in the fraud.
WorldCom ranked as the second-largest US telecom corporation in the 1990s. However, in 2002 the business failed as a result of extensive accounting fraud being discovered. As the popularity of mobile phones increased in the 1990s, telecom businesses fared quite well. Later, when pressure on the sector increased, WorldCom executives started falsifying their financial records. To provide the idea that the business was still profitable and expanding, they inflated revenue and classified expenses as investments.
At its peak, the corporation was valued at $180 billion because investors thought the stock was still a sound investment. This indicated that it was one of the most valuable corporations in the world at the time. The stock price swiftly dropped from $60 to $1 as auditors found that revenues and earnings had been inflated by as much as $7 billion, and thousands of workers lost their jobs. The business declared bankruptcy and later reappeared as MCI, a somewhat smaller reorganized business. Later, Verizon Communications purchased MCI.
WorldCom’s CEO, Bernhard Ebbers, received a 25-year prison term in 2006. After serving 15 years, he was released earlier this year, and shortly after, he passed away. One of the biggest business scandals in history, the WorldCom fraud cost investors approximately $180 billion and caused thousands of job losses.
– Mississippi Bubble
The Mississippi Bubble was one of the earliest financial scandals to be chronicled. A peculiar Scottish economist, the French economy, and one of the first banks to print money all played a part in one of the oddest financial histories ever told. For some reason, John Law, a runaway from England, was chosen as de facto Minister of Finance by the Duke of Orleans, who was serving as Regent in France.
Debt had ruined France’s economy, and Law was granted the power to try to repair it. He sought a number of alternatives, one of which was to create monopolies under state control to bring in money for the government. Another was establishing a new bank that printed paper money, which was still novel at the time. The Mississippi Company, which would combine the trading enterprises in Louisiana into one organization, was one of the monopolies that Law formed.
Despite the fact that Law was permitted to issue 50,000 shares, investors only had to make a down payment equal to 15% of the share price. Law was able to issue an additional 300,000 shares because investors hurried to buy shares. The share price increased from 500 to 10,000 livres in a matter of months. Law was able to lend the French government enough money to pay off the country’s debt because of the amount of money he was able to raise.
The issue was that Law’s bank had to print more money since investors needed so much cash to purchase the shares. Law attempted to deflate both the currency and the share price in a regulated manner after realizing that they were both overvalued. This, regrettably, led to a selling frenzy where investors tried to sell their shares and then convert the money into gold. In the end, the business failed, rendering the shares and the French franc worthless. Following widespread uproar, Law, who had already been dismissed, was forced to leave Paris and go into hiding.
– The Ponzi Scheme of Charles Ponzi
By no means was Charles Ponzi’s scheme the largest or even the first financial scandal. In actuality, Ponzi had a history of defrauding people even before the scheme that made him famous. But because it was such a big deal at the time, it’s important to note that some kinds of pyramid schemes are now recognized as Ponzi schemes. Ponzi devised a scheme to exchange worldwide reply coupons in 1919. (IRCs). These coupons can be used to purchase postage stamps. He thought it was possible to purchase IRCs at a discount in Europe and then swap them at face value in America. In order to attract investors, he made a 90-day, 100% return guarantee.
The plan soon gathered traction, and he had no trouble raising more money. He was bringing in up to a million dollars per day at one point. But in actuality, the plan grew so large that it was no longer manageable. Ponzi discovered, however, that he could simply pay the promised returns to investors from new investors, and that majority did so nonetheless. In fact, the technique was bringing in so much cash that he could afford to live the high life. However, the plan was exposed within a year when investors demanded their money back as a result of several pieces in the Boston Post.
Ponzi ended up serving time in prison, but astonishingly, as soon as he was released, he started another scam. Most nations forbid the use of pyramid and ponzi scams. They are comparable in that both are unsustainable and pay investors’ returns using money from new investors. A pyramid scheme encourages each investor to bring in new investors, but a Ponzi scheme relies on one central operator to find investors.
– Bernadette Madoff
In 2008, Bernie Madoff’s hedge fund business was revealed to be a massive Ponzi scheme and another Wall Street scam. This tale differs from others in that wealthy investors and fund managers, not regular people, fell for the con and lost money. For his hedge funds, Madoff reported outstanding but fictitious returns. He allegedly invested in blue-chip stocks before hedging his portfolio by purchasing S&P 500 option contracts.
He had a consistent stream of new cash flowing into his funds since they appeared to produce constant returns with no volatility. He was able to keep the illusion going for a very long time because very few investors ever actually withdrew their money. After the global financial crisis of 2008, it eventually became apparent that the charade was going to end. Madoff was reported to the SEC by his own sons. Despite the fact that the money was never truly there in the first place, investors lost a total of $64 billion. In the end, Madoff received a 150-year prison term.
It’s unclear exactly when Madoff’s business transitioned from being a respectable enterprise to a Ponzi scam. According to some, the scam started in the 1980s, meaning the man ran the scheme for up to 20 years. Long before the fund crashed, financial consultants and traders also raised red signs, but the SEC disregarded their advice. It also seems like some investors were greedy despite knowing the rewards were too good to be true.
– Global Financial Crisis of 2008
Economic crises like the Great Financial Crisis of 2008 are not often considered financial scandals. However, a vast list of unethical behavior, conflicts of interest, and corporate fraud are included in the various causes of the crisis. To begin with, issuers paid rating firms to assign investment-grade credit ratings to exceedingly hazardous instruments. Because rating organizations had a financial incentive to ignore the underlying risk an investment held, this created a conflict of interest.
Then, to increase the likelihood that their mortgage applications would be accepted, mortgage originators urged home buyers to overstate their income and assets. In order to sell mortgages, they also employed pushy sales techniques. Later, it was discovered that banks were wrongfully foreclosing on properties. Banks offered investors securities that they were well aware were very dangerous. In some instances, banks were pushing to fund managers the same securities they were short selling. In order to help hedge funds bet against the mortgage market, banks also developed synthetic products.
Lehman Brothers, which declared bankruptcy after being unable to receive a bailout, was one of the major causes of the crisis. A extremely questionable approach of pricing repurchase agreements on the bank’s balance sheet was one of the elements that led to its demise. They were able to use repurchase agreements to conceal the true level of their leverage and debt because to a flaw in the accounting standard.
As we all know, the crisis led to a significant stock market meltdown and recession because of these unethical businesses. The GFC is viewed as a black swan event by the majority of people. However, there were several investing warning signs and red flags for those who were keeping a careful eye on things.
One of Europe’s worst financial scandals has emerged as a result of the recently discovered theft at Wirecard. One of the biggest fintech success stories in history, Wirecard, which was a component of the top stock index in Germany, crashed in June of this year. In reality, the Wirecard fraud was incredibly straightforward. A business called Wirecard handled payment processing for retailers. In several nations, Wirecard outsourced the processing of these payments to subsidiary firms. The corporation later started reporting fictitious income from these companies, which ultimately made up the majority of Wirecard’s profits.
When analysts, investors, and journalists questioned why the subsidiaries weren’t generating any cash flow, Wirecard responded that the money was all being held in escrow in the subsidiary accounts. This would imply that the money was in the same account that was used to handle payments, making it impossible to refute. When multiple whistleblowers and the media claimed the revenue didn’t exist, Wirecard charged that they were attempting to influence the share price for short sellers. They even filed a lawsuit against the Financial Times, which led German officials to look into the journalists rather than the publication. When financial scandals include publicly traded corporations, this pattern is becoming more and more common.
Short sellers and hedge funds are frequently accused of attempting to manipulate the share price by company management. Regulators frequently support the corporation because they are concerned about the impact financial scandals may have on investor trust. The financial sheet had a hole, which was eventually proved when KPMG was requested to look into it. In the end, it turned out that there were no liquid assets worth about $2 billion. The share price fell from €100 to $0 in a matter of days. Wirecard, once valued at $28 billion, is currently bankrupt. This makes it one of the largest financial fraud cases in both Germany and Europe.
2009 saw the start of one of Asia’s greatest financial scandals, which is still being investigated. Goldman Sachs, who served as Malaysia’s prime minister at the time, and the blockbuster film starring Leonardo DiCaprio are all involved in the 1Malaysia Development Berhad (1MDB) narrative. The fraud’s mastermind, a young banker named Jho Low, is currently wanted on a global scale. Najib Razak, the prime minister of Malaysia, established 1MDB as a government-owned strategic development enterprise in 2009.
The fund’s goals included ESG investing and supporting initiatives that would expand Malaysia’s economy. The fund then started about establishing businesses and joint partnerships with particular goals. The business that created the popular film “Wolf of Wall Street” was one of the investments. Goldman Sachs assisted 1MDB in raising $6.5 billion by selling bonds in 2012 and 2013. But after missing two loan payments, it was discovered that $700 million in company funds had been transferred to Razak’s bank account. Following the scandal’s development, Razak’s party experienced its first power vacuum in decades, and he and his supporters made an attempt to leave the nation.
Since then, it has come to light that important officials may have embezzled as much as $4.5 billion. By sending money back and forth across an intricate web of shell businesses, the offenders were able to hide their traces. Investigations are still continuing on, but it is obvious that billions have vanished and were used to pay for Jho Low’s extravagant lifestyle as well as to purchase jewelry and a super yacht. The main characters in the story have all maintained their innocence and have been blaming one another. For its part in the fraud, Goldman Sachs did, however, agree to a $3.9 billion settlement with the Malaysian government.
The biggest financial scandals in history, in conclusion
No matter how much fundamental research you conduct to assist in stock selection, you could occasionally nonetheless find yourself invested in a company at the center of a financial scandal. Business scandals may raise red signals, but they can also appear out of nowhere. The best thing you can do is to appropriately manage portfolio risk in addition to keeping an eye out for warning indicators. The best way to accomplish this is through a diversified asset allocation across numerous investments and asset classes.