Fraudulent Accounting and Tax Evasion

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In the recent past, high profile cases due to fraudulent accounting and tax evasion have led to substantial changes in the regulations of corporate governance and accounting (Crocker & Slemrod, 2005). Fraudulent accounting and tax evasion has been established as an avenue through which corporations can increase their profits and as such requires increased regulation (Crocker & Slemrod, 2005).

In this regard the Sarbanes Oxley bill passed in 2002 set up a regulatory board charged with oversight of the accounting industry. Based on new regulations there are harsher penalties for corporations or officers found to have colluded in the evasion of taxes (Crocker & Slemrod, 2005).

The evasion of taxes is a more serious issue in some economies than in others. It is reported that with moderate government regulation the rate of tax evasion is reduced and an increased compliance is observed coupled with greater economic growth (Chen, 2003). However, the enforcement of law in international corporations is difficult given varying legal requirements.

This problem could be overcome through listing of foreign companies in the U.S. stock trading market with a view to deterring officials from engaging in embezzlement and tax evasion (Siegel, 2005). This can be performed through an American Depository Receipt or direct listing on a major American stock exchange. This procedure has been found effective by international companies seeking to force compliance and deter corrupt officials (Siegel, 2005).

In addition to the above practices insider trading is a practice that has drawn concern among regulators and participants in the financial industry. It is not permitted for banks to use private knowledge based on information such as credit default swaps (CDS) to trade. However, reports suggest that many institutions have been doing this to reduce risks to their own balance sheets (Acharya & Johnson, 2007).

Studies have indicated that there is a flow of information from CDS markets to equity markets most often emanating from sources within the financial organizations (Randazzo et al., 2005).Following such actions the committee that developed the Sarbanes Oxley bill made provisions to allow for prosecution of individuals within the organization as well as provisions that could protect whistle blowers (Wallison, 2005).

Brief Historical Context of Sarbanes Oxley Act

The bill passed in 2002 and implemented by the Securities and Exchange Commission (SEC) came into being following the financial scandals that led to the collapse of Enron, WorldCom and several other major companies (Wallison, 2005).

The main component of the act is that it places responsibility on the shoulders individuals and systems to prevent fraud before it happens. The directors, auditors and accountants must comply with more stringent internal controls in an attempt to end unfair trading practices within organizations thus reducing risks to shareholders investment (Wallison, 2005).

The implementation of the act has been useful in addressing some ethical issues that before were not appropriately catered for thus creating loopholes. Following the huge losses that were made in the scandals involving Enron, WorldCom and the like it became apparent that the CEOs should be held directly accountable for their decisions with regards to the organizations finances (Wallison, 2005).

In addition to this the act through such measures also provided an avenue to curb the actions of insiders who perform illegal trade activities without authorization. The improved requirements for information security thus make it much harder for such actions to be undertaken (Pinder, 2006).

The act has also improved the rate of compliance with regard to taxation by the increased requirement on regular audits. This coupled by the fact that the auditors are also expected to satisfy strict requirements ensures that tax compliance and economic growth can be improved (Kirchler & Wahl, 2010).

It has already been established that moderate degree of government involvement is a key ingredient for improved compliance (Crocker & Slemrod, 2005). In addition to this the requirement for organizational ethics programs are a suitable method of ensuring the selection of the right leaders by shareholders as opposed to the most profitable leaders (Wallison, 2005).

Despite the increased monitoring that has been introduced through the bill it is possible to assume that there has been an improvement in auditing standards within the industry.

Unfortunately the implementation of the act has caused auditing costs to increase significantly. As a result it is still difficult to observe whether the act has made trade in the securities markets more profitable (Vakkur, McAfee & Kipperman, 2010). This has led some practitioners to suggest that the stricter rules based regime may not necessarily produce greater results than a principle based regime.

References

Acharya, V. V., & Johnson, T. C. (2007). Insider Trading in Credit Derivatives. Journal of Financial Economics, 84, 110-141.

Chen, B. L (2003). Tax Evasion in a model of Endogenous Growth. Review of Economic Dynamics, 6, 381-403.

Crocker, K. J., & Slemrod, J. (2005). Corporate Tax Evasion with Agency Costs. Journal of Public Economics, 1-29.

Kirchler, E., Wahl, I. (2010). Tax Compliance Inventory TAX-I. Designing an Inventory for Surveys on Tax Compliance. Journal of Economic Psychology, 31, 331-346.

Pinder, P. (2006). Preparing Information Security for Legal and Regulatory Compliance (Sarbanes-Oxley and Basel II). Information Security Technical Report II, 32-38.

Randazzo, M. R., Keeney, M., Kowalski, E., Cappeli, D., & Moore, A. (2005). Insider Threat Study: Illicit Cyber Activity in the Banking and Finance Sector. Technical Report, CMU/SEI-2004-TR-021, 1-37.

Siegel, J. (2005). Can Foreign Firms Bond themselves effectively by Renting U.S. Securities Laws? Journal of Financial Economics, 1-96.

Vakkur, N. V., McAfee, R. P., & Kipperman, F. (2010). The Unintended Effects of the Sarbanes Oxley Act of 2002. Research in Accounting Regulation, 22, 18-28.

Wallison, P. J. (2005). Sarbanes-Oxley and the Ebbers Conviction. American Enterprise Institute for Public Policy Research, 1-8.

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