Dr. Lie
Erik Lie, a finance professor at the University of Iowa, catches cheats. His numbers don't lie.
“If you ain’t trying to cheat a little, you ain’t likely to win much.” – Richard Petty
University of Iowa finance professor Erik Lie keeps an old paper stock certificate on the wall in his office. It’s framed with a plaque stating the company’s four core values: “Respect, Integrity, Communication, Excellence.”
The company? … Enron.
Lie’s students rarely notice the relic, which offers “best wishes” to CEO Ken Lay who died of a heart attack shortly after his conviction.
Enron was ranked as one of America’s largest companies until it became one of America’s biggest bankruptcies in 2001, collapsing under the weight of its Byzantine accounting tricks and wiping out the life savings of thousands of employees and retirees. But even history’s most devastating frauds can be forgotten in a market culture that is all-too-ready to move on to the next thing.
Read More: Enron Was A Parody Of Itself (Business Blunders)
Lie’s leap to finance industry fame came about five years after Enron when his forensic work helped expose another historic scam: A widespread stock-option backdating scandal.
His research led to the congressional hearings, regulatory investigations, shareholder lawsuits and the ousting of more than 70 corporate executives.
It revealed that scores of America’s best and brightest corporate executives had found a way to play the winning lottery numbers before the balls even dropped. For a time, even Apple’s over-idolized Steve Jobs was ensnared.
Lie shared his research with The Wall Street Journal, leading to series of hard-hitting stories, including “The Perfect Payday.” In 2007, it resulted in the newspaper’s only Pulitzer Prize for Public Service, journalism’s most-coveted award, and Time magazine enshrined Lie on its list of 100 most influential people in the world.
I barely remember writing about all this corporate chicanery, but this was my take at the time:
“It’s hard to imagine that it’s 2006, Enron’s top executives have been convicted and yet we are still uncovering the ways that corporate executives have cheated investors.”
Boy, was I naive. I never imagined living all my days in the Golden Age of Grift. I thought somebody would clean up this mess. But here we are.
Read More: Backdating: A Scandal In Waiting (The Denver Post - 2006)
Lie can still help. Earlier this month, he came out with a new book: “Catching Cheats: Everyday Forensics To Unmask Business Fraud.” In it, he showcases a slew of research and techniques that can put bright lights to dark orders.
“Systemic fraud inevitably leaves behind a trail of data crumbs that attentive and skilled individuals can recognize,” Lie writes.
(The name, by the way, is pronounced, “Lee.” He’s Norwegian, OK? And it’s Erik with a K. Sorry, I just happen to enjoy dropping ironic surnames, like Eric (with a C) Conn, who pulled off the largest Social Security con in U.S. history.)
Lie’s book explores the ways large data sets can reveal patterns – like when companies magically outperform their industry benchmarks for quarters on end, or when brokerages surreptitiously shave fractions of pennies from thousands of transactions and steal millions.
Fun fact: Did you know that the number 4 rarely appears in the first decimal of earnings-per-share figures released by many companies? Better to puff it up to at least 5. That way you can round higher. What CEOs want to announce 32 cents a share when they can announce 33 cents per share?
Almost nobody is counting fractions of pennies and CEOs have to keep Wall Street analysts happy. Right? But Lie cites research that companies massaging their 4s often end up making earnings restatements and facing regulatory investigations and lawsuits.
This is the magic of numbers.
This is why the world needs more forensic finance sleuths like Dr. Lie. (PhD in Finance from Purdue University.)
Watch: Accounting wiz Francine McKenna interviews Lie on The Dig.
‘I’m shocked – shocked … ’
Lie’s book offers a tour through many of the fabulous frauds that I have covered myself over the years and memorialized in the Business Blunders Hall of Shame.
His cast of characters includes Ponzi schemer Bernie Madoff as well as hedge fund billionaire Raj Rataratnam, who was convicted in a massive insider trading scheme, and even dear old Martha Stewart. Bless her heart.
What I’ve learned over the years is that few people want to believe that our business world is just this crooked. Not until it’s very painstakingly exposed. Not until they wake up to discover that they are the victims.
Investors are optimists. And finance professionals, while good with numbers, can be naive about human nature.
In 2005, the first thing Lie received after submitting his stock-option research to the Journal of Finance was a harsh rejection letter:
“Clearly, executives would be reluctant to go to jail for timing their stock option grants … The idea that most directors in the United States deliberately violate their firm’s charter and possibly face class action suits and … criminal investigations in order to backdate options makes little economic sense.”
Oh, does it now?
Everyone at this esteemed publication deserves a signed copy of Lie’s new book.
(Disclosure: I cribbed the Richard Petty quote from the preface of Catching Cheats. I always begin Business Blunders with a quote. This one was just too good to pass up.)
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The neat catch of 4s and 5s brings up a bigger problem. Most traders now are dealing with huge quantities of minuscule fractions. When you can pile up billions of arbitrages per minute, a millionth of a cent can accumulate fast. The bitcoin world concentrates in this direction, taking advantage of ordinary people who think they're math whizzes. Before HFT, each trade took minutes or hours to get through a broker and a NYSE floor trader, so there wasn't as much reason to deal in infinitesimal fractions.