If you are running a business, you may have experienced instances of employee fraud. But, if you can figure out ‘why’ employees commit fraud, you can prevent fraud, before it actually happens. Similarly, if you can figure out ‘how’ employees (or any person, for that matter!) commit fraud, you can design policies and create internal controls to reduce the occurrence of fraud.
In this article, we will discuss an important model that has assisted business owners for years to understand and analyse fraud. After going through this article, you will understand the mindset behind employee fraud and based on this, you can devise adequate measures to prevent and reduce the occurrence of fraud.
Here we go!
Let’s start with the very basics first!
What is the concept of ‘Fraud Triangle’?
Donald R. Cressey, a criminologist, introduced the "fraud triangle" model in the 1970s. He observed that when an employee has the motive to commit fraud, gets the opportunity to accomplish this without getting caught and can justify their actions, they are more likely to commit an occupational crime. Thus, the fraud triangle depicts the three factors that can contribute to increased cases of occupational fraud: motivation, opportunity and rationalization.
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Who commits fraud at occupation?
A 2020 study by ACFE ( Association of Certified Fraud Examiners) on occupational fraud and abuse threw ample light on who commits fraud in occupation. As per this report, 90% of fraud offenders have no prior history of fraud. Also, 55% of them are without any history of workplace misconduct either. 87% of the fraudsters did not even have a mediocre performance evaluation on their records.
People commit fraud because of circumstances, not because of personality attributes. In fact, a report by the National Association of State Auditors, Comptrollers and Treasurers (NASACT) says that under the appropriate circumstances, most individuals would be motivated to commit fraud. This is known as the "10-80-10 Rule." According to the report, 10% of people would never attempt fraud for any reason, 10% are constantly seeking opportunities to commit fraud and the remaining 80% lie somewhere in the middle.
Members in this middle category are not by nature fraudsters, but they are also not consistent in their commitment to a life devoid of crime. For example, an employee with a perfect track record may suddenly find justification for misappropriation if their child is diagnosed with a terrible illness that necessitates pricey therapies. Each person's circumstances—which is a unique combination of the fraud triangle components, will make fraud feel 'worth trying'. Business owners can prevent employee fraud by analysing each of the fraud triangle elements. We will discuss these components in detail now.
Components of Fraud Triangle
Component 1: Motivation
The "10-80-10 Rule” suggests that 10% of people are constantly seeking opportunities to commit fraud. Other than these, most people will not turn to fraud without a solid reason. The appropriate motivation can persuade usually honest employees to consider defrauding their employers. However, these reasons can be different for different people. What one person considers a valid justification may not be compelling to another. There can be as many reasons for fraud as there are people on the planet, but they can be grouped into a few broad categories:
- Survival- for example, inability to feed the family or to afford life-saving medicines
- Sudden changes in circumstances: unexpected dip in income, job loss for a partner, a surprise medical bill
- A sense of being wronged: frustration with the expectations in the current job, being denied a salary hike or ignored for a promotion
- Status pressure: feeling compelled to keep pace with the earning or spending of the peers
How well you know your employees affects your capacity to identify their potential motivations for fraud. When you spend time with employees, you are more likely to detect unexpected changes in behaviour. This may indicate a personal difficulty or family tragedy and you may ask them if anything you can do to help. Empathy for your employees will demonstrate that you are concerned about their well-being and are eager to help them in both good and bad times. Workers have significantly fewer incentives to commit fraud when they have a supportive employer on their side.
Component 2: Opportunity
Opportunity is perhaps the easiest element of the triangle for business owners to control. No matter how angry or desperate your employees are, they can commit fraud only if they are given the opportunity to do so. In fact, the ACFE study we mentioned above mentioned that 35% of reported fraud cases come from organisations that lack internal controls. Standardised processes and stringent oversight procedures are critical to preventing fraud in your operations. However, simply putting these measures in place does not eliminate the possibility of fraud. If security protocols are established but are unmonitored, inadequate, or unenforced - the opportunity for fraud would remain.
Particularly in the case of fraud related to cybersecurity access, regular testing and adjustments are essential to ensure that the security protocols remain effective. It is also critical to have a plan in place for what happens when a breach is discovered. If alerts are ignored, or if violations are not addressed with meaningful consequences, employees will be more prone to take chances in the expectation of remaining undetected.
Component 3: Rationalisation
Rationalization is the final component of the fraud triangle. Even if they have the motivation and the chance, most employees will not act until they are convinced that their fraud is "alright." Even individuals who could be tempted to fraud, if given the correct reason, would usually refuse if it meant harming someone else. When it comes to defrauding a company, however, many fraudsters might convince themselves that their crime is victimless. For example, when an accountant observes how much their sales department invests in entertaining potential clients, they may justify stealing a few bucks here and there. Or, on a business trip, an account manager may charge useless extras to their hotel room since he believes "everyone does it."
Promoting transparency in company finances is an excellent method to prevent these types of rationalisations. Employees will comprehend the significance of a few bucks here and there if you explain to them that their bonuses depend on the company's ability to meet a particular profit margin. Employees can engage emotionally in the success of the team when they see the company's profits being reinvested in its workers. it will also support fairness standards, and promote open communication and transparency.
Please note that the combination of these three elements discussed above creates a high-risk environment favourable to committing fraud. Each element communicates with the others. While an employee may be under a lot of financial pressure, they will not commit fraud if there is no apparent opportunity or if the risk of being caught is too severe. Meanwhile, even if they had the opportunity, a well-rewarded, content employee with minimal financial pressure is unlikely to commit fraud. Similarly, if a person recognises an opportunity to manipulate financial figures and has the incentive to commit the fraud, is unlikely to do so if he understands it is wrong and cannot justify the fraud.
However, when the temptation to commit fraud grows, a potential fraudster may start to find more opportunities to bypass controls and may start to justify his thinking. Maintaining awareness of the fraud triangle circumstances can assist managers and business owners in reducing the risk of fraud in their organisations.
