[MUSIC] To better understand why people commit fraud, consider the fraud triangle. A model developed by Donald Cressy, a Sociologist and Criminologist that studied the behavior of white colour criminals. The Fraud Triangle is based on the premise that for an ordinary individual to commit fraud, three components must exist. There must be a perceived pressure, a perceived opportunity, and a rationalization. Let's spend a few minutes looking at each of these components, the first leg of the triangle represents pressure. This pressure does not need to actually exist. A perceived pressure is real to the individual committing fraud. A potential fraudster must feel that the pressure is non-sharable, that it must be dealt with alone. The individual usually believes that the problem is impossible to resolve legally. And if the problem continues, the ultimate result will be financial collapse. Frequently, the current issue is related to a personal or external problem such as excessive debt or loss of employment. Many of the problems originate with vices such as drug or alcohol abuse, gambling, extramarital affairs or living beyond ones means. Perceived pressures are a challenge for the forensic auditors to deal with. Because the auditors have limited contact with the individuals, and therefore have no baseline for the symptoms of the problem for which the fraudster is dealing. The second leg of the fraud triangle related to opportunity. Before an individual commits fraud, there must be the perception of an opportunity to take advantage of the system without being caught. Allowing removing the pressure in secret. The primary source of opportunity relates to poor or inadequate internal controls within the organizations financial system. We'll talk about internal controls in detail next week. But basically, internal controls only allow an individual to access the specific task required for that individual's job. Separation of duties are a set of controls that split accounting functions among various people to prevent problems. Collusion exists when two or more people cooperate or collude to get access to each other's parts of the system. Combined they have the opportunity to commit fraud, where individually neither had that opportunity. For example, when someone that has the authority to order an item, but not approve payment the item, teams up with or colludes with an individual that has the authority to approve payment. But not to order the items, together through collusion, they can order and pay for items that are not related to the organization’s mission. You can see why collusion is difficult to detect, everyone is doing their individual job. Another difficult to address issue is management's opportunity to override internal controls. Management with full authority within the system can override or ignore controls that are in place. This is a difficult issue because employees that see what’s going on may not have a framework to report the problem other than to their manager. And we know that if the manager is the problem, that reporting will not happen. Other items that relate to the fraudster's perception to opportunity include poor or inadequate training. Which often leads to the defense, I did not know any better. Another is lack of supervision. People are less likely to identify a situation as an opportunity if they're adequately supervised. Unfortunately, opportunities are identified and taken advantage of when organizations do not prosecute fraudsters or have otherwise weak ethical cultures. If the tone of the organization is to look the other way when a problem occurs someone with a perceived pressure will likely find opportunities to commit fraud. The last leg of the fraud triangle is rationalization. People are generally honest, fraud involves theft. To prevent fraudsters from perceiving themselves as criminals, there is rationalization. Rationalization helps justify the crime in a way that makes in acceptable in the mind of a fraudster. One of the most common rationalizations is I deserved it, or they owe it to me. Employees that believe that they're underplayed or otherwise financially taken advantage of, frequently use this form of rationalization. They treat me bad is a non-financial variation of the I deserve it rationalization. Another rationalization is I'm just borrowing the money, mainly it's much easier to justify borrowing than stealing. The problem is that the pressure to take the money is usually not gone when repayment needs to be made so the borrower never repays the debt. Another problem with this excuse is that when one borrows it's only reasonable for the lender to know about the transaction. The final rationalization where mention is, it's not my fault, which is used to transfer blame to someone else. This can be used in many circumstances, those prevalent when the individual has access to something that should be protected. For example, a computer is found logged on in the company's pay maintenance screen. The rationalization is not my fault, someone left the computer unattended, enabling me to change my pay rate. The fundamental premise of the fraud triangle suggests that when an ordinary person or accidental fraudster commits fraud, all three of the legs of the triangle must be present. There must be a perceived problem that cannot be shared or pressure. Additionally, there must be an opportunity available that the fraudster believes can be used to solve the problem. And finally, the person will rationalize the fraud, to help in the denial that the action is wrong. Understanding the fraud triangle, helps us understand the person behind the fraud as well as helping us in the detection of the fraud. Now that you understand the fraud triangle, it may be obvious to you that the easiest leg to address is opportunity. >> When trying to provide an understanding of fraudsters, this example from the Wall Street Journal was perfect. While the article appeared in 2005, the lessons learned are timeless. The alleged perpetrator pictured is a man by the name of Thomas Coughlin. Before his alleged fraud came to light, Mr. Coughlin was the Vice Chairman of Walmart. So there's the chairman of the board, vice chair and then the executive management. Mr. Coughlin is basically second in command. According to the article, he needed some alligator boots, a dog pen, and a hunting vacation. Now a question, is it appropriate to ask Walmart to pay for this? As fraud examiners and forensic accountants, we need to be careful. Depending upon Mr. Coughlin's terms of employment, his contract Walmart Travel and Entertainment policies. It is possible that he was entitled to reimbursement for the cost. However, the Wall Street Journal article would suggest that reimbursements were not in compliance with Walmart policies. Because Mr. Coughlin used false documentation and fake invoices so the expenses would qualify. As a side note, it's the deception, the act of concealment, that convinces fraud examiners that the perpetrator knew his or her actions were wrong. If they were not wrong, why attempt to hide the act? Back to Mr. Coughlin, according to the article, estimates suggest that Mr. Coughlin may have defrauded Walmart by as much as $500,000 over three years. Mr. Coughlin never admitted any wrongdoing, so the actual amounts may never be known. If we assume $500,000 over three years that works out to be about 150 to 175,000 per year. Where this story gets interesting is the following. In your mind, guess how much Mr. Coughlin made in salary and bonus in a single year, before he resigned in disgrace and was tried in court for his act. How much salary and bonus? $6 million dollars, yes, $6 million, at some level, it appears that Mr. Coughlin was willing to sacrifice everything. His income, his employment, and his reputation, for an extra 150 to 175,000 per year. Does that make sense to you? There are couple of important lessons. One, do not inflict your values system when trying to understand what others might do, often times fraud in related financial crime do not make sense. When examining the facts and circumstances and evidence of a fraud, always keep an open mind. Follow the evidence, document the evidence, and do not make assumptions. Use the evidence to determine who, what, when, where, and how. Mr. Coughlin is a great example of the accidental fraudster. The typical fraudster is often depicted as the first time offender, who is doing something seemingly out of character. The Fraud Triangle suggest that the perpetrator has a non-sharable problem that is grounded in financial short comings. And when align with opportunities in rationalization, and otherwise good citizen succumbs to committing fraud. This person might be characterized as the accidental fraudster. Not withstanding the fraud act, the accidental fraudster is considered to be a good, law abiding person who under normal circumstances would never consider theft, breaking felonious laws or harm others. When discovered, family members, fellow employees, and others in the community are surprised or even shocked by the perpetrator's alleged behavior. Cressey's fraud triangle hypothesis helps the anti-fraud community understand the accidental of fraudster.
