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OVERCOMING THE FRAUD TRIANGLE

By Curtis C. Verschoor, CMA, CPA
June 30, 2015
6 comments
7ethics2

Companies still need to do more to lessen the financial pressures and reduce the rationalizations that lead to fraud.

 

The Financial Executives Research Foundation (FERF) recently published the results of its surveys of financial executives, managers, and staff. The report, Breaking the Cycle of Fraud, recommends strategies to mitigate wrongdoing in the two areas of the fraud triangle that are most closely connected to ethical matters: financial pressure and rationalization.

 

The fraud triangle was created by criminology researchers Edwin Sutherland and Donald Cressey to describe the three elements that come together when an individual commits fraud:

 

* Opportunity (weak internal controls) allows the fraud to occur.

 

* Financial pressure (motive) is the perceived need for committing the fraud.

 

* Rationalization (weak ethics) is the mind-set of the fraudster that justifies the crime.

 

By imposing stronger internal controls and processes, companies can take specific, visible action to reduce the risk of opportunity. But financial pressure and rationalization closely involve individuals’ ethical framework and organizational culture, and those are much more difficult to influence overtly and directly.

 

FINANCIAL PRESSURE

 

Breaking the Cycle reiterates the widely described importance of a positive tone at the top of the organization in mitigating financial pressure. The report describes numerous historical examples where a pressured corporate culture brought ruin. In these cases, achieving short-term financial performance targets for bonus purposes was given far higher priority by senior executives than was acting ethically and considering the sustainability of the enterprise.

 

A resulting ethical culture of failure to “walk the talk” permeates the attitudes of lower-level executives and employees who are likely to do almost anything to please their bosses—even if it violates provisions in the organization’s code of conduct as well as their own personal ethical standards.

 

It doesn’t seem like companies are expanding performance goals to avoid this trap. On April 29, 2015, the SEC announced a proposed rule to require companies to disclose “the relationship between executive pay and a company’s financial performance.” The new rule is intended to help shareholders be better informed when electing directors and voting on executive compensation. The metric chosen to represent company performance is total shareholder return (TSR) calculated on an annual basis and compared to the TSR of a peer group of companies. But this rule will only reinforce the existing focus on short-term financial goals and targets. Performance measurements for rewarding senior executives and others should be expanded to include accomplishment of more ethics-based matter.

 

RATIONALIZATION

 

The FERF report lists a number of important aspects of an effective ethical culture that strengthen efforts to avoid rationalization of improper behavior. These include useful ethics training tailored to the organization, annual surveys of employee attitudes, and effective whistleblowing programs. The training should involve all levels of the organization. It should contain real-world examples of the negative consequences of unethical behavior, be based on the organization’s code of ethics, and include true-to-life applications. Other research has shown that in-person training is likely to be most effective.

 

The annual surveys of employee attitudes and evaluations of the ethical climate recommended by Breaking the Cycle must be professionally designed to avoid leading questions. Surveys must also be administered anonymously to encourage truthful responses that will be helpful in assessing the ethical climate of the organization and the effectiveness of the ethics program. Otherwise, the effort could backfire.

 

If administered properly, whistleblower or helpline programs are extremely important in detecting and deterring unethical behavior in an organization. The 2014 biannual survey by the Association of Certified Fraud Examiners (ACFE) reports that the most common method through which occupational fraud and abuse is revealed (40%) is tips. This is “more than twice the rate of any other detection method. Employees accounted for nearly half of all tips that led to the discovery of fraud,” according to the report.

 

ENCOURAGE WHISTLEBLOWING

 

The Anti-Fraud Collaboration reported in 2014 that many employees are hesitant to report wrongdoing internally using their organization’s reporting process. The reasons for hesitating are because they have a significant fear of retaliation or because they believe that senior management is involved or won’t take any action to stop unethical behavior. There are some legal protections for whistleblowers in some states and some industries. This is why the IMA Statement of Ethical Professional Practice recommends that individuals having an ethical conflict should consult their own attorney—not someone affiliated with their employer—regarding their legal obligations and rights.

 

Ethics training should include motivation for everyone in the organization, as well as suppliers, to utilize the helpline when warranted. Some of the features of a well-designed whistleblower helpline include wide access with global language capability and adaptation to local customs, if necessary; a single helpline for all ethics-related issues; protocols for handling any reports professionally, including documented formal processes for timely investigation and procedures for confidential reporting of results; and formal data security and document retention policies.

 

The IMA Statement requires that all members “shall encourage others within their organization to act in accordance with its overarching principles: Honesty, Fairness, Objectivity, and Responsibility.” Have you done your share of encouragement lately?

 

 

Curtis C. Verschoor, CMA, CPA, is the Emeritus Ledger & Quill Research Professor, School of Accountancy and MIS, and an honorary Senior Wicklander Research Fellow in the Institute for Business and Professional Ethics, both at DePaul University, Chicago. He also is a Research Scholar in the Center for Business Ethics at Bentley University, Waltham, Mass., and chair of IMA’s Ethics Committee. Trust Across America-Trust Around the World awarded him a Lifetime Achievement Award in 2016 as a top thought leader in trustworthy business. His e-mail address is curtisverschoor@sbcglobal.net.
6 + Show Comments

6 comments
    karen July 14, 2015 AT 2:27 pm

    article for acct 310

    David johnson July 23, 2015 AT 1:06 pm

    GREAT article

    […] Articles: Overcoming the Fraud Triangle – Strategic Finance The Importance of Internal Controls – Forbes Nine Steps to Make Your […]

    Adrienne January 5, 2016 AT 9:04 pm

    Loved the article!!! Used for a paper on fraud

    Vincent Killewald May 18, 2016 AT 11:26 am

    Sounds like a good publication.

    Brad Gurney May 20, 2016 AT 10:48 am

    Very helpful. a wake up call for all business owners.

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