Although financial reporting fraud generates considerable losses, we find that investors do not fully exploit publicly available information relevant for detecting fraud. We show that firms with a high probability of overstated earnings have lower future earnings, less persistent income-increasing accruals, and lower future returns. The trading strategy based on the probability of manipulation ranks subsumes the relation between accruals and future performance and yields a hedge return of 13.9%, mostly arising from the short position. Although this suggests a limits-to-arbitrage explanation, we show that institutional investors actually increase their holdings in firms with a high probability of manipulation, and that hedge returns remain large for firms with market capitalization in excess of $1 billion. Thus, the returns concentrated on the short side of the strategy appear to arise not from asymmetric arbitrage costs, but from asymmetric errors in the expectations of (even sophisticated) market participants.