We have prepared a series of articles as part of International Fraud Awareness Week which takes place from 15 to 21 November. International Fraud Awareness Week is an initiative of the Association of Certified Fraud Examiners (ACFE), and this is the first of these articles.
Norman is an average man in his forties. He is qualified (with a B.Comm degree and a post graduate degree in accounting) and has a wife and two kids. Norman has been the Financial Controller for the last six years at a listed company which sells mining equipment. He has a steady career and has not been the subject of any disciplinary action before.
Today, Norman faces a sticky situation. He has a meeting with the auditors and needs to hide the fact the company has an R100m exposure in its balance sheet. Instead of revealing this, he has fabricated certificates which record the incorrect value of investments held by the company. If the losses were exposed, the share price would depreciate quickly and other stakeholders, such as customers, suppliers, financiers and regulators would re-evaluate their business relationship and ask more questions. In any event, Norman believes that the losses are short term and the value of the investments will recover soon, and he believes that he is acting in the best interests of the company.
The meeting with the audit manager goes well and the concocted story is accepted without too much questioning. At the end of the day, Norman goes home to bath his kids and at the end of the month, the company’s Annual Financial Statements are finalised (showing a rosy picture of the company, far from the actual picture where the company has incurred a loss).
The above scenario is fictional and Norman, and the mining company for which he works, do not exist.
Financial statement fraud
Although Norman does not consider himself a fraudster since he received no benefit from his misrepresentation to the auditors, it is clear that he intentionally caused a misstatement of material information in the organisation’s financial reports, by providing information leading to an improper asset valuation and hiding a material loss, to the auditors. In doing so, he is guilty of financial statement fraud.
The fraud triangle
The above case study highlights the three conditions which are typically present in each fraud. These three conditions together are known as the fraud triangle. The fraud triangle is a theory by Donald Cressey which holds that the following three conditions typically drive fraudulent conduct:
- Opportunity – conditions and opportunities must exist to allow the fraud to occur, such as internal control deficiencies
- Pressure (or incentive) – this provides the reason for which people commit the fraud, such as to fuel a gambling addiction
- Rationalisation – the justification put forward for committing the fraud, such as the fact that the fraud did not harm anyone.
In the above case study, the fraud was driven by the pressure faced by Norman to hide the fact that the company had made a significant loss. The consequence of this would have been a sharp decline in the share price of the company and perhaps even the scrutiny of the business by a regulator.
The opportunity arose via the fact that the documents on which the auditors relied were relatively easy to falsify. As financial statement frauds are typically designed to deceive the auditors, statistics have shown relatively low detection of fraud by external auditors, which is highlighted below.
The rationalisation for the fraud by Norman was that he genuinely believed that his fraudulent activity was in the best interest of the company and that the benefit that they were to receive as a result of the fraud was minimal. Furthermore, the fraud was to be of no consequence once the market rebounded and the investments regained their value.
The above scenario also highlights common trends, as borne out by the 2014 Report to the Nations by the ACFE, in the world today. The results of the ACFE’s survey are set out below.
Financial statement fraud is the most costly form of fraud causing median losses of $1 million per instance. In the abovementioned scenario, it appears that the fraud was significant (hiding the losses of approximately R100 million).
Norman falls squarely within the demographics of the typical fraudster. It was found that a typical fraudster is a man aged between 31 and 45 years’ old (with 52% of fraudsters being within this age category). Male fraudsters outnumbered females two (67%) to one (33%), and the median losses caused by men were $185 000 compared with $83 000 by women.
Furthermore, the tenure of fraudsters who cause the most damage to companies range from one to five years, with 40.7% of the frauds occurring in this band. The median loss caused by individuals who have been employed at a company between six and 10 years is $200 000, whereas the median loss caused by individuals who have been employed at a company between one and five years is $100 000. The median loss caused by employees with a tenure of greater than 10 years is $220 000. The median loss to fraud caused by someone of Norman’s age is $153 000, while the average loss to fraud caused by someone between 46 and 50 is $190 000.
Further statistics show that members of Management with post graduate degrees are more likely to steal larger amounts than less educated people. The median loss caused by employees with a post graduate degree is $210 000, whereas the median loss by an employee with a university degree is $200 000. Compare this to median loss of $82 000 caused by employees with only a high school diploma. Moreover, the median loss caused by executives ($500 000) result in much greater losses to companies than frauds perpetrated by non–Management employees ($75 000). In the words of Theodore Roosevelt: “A man who has never gone to school may steal from a freight car; but if he has a university education, he may steal the whole railroad.”
The majority of frauds are committed in the Accounts department with 17.4% of the frauds occurring in this area, while Operations and Sales are second and third respectively. Most fraudsters are first time offenders and have previously not been punished or had their employment terminated (the survey identifies that 81% of the fraudsters had not previously been punished or terminated).
The survey also show that only 3% of frauds are detected by external auditors, a trend which seems to have been exploited by Norman.
In this fictional scenario, the company operates in the mining industry. Although this is not a sector prone to the greatest volume of fraudulent transactions (1% of the volume of instances), it is the sector which carries the highest median loss per fraud ($900 000).
The idea of this article is to highlight the fact that Norman looks normal (Norman’s name even sounds ‘Norm’al). The typical white collar criminal looks like Norman. He may not stick out as a person who would commit fraud, in fact it is likely that he is unassuming, flies under the radar at work and is very good at his job. Hence, the title of this article “they walk among us” is meant to highlight the risk that white collar criminals are indistinguishable, inconspicuous and cannot be identified as criminals.