Fraud has always been a hot topic for businesses, governments and even the public. When hearing about a new fraud case or incident we usually tend to start imagining the whole processes as a Hollywood movie and start wondering, why did he/she do it?, How could he/she do it?, Who helped him/her?, What was he/she planning to do with the money? and many others.
In this Article we will try to dig deeper into this topic, first by understanding what fraud is, what are the major fraud categories and by providing examples of real-life fraud cases. We then proceed in dissecting the Fraud Triangle which is a well-known framework that can help in understanding and addressing fraud.
What is Fraud?
As defined by Black Law Dictionary, Fraud is defined as follows: “A knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment. It involves incompliance with a certain control (being it a law or a company policy) to make unjustified gain.“
Fraud in general can be very complex and usually involves different parties/individuals and can take various forms.
Fraud Categories:
As per the Association of Certified Fraud Examiners (ACFE), fraud can be classified under three main categories as follows:
Corruption: Usually involves governmental employees and is difficult to detect.
Asset Manipulation: The outright theft of cash or inventory is a form of asset misappropriation. Overpaying vendors or employees – or paying vendors and employees that do not actually exist on a group/company.
Fraudulent Financial Statements: Usually more common in the private sector and is sometimes called cooking the books. The company’s maliciously alters its balance sheet or income statement thus resulting in a misrepresentation of the actual figures.
Additional examples of fraudulent acts include the following:
Kickbacks: Also known as bribes.
Identity Theft: Unlawfully claiming and using the identity of another person.
Embezzlement: Also known as theft.
Bid Rigging: When bidding parties illegally collide and agree on the winning tender.
Payroll Fraud: Includes, as an example, faking attendance records to avoid payroll deductions.
The above is just to provide a “feel” of what fraud is. Fraudulent acts are not limited to the ones mentioned above.
Fraud Cases – Company Level:
In regard to fraud cases at company level, the case of Enron is one of the most famous financial statement’s misrepresentation cases that most business professionals have heard of, especially in the audit field. The importance of this case be derived from the following 3 main root causes:
a. Scale of Enron: Being one of the largest energy companies at that time, Enron was considered to be the 7th biggest company in the US in terms of revenue during the late 1990s and the early 2000 prior to its collapse in 2001 when the company first filed for bankruptcy.
As per the article titled “Enron: The Fraud that Changed everything” published by the Independent on 9th of April 2006, “It was on 2 December 2001, that Enron finally admitted it was bust. Its 20,000 employees were told they would lose their jobs, their health insurance, and their pensions. Its shareholders were told their investment was worthless”.
b. Involvement of one of the biggest audit firms – Arthur Andersen: Arthur Andersen, which was considered as one of the biggest audit firms back then and which later went extent for some time, was accused explicitly for being part and heavily involved in this scandal.
As relevant WSJ article titled: “Arthur Andersen Admits It Destroyed Documents Related to Enron Account” states “Arthur Andersen disclosed to federal agencies investigating the energy trading firm that individuals at the accounting firm in recent months disposed of a “a significant but undetermined number” of documents related to its work for Enron”.
c. Sarbanes Oxley Act 2002: The fraud scandal of Enron, along with other similar cases which were occurring in the period from 2000 till 2002, luckily lead to the adoption of Sarbanes Oxley or SOX Act. A law, that is considered till today, as the foundation for audit and governance practices.
The introduction of the law as adopted in the United States Congress states the following: “An Act To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes”. The act which was enacted on July 30, 2002, defined the reporting and control requirements to be applied by public companies, board of directors and audit firms.
Another recent case that came to the surface couple of months back in the UAE was that of MNC Health. The Company which was initially incorporated by its founder B. R. Shetty back in 1974 became to be one of the biggest health institutions in the UAE with sister companies operating in various other industries.
When first accused with Fraud and as requested by London Stock Exchange, an internal investigation was initiated which lead to the following preliminary conclusion: “The company now believes its liabilities are at least $6.6 billion — $1.6 billion more than the previous estimate and more than three times its debts when investigations began in January. It has also identified about $50 million in cheques that it believes were improperly written by group companies“. As per the article titled “Fraud discovered at UAE’s NMC Health” and published on Gulf News on March 12, 2020.
Several banks have reported certain level of exposure on NMC’s activities including HSBC Oman, Emirates NBD, and several other international and regional financial institutions. A major aspect of MNC Health case is financial misstatement that involved usage of accounting methods and wrong accounting/control practices to falsify and report inaccurate financial data on the position and performance of the Company and accordingly misleading creditors, investors and regulatory bodies.
Fraud Cases – Individual Level:
As for individual fraudulent activities, a famous example of embezzlement occurred in 2018 with a manager called Cesar from Webster Bank, USA, embezzled money from customers account without their knowledge and/or consent. The United States Attorney’s office, District of Connecticut, described the case as follows:
“Between 2003 and 2016, Cesar withdrew at least $535,600 from account holders’ certificate of deposit (CD) accounts at Webster Bank, without the knowledge or consent of the account holders, used the embezzled funds for her own purposes, and took steps to conceal her misconduct.”
Fraud Cases – Government Level:
Fraud is not limited to commercial companies as it is also evident at the scale of the governmental sector. Corruption, which is a form of fraud, is strongly evident in the public sector and especially within the developing economies.
The corruption perception index scores and ranks governments/territories based on “how corrupt a country’s public sector is perceived to be by experts and business executives. It is a composite index, a combination of 13 surveys and assessments of corruption, collected by a variety of reputable institution”, as defined by Transparency International, a global movement working to end corruption.
In 2019, Denmark and New Zealand had the first position while Somalia, South Sudan, Syria, and Yemen had the last positions.
Transparency International estimates that the cost of corruption in EU member states is approximately USD Billion 132 per year while it can cost developing countries up to USD Trillion 1.26 per year.
So based on all the above, it is evident that fraud can have great adverse impact on individuals, businesses, communities and even countries, but the positive thing is that this concept has been thoroughly studied by professionals and scholars and existing frameworks can really be useful in further understanding this phenomenon.
Fraud Triangle:
Extensive professional research has done on fraud has led to some universal principles/frameworks.
A very interesting and well known framework that can help in understanding and addressing fraud is something referred to as the “Fraud Triangle”. This framework is currently taught in many professional curriculums and programs covering the fraud topic.
So, what is this triangle?
The idea was first put forward in an article by Donald Creesey and Edinw Sutherland; the term was later coined by Steve Albretch.
Several decades ago, after considerable research, Donald R. Cressey, a well-known criminologist, developed the Fraud Triangle. Interested in the circumstances that led embezzlers to temptation, he published “Other People’s Money: A Study in the Social Psychology of Embezzlement.”
Cressey’s hypothesis was: “Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-sharable, 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 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”.
Simply, the triangle states that individuals are motivated to commit fraud when three elements come together:
1) Pressure: Perceived pressure, the motive/need for committing the fraud (e.g. need for money, addiction, etc.)
2) Opportunity: Perceived opportunity, the situation that enables the fraud to occur, such as in the case of weak/non-existence internal controls (e.g. improper segregation of duties, weak access rights controls, absence of records reconciliation, etc.).
3) Rationalization: some way to rationalize the fraud as not being inconsistent with one’s values. In brief, it is the mindset of the fraudster that justified them to commit fraud (e.g. “I’ll pay the money back, they will never notice the funds went missing”, etc.)
In the below listed fraud scenarios, we analyze the contribution each element of the fraud triangle had towards the fraud act.
Scenario 1:
“Marc works in a large-scale grocery store that operates 24/7 and usually attends to night shifts alone. He has severe gambling addiction”.
One night, Marc decide to take some money from the cashier for his own use especially that no cameras are in place and the cash check/inventory check is rarely done by his supervisor.”
So, by analyzing the above based on the fraud triangle framework, the following can be understood:
Pressure: His gambling addiction is causing Marc to lose all his money and accordingly he is not being able to cover his day to day expenses anymore.
Opportunity: The control weakness, in terms of not doing periodic and repetitive inventory/cash count to confirm that the sales are being reflected in inventory decrease and increase in cash and the absence of surveillance cameras.
Rationalization: Most probably Marc would have convinced himself that since this is a large grocery shop with probably millions of sales per year, this small amount that he took will not actually severely affect the business, its owners, or its employees.
Scenario 2:
Rana is a governmental municipality employee that is responsible for collecting to prepare, approve invoices and collect cash relating to the cleaning services the municipality offers within its jurisdiction.
Rana’s daughter wants to pursue her higher education in an international university and Rana is having some challenges in providing the necessary funds.
Rana decided to add 1$ for each invoice she is issuing/collecting especially when dealing with elderly citizens. This scenario continued for a period of 1 year and she was to fraudulently collect a value approximate to USD 100,000.
Similarly, by analyzing the above based on the fraud triangle framework, the following can be understood:
Pressure: Rana’s pressure to provide funding for her daughter’s education was posing daily psychological and emotional pressure on Rana.
Opportunity: The fact that Rana was authorized to prepare and approve invoices and at the same time collect the relevant cash is a considered a major control weakness. This control weakness is usually referred to as the absence of segregation of duties.
Rationalization: Most probably Rana considered that adding 1$ per invoice will not have a major impact on the citizens and accordingly she will not be materially impacting them, their lives or well-being.
If you now consider any fraud case you have heard of and try to further understand it based on the elements of the fraud triangle framework, I am sure it will make more sense.
In the upcoming article, we will address the key challenges which governmental bodies may face in breaking down the fraud triangle and the practical strategies and tools which may be applied to overcome such challenges.
As for the quote of the day, the ancient Greek dramatist once said, “Rather fail with honor rather than succeed with Fraud.”