Technology can suppress fraud. There will be no more "late" trading of mutual funds when we get 24/7 global trading and real-time pricing of the stocks that funds own.
Fraud used to consist mainly of one-step trickery, in which the cheating depended on exchanging two quite different things--good cash for, say, a bad check. Today all the cleverest frauds involve two-step transactions, in which the losing party ends up with exactly what he had at the outset--all the cheating is in the timing. Which means we're going to have to rethink what we expect from public auditors. Their mission, as traditionally defined, is now obsolete. Pretending otherwise is a confidence game in itself.
The old fraud was writing a bad check or variations on the same idea: Take something valuable, leave something worthless to fill the void. People who were in a position to control appearances--bookkeepers, for example--could keep such frauds going for quite some time.
The independent auditor was brought in to ensure that appearance matched economic reality. If the company's books said there was a million dollars in the bank, the bank statement had to say so, too. The audit was a snapshot. It verified that the company owned what it said it owned and did not owe any more than it said it owed.
Now consider the essence of the recent mutual fund scandals. The details hardly matter--just look at what the improper trading is called. Late trading means that brokers or funds allowed favored customers to buy or sell after the deadline for putting in orders--the bad guys got in or out at the 4 p.m. price after hearing market-moving news at 4:15. Market timing is short-term trading designed to exploit the fact that the 4 p.m. price may incorporate some 3 a.m. Asian prices that are 13 hours stale.
Insider trading is a timing fraud, too. It's not the trading that's illegal, it's selling your ImClone shares a day before the public hears about what the Food & Drug Administration is going to do with the application for the Erbitux license. (Martha herself wasn't an "insider," however; the charges against her were and remain legal junk.)
Notice that with all these frauds, the underlying assets generally end up exactly where they began. The fund is poorer because it sold low and bought back high; ImClone shareholders are poorer because they bought high and sold low, but the ultimate value of Erbitux would not have been diminished by Sam Waksal's trades. No conventional audit will pick up this sort of thing. At any instant in time the books accurately reflect the underlying value owned, and each individual transaction is for what appears to be "fair value" at that particular moment in time.
Opportunities for timing-based frauds are multiplying because technology has made it so easy to trade so much, so fast. It's probably no coincidence that two of the biggest recent corporate frauds--Enron and MCI--involved companies that specialized in moving information very fast: Enron as a trader of power and other commodities, MCI as a mover of bits. In such lines of business, perhaps, managers easily come to believe that so long as wealth remains in rapid transit, it doesn't much matter how much of it is really there in the pipe.
But technology can suppress fraud, too. Check-kiting is pretty much a thing of the past now, or ought to be--deposits and withdrawals can and should be cleared across banks instantly. There will be no more "late" trading when we get to 24/7 global trading, as we inevitably will--electronic clearing houses can now readily displace the anachronism of floor traders milling about, shouting and waving their arms. Market timing can be solved by pricing mutual fund shares to market in real time--again, something that just about any desktop computer with the right database and Web connection can achieve.
As for insider trading, the only real antidote is to promote faster, freer flow of information to the public. Sam Waksal certainly should have told all his shareholders, not just some, what the Food & Drug Administration was telling him. But why are the workings of the FDA itself so opaque to outsiders, yet so accommodating (at least by comparison) to drug-company insiders like Waksal? The agency understandably fears the prospect of desperate patients--those suffering from advanced-stage colorectal cancer, say--beating down its doors when early tests show promise. It's easier, all in all, to keep information secret until the last moment and then just announce a yes or no. Be that as it may, the most valuable information about ImClone for the past three years has been in the cupped hands of the official government auditors of medical science. When they withhold information from patients and drug companies, it isn't fraud, it's public policy.
Original Source: http://www.forbes.com/columnists/business/free_forbes/2004/0329/064.html