Why employees commit fraud
It's
either greed or need.......
It is
important for Auditors to understand what motivates people to commit fraud so
they can better assess risk and assist employers or clients in implementing
appropriate preventive and detective measures. One element common to most
occupational fraud offenders, from the Chief Executive to the rank-and-file
employee, is that almost none of them took their jobs for the purpose of
committing fraud - they are typically first-time offenders.
Facing that fact, one must ask the logical question: How do good
people go bad? An obvious answer is greed. But many so-called greedy people do
not lie, cheat and steal to get what they want. There are two separate but
related theories about why employees commit fraud.
The
first is based on a 20-year-old Hollinger and Clark study of 12,000 employees in
the workforce. It found that nearly 90% engaged in "workplace deviance," which
included behaviour such as workplace slowdowns, sick time abuses and pilferage.
On top of that, an astonishing one-third of employees had actually stolen money
or merchandise on the job. (Remember: Even top executives are "employees.")
Wages
in kind
The
researchers concluded the most common reason employees committed fraud had
little to do with opportunity but had more to do with motivation - the more
dissatisfied the employee, the more likely he or she was to engage in criminal
behaviour. One criminologist described the phenomenon as "wages in kind." All of
us have a sense of our own worth; if we believe we are not being fairly treated
or adequately compensated, statistically we are at much higher risk of trying to
balance the scales.
A
second theory about why employees commit fraud is related to financial
pressures. In the late 1940s, criminologist Donald R. Cressey interviewed nearly
200 imprisoned fraudsters, including convicted executives. He found the great
majority committed fraud to meet their financial obligations. Cressey observed
that two other factors had to be present for employees to commit fraud. They
must perceive an opportunity to commit and conceal their crimes, and be able to
rationalise their offences as something other than criminal activity.
Opportunity is the key
Fraud
does not occur in isolation. All crime is a combination of motive and
opportunity. The opportunity to commit fraud is typically addressed through
internal controls - if the proper checks and balances exist, it is more
difficult (though still not impossible) to defraud an organisation.
To
deter opportunity, divide responsibility. If one person controls both the books
and the assets, the ability to commit fraud is limited only by that person's
imagination. But if another employee shares a task, it is less likely a
perpetrator can succeed. Furthermore, if an employee needs help to defraud an
organisation, opportunity is greatly reduced. It is one thing to commit a fraud
by yourself, quite another to ask someone to aid in your scheme.
Some
argue that internal controls are simply not enough to deter fraud. They cite two
reasons: First, controls are supposed to provide only reasonable assurance.
Second, there are few controls that cannot be overridden or circumvented by
people with sufficient motivation.
The
body of research into why "good" employees turn to fraud can be distilled into
at least two important concepts. Employees and executives who feel unfairly
treated sometimes believe they can right the scales by committing occupational
fraud and abuse. Workplace conditions are therefore a major risk factor in
predicting fraud. Also, employees faced with embarrassing financial difficulties
pose a significant problem. The simple moral to the auditor is to pay attention
to what goes on outside the books, too. So while you're looking at the numbers,
keep one eye and both ears open for disgruntled or financially strapped
employees. It may mean all the difference in detecting fraud.
Case
Study - McKinley and his tractors
Tractors - that's what brought McKinley down. The simple but vital machines were
the main reason McKinley stole a substantial amount from the bank where he
worked as a chief financial officer.
McKinley's tale of woe had actually begun years earlier. He was a graduate from
a prestigious University with a degree in accounting. McKinley came from the
right family, had a good marriage, attended the right church and went to work
for the right bank. His future looked bright, but in McKinley's opinion, not
bright enough. It seems that his lineage didn't come with a lot of money. So
like many of us, McKinley decided to regularly invest a portion of his pay
cheque, hoping the investment would eventually bring him financial security.
Then
McKinley did a very un-accountant-like thing. He invested all his money in a
local tractor dealership. On top of that, he borrowed all the money he could
from his own employer and invested that as well. McKinley bragged to his fellow
workers about his new acquisition as evidence of his business acumen. But before
long, McKinley's investment soured. He was then faced with a dilemma, he would
have to tell the bank the truth - that even though he was in charge of the
bank's money, he could not manage his own finances. The thought of admitting
that, to acknowledge that he, the hot-shot executive, wasn't all that savvy, was
unthinkable to McKinley. So he concocted a scheme.
McKinley's big idea
First,
McKinley had to raise more money to get his bank loan out of default. Since he
helped install the bank's system of internal control, he knew there was a simple
way to override it. Specifically, as the bank's Chief Financial Officer, he was
the ultimate authority on journal entries. He not only reviewed the entries of
other employees, but also could make them himself. Other than the bank's
regulators and external auditors, no one saw the numbers after McKinley.
To
cover the money he needed, McKinley made a journal entry. The debit was to a
bank correspondent account, a clearing account with lots of volume. That way,
the entry was more likely to be lost in the shuffle. The credit was to
McKinley's own personal checking account at the bank. Then he made a second
entry, crediting the bank's correspondent account and debiting one of the bank's
expense accounts: consulting, advertising or other "soft" expenses.
The
trick worked. McKinley got the money to cover his overdue bank loan repayments,
and no one was the wiser. It may have been that the technique was a little too
easy, because the next time McKinley needed money, he reverted to the same
method. In just over a year, he stole in excess of £100,000, using some of the
money to cover his debts.
Lessons learned
The
bank's external auditors did not detect McKinley's thefts. The loss was not
material to the financial statements as a whole, so there was no responsibility
for the auditors to find the theft. Still, this incident proved embarrassing;
the bank lost faith in the audit firm for not detecting the theft and changed
auditors as a result. Even though the original auditors were not required to
detect such a fraud, most of us want to get the best service possible. And
sometimes, as in this case, clients don't really want to hear the limits of an
audit; they want to affix blame.
Could
the auditors have seen any of the indications of fraud? Perhaps. Considering all
the circumstances, the outcome might have been better had the auditors taken a
different approach. First, there were clues in the books. Some were well-hidden;
others were not. Fraudsters frequently prefer to hide their thefts in
high-volume accounts. Had the auditors known this fact, perhaps they would have
looked more carefully at the correspondent accounts.
Another accounting clue was that McKinley eventually hid his thefts in "soft"
expenses. Finally, auditors for financial institutions have access to the
personal accounts of officers and employees. Had McKinley's account been
examined, the auditors would have noticed that he had deposited all his
ill-gotten gain in his own account at his own bank. This is not a smart move,
but for some inexplicable reason, almost every fraudster does exactly the same
thing.
A very simple question
It would also have been helpful if the auditors had stepped back
from the books long enough to privately ask each employee they worked with a
powerful but simple question: Do you suspect any fraud within this organisation?
Had they done so, the auditors might have learned that employees were already
suspicious of McKinley.
Even
though he had started out well regarded at the bank, McKinley's life changed
when he began stealing. He started becoming moody and irritable, and it was
clear to the other employees that he was living well beyond his means. McKinley
thought he was doing a good job covering his tracks, but his ill-fated tractor
investment and his family troubles were well known to many of the bank's
fifty-plus employees.
Why didn't any of these employees tell what they knew? Because
no one asked. You need to ask the right questions to get the right answers
When "Yes" is a warning sign
There are
a number of characteristics that may influence employees to commit financial
statement frauds and asset misappropriations. The more "yes" answers you give to
the questions below, the more likely it will be that you will find the
motivation for fraud.
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Is
management compensation tied closely to company value?
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Is
management dominated by a single person or a small group?
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Does
management display a significant disregard for regulations or controls?
-
Has
management restricted the auditor's access to documents or personnel?
-
Has
management set unrealistic financial goals?
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Does
management have any past history of illegal conduct?
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Is an
employee obviously dissatisfied?
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Does
an employee have a past history of dishonesty or illegal conduct?
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Does that employee have known financial pressures, such as
excessive debt, bad credit or tax liens?
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Has
that employee's lifestyle or behaviour changed significantly
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