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.
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.
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 websites 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.
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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