Much like the weather, though, not all elements can be controlled by an organization or individual. Knowing and identifying them, however, is possible and critical in the fight against fraud. In 1951 sociologist Donald Cressey published his theory on a “Fraud Triangle” that endures and is still the benchmark on studying fraud 65 years later. So how does it work?
For embezzlement to occur 3 elements must exist:
- Pressure (Motive)
- Opportunity (Access)
- Rationalization (Justification)
If one or more can be controlled, the occurrence of fraud can be controlled and the risk can be mitigated. If all three are allowed to occur, your organization is ripe for a fraud.
Let’s use a simple example with these facts that we will expand as we go:
Sam is the head cashier at a retail store, has been employed there 10 years and is trusted by the owner. Sam gathers the receipts from the registers at the end of the day and reconciles the cash register tapes to the money received, then prepares a deposit slip and drops the cash in the bank’s night depository.
Ok, we have established that Sam clearly has the opportunity (access) needed to embezzle, so we have one of three sides of the triangle. But Sam lives within his means, is treated fairly at work and really has no reason to steal the money—so we’re all good, right?
Meanwhile … we learn that this year none of the employees received the normal holiday bonus, which is disappointing because the store seemed to do very well. Heck, the owner even has pictures of a fishing boat on his desk now. Sam also believes that his superb customer service is one of the reasons the store did so well … and what about that boat, anyway??
We all see where this is headed, right? Getting stiffed on the bonus, coupled with the owner displaying pictures of a boat (which, by the way, Sam is convinced he contributed to). Yes, we now have a second side to the fraud triangle: the rationalization (justification) of stealing. For all we know, the business didn’t do as well this year and the owner is trying to motivate himself by looking at a picture of the boat he’s always dreamed of having. Oops, too late, Sam has already rationalized (because of his perception) that if he stole money, it was what he deserved anyway for busting his hump all year. Sam may be upset and may have misjudged the circumstances, but he still has no reason to steal, so we’re still okay.
Actually, it turns out that Sam is in a nasty child-custody battle with his ex-wife. He desperately needs $10,000 to hire a good attorney to fight for him.
With the final addition of pressure (motive) the Fraud Triangle is now complete. Sam may or may not go ahead with the theft, but all the elements are present and the threat of fraud at the store is at its peak, like a volcano ready to erupt at any time.
The circumstances above can happen in any chronological order, yet still come together for the ultimate perfect storm. The pressure and rationalization may have existed first, but the opportunity came later and Sam then acted upon it. Or maybe the rationalization came last after Sam was passed over for the promotion and pay raise he felt that he deserved more than anyone else at the store.
So which sides in the Fraud Triangle are “controllable”?
- Pressure is definitely the hardest to minimize, let alone prevent. You certainly cannot control (or even be aware of) everything happening in peoples’ lives. There is not a great deal you can do, apart from promoting an ‘open door policy’ and letting your people know that they can come to you for help or advice when they experience hardships.
- You can attempt to control rationalization, but will be successful to only a certain extent. You can treat your employees fairly and offer the highest pay in the industry, but what you can’t do is please all of the people all of the time. You can try to reduce the rationalization side of the triangle, but likely will not be able to eliminate it.
- That leaves us with opportunity. You can control opportunity and the access to assets (i.e., money, inventory, supplies). Proper internal controls can definitely offer the lines of defense and detection that will provide both the necessary perceptions and reality that embezzlements will be identified, and that will minimize the risk of the fraud triangle being able to come together to create that perfect storm.
Being aware of the circumstances that allow fraud to occur and prosper—and knowing which areas can be mitigated through management involvement and heightened internal controls—will give you an edge in combating such incidents within your organization.
Author: Richard C. Gordon, CPA/ABV/CFF, CFE, CGMA, Director of Forensic and Valuation Services