The Triad of Fraud

Donald Cressey is supposed to have developed the understanding that in order for someone to actually commit fraud, they need 3 things to come into being or alignment –

  1. A need for the money – an unsharable or secret need. Drug addiction, gambling, drinking, sex, or other type of driving need for extra cash.
  2. An opportunity. There has to be some way for them to carry out the fraud. This, virtually by definition, involves a lack of internal controls.
  3. A rationalization. They need to develop a story they can convince themselves of, of why they should have or deserve the money. This can often consist of a half-hearted intent to eventually pay back the money, perhaps with their gambling winnings. Or I work harder than everyone else, I deserve extra pay. Or the owner is a complete jerk and deserves to be a target.

I think the premise holds up pretty well, for the most part, If you are stuck in 1953, but I’m very focused on 1.) preventing fraud and 2.) discovering fraud soon after it’s been committed to minimize losses.

In terms of practical significance and value, the “triad of Fraud” is a complete failure.

There is an excellent real world example of pro-actively searching for, and finding, actual fraud using some of the basic data analysis tools that anyone can access. The link to this is:

www.rtedwards.com/journals/JFA/II-2/203.pdf

 I have maintained for a long time that given the opportunity at any large company, I bet I could pro-actively discover fraud in excess of my salary and benefits within the first year. These guys, Conan C. Albrecht,W. Steve Albrecht and J. Gregory Dunn, were able to prove it.

The following is obviously just my opinion, based on my experience. Please feel free to disagree or to reinforce my opinions by leaving your comments.

I’ve found that fraud conference speakers commonly describe and accept the fraud triad at face value. No one seems to debate the merits. But I’m a bit of curmudgeonly and grumpy old man skeptic on many things, and I’m not convinced nor am I impressed. I think these speakers are lazy and ineffective.

Let’s address the need aspect. Who doesn’t find themselves in a position of needing more money? Find anyone earning $20,000 a year. They will tell you that if they could have just an extra $1,000 a month, man, their life would be so much better. That would really make them happy. Next find someone making $32,000 a year, and you will get the exact same answer. Jump to someone making $250,000 a year and you will find they are spending every penny they make, paying for school and college tuition, skiing vacations, car lease payments, etc., etc. I admit that some pressing external need like medical care or an addiction MIGHT drive someone to fraud more quickly. But I don’t think the difference is particularly significant.

Now jump to the rationalization aspect. I believe that people almost universally are experts at lying to themselves, and can rationalize almost any and every odd, distinct, weird or illegal behavior at the drop of a hat. On the other hand, I also think that a significant factor in fraud can be identified here in terms of the perpetrator’s personality. I think people who are isolated in some significant way have a much higher propensity for committing fraud.

The first category I can distinguish would be the autocratic leader or manager or supervisor. They are demanding, uncompromising, harsh, brash, and as a result, isolated. People are afraid to cross them, people are afraid to question them, people are just generally afraid of them. This gives them an opportunity plan, conduct and conceal their fraud with less chance of detection. Any manager exhibiting these traits should be singled out for more serious attention and investigation, regardless of the engagement. This includes tax preparation, audits and fraud investigations.

The second category of isolated individual is the one-person shop or one-person department or that one person who does everything. These characters are also isolated, but in a more operational way. I think of it in terms of segregation of duties. The isolation can also be physical – the lone store employee closing up for the night. The lone security guard or warehouse worker. If you can identify situations of physical, operational, or organizational isolation without some pretty strong and explicit control processes, you have a situation that is just ready for fraud.

I finally come to the opportunity aspect. Here is where I think all the factors come together. Without a means or opportunity, the fraud remains frustrated, which is a good thing. I can understand that people might think I am unreasonably focused on preventing and detecting fraud in terms of business success. Yes and no. Fraud is certainly exciting, and the stories are generally entertaining. But fraud prevention is the exact same thing as good general business practices. That is the real focus of my interest.

 

Combine the rationalization and opportunity, the arrogant isolated personality and his/her rationalization and a lack of internal controls as a preventive and detective measure,  and I think the most powerful aspect of related to committing fraud is the belief that you will never get caught.

 

And I do have some recommendations. For the need aspect, I recommend the supervisors, managers and owners get to know your employees. Understand who they are, what their goals and challenges are, both professionally and personally. Be supportive to the extent you can be.

For the isolation aspect, you should avoid any chance to place your employees in an isolated circumstance. That’s not always possible. You can’t afford a driver and an assistant for every road trip. But learn to recognize the risk of isolation and take what steps you can to address the risk.

With respect to internal controls, I find many business professionals, even seasoned and experienced ones, often need professional assistance in designing, developing and implementing cost-effective internal controls.

 

Cressy’s Flawed Venn Diagram

The True Fraud Venn Diagram

 

 

 

 



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This entry was posted on April 9, 2012 and is filed under Fraud and Embezzlement. Written by: . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.