What makes a person commit fraud? Where do internal controls and risk analysis come together when it comes to violating financial trust?
Fraud seems rampant and can be devastating, but internal controls can not only help detect and deter fraud, but they can also improve the speed and accuracy of information processing, and that leads to lower costs and higher revenues. Investing in internal controls is a smart move but to do it successfully we need to apply a good deal of critical thinking to try and understand the source of fraud, or at least, question what we have learned.
In every fraud seminar I've ever attended, they reference Donald Cressey and his book, Other People's Money, as the definitive answer to fraud. I thought it seemed both too simplistic and not very effective or helpful in detecting and deterring fraud in modern times. So I decided to dig deeper and ordered a copy through the free national inter-library loan program. There may have only been one copy available, but I received it and read it. What comes next are my observations and an attempt to a fresh look at the issue of fraud.
The Fraud Triad
Donald Cressey’s Other People’s Money book was written 70 years ago. It is still frequently, if not always, cited or referred to in some manner during any discussion or class that deals with fraud.
Cressey reviewed 503 files, from three different penitentiaries and refined a sample of 133 cases for study based on these criteria:
1. Accepting a position of trust in good faith, and
2. A criminal violation of financial trust.
He dedicated an average of 15 hours to each case. His final hypothesis encapsulates the idea that a trusted person becomes a violator when three factors come together: they identify an unshareable financial problem, can secretly resolve this problem by violating their position of trust, and can justify their actions.
This is known as the Fraud Triad:
Foto + grafica “Trusted persons become trust violators when they conceive of themselves as having a financial problem that is non-shareable, are aware that this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.” (p. 30)
There is also a lot of discussion regarding an innate defect, depravity or other mental abnormality. The subjects often describe themselves as not acting in their right mind, or other words to that effect. However, the author does not include any psychology as background or discussion, or support for his hypothesis. It seems to me that an individual’s psychological makeup and health would be at least a factor in a discussion of criminal behavior.
The Issue With the Triad
As I read through the book, I get the distinct feeling that he is stacking the deck in his favor.
Although the author takes great pains to describe his scientific rigor the narrative seems to use a lot of subjective rationalizations to ensure the cases fit neatly within his theory. He claims that “The formulation of hypotheses was guided entirely by the search for negative cases.” (p. 17) But he admits that future revision will be necessary if negative cases are found, that is, cases where the facts would not support his hypothesis.
But to me, perhaps the most striking aspect of his description and narrative is just how much life, culture, business and technology has changed since the book was written. To be fair, the book was written 70 years ago so the narrative is completely infused with the perspective of the Depression, World War II, and the environment immediately thereafter. The world he writes about and the world that defines his universe is completely alien to today’s world.
His subjects are all male. Although there is no discussion of it, I am going to go out on a limb and assume they are all white. Does anyone but me else detect a flaw in his sample? There was no automation or information technology in the 1940s. The world worked differently. Businesses were organized, structured, and run differently. Many examples concern bank officers and business owners shuffling and juggling funds and accounts simply to keep the business afloat.
For example, back then, when a customer paid cash on deposit for any item, the culture and standard was to keep those funds separate, segregated, and in escrow. Today, such funds are simply business cash flow. I believe that in today’s environment, many of his cases would have simply led to a routine bankruptcy instead of incarceration. I dispute the relevance of his definition of embezzlement in today’s terms.
While reading Cressey’s book, it’s easy to be transported back in time, and you get a vivid feeling of a 1940s film noir movie. You almost expect to see Humphrey Bogart or Jimmy Stewart step out of the pages. From today’s perspective, it seems quaint and unreal.
None of his examples involve collusion. Don’t we have lots of examples of fraud and embezzlement that involve collusion? Where is the “unshareable problem” when the fraud involves or requires collusion? There were no massive multinational corporate entities like we have today. No global markets with 24-hour-per-day trading. No derivative investments are so complicated that virtually no single person can understand them.
The Need For a New Framework
Non-shareable Problem
I’m convinced that Cressey’s non-shareable problem leg is incomplete, if not irrelevant. Everyone has some non-shareable problem. One non-shareable problem that Cressey seems to virtually ignore is simple greed.
Wouldn’t most of us love to have more? More of everything? Today, we are literally bombarded with media depictions of seemingly endless wealth and prosperity enjoyed by a limited few people. Doesn’t our base instinct for survival tend to drive us toward accumulating wealth?
Clearly, in today’s world, this basic instinct has been allowed to flourish to absurd proportions in some cases. But the underlying drive is there in all of us, bonded deeply with our nature. Today, almost everyone seems to possess the non-shareable problem of being greedy. And everyone has a myriad of other personal problems. Clearly, everyone has a high capacity for fulfilling this “leg” of the triad. It seems to me that this is not in any way predictive of fraud.
Rationalization
I agree with the rationalization aspect up to a point, except that I think it’s more often that once the perpetrator can manufacture an adequate rationalization for him/herself, that becomes the trigger for the fraud to begin. I also think that one of the most common rationalizations is, “Can I get away with it?”
It also occurs to me that virtually all humans seem to be able to rationalize almost any conceivable behavior. Rationalization is a significant aspect of everyone’s personality. Absolutely everyone has a high capacity for fulfilling this “leg” of the triad. It seems to me that this is not in any way predictive of fraud.
I’m tempted to believe that there is an aspect of learned behavior here, too, that touches on cultural and individual behavior norms. We like to compare life in Maine with life in Massachusetts. There is a stronger culture in Maine of being proud of our reputation for honesty and our sense of shared community and shared sacrifice. Life in Maine is more difficult in many ways than life elsewhere, and Mainers need to look out for each other. The commonly held belief in Maine is that for folks in Massachusetts, and points south (people from away), it’s every person for themselves, and you grab what you can, when you can, before someone else beats you to it. So I would bet that, yes, there is less fraud in Maine, but I have no idea how much less. It might turn out to be insignificant, a myth.
I am always amazed at the number of people who view religion, religious behavior, piety, etc., as a reason why they or someone else could not possibly commit or be guilty of fraud. If you have ever had any formal interview training (as opposed to interrogation training), one clue that the person being interviewed is guilty is when/if they claim, “I swear to God I didn’t do it,” or, “As God is my witness…”
Opportunity
So, of Cressey’s three legs of fraud, the fraud triad, I think the first two are relatively insignificant if not completely irrelevant. We all have problems, and given enough time, the human brain can rationalize virtually any behavior. The place for us to focus our attention on is opportunity. That is where internal controls and risk analysis come together.
We need a new framework for understanding fraud, and a stronger effort to combat it.
How the world really works!
Benson Dana
Retired CPA and author of "Tales From The Trenches: A CPA Internal Auditor's Stories of Fraud, Internal Controls, Auditing, and Embezzlement".
