The Fraud Triangleby Michelle Bomberger | October 11, 2012
Guest blog from David Lightfoot, B2B CFO
In my career I’ve been exposed to fraud only a few times. My impression used to be that fraud is relatively rare. Maybe it was or maybe my experience wasn’t representative, but it seems that fraud has become a lot more common.
Technology has certainly made it easier to steal. Fortunately, technology has made it easier to prevent fraud too. B2B CFO has an internal forum for the partners to discuss issues and there is plenty of experience with clients experiencing fraud. In fact, that’s often why a B2B CFO is called in. It isn’t just the Enrons of the world; it happens all the time in small and medium-sized businesses.
The Fraud Triangle
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.
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.
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.
Most of us have a strong sense of right and wrong and fraud (stealing) is wrong. How does someone committing fraud justify stealing? They rationalize it through various ways. The perpetrator may believe they are justified to save a family member, especially a child. The fraudster may think they will lose everything if they don’t get the money. Often, the stolen money is thought of as a loan and the person committing the fraud has every intention to pay it back. Often a dissatisfied 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 can trust in key position. Let me say it clearly: Trust is not an effective fraud prevention strategy. 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.
The consequences of fraud on a business include financial 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.