During my career as a finance professional, I have uncovered many cases of fraud and have learned about many others from peers, professional organizations and, professional periodicals I read. So, you might think that nothing would surprise me any longer but it does. The surprise is not that people think they can get away with it but that business owners think it won’t happen to them. In fact, according to the Wall Street Journal, 31% of all business frauds nationally were in companies with fewer than 100 employees and another 23% were suffered by those with fewer than 999 employees. Moreover, the median loss for small companies was $150,000. So you can see, it is not rare and is expensive and can be devastating.
Because preventing fraud begins with education, I am starting a series of articles that I hope will help you avoid these problems. It’s not a new story by any means but bears repeating. Check out my first article below, “The Fraud Triangle”. This article addresses the conditions that make fraud possible. In future newsletters I will address why employees steal and some of the more common techniques used to perpetrate the crime.
The Fraud Triangle – The Preconditions for Fraud to Happen
What is called “The Fraud Triangle” is well established. In order for fraud to occur, all three elements of the triangle must be present. These three elements are: pressure, opportunity and rationalization. Any organization can take measures to reduce the exposure to all three elements, thus reducing the chance that fraud will occur.
(1) Pressure: Pressure in this case means financial pressure. This can be caused by any number of things including medical bills, drug addiction or excessive lifestyle costs. Often the person committing the fraud feels they must solve their problem on their own and cannot turn to legitimate solutions for help. A boss of
mine once told me that desperate people do desperate things. How true!
(2) Opportunity: Opportunity is when there is the ability to commit fraud. This is created by weak internal controls, poor oversight by management, failure to establish procedures to detect fraud or other factors. Of the three factors in The Fraud Triangle, this is the one that businesses have the most control over.
(3) Rationalization: Most of us have a strong sense of right and wrong and fraud (stealing) is wrong. How does someone who is committing fraud justify stealing? They rationalize it in various ways. The perpetrator may believe they are justified to save a family member, especially a child. (S)he may think they will lose everything if they don’t get the money. Often, the stolen money is thought of as loan and the person committing the fraud has every intention to pay it back. Often a dis-satisfied employee believes they are owed something because they perceive they have been treated unjustly. And occasionally, a person has just lost all sense of right and wrong.
The Trust Factor: Owners of closely held businesses often don’t set up proper internal controls. Frequently, real segregation of duties is impossible–there just aren’t that many employees. Business owners console themselves with people they think they can trust in key positions. Let me say it clearly: Trust is not an effective fraud prevention strategy. Even in a very small company effective controls can be put in place that will mitigate the risk of fraud.
Business owners think “It can’t happen here.” They are wrong. Internal frauds are always perpetrated by trusted employees. And business owners always think “I’d spot it” if fraud occurred. The truth is, they wouldn’t. Fraud is fairly easy to hide and people are amazingly creative in their schemes.
Consequences: The consequences of fraud on a business include losses, of course. But there are also creditor and vendor impacts, HR issues, legal issues, insurance repercussions, and negative public relations. In the end, it can mean the failure of the business.