But what if there is so much more fraud that we just don’t know about? That’s what a recent paper by three finance professors tried to pin down—and their findings indicate SBF, Holmes, et al. are just the tip of the proverbial, well, you know.

“It’s very difficult to know the pervasiveness of crime, because the only thing you observe is the crimes that are caught,” noted Luigi Zingales, a University of Chicago professor and coauthor of “How pervasive is corporate fraud?” published in the Review of Accounting Studies.

To nail down how common fraud is, the authors (Zingales, along with Alexander Dyck of the University of Toronto, and Adair Morse of the University of California, Berkeley) looked at corporate clients of accounting firm Arthur Andersen, which collapsed in 2002 after helping Enron perpetrate the biggest accounting scam in history.

After Arthur Andersen’s demise, clients were forced to find new accounting firms—and the new auditors would have extra incentive to ferret out any wrongdoing. By looking at rates of fraud across all businesses before and after the firm’s collapse, the authors came up with a conservative estimate: About one in 10 large companies engages in fraud every year, they calculate, and that costs shareholders hundreds of billions of dollars.

Only one in three cases of fraud is detected, they estimate. “Fraud is indeed like an iceberg with significant undetected fraud beneath the surface,” they write.

Is it fraud, or just a mistake? 

To be sure, the authors take a broader definition of alleged fraud than some legal observers might.  

“Colloquially, what we call fraud are major episodes of misgovernance that end up costing a large amount of money to the company,” said Zingales. He described it as a matter of necessity, since most cases of corporate wrongdoing in the U.S. are settled, and don’t result in a fraud conviction. 

“From a legal point of view, fraud needs intent, and intent is only documented in a court of law,” he clarified, but the general principle holds of misrepresentations costing shareholders money. 

Zingales and his coauthors looked at several datasets, including filed shareholder class-action lawsuits, accounting and auditing enforcement actions from the Securities and Exchange Commission, and SEC securities fraud cases. 

That allowed them to capture what Zingales called “the universe of financial mistakes,” or “basically every form of violation of law, whether it’s a misstatement, or an antitrust action, or that ‘I didn’t follow EPA regulations’ and hurt the share price,” he said. 

This broad definition has prompted some pushback from enforcement professionals. Former SEC commissioner Joseph Grundfest, who now teaches at Stanford, told the New York Times that the paper wrongly includes “honest mistakes and differences of opinion about accounting treatment” in its definition of fraud. 

But intentional or not, these mistakes cost company shareholders hundreds of billions of dollars annually. The costs of fraud fall between 1.2% and 2.2% of public companies’ market value, meaning that, in 2021, it cost shareholders $830 billion. That’s a problem not just for the investor class but for the American public as a whole, which is invested in these large public companies through retirement accounts and pension funds.

And who’s to blame for this epidemic of fraud? Corporate managers, to be sure—but also the audit industry, Zingales said. He argued that, since the Enron collapse, auditors as a whole decided that their responsibility was simply to make sure a corporation’s numbers add up, and not to ferret out whether their clients were committing misdeeds. But of late, auditors have struggled even with the numbers: Some 40% of audits last year contained errors, according to a government watchdog report this summer that declared the state of the industry “completely unacceptable.” 

Zingales, who praised the report, also supports requiring auditors to flag accounting problems to the regulatory authorities. Currently, they are required to do so only in limited circumstances. “That is probably the biggest change that needs to be made,” he said. 

Until such a time, he believes the low rates of fraud detection—two-thirds of instances aren’t caught—will ensure it persists. 

“That’s the reason fraud continues, because it actually pays off,” he said. 

“Even when they’re caught, very, very few of these people end up in jail,” he continued. “If two-thirds of the time you get away with murder, and one-third of the time you get a slap on the wrist, are you surprised there is so much fraud?”