chapter 2 fraud

Chapter 2: Who Commits Fraud and Why: The Profile and Psychology of the Fraudster

BU5505 Forensics & Fraud Examination

Dr. Patrick O’Brien

Module 1: Criminology, Fraud, and Forensic Accounting

  • Criminology Definition:

    • The sociological study of crime and criminals.

  • Fraudster Characteristics:

    • Fraudsters often look like everyday individuals, many are first-time offenders.

  • Reasons Most Individuals Do Not Commit Crimes:

    • Fear of punishment.

    • Desire for rewards.

    • Moral considerations aligned with societal standards.

  • Civilized Societies:

    • Depend on individuals to uphold moral standards and do the right thing.

Occupational Fraud and Abuse

  • Definition:

    • Use of one’s occupation for personal gain via deliberate misuse or misapplication of organizational resources or assets.

  • Range of Fraud:

    • From sophisticated investment frauds to petty theft.

  • Common Elements of Occupational Fraud:

    • Clandestine Nature: Activities are hidden from detection.

    • Fiduciary Violation: Breaching the duties owed to the employer.

    • Financial Benefit: Committed for direct or indirect financial gain.

    • Cost to Employer: Results in losses of assets, revenues, and reserves.

  • Employee Definition:

    • Any person receiving regular compensation from an organization for labor.

White-Collar Crime and Organizational Crime

  • White-Collar Crime Definition:

    • Criminal acts by respectable business and professional individuals within upper classes, often involving trust violations and abuse of power.

  • Organizational Crime:

    • Engaged by legitimate entities (companies, nonprofits, etc.) in criminal offenses.

  • Key Points:

    • Organizations can become trust violators under high-standing individuals.

    • Includes administrative breaches, fraud (financial reporting, bribery), and environmental violations.

  • International Issues:

    • These crimes often involve unfair practices and violations such as tax evasion and are prevalent on a global scale.

Organized Crime

  • Complex Nature:

    • Involves multiple individuals, organizations, often spanning various jurisdictions.

  • Types of Organized Crime:

    • Money laundering, mail and wire fraud, conspiracy, racketeering.

  • Key Definitions:

    • Money Laundering: Process of disguising illegal earnings as legitimate.

    • Mail and Wire Fraud: Schemes that utilize postal or electronic communication for fraudulent activities.

    • Criminal Conspiracy: Agreement between two or more individuals to engage in an illegal act.

  • RICO Act:

    • Addresses organized crime involvement and includes provisions against illegal funding of businesses and conducting business affairs with tainted funds.

Torts, Breach of Duty, and Civil Litigation

  • Negligence Overview:

    • Occurs when one party fails to meet minimal care standards.

  • Five Legal Elements of Negligence:

    • Duty: Existence of a duty to act.

    • Breach: Failure to use reasonable care.

    • Cause in Fact: Actual connection between breach and harm.

    • Proximate Cause: The breach must contribute to the harm.

    • Damages: Injured party must show damages resulted from breach.

  • Winning Damages:

    • The injured must prove liability and that damages were foreseeable and have a reasonable certainty of claim.

  • Role of Forensic Accountants:

    • Assist in establishing evidence in tort cases.

Module 2: Who Commits Fraud and Why: The Fraud Triangle

  • Typical Fraud Perpetrator Profile:

    • Male, middle-aged to retired, long-term with the company, no prior criminal record, well-educated, occupies a role in accounting or management, usually acts alone.

  • Common Misconceptions:

    • Frauds are often executed by individuals with no prior criminal backgrounds, resembling typical members of society.

Fraud Theory

  • Edwin Sutherland's Concept:

    • Coined the term "white-collar crime"—criminal acts by professionals.

  • Donald Cressey's Definition of Trust Violators:

    • Individuals view themselves as facing non-shareable financial problems who rationalize their criminal actions as justifiable based on their circumstances.

  • Non-Shareable Financial Pressures:

    • Arise from debts, gambling habits, lifestyle maintenance, or an inability to secure desired items through legitimate means.

  • Social Comparison Pressure:

    • Pressure from societal expectations to maintain or elevate one's status.

The Fraud Triangle

Components of Fraud

  • Perceived Pressure:

    • Can stem from various financial stressors like debt, addiction, or expenses, influencing the likelihood of fraudulent behavior.

  • Perceived Opportunity:

    • The belief that one can commit fraud without detection based on their knowledge and technical skills.

    • Job roles often dictate the type of fraud a person can commit, mitigated by effective internal controls and a strong ethical culture.

  • Rationalization:

    • Self-justification narratives of fraudsters to alleviate feelings of guilt, often beginning with minor justifications that escalate.

    • Categories of rationalization include beliefs of entitlement, misunderstanding regarding impact, or viewing crime as a normative behavior in their context.

Types of Fraudsters

Independent Businesspeople

  • Individuals converting deposits for personal use, often rationalizing theft with claims of “borrowing” or that their funds are misallocated.

Long-Term Violators

  • Regularly stealing small amounts over time, often rationalizing their actions as compensatory for workplace inequities; can track “borrowings.”

Absconders

  • Individuals who flee after theft, typically with minimal ties to their previous life, less moral reservation, and are often predisposed to criminal behavior.

Module 3: The Role of Personal Integrity, Capability, Gender, and the Influence of the Organization

  • Dr. Steve Albrecht’s Study Findings:

    • Perpetrator Characteristics:

    • Living beyond means, desire for personal gain, substantial debt, and close customer relationships.

    • Organizational Environment Factors:

    • Excessive trust in employees, poor transaction procedures, inadequate separation of duties, lack of oversight, weak internal controls.

Fraud Scale

  • Albrecht’s Fraud Scale:

    • Correlates situational pressures and perceived opportunities against personal integrity; higher situational pressures and opportunities with low integrity indicate a greater likelihood of occupational fraud.

Capability and Arrogance

  • Capability:

    • Essential for committing fraud and involves intelligence, position, and internal control fluency.

  • Arrogance:

    • A belief in superiority and entitlement that often creates disregard for corporate policies and leads to more sophisticated fraudulent acts.

  • Fraud Diamond and Fraud Pentagon:

    • Models representing the interplay of rationalization, opportunity, capability, and pressure in fraud occurrences.

Hollinger and Clark Research Findings

  • Employee Theft Motivation:

    • Primarily results from workplace conditions.

  • Employee Deviance:

    • Refers to detrimental behaviors against the organization; generally categorized into property acts (theft/misuse) and productivity violations.

Job Satisfaction and Deviance

  • Relationship:

    • Dissatisfaction leads to counterproductive behaviors; correlations exist between age and theft inclination with younger employees more likely to deviate.

Organizational Controls and Deviance

  • Unable to find strong causal relationships between controls and deviant behaviors but education perceived as a deterrent measure.

Employee Perception of Control

  • The perception of detection is crucial; strong beliefs in potential exposure to theft decrease likelihood of engaging in deviant behaviors.

  • Control packets consist of formal (external pressures) and informal controls (internalizing organizational norms).

Module 4: The Psychology of the Fraudster, a Deeper Look: M.I.C.E., Predators, and Collusion

Predatory vs. Situational Fraudsters

  • Typical Fraudster Profile:

    • Middle-aged, trusted position, family-oriented.

    • Situational fraudsters often embody non-shareable problems leading to perceived pressure, aligning with opportunity and rationalization factors.

  • Predators:

    • Seek immediate opportunities to exploit upon employment, more organized and deceptive than situational fraudsters, characterized by an absence of rationalization processes.

Collusion and Collusive Groups

  • Nature of Collusion:

    • Joint efforts increase the risk of losses, with opportunity enhanced when working in groups.

  • Comparison of Fraud Types:

    • Collusive fraud is typically executed by younger, less educated individuals, while solo frauds often result in larger damages and are discovered through formal channels.