Forget Bermuda, Welcome To The Fraud Triangle by Clarissa Slabbert

Economic crime is reaching extreme levels worldwide, but especially in South Africa. As a result, there seems to be a renewed emphasis on - and appreciation for - the Forensic Practitioner.

But what do they actually do?

 Essentially, their key role is to detect, investigate and, ideally, prevent fraud and other forms of economic skulduggery. There are many ways in which they do this, but one of the most important factors they consider is why the crime was committed in the first place.

 There are several criminological theories that attempt to decode the motivation for committing crime in general, but there is currently only limited research as to the specific motivations for economic crime.

 This is significant because economic criminals generally have quite complex modus operandi, and their motivations tend to be more complex than most other criminals.

 The Fraud Triangle

 One of the few criminological theories that does focus on economic criminals is something we refer to as the Fraud Triangle. This is universally accepted in almost every instance where fraud is analysed or described.

 According to Dr Steve Albrecht, an internationally respected speaker, trainer and consultant known for his expertise in security issues, the theory is based on in-depth interviews with people who have been convicted of trust violations.

 It was developed in 1951 by criminology researcher Donald Cressey. In his book, Other people’s money, a study in the social psychology of embezzlement, he defines the problem of fraud as a “violation of a position of financial trust” that was originally taken in good faith.

 Cressey concluded that all the cases he studied conformed to the same three-step process, which make up the three sides of the Fraud Triangle:

 1.     Pressure.

2.     An opportunity to violate trust.

3.     The rationalisation that defines the behaviour as appropriate for the specific situation.

 Pressure

According to Marshall Clinard, an American sociologist who specialised in criminology, pressure can be described as a “financial problem that cannot be resolved by asking for help from another person due to the fear that they will lose their status and the respect of others.”

 It rests upon another criminological theory known as the strain theory, which in turn is made up of six aspects:

1.     Violation of assigned responsibility

2.     Personal failure

3.     Business reversals

4.     Physical isolation

5.     Status acquisition

6.     Employer-to-employee relationships

 Opportunity

This refers to how confident a person’s is that they can commit fraud without serious, or perhaps even any, consequences.

 According to Dr Albrecht, the more complex the organisational environment, the more difficult it becomes for auditors, boards, and external bodies to understand the exact financial state of a company.

 This gives CEOs and employees more places to hide their fraudulent activities.

 Insufficient internal controls are also a factor, making it less likely that the wrongdoers will be caught.

 Rationalisation

Essentially, this is a way for someone to accept the fact that they are committing fraud. Common rationalisations include:

 “This is for the good of the company.”

“The scheme will only be temporary.”

“I don’t have any other choice.”

“No one is getting hurt.”

“I deserve more as I work long hours.”

 According to Dr Albrecht, the higher your organisation’s values, the lower the likelihood of fraud.

 Why?

 Because people with higher values and integrity find it harder to rationalise fraudulent activities.

 All three sides of the Fraud Triangle are interactive: the greater the opportunity, or the more intense the pressure, the less rationalisation is needed to commit fraud.

 Extensions To The Fraud Triangle

 Fraud Diamond

According to David T Wolfe, one of the pioneers of modern-day forensic accounting and investigation, and Dana R Hermanson, a respected professor of accounting, the fraud triangle needs another component – capability.

The nature of financial systems is often complex, and financial crimes are often of high value and ongoing over a long period of time. A person must therefore have the personal and positional capability to commit the crime.

 In addition to their position and function within the business, capability includes a person’s intelligence, confidence/ego, coercion skills, how effectively they lie, and their overall immunity to stress.

Fraud Square

According to Dr Joshua Cieslewicz, an expert in the international aspects of accounting and ethics, the fraud triangle also leaves out societal-level factors. He believes there are multiple social forces influencing the prevalence of fraud, including:

• Failure to prosecute
• Larger, more complicated businesses
• Ostracism of whistle-blowers
• More computers
• Failure of the criminal justice system
• Lack of honesty training
• Economic and social welfare
•  Inflation.

Fraud Pentagon

Jonathan T Marks, a global forensic, compliance, governance and risk strategist, believes we need to update the model of a fraudster’s behaviour to reflect both the changes in human behaviour as well as in the business environment.

He believes the solution is the Crowe Fraud Pentagon.

 Like the Fraud Triangle, this theory includes pressure, opportunity and rationalisation, but adds competence and arrogance.

 Competence is person’s ability to override internal controls, develop a sophisticated concealment strategy, and control the social situation to their advantage.

 Arrogance is an attitude of superiority, combined with entitlement or greed, as well as the belief that internal controls do not apply to them.

 How effective is the Fraud Triangle?

Although a useful framework for analysing fraud risk and detecting and preventing fraud, the Fraud Triangle has largely been built on individuals acting in isolation.

 In most of the most expensive and complex fraud cases however, it’s obvious that collusion is an important factor. In fact, it’s almost impossible to identify a major recent organisational fraud that has not implicated multiple members of the organisation.

 It’s also worth considering that some people simply don’t see what they’re doing as rule breaking. As such they don’t need a specific motivation before committing fraud. All they need is opportunity.

 Perhaps one of the biggest limitations of the Fraud Triangle is its inability to sketch an adequate profile of a financial fraudster. It also makes no allowances for the fact that someone may commit an economic crime simply because that’s how they’re wired.

In addition, it only considers that pressure, opportunity and rationalisation are all that’s needed for economic crime to take place. Other criminological theories take many more elements into consideration.

 Let’s compare:

Over and above all this, the Fraud Triangle was developed in the 1950s, and has not been updated to consider the changes in society.

 Conclusion

Economic crime is a serious problem for business owners. It is critically important to have a full and deep understanding of the economic criminal to be better equipped to prevent these crimes from happening in the first place.

 Essentially, we have two key weapons in our arsenal in this regard: Risk Assessment and Integrity and Ethics training.

 Risk Assessment

This is essential when it comes to proactively identifying both external and internal risks that can have a significant impact on a business’ reputation, exposure to criminal or civil liability, and assets.

 While it’s obviously impossible to eliminate all fraud risks, a risk assessment is a powerful tool in reducing the probability and severity of those risks.

 Once these risks have been identified, effective mitigation strategies can be developed.

 Integrity And Ethics Training

 Statistics show that implementing an effective code of ethics in your business can prevent losses due to fraud by as much as 81%. And yet it remains one of the most unrecognised tools with which to fight corporate fraud.

 Being a moral crusader can feel like a very lonely calling, but it’s a valuable one. Ethics and integrity are litmus tests for the maturity of our society, and it’s critical that we train our employees in how to apply them to both their professional and personal lives.