Chapter 5
Fraud, Negligence, and Entropy:
What Can Go Wrong and
How to Prevent It
In This Chapter
Describing fraud
Defining negligence
Figuring out the consequences of bad management and inefficiency
Getting clean
C
omplying with regulations such as Sarbanes-Oxley (SOX) now means
that companies and their senior executives have to get clean: certify
that their financial reports are accurate, abide by a stated code of ethics,
disclose changes to their material information, and refrain from shredding
documents. Regulations also mean companies have to stayclean, and this
process is called governance.This chapter addresses how things got messy in the first place. We look at
what the errors are — intentional or otherwise — that companies make on
a day-to-day basis that open them up to fraud and bad governance.In the U.S., the SEC prosecutes three levels of culpability: negligence, gross neg-
ligence, and fraud. In this chapter, we address these, as well as another quality
that makes for financial unkemptness: entropy. Entropymeans that things fall
apart, not intentionally, but through bad management and bad systems.The good news is that SOX’s rigorous financial reporting requirements have
led to fewer prosecutions for fraud and negligence. Research from Deloitte
shows that the number of fraud actions has fallen since 2003, when SOX
became law. Companies are getting clean and staying clean.