In business, we often first deal with fraudulent activities after something has already happened. The barn door is open, the horse is gone and the question is: What do we do now?
The first questions to be answered are:
- How did the fraudulent activity come to light? (or how did we learn of the fraudulent activity?)
- Are there really fraudulent actions or only claims or assertions?
- What are the effects of these actions?
- Is the existence of the company endangered?
- Who must be informed?
And most importantly: What could we have done to prevent this happening at all? Unfortunately, very few companies actively try to prevent fraud. Even the German business auditor (WP) is not obliged to examine for fraudulent activity as part of the final audit.
This series of articles will discuss the questions above with examples from our experience.
First, let’s look at the human factor in fraudulent activity. Donald Ray Cressey (1919-1987) was a sociologist and criminologist in the United States. At the beginning of his career he considered himself more of a social psychologist studying criminal behavior from the perspective of behavioral theory.
In 1950, Cressey created a stir with the publication of his book „Other People’s Money“, which he based on his doctoral thesis. At the time it was not only rare but also prestigious to publish a book on a criminological topic.
Cressey considered the cases of 503 male inmates at three different prisons, all of whom had been convicted of various forms of embezzlement. He then selected only crimes resulting from the abuse of a position of trust, which focused his study on 133 cases.
He questioned each man for an average of 15 hours over the course of five months in order to learn the reasons for his crimes.
Cressey’s goal was to determine the motivation for all these men and express it in the form of a hypothesis. After a few tries, his fifth hypothesis was confirmed by all 133 cases.
His verified hypothesis states:
„Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware 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, verbalization which enables them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.” 
This „non-shareable problem“ exists (in the eyes of the fraudster) when his financial problem cannot be solved with help from others because the perpetrator is afraid of losing respect or social status in the eyes of others. The criminal fears the potential social isolation.
This hypothesis was also proven true for the 200 cases collected but not published by Cressey’s professor, Edwin H. Sutherland (1883-1950).
His hypothesis led Cressey to set out his „fraud triangle“, which helped him to explain the pre-requisites for fraud in an occupational setting, now also known as white-collar crime.
Three conditions favor occupational fraud, according to Cressey:
- Opportunity: Ineffective or missing controls or checks and the perpetrator’s knowledge of these gaps
- Motivation: An incentive or provocation for the deed, there must be a reward
- Justification: The criminal must be able to justify the crime to himself later
The presence of these three conditions does not mean that fraudulent activity will automatically happen, of course. But they are indeed „red flags“ or indicators that it is highly probable that fraud can or could take place.
Back to Cressey: The „Fraud Triangle“ was considered to be the perfect explanation for fraud for many years.
Recent criticism of Cressey’s research points out that he only examined men who were already employed in an organization and who fulfilled the three pre-requisites mentioned above. Cressey excluded criminals who took a position with the intent to commit fraud or who had committed fraud in the past. Cressey focused on fraudsters who had not planned to commit fraud when they joined the organization.
Today we know that some employees join organizations with exactly that intent, however. This may vary in countries with different termination laws and employment laws as are common in Europe but cannot be discounted in principle.
Recent financial scandals known around the world have also shown that some people commit fraud even without personal financial pressure or a „non-shareable problem“.
In general, the „fraud triangle“ can be used as a tool to explain a (potential) fraud, though it does not explain why a newly hired employee defrauds a company. There are also cases in which employees commit fraud simply for the kick or to „beat the system“.
The second and third articles in this series will discuss the questions posed in the introduction so that the fourth article can report on active fraud prevention. Please feel free to contact me, I look forward to answering your questions.
Dr. Michael-A. Leuthner studied mechanical engineering and economics, writing his doctorate with a professor for financial auditing. In addition, he holds the following qualifications:
- Certified Public Accountant (State of Washington)
- Certified Internal Auditor
- Certified Fraud Examiner
- Certified Financial Services Auditor
Focus of Dr. Leuthner’s work is restructuring and fraud discovery and prevention in international firms around the world.
 Illinois State Penitentiary in Joliet, California Institution for Men in Chino and the United States Penitentiary in Terre Haute, Indiana
 Cressey, D. R. (1973): Other people’s money: A study in the social psychology of embezzlement. Montclair, NJ: Patterson Smith. (Original work published 1953)
 Robert L. Kardell (2015): Defrauding for fun not need, fraud triangle doesn’t explain fraudsters who steal only for enjoyment. Fraud Magazine, July/August 2015, pp. 35-40.