1. Fraudulent Financial Reporting
The equity and credit markets (capital markets) in the United States are considered to be among
the most efficient in the economically developed world. One reason for the efficient operation of
these markets is the public availability of creditable financial statements to individuals and
institutions and the confidence in these statements by those using them as a basis for their
investment and credit decisions. A potential serious threat to the efficient functioning of these
markets is the incidence of fraudulent financial reporting.
Fraudulent financial reporting is intentional or reckless conduct, acts, or omissions, that result in
materially misleading financial statements. Confidence in the operation of capital markets is
diminished when the system of public disclosure is eroded by reported instances of fraudulent
reporting.
In the mid-1980s, the failure of a number of financial institutions led various groups to deter
mine possible causes, including the extent of fraudulent reporting involved in the failures. The
Subcommittee on Oversight and Investigations of the U.S. House of Representative's Committee
on Energy and Commerce held hearings concerning the accounting profession. The
subcommittee's intent was to determine whether the system of public disclosure and reporting
needed corrective action. In opening the hearings, the chairman, Representative John Dingell,
questioned whether the public disclosure and audit system then in effect was meeting public
expectations. In August 1986, Congressman Dingell and other members of the committee
proposed legislation to amend the Securities and Exchange Act of 1934 to require independent
public account ants (auditors) to include procedures for material financial fraud detection, to
require reporting on internal control systems, and to require the reporting of fraudulent activities
to appropriate enforcement and regulatory authorities. The legislative proposals were not
accepted. There persisted the belief that the profession could respond successfully to the
challenges without further legal requirements.