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What Attorneys Need To Know About Fraud

Posted in Forensic Accounting, on Sep 2018, By: Mark S. Gottlieb

Looking At The Fraud Triangle & Beyond

Occupational fraud continues to wreak havoc on businesses, with annual business losses reported to exceed 5% of revenues.  Fraud experts have long suggested that the presence of three conditions, known as the “fraud triangle,” greatly increases the likelihood that an organization will be defrauded.

The classic fraud triangle, as conceived by criminologist Donald Cressey, consists of Pressure, Rationalization and Opportunity.  The following provides a short description of each.

Pressure

A perpetrator experiences some type of pressure that motivates the fraud. Pressure can come from within the organization – for example, pressure to meet aggressive earnings or revenue growth targets. Alternatively, the pressure could be personal, such as the need to maintain a high standard of living or pay off debt from credit cards, medical bills or gambling.

Rationalization

Perpetrators often mentally justify their fraudulent conduct. They might tell themselves that they’ll pay back the money before anyone misses it, or reason that:

  • They’re underpaid and deserve the stolen funds,
  • Their employers can afford the financial loss,
  • They’ll lose everything (or someone) if they don’t commit fraud,
  • “Everybody” does it, or
  • No other solution or help is available for their problems.

Most employees who commit fraud are first-time offenders who don’t view themselves as criminals but as honest people caught up by circumstances beyond their control. By rationalizing, perpetrators overcome ethical barriers that generally guide their conduct.

Opportunity

Without opportunity, even motivated and rationalizing would-be perpetrators can’t commit fraud. Occupational thieves exploit perceived opportunities that they believe will allow them to go undetected. Poor internal controls, weak management oversight and ineffective or nonexistent audits all create opportunities for fraud. Note that the opportunity leg represents the best avenue for preventing fraud because it’s within an organization’s control.

Other Fraud Models

Since Cressey’s original fraud configuration, other experts have proposed expanding the conceptual framework to account for societal influences, integrity, arrogance, competence, personal greed and employee disenfranchisement.  While one or more of these conditions may be present, the most widely supported addition is what’s being called capability.  So, the three angled triangle may be replaced with a fourth item to create a “fraud diamond.”

Not every employee with motivation, rationalization and opportunity commits fraud. Some people have a mindset that makes them more able to commit ethics violations or break laws without experiencing the guilt or stress that might afflict others. Capability comprises a range of considerations, including position, intellectual capability, confidence, resilience to stress and guilt, and ability to coerce and cajole others.

The MICE (Money, Ideology, Coercion and Ego) model shares similar considerations with the fraud diamond. MICE retains the original three sides of the fraud triangle but shares the opportunity leg with a second triangle that also has sides for criminal mindset and arrogance.

Fraud perpetrators with characteristics matching the original motivation, rationalization, and opportunity triangle are categorized as “accidental fraudsters” – who wouldn’t commit fraud in the absence of motivation. Those on the side of the criminal mindset, arrogance, and opportunity triangle are deemed predators, or pathological fraud perpetrators. These individuals require only opportunity.

Red Flags

It’s important to remember that the presence of the conditions discussed above doesn’t constitute proof that fraud has been committed – or that an individual will commit fraud. Rather, the fraud triangle and its variants are designed to help organizations identify risk and understand the importance of eliminating the perceived opportunity to commit fraud.

More often than not a firm like ours is engaged in a fraud examination once something has been identified.  That “something” may be a low cash balance in an account that has always been sufficient, missing assets, sharp decrease in revenues and/or material changes in one or more expense category.

For additional information on this or any other issues related to business valuation, forensic accounting or litigation support please feel free to contact our office at the above phone numbers. You can also email our office at msgcpa@msgcpa.com for immediate assistance.