Financial Fraud

Article excerpt

Fraud continues to be an ever-present concern for accountants, auditors, and antifraud professionals. In its 2012 Report to the Nations on Occupational Fraud & Abuse, the Association of Certified Fraud Examiners (ACFE) estimated that the annual cost of fraud approaches 5% of an organization's revenues and may be as large as $3.5 trillion worldwide. In this article, the authors present a meta-model to serve as a framework for considering possible fraud acts, as well as for more effective and efficient fraud prevention and deterrence.

Meta-Model of Fraud

Beginning with the fraud triangle and moving on to the triangle of fraud action - also referred to as the elements of fraud - these seemingly disparate concepts are connected in a meta-model (Exhibit 1) that can help fraud professionals understand prevention, deterrence, detection, investigation, and remediation of fraud acts in a more comprehensive manner.

The meta-model relates the internal perceptions of a potential fraudster (perpetrator) to the actions necessary to carry out the fraud (crime). The potential fraudster must examine his personal situation in the context of the deterrence, prevention, and detection conditions and determine whether a fraudulent act can be successfully executed and concealed. The fraud triangle is the component of the meta-model that captures the perceptions of the potential fraudster. Steve Albrecht's triangle of fraud action represents the three key elements of a financially based crime: the criminal act, the concealment, and the conversion (into benefits) to the perpetrator. The probability of fraud is influenced by environmental factors such as internal controls, corporate governance, and legal and regulatory measures aimed at reducing the incidence of fraud acts. These are the factors that stand between the potential perpetrator and the financially motivated crime.

Antifraud interventions are described as deterrence, prevention, and the perceived threat of detection. Generally, antifraud efforts are beyond the control of the potential fraudster, and each exerts an influence on a perpetrator's assessment of the probability of success in terms of completing and concealing the criminal act.

The Fraud Triangle

During his work in the 1950s with white-collar criminals, Donald Cressey noticed three common characteristics that were associated with a violation of trust 1) the pressure of a nonshareable financial problem, 2) an opportunity to violate a position of trust, and 3) the ability to rationalize the violation of trust as justifiable.

According to Cressey's generalization, an otherwise upstanding individual with a nonshareable financial challenge, a perceived opportunity to act with little fear of detection, and a morally defensible excuse might commit fraud. The fraud triangle, shown in Exhibit 2, was developed based on these three fundamental attributes; it forms the basis for many discussions of white-collar crime.

As the fraud triangle evolved over time, practitioners and academics have supplemented Cressey's work with additional observations. These enhancements to our understanding of why good people make bad choices include the fraud scale (Steve Albrecht, Keith Howe, and Marshall Romney, 'Oeterring Fraud: The Internal Auditor's Perspective," Institute of Internal Auditors Research Foundation, 1984); the fraud diamond, which includes capability as a fourth characteristic (David T. Wolfe and Dana R. Hermanson, "The Fraud Diamond: Considering the Four Elements of Fraud," The CPA Journal, December 2004); the fraud pentagon, which adds arrogance as a fifth element (Jonathan Marks, "Playing Offense in a High-risk Environment" Crowe Horwath, 2010); and the acronym MICE - that is, money, ideology, coercion, and ego/entitlement (Thomas). These enhancements are examined in further detail in the authors' 'Beyond the Fraud Triangle: Enhancing Deterrence of Economic Crimes" (Jack W. …