WHY PEOPLE COMMIT FRAUD

Chapter 2

WHY PEOPLE COMMIT FRAUD
Discussion Questions

1. Research shows that anyone can commit fraud. Fraud perpetrators usually cannot be distinguished from other people on the basis of demographic or psychological characteristics. Most fraud perpetrators have profiles that look like those of honest people. In other words, the types of people who commit fraud are ordinary people, just like you and me.

2. People can be motivated to commit fraud because of financial pressures, vices, or because of work-related pressures. As well, perpetrators of fraud can be motivated by a perceived opportunity to commit fraud and the ability to rationalize that what they are doing is not wrong. Their motivations are usually combined into the fraud triangle of perceived pressure, perceived opportunity, and rationalization.

3. The fraud triangle includes three elements that almost always must be present in order for someone to commit fraud: a perceived pressure, a perceived opportunity, and some way to rationalize the fraud as acceptable. The fraud triangle is important because it helps us to determine the motives, reasons, and opportunities that someone had in committing fraud. By using the fraud triangle, we can better focus on areas in an organization that will help us detect and prevent fraud.

4. The fraud scale illustrates the relationship between the three elements of the fraud triangle. It shows that perceived pressure, perceived opportunity, and rationalization are interactive. In other words, the greater the perceived opportunity or the more intense the perceived pressure, the less rationalization it takes to motivate someone to commit fraud. Likewise, the more dishonest a perpetrator is, the less opportunity and/or pressure it takes to motivate fraud.

5. Many types of pressures motivate someone to commit fraud. They include financial pressures, vices, work-related pressures, and other types of pressures. Financial pressures include greed, living beyond one’s means, high bills or personal debt, poor credit, personal financial losses, and unexpected financial needs. Vices include addictions, such as gambling, drugs, alcohol, and extramarital relationships. Work-related pressures include feeling overworked or underpaid.

6. The controls that prevent and/or detect fraudulent behavior have to do with providing deterrence to those who are thinking about committing fraud. Having an effective control structure is probably the single most important step that organizations can take to prevent and even to detect fraud. There are five components in a company’s control structure: the control environment, risk assessment, information and communication, control procedures or activities, and monitoring.

7. Many factors provide opportunities for fraud including the inability to judge the quality of performance; failure to discipline fraud perpetrators; lack of access to information; ignorance, apathy, and incapacity; and lack of an audit trail.

8. Nearly every fraud involves the element of rationalization. Most perpetrators are first-time offenders who would not commit other types of crimes. Rationalizing helps minimize the perceived dishonesty of their acts. Common rationalizations include:

• The organization owes me.
• I am only borrowing the money—I will pay it back.
• Nobody will get hurt.
• I deserve more.
• It’s for a good purpose.
• We’ll fix the books as soon as we get over this financial difficulty.
• Something has to be sacrificed.

When interviewed, most fraud perpetrators say things like, “I intended to pay the money back. I really did.” They are sincere. In their minds, they rationalize that they will repay the money, and since they judge themselves by their intentions and not by their actions, they do not see themselves as criminals.

9. Jim Bakker rationalized his actions by convincing himself that the PTL network had a good purpose and that he was helping others. Bakker believed that any money he received would directly or indirectly benefit his followers. He had numerous pressures, including greed, selfishness, and a lust for power, and Bakker was in a position of trust. As with most people in positions of trust, he had numerous opportunities to commit fraud.

10. Dr. Sam Waksal committed fraud by transferring shares into his daughter’s trading account and then having her trade in his company’s stock (insider trading). Because he had insider information, he understood that it would be unethical for him to make trades. However, he rationalized that if he had his daughter make the trades, rather than himself, then his actions would be legal and ethical.

Later on, when explaining his actions, Waksal said the following: “I could sit there and think that I was the most honest CEO that ever lived. And, at the same time, I could glibly do something and rationalize it because I cut a corner, because I didn’t think I was going to get caught. And who cared? Look at me. I’m doing “X,” so what difference does it make that I do a couple of things that aren’t exactly kosher?”

Waksal’s rationalization allowed him to have a long history of ethical lapses, reckless behavior, and embellishing the truth. He had been dismissed from a number of academic and research positions for questionable conduct, for example. One former colleague said “cutting corners for Sam was like substance abuse. He did it in every aspect of his life, throughout his entire life.”

11. Power is defined as the ability to influence someone else. When a fraud takes place, the conspirator has the desire to carry out his or her own will—influence another person to act and do as the perpetrator wishes—regardless of resistance.

12. Fraud perpetrators use power to influence and persuade individuals to participate in fraud. Fraud perpetrators can get potential co-conspirators to join the fraud by promising a reward or benefit (reward power), by following the orders of a person who is in a position of authority (legitimate power), by making the potential recruit feel fear for not joining the fraud scheme (coercive power), or through deceiving someone because the potential recruit has a lack of knowledge (expert power). Finally, perpetrators can get potential perpetrators to join the scheme through the influence of a relationship (referent power).

Multiple Choice

1. b

2. d

3. c

4. a

5. d

6. d

7. c

8. e

9. b

10. a

11. b

12. c

13. c

14. b

15. b

16. e

17. e

18. c

19. c

20. b
Short Cases

Case 1

1. Authorization. The managers of the stores should follow the authorization policy and review all requests for large amounts of credit and the approval of new credit customers.

2. Segregation of duties and independent check on performance. A second individual, preferably someone not in the accounting department, should perform the bank reconciliation.

3. Segregation of duties and/or independent checks. With respect to separation of duties, various functions should be assigned to different people. If two separate individuals performed the record keeping and physical handling of inventory, the opportunity for theft would be greatly reduced. With respect to independent checks, test counts of his record keeping could be performed.

4. Adequate document and records. A well-designed document should be formatted so that it can be handled quickly and efficiently.

Case 3

1. The company lacks good control activities or procedures. Mainly, it lacks segregation of duties, a good system of authorizations, independent checks, physical safeguards, and documents or records. Helen was allowed to sign the payment voucher for services rendered, and she was also allowed to sign for all voucher payments less than $10,000.

2. Helen was a trusted employee. The company also lacked good control activities. To perpetrate the fraud, all she had to do was continue to process the checks to the terminated vendor and sign the vouchers.

3. The fraud would have been detected if the company had possessed a good internal audit department, combined with security or loss prevention programs. A good accounting system would have helped in the discovery of the fraud and would have made it difficult for Helen to conceal.
Case 5

1. The company should implement independent checks and segregation of duties controls. The accountant should not be posting to the General Ledger, paying the bills, and signing the checks. The CEO or someone else should sign the checks. Also, the accountant’s work should be reviewed for errors and fraud by an independent source. The accountant should be prosecuted civilly and criminally for mail fraud, embezzlement, and money laundering. In addition, it would be a simple task to have the auditors run a computer analysis on the addresses of vendors to look for companies with the same addresses.

2. The company should implement segregation of duties controls. The warehouse manager should not be able to both receive returned items and issue the credit memos. The accounts receivable department should create credit memos, which are then taken to the warehouse where additional goods can be issued. In addition, another worker must process returned defective merchandise. Both the manager and the worker should sign off. The warehouse manager should be prosecuted, and his son should spend more time in the gym.

3. A system of authorizations should be implemented. The board should not allow the CEO to fire his employees and rehire them as contractors. The accountant who prepares payroll records should notice this problem. In addition, if the CEO prepares payroll records, there is also no segregation of duties. The CEO should be prosecuted for tax fraud and money laundering.

4. Authorization and segregation of duties controls should be implemented. The accounts payable clerk should not have custody of the supplies she purchases. Supplies should be logged into a warehouse and then distributed as needed. The accountant should also independently record the clerk’s activities. She should not be able to sign checks.

Case 7

1. Joel has many opportunities to commit fraud. He is a trusted friend of the family. At the restaurant, there is no segregation of duties, system of authorizations, independent checks, or physical safeguards to prevent Joel from committing fraud.

2. An increase in revenues accompanied by a decrease in profits may signal a possible fraud. The changed profit margin ratio (net income/revenues) is a possible symptom of fraud.

3. In this case, as in most cases, a few simple controls could substantially reduce the opportunities for fraud. For example, Bob and Tom could install an automated register into which all sales would be recorded. They could have mystery shoppers eat at the restaurant and pay in cash in order to see if the receipts were recorded. They could make the deposits and reconcile the bank account themselves.

4. Possible answers might be:

• Segregation of duties—do not allow Joel to do everything he is doing.
• System of authorizations.
• Independent checks.
• Physical safeguards—such as automated registers.
Case 9

A couple of possibilities may explain the rationalization element of the fraud triangle. First, since many of the clients were expatriates working outside the United States, there may have been rationalization on the part of Hammond and FCS that it was okay to sell them high-yield investment schemes because they couldn’t follow the stock market on a daily basis. The second possibility is that Hammond knew that the accounts were or might be misleading, false, or deceptive. Although he may have thought this, if the other two factors are present, it is easy to rationalize that even though they may be false, they also may be real or genuine. Instead of looking at the situation objectively, he probably rationalized the possibility of it being a legitimate opportunity.
Case 11

1. Yes, it is a fraud to charge the company for personal lunches that you submit as business expenses. Fraud is often defined by the rules of an organization, and charging the company for personal expenses is intentionally not following the rules.

2. In this example, all three elements of fraud may be present: pressure, opportunity, and rationalization. The opportunity to commit fraud is high, and certainly rationalization is present. It is difficult from the limited facts to know whether a pressure is present.

3. How one responds to the mentor is a subjective answer. If the new employee was aware that such charges represented fraud, she should decline to participate and let the mentor know that she does not agree with charging lunches against company policy. Additional steps could be taken to notify supervisors and suggest that they further educate company personnel regarding company policies.

Case 13

1. Lauersen could have felt some pressure to make fertility treatments affordable for his patients.

2. Lauersen perceived that the insurance company did not check carefully on the types of surgeries performed, and therefore it was easy for him to lie about the surgeries.

3. Lauersen may have felt that he was helping women who could not afford to have children. This was the primary factor in his decision to commit fraud.

4. Lauersen could have recommended different insurance companies that covered fertility surgeries. Or, to help maintain his and his clients’ integrity, he could have recommended adoption services for those patients unable to afford fertility surgeries.
Case 15

1. Joe had several financial pressures: his wife just had a fourth child; they had just purchased a new home; and he had experienced a severe drop in commissions earned. His opportunity arose from the fact that the company had poor internal controls over petty cash. Shortages were usually written off. Joe’s rationalizations could have been that his thefts were only temporary; the company owed him more money; or he worked hard and deserved the money.

2. The company could have prevented the fraud from occurring by having better controls over the petty cash. For example, the company could have had one person be the petty cash custodian requiring anyone with a need for petty cash to go through that person. There should also have been periodic reconciliations of the petty cash fund.

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