Fraud Basics – The Fraud Triangle – what are the drivers of fraud

To understand fraud, we have to understand what drives people to it. Are some people born to be fraudsters? What facilitates or motivates people to commit fraud and what can organizations do to prevent fraud.

In the 1950’s studies by Dr Donald R Cressey on the behavior of individuals who had embezzled funds lead to the hypothesis of the Fraud Triangle. The Fraud Triangle holds that there are three drivers of fraud: opportunity, motivation and rationale. To date the findings of Cresseys study still hold. An additional driver or facilitator has been identified as capability. According to KPMG’s 2014 study Global profile of a fraudster, People commit fraud when three elements occur simultaneously, the perfect storm; motivation, opportunity and ability to rationalize the act. In almost all cases, this explains why the fraud occurs and why a particular type of person becomes a fraudster.

Every professional involved in fraud examiners should understand the fraud triangle as a starting point in understanding fraud.

To understand the fraud triangle consider the following example. James is the Head of Finance for a Savanna Holdings. Savanna Holdings deals with purchase and sale of premium animal feed in Kenya. The animal feeds are imported from Denmark. Savanna holds all its stock in a warehouse in Nairobi from where dispatches to customers are done. As the Head of Finance James is in charge of the warehouse, the finance department, logistics and administration.  James Joined Savanna as an intern in the warehouse department. Over the course of his 17 years employment at Savanna, he has worked in the logistics department, administration department and in internal audit. Most of the policies, procedures and controls in place at Savanna were developed while James was an employee. During last year’s Audit by Milestone Associates – CPA, the auditors recommended that a detailed investigation be performed on the company’s inventory records and non performing debtors.

Momentum Advisory – CFE conducted the investigation. Their findings were that James in collusion with other employees had defrauded the company Kshs 170 million – (approx. USD 2million).  The fraud had taken place for the last three years. The investigation also found the following:

·        That James had divorced his wife and the court had ruled that about 50% of his wealth be transferred to his wife. In addition he was required to pay child support of Kshs 150,000 per month.

·        James was the overall authority in approval of all credit sales, signing off of inventory records at the end of year, signing off of bank reconciliations.

·        The ownership of Savanna had overlooked in the appointment of a new CEO four years ago.

 

The theoretical case above provides an example of how cases of fraud will exhibit the three drivers mentioned in the fraud triangle.

Opportunity and Capability

People who have stayed in the organization long enough have gained trust of the organizations. In addition, they understand the controls of the organization. In this case James has worked in the organization for 17 years, he has worked in virtually all departments that now report to him. At his position no member of staff can question his actions. These circumstances have created the opportunity for him to commit fraud. It’s like leaving the safe unlocked just because you trust your colleagues. The open door is the opportunity.

Motivation and pressure

James was recently divorced, he also has child support to take care of. These circumstances have created pressure on James to find alternative ways of raising his income. Fraud like any other crime requires motivation, this could be greed, financial gain or financial difficulty. For someone at James level, it could be difficult to observer aspects of greed[1]. If James an expensive car, nobody would think about it too much given his position of CFO.

Rationale

Fraudsters, as with other types of criminals, will frequently provide a rationale for their deeds. For example in James case, he may feel that he is getting even with the organization for overlooking him in their search for a CEO. James may also feel that he is superior enough not to play by the rules of the company.

Although the above case is theoretical, I have seen similar cases in my investigations over the years. Opportunities for fraud are many depending on the type of organization. Organizations need to be vigilant to ensure that controls are tight enough and oversight is strong enough to identify where such might occur.

Recognizing these drivers may assist organizations reduce fraud. Internal controls and trust is good, but recognizing that you are dealing with or relying on human element may enable an organization prevent fraud.

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[1] KPMG 2014, Global profiles of a fraudster survey