Howard Schilit, MS ’74, knows the power of a good story, and he reads a lot of them in his profession. What he’s reading are financial statements — reports he calls “story books” — chock-full of numbers and sunny narratives that companies use to pitch themselves to investors.
As a forensic accountant, Schilit knows that numbers can be used to manipulate and obfuscate the story. “Companies are trying to weave whatever positive spin they can within the rules of the game. So they are telling a story,” he says.
His job is to add up the facts, subtract the fictions and tally the truths. His book, Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, now in its third edition, details the way corporations can exploit the numbers in a financial report — revenues, earnings and cash flow — to deceive, rather than inform, the reader. Schilit’s reputation as an accounting sleuth earned him the moniker “the Sherlock Holmes of accounting” from Businessweek Magazine.
First published in 1993, Financial Shenanigans was updated in 2010 to include details about the way executives at Enron and WorldCom drove up their stock prices with fraudulent financial statements and bankrupted their companies, with some of those responsible for the fraud sent to prison. His keen eye also can tease out what he calls an “aggressive” approach to accounting that might puff up a company’s revenues or earnings, but falls within the boundaries of acceptable accounting rules.
A company may record income too soon, shift expenses to later reporting periods or inflate cash flow through acquisitions or sales.
“Our clients reach out to us when they get nervous,” says Schilit, of Key Biscayne, Fla., founder and CEO of Schilit Forensics. “My role has been to help investment firms that want to know if a company’s financial statements are fair representations of the underlying economics of the business, or whether the companies are faking it.”
Schilit arrived at Binghamton in 1973 to earn his master’s degree in accounting, studying under Professor Philip Piaker, a founding member of the University’s School of Management and first chairman of its Department of Accounting.
Schilit went on to earn his doctorate at the University of Maryland and teach accounting from 1978 to 1996 at American University in Washington, D.C. Then he decided to use what he’d learned — and taught — in the world of international commerce by founding the Center for Financial Research & Analysis.
There’s an art and a science to reading financial statements. Schilit looks for red flags; footnotes can provide clues and so can a list of the company’s board of directors. If a majority is from
one family, as was the case when millions of dollars were looted from investors of Adelphia Communications, he lets investors know they should take notice.
A company’s rosy report of bountiful revenues and profits can be a good sign to investors — if those revenues and profits are not a fairy tale.
In 2011, Schilit was hired by several investment companies that were considering the prospectus for the initial public offering of an online consumer discount service that had shown rapid revenue growth since its inception a few years earlier. But as Schilit dug into the report, he discovered that the cheerful revenue numbers weren’t quite as good as advertised. The company had booked its total revenues, but had failed to properly account for the payments it later passed on to the merchants to pay for the discounted services.
“I concluded that the company had inflated its revenue by 100 percent,” he recalls. “It wasn’t a small bit of spin. And the Securities and Exchange Commission later concluded that the company needed to restate its revenues.”
So it goes in the world of high finance, where corporate bean counters are looking to make their number each quarter and may cut corners to do so. This can be especially true in the run-up to an initial public offering, when the investment bankers want to whip up interest in the new stock. Schilit’s clients — the mutual fund companies considering a multimillion-dollar gamble — want his analysis of the financial tale before making their investment.
“The sell-side needs sizzle,” Schilit says. “My clients want me to help them figure out whether the guys on the sell-side are putting on a moderately benign type of spin or whether they are doing things over the top and basically changing the story line.”