Daniels Midland employee who embezzled millions, to the bookkeeper in Maine who took thousands from the church's coffers. The current rough economy and easy access to sophisticated technology are potent ingredients for creating the perfect storm for organizational fraud.

Enabling technologies like sophisticated color printers, remote access to linked computers, and data-capturing viruses have played a significant role in how employees can commit and conceal fraud. Even without accessible technology, the lack of segregation of duties and "less paper" (making for fewer paper trails) in the working environment make it easier for employees to commit fraud. Strong computer system design and retaining the proper number of employees to maintain adequate segregation of duties can be a difficult challenge for smaller organizations.

While technology and the economy may facilitate fraud, it is an employee's motivation and opportunity that are the most important elements in understanding fraud risk. Motivation (also known as incentives or pressures), opportunity, and rationalization of the fraudulent behavior are the three critical elements necessary for fraud to occur. Known as the Fraud Triangle Theory, the concept simplifies a very complex combination of factors and allows us to understand and possibly reduce fraud risk in an organization.

UNDERSTANDING THE ELEMENTS OF FRAUD

Incentives/pressures are usually what cause an employee to commit fraud, although some may need very little incentive, while others may need to be faced with truly dire circumstances before they feel enough pressure to steal. In many cases, it's a combination of circumstances that creates the perceived need for money: an employee who has a spouse with a struggling business may suddenly be saddled with large medical bills. Perhaps someone is going through a divorce and may lose his home without a way to make a large payment. An employee who is dealing with his own or a loved one's addiction to gambling, drugs or alcohol, and becomes the subject of a lawsuit, may be pushed to commit fraud by "borrowing" money that they fully intend to pay back when circumstances permit.

Pressure doesn't always have to be heartrending; for some people maintaining a lifestyle well beyond their means or being unable to achieve performance goals may prove sufficient motivation to commit fraud. One woman who was convicted of stealing hundreds of thousands of dollars from one of her Maine bookkeeping clients claimed that she needed to buy new appliances and take her family on vacations just to keep up with her neighbors. Whatever the incentive, a perpetrator sees their employer as a means to solve their problem.

Opportunity is the one area that an employer can best control in order to drastically reduce the risk of fraud in his or her workplace. Being able to conceal the fraud is very important to the employee and, when opportunities exist to both commit and conceal fraud, the risk of fraud increases substantially. Opportunity occurs when there is lack of segregation of duties or poor system designs including internal controls and IT systems. Companies that provide adequate resources to address these risks stand a significantly better opportunity to prevent fraud. Blocking an employee's opportunity to commit fraud is an important consideration when developing or modifying company systems.

Rationalization is the final component of the 3 elements and perhaps the most difficult to pin down in advance of perpetrated fraud. Outward (and sometimes hidden) manifestations of rationalization can include:

  • Feeling unappreciated, undervalued or mistreated at work
  • Doing "whatever it takes" to save a family member or loved one from an illness, jail, or worse
  • Feeling the company/department/ customers don't need the money
  • Believing the company is so large it will never notice the fraud

One of the enabling components of rationalization for many fraud perpetrators is their belief (real or self-serving) that they will repay the money, so they are just borrowing it. Rationalization is simply the employee's way of justifying their actions.

Using the Fraud Triangle Theory gives us a means to understanding and deterring fraud by identifying and mitigating the elements necessary to enable fraud. Removing weak internal control systems and replacing them with stronger systems, observing employee behavior, and modeling behavior from the top down, can reduce a company's fraud risk tremendously.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.