Seek the Symptoms of Fraud
September 2008
Much is made of the "Fraud Triangle,"
which is attributed to criminal sociologist Dr. Donald Cressey and was
introduced to finance and accounting professionals in Statement on Auditing
Standards No. (SAS) 99: Consideration of
Fraud in a Financial Statement Audit.
by
Scott Langlinais
Langlinais
Fraud and Audit Advisory Services
SAS 99 describes the concept in a single paragraph, which leads with:
"Three conditions are generally present when fraud occurs," followed by
explanations of the three conditions—pressure, opportunity, and
rationalization/attitude.
Opportunity is when a bartender's friends come to the bar and he splashes
a little more scotch into their drinks. No one is looking, and no one
analyzes the scotch depletion at the end of the night. Another example of
opportunity: a retail sales cashier rings up a false refund when the store
is empty so she can remove cash at the end of the day. The register will
balance with her transactions as long as she kept track of the exact dollar
amount of false refunds.
Pressure in the bartender's case might come from his peers and their
expectation he'll treat them right if they come into the bar to see him. The
retail sales cashier might have financial pressure of children in college
and a mother who just entered the nursing home.
Rationalization for the bartender: "Everyone does it, plus it's not like
they didn't pay for the drinks. We're too stingy on our pours anyway." And
for the cashier: "I'll pay it back when I'm out of trouble."
Imagine you are a professional charged with fraud detection and
prevention in your organization, and now you are armed with the knowledge
that the confluence of pressure, opportunity, and rationalization are often
present where there is fraud. What exactly are you going to do with that
knowledge?
There is absolutely nothing you can do with rationalization, because to
some extent, everyone rationalizes their bad behavior. And no one is going
to signal their fraud intentions to you by announcing a rationalization
before committing a crime.
What about pressure? Pressure is a suspect indicator of fraud. Former
Chief Executive Officer of Tyco, Dennis Kozlowski, along with the former
Chief Financial Officer, was convicted of misappropriating hundreds of
millions of dollars. Most famously, Tyco doled out $6,000 for shower
curtains in Mr. Kozlowski's company-paid New York City apartment, and also
contributed $2 million toward his wife's birthday party on the island of
Sardinia. Do you believe Mr. Kozlowski, who took home eight-figure bonuses
and sold over $100 million in stock, was under pressure to steal more money?
Consider Jonathan Nelson, former Chief Financial Officer of Patterson
Energy, who pleaded guilty to stealing $77 million from his company. Was he
under pressure to turn that $60 million into $77?
With pressure, like rationalization, there is little we can do about it.
How would you learn whether or not someone is under pressure to perpetrate
fraud? Conduct personal interviews about individuals' finances? With all
employees? There are some pressures we can stop, such as forbidding managers
from telling their employees to hit their goals at all costs. But even if
you learned that someone is struggling at home and has a serious need for
more money, does that mean they are perpetrating a fraud? Pressure might
drive some people to fraud, but it is not a symptom of fraud. Smoking is
proven to cause lung cancer in some people, but smoking is not a symptom of
lung cancer. Not everyone who smokes dies from lung cancer, and many
nonsmokers have died from it.
Opportunity is also suspect as an indicator. Implied within opportunity
is the absence of strong controls which provide people with an opening to
perpetrate fraud. However, again, control weaknesses are not symptoms of
fraud. Our bartender has an opportunity to double-up drinks, but that does
not mean he does. Our cashier has access to cash all day, but that does not
mean she's stealing it.
If we pay any attention to the fraud triangle or any future shapes as
guides to deterrence, it is within opportunity, because that is really the
only leg we can influence. Reduce the opportunity for people to commit
fraud; make it more difficult. Segregate duties so that no one has sole
control over accounting, reconciling, custody of assets, and approval of
transactions. Ensure transactions involving the most liquid assets have
adequate oversight in which managers seek and follow-up on unusual
transactions. Make it such that if a person is going to steal a lot of
assets, they are going to have to be very clever, avoid several pairs of
eyes, and then run the gauntlet of people reconciling accounts and
monitoring budgets.
Why So Much Discussion about the Fraud Triangle?
SAS 99 is not at fault here. Problems lie in its interpretation by
today's finance and accounting professionals. SAS 99's explanation of the
three conditions seem more definitional than strategic; it does not state
these three factors are causal, nor does it state they are ubiquitous where
there is fraud.
Yet many professionals employ the triangle in their advice to other
professionals about deterring fraud. Of the first 10 Web sites listed in a
simple Google search on the fraud triangle, five of them interpret the fraud
triangle much more aggressively than the authors of SAS 99. Articles from
three of the sites claim the three factors must
be present for fraud to occur. One of these articles was written by a
founder of a CPA firm, another written by an author of a book on corporate
fraud. An article cowritten by a CPA founder of a forensic accounting firm
and a PhD professor write that fraud is "more likely" to occur where the
three elements are present. One site claims the fraud triangle
must be broken to deter fraud.
As if the discussion about the fraud triangle were not enough, now
there's the fraud diamond, which replaces rationalization with incentive (a
need to commit fraud) plus capability (personality traits enabling the
person to pull it off). What's next, an octagon?
While Dr. Cressey provides credence to the three elements generally
present where there is fraud, let us not overstate its relevance in fraud
detection and deterrence. A doctor may be interested whether or not someone
smokes, but he or she is listening for wheezing, examining struggled
inhales, and looking at x-rays of the chest for tumors.
The elements of the fraud triangle seem best served as explanations in
articles deconstructing why a particular fraud occurred. But as a
fraud-deterrence tool, it falls far short of seeking the symptoms, and at
worst, can clutter a professional's thinking when he or she sets out to
detect fraud. As you read about or discuss a new method to analyze fraud
risks, challenge the process and ask yourself whether the concept will
really help you prevent, detect, or respond to fraud.
Forget the Geometry
To detect fraud, the best method is still to seek the symptoms, such as
unusually high inventory write-offs in a particular warehouse, cash
shortages in the vault, or terminated employees left on the payroll.
Symptoms are not control weaknesses: how the fraud appears in the books and
records.
The opportunity leg of the fraud triangle speaks to control weaknesses,
not symptoms. Just because someone has custody of the cash, the combination
to the vault, or the sole responsibility for counting and reconciling the
cash with the bank does not mean the person is stealing. And if the duties
were segregated, such that separate people performed all of these functions,
this does not mean no one is stealing.
Forget the geometry. Seek the symptoms, like doctors.
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not necessarily held by the author’s employer or IRMI. This article does not purport
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