Asymmetrical Information and Fraud – Part 1

Asymmetrical Information and Fraud – Part 1

In terms of fraud there is little written about asymmetrical information and whether or not it constitutes fraud.  In my opinion it constitutes fraud if someone knows that the information leads to the detriment of someone else.  So let’s break it down to make an argument for including asymmetrical information as a type of fraud.

First of all we should define each independently and then observe their relationship.  Fraud is the intentional misstatement of material fact to the detriment of another person who relied upon the statement.  Or, basically, saying something that leads someone to make the wrong decision to financial detriment.  Asymmetrical information in terms of contract theory is where one party has more or better information than the other.  So how could asymmetrical information relate to fraud?

Let’s consider a case where a government entity is receiving bids from CPA firms for auditing services.  You could have multiple bidders but only one of them has a former employee as a staff auditor.  Now, they’ve committed as part of their code of conduct not to allow this auditor to work on this specific audit, because it is possible they may audit their own work which is an obvious conflict of interest, but they instead ask them about the scope of the audit.  This auditor opines that the control environment is sound, that the risk is extremely low and that the transactions were always in compliance.  What does this mean to that firm, that they can feel comfortable bidding low and most likely receiving the contract.  Does this necessarily constitute fraud?

In the case above this is not really fraud, the employee was not hired solely to get this bid, the information was actually true, and the information was not utilized to the direct detriment of someone else.  Had the governmental entity intentionally provided this information to a bidder they wanted, or had the company obtained the information through compensation of a current employee of the governmental entity then absolutely, but this does not fit into a category or definition of fraud.

In my next blog I’ll take a look at a different situation that may actually constitute fraud from asymmetrical information.

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