PWC: A Guide to Forensic

Accounting Investigation 2nd

Edition
Chapter 2: Psychology of the
Fraudster

Feb. 2014 Update

1

The Good, The Bad and The Ugly

The Good Most people are honest.

The Bad and The Ugly Sadly, human
history and human nature tell a
different story (and so do the stats).

Recall the Weasel Axiom.

Most societies abhor violent crime and
bodily harm.
But many societies hold financial fraud as a
less reprehensible wrongdoing.
2

Research & Other

Information on Fraud
Why People Commit Fraud
A Sidebar From Joseph
Wells, Principles of Fraud
Examination and ACFE
course, Inside the Fraudsters
Mind
3

Occupational Fraud and

Abuse Research

Edwin Sutherland
Donald Cressey

Cresseys Hypothesis

Dr. W. Steve Albrecht

Hollinger-Clark Study

Sutherland

Scorned traditional theories of

crime that blamed poverty, broken
homes, and disturbed
personalities.
Noted many lawbreakers were
wealthy, from happy family
backgrounds, and in good mental
health.
5

Sutherland

Publishes White Collar Crime in

1939.
Defines White Collar Crime as a
crime committed by a person of
respectability and high social
status in the course of his
occupation.
He coined the term white-collar
crime.
6

Sutherland

Sutherland explained white-collar crime

with his theory of differential
association.

He conjectured that white-collar crime was

learned behavior that is related to the
environment in which a fraudster works.
Prior to Sutherland (and still applied to
street crime), criminologists held the view
that crime was genetically based, criminals
beget criminal offspring.

Sutherland posited that the environment plays a

role in criminal behavior (and should also apply to
street crime).
7

Sutherland
It is clear how Sutherlands
differential association theory can
be applied to occupational
offenders: Dishonest employees
within an organization will
eventually infect a portion of the
honest ones, and honest
employees will eventually have an
some of those who
*Recallinfluence
Walt Pavlo aton
MCI/WorldCom.
8
are dishonest*.

Cressey

A student of Sutherland.
Cresseys dissertation examined
embezzlers.

Interviewed about 200 incarcerated

embezzlers.
He called embezzlers trust
violators.
Interested in the circumstances that
led these people to be overcome by
temptation.
9

Cressey

Cresseys final hypothesis was,

what is now called, the Fraud
Triangle.
The Fraud Triangle legs represent:

Perceived non-shareable financial

need (pressure or motive)
Perceived opportunity
Rationalization
10

Opportunity

Fraud
Triangle
Pressure

Rationalization
11

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Trust violators perceive that a financial

problem cannot be shared with other
persons.
What is non-shareable is relative to
each person (whats non-shareable to
one person is no big deal to another).
Financial because they generally can
be solved by the theft of cash or other
assets.
12

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Cressey found that non-shareable

problems could be divided into 6 basic
categories:

Violation of ascribed obligations

Problems resulting from personal failure
Business reversals
Physical isolation
Status gaining
Employer-employee relations

They tend to be status-oriented.

13

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Violation of ascribed obligations: People

believe their status requires them to act
in a certain manner.

If a person violates this tenet, s/he has a

non-shareable problem (e.g., a crack-head
CFO; this behavior just doesnt fit in with
what we believe a CFO should be doing).
Its too embarrassing to admit the problem.
Dont want to lose status.

Steal to buy drugs and you dont

have to share your drug

14

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Problems resulting from personal

failure: Problems the trusted person
feels s/he caused through bad judgment
and therefore feels personally
responsible for.

Business venture gone bad, but not due to

economic conditions, but own bad
judgment, own fault, or own stupidity.
Example: John
Edwards
affair
bastard child) with Ms.
Fear
a loss
of(and
status.

Hunter (while his wife is dying of cancer) and have his aide,
Andrew Young, take the blame --- what a great guy --- he
could have been the US VP! Edwards personal failure (affair
& love child) had him pressure his aide to lie which is also a
15
lie on Edwards part.

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Business Reversals: Problems

arising from conditions beyond the
control of the violator.

Business venture gone bad, but not

due to own bad judgment, own
fault, or own stupidity, but
economic conditions. (compare to
previous category)
Fear loss of status. (Gotta maintain
the appearance of success.)
16

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Physical isolation: Violator has no

one to turn to.

Loner who makes a dumb move.

S/he doesnt have anyone to talk to,
etc.

Paint yourself into a corner.

17

I. Non-Shareable Financial
Problems
(Pressure/Motive)
Status gaining: The offender is
motivated by a desire to improve
Recall Walt
his/her status.
Pavlo in Tone

at the Top
video: He
wanted some
tech bubble
status/goodie
s, but
couldnt earn
them

legitimately
(give his
status at

Extreme example of keeping up with the

Joneses.
Problem becomes non-shareable when

S/he cant renounce his/her aspirations for

membership in the desired group or
S/he cant obtain the prestige symbols necessary
for group membership.

Turns to fraud when s/he cant accept lower

status and cant obtain the finer things
through legitimate means.
18

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Really?

Employer-employee relations: The

violator resents his/her status
within the organization, doesnt
see a change in status on the
horizon, and has no choice but to
continue working for the
organization.

Dr. Frank: How can this be? One

can always quit. LIU story.
Violator has a desire to get even.
19

I. Non-Shareable Financial
Problems
(Pressure/Motive)

Solving the Problem in SECRET: Cressey

found it was crucial that the violator be
able to resolve the financial problem in
secret.

Key: Its not the embezzlement itself that

creates the need for secrecy, its the
circumstances that led to the
embezzlement.

The CFO doesnt keep the embezzlement secret

because hes stealing money, hes keeping his
crack addiction secret --- although the solution
to steal is also kept secret.
20

Dr. Frank Perspective

But I think its a 2-level issue (of

secrecy) A secret problem leads
to fraud which must be kept secret
on 2 levels: (1) to keep the
motivating problem secret and (2)
to keep the fraud secret (since it
was a bad action).

21

II. Perceived Opportunity

The non-shareable financial problem

creates the motive for the crime to be
committed, but the employee must also
perceive that he has the opportunity to
commit the crime without being caught.
Two components of perceived
opportunity:

General information
Technical skill
22

II. Perceived Opportunity

General Information: Simply the

knowledge that the employees
position of trust could be violated.

Hearing about embezzlements

See dishonest behavior by other
employees
Generally aware that positions of trust
can be violated.

Sutherlands Theory of Differential

Association. Recall Walt Pavlo.

23

II. Perceived Opportunity

Technical Skill : Refers to the

abilities needed to commit the
violation.

Recall that
Walt Pavlos
(Tone at the
Top video)
fraud related
to accounts
receivable --the area
where he

Usually the same abilities that the

employee needs to have to obtain
and keep his position in the first
place.

Most embezzlers adhere to their

occupational routines and job skills to
perpetrate their crimes.
In essence, the perpetrators job and
24 the type
position will tend to define

Financial Pressure + Able to Rationalize the Fraud +

Opportunity (has access to assets) = Commit Fraud

III. Rationalizations

Significantly, the rationalization is a

necessary component of the crime
before it takes place; in fact, it is a part
of the motivation for the crime.

Because the embezzler does not view

himself as a criminal, he must justify his
misdeeds before he ever commits them.
The rationalization is necessary so that
the perpetrator can make his illegal
behavior intelligible to himself and maintain
his concept of himself as a trusted person.
25

III. Rationalizations

After the criminal act has taken place,

the rationalization will often be
abandoned.

So, fraud often starts out with a

rationalization and them proceeds to nonrationalized crime.

Cressey found that embezzlers

generally rationalize their crimes by
viewing them

As essentially non-criminal (borrowing)

2)
As justified
I cant3)control
As part of a general irresponsibility
for
26
1)

III. Rationalizations

Cressey found that rationalizations

tended to be linked to violators
positions and the manner in which
they committed their violations.

Independent Businessmen: Own your

own firm (or partnership), etc.

They borrowed or believed they

couldnt steal from themselves.
Fraud brought on by an unusual
situation.
27

III. Rationalizations

Long-Term Violators: Converted small

amounts over a relatively long period
of time.

Tended to use the borrowing

rationalization along with:

Keeping their families from disgrace, shame,

or poverty
Theirs was a case of necessity; their
employers were cheating them financially
Their employers were dishonest toward others
and deserved to be fleeced.

Recall Mettenheimers warning over 140

years ago!

28

III. Rationalizations

Long-term violators eventually reach a

point where they are in too deep.

The violator faces a crisis:

The rationalization cannot be maintained.

The perpetrator must face facts; he is a criminal.

This conflict (rationalization vs. reality)

creates a great deal of anxiety for the
perpetrator.

We can use this to spot fraudsters (they tend to

be very defensive when questioned about a fraud
or exhibit personality changes).
May cause a perp to run (or kill himself) --- next
29
slide

The Rationalization Dead

End
Example of a perp killing
him/herself:
Chris Kelly, ousted Illinois Gov.
Blagojevichs former chief
fundraiser, plead guilty to federal
fraud charges (around 9/12/09)
and then killed himself with an
overdose of painkillers.
It seems Chris couldnt escape
the
30

III. Rationalizations

Absconders: People who take the

money and run.

Tend to be physically isolated people.

Tend to have lower status.
Rationalize their conduct by noting that
their attempts to live honest lives has
been futile (hence their low status).

31

Fraud Triangle

Conjuncture of Events: One of the

most fundamental observations of
Cressey was that it took all three
elements pressure, opportunity,
and rationalization for the trust
violation to occur.

If any of the three elements is

missing, trust violation does not
occur.
32

Dr. W. Steve Albrecht

Albrecht believes occupational

fraud perpetrators are hard to
profile and that fraud is difficult to
predict.
Albrecht researched red flags of
fraud and abuse.
Albrecht developed the Fraud
Scale.
33

Red Flags

Albrecht categorized the red flags

into two categories:

Personal characteristics (pressure

related) and
Organizational environment
(opportunity related).

He listed 25 red flags in each

category and used internal
auditors to select the top 10 in
each category.
34

Top 10 Personal
Characteristics (Pressure
Related) Red Flags
1.
2.

3.
4.

5.

Living beyond their means.

An overwhelming desire for
personal gain.
High personal debt.
A close association with
customers.
Feeling pay was not
commensurate with responsibility.
35

Top 10 Personal
Characteristics (Pressure
Related) Red Flags
6.
7.

8.
9.
10.

A wheeler-dealer attitude.
Strong challenge to beat the
system.
Excessive gambling habits.
Undue family or peer pressure.
No recognition for job
performance.
36

Top 10 Organization
Environment (Opportunity
Related) Red Flags
1.

2.

3.

4.

5.

Placing too much trust in key

employees.
Lack of proper procedures for
authorization of transactions.
Inadequate disclosures of personal
investments and incomes.
No separation of authorization of
transactions from the custody of
related assets.
Lack of independent checks on
performance.
37

Top 10 Organization
Environment (Opportunity
Related) Red Flags
6.
7.

8.

9.

10.

Inadequate attention to details.

No separation of custody of assets
from the accounting for those assets.
No separation of duties between
accounting functions.
Lack of clear lines of authority and
responsibility.
Department that is not frequently
reviewed by internal auditors.
38

Fraud Scale

A subjective device to weigh three

components (pressure,
opportunity, and personal
integrity) to yield a likelihood of
fraud; where the likelihood of fraud
is increasing in pressure and
opportunity and decreasing in
personal integrity.
39

Fraud Scale-Examples
Pressure
Low

Opportuni Integrity Fraud

ty
Low
High
Low

Low

Low

Low

Low/Med.

High

Med.

Med.

High

High

Low

Med./Hig
h
High
40

Hollinger-Clark Study

Looked at data from retail, hospital, and

manufacturing industries (9,175 valid
employee questionnaires).
Contrary to Cressey, H-C found that
employees steal primarily as a result of
workplace conditions.
Why might Cressey and H-C come to
different conclusions? Did they examine
the same population of weasels? (While
white collar criminals and street criminals both steal,
they are not the same (in composition).) 41

Hollinger-Clark Study

Hypotheses of employee theft:

External economic pressures

2.
Young employees not as hardworking and
honest as those of the past
3.
Every employee can be tempted to steal
from an employer; people are greedy and
dishonest by nature (Weasel Axiom)
4.
Job satisfaction
5.
Shared formal and informal structure of
organizations (over time, the group norms
good or bad become the standard of
conduct)
Sutherlands Theory of Differential Association.
1.

42

Hollinger-Clark Study

H-C concluded that employee deviance

is caused by job dissatisfaction.
They categorized employee deviance
into two groups:

Acts by employees against property

(property deviance): Misuse and theft of
company property.
Violations of the norms regulating
acceptable levels of production (production
deviance): Goldbricking, slackers, etc.
43

Hollinger-Clark Study

H-C found that

about 33% (wt. avg. across all 3

industries) of employees admitted to
committing some form of property
deviance.
about 70% (wt. avg. across all 3
industries) of employees admitted to
committing some form of production
deviance.
44

Hollinger-Clark Study

Other Findings

No relationship between absolute income

and employee theft.
A statistical relationship between
employees concern over their financial
situation and the level of theft.
Correlation between age and theft
younger employees are more likely to steal
(young & dumb and not committed to the
company).
45

Hollinger-Clark Study

Other Findings:

Direct relationship between employees

position and the level of theft thefts
highest in jobs with greater access to the
things of value in the organization (the
DUH! factor).
Employees who are dissatisfied with their
jobs (across all age groups, but especially
younger workers) are most likely to steal (to
right the perceived inequity).
46

Hollinger-Clark Study

Other Findings:

Controls are a mixed bag

Can reduce theft.

Can enhance the feeling of inequity and increase
the likelihood of theft.
Controls often have little or no deterrent effect on
theft (theyre not deterred because they do not
plan on getting caught).
The stronger the perception that theft would be
detected, the less the likelihood that an employee
would engage in deviant behavior. (A common
finding in criminology studies its about the
perception of getting caught.)
47

Liars lie, cheaters cheat, and fraudsters commit fraud;

and they tend to be the same kind of person --scumbags.

Hollinger-Clark Study

Other Findings:

Increasing internal security presence

does not seem appropriate (could
worsen things).
Same kind of employees who engage
in other workplace deviance are also
principally the ones who engage in
employee theft (a type of person?).

Weasels in many aspects of their lives --crosses over into their professional/work

48

Hollinger-Clark Study

Other Findings:

Hydraulic Effect: Efforts to reduce employee

theft without reducing its underlying causes
(e.g., employee dissatisfaction, lack of
ethics), results in increases in other deviant
behavior.

If a company pushes down theft, that action may

push up goldbricking.

Increased mgt. sensitivity to its employees

reduces all forms of workplace deviance.
Special attention should be afforded young
employees.
49

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)

Most people who commit fraud or

other unethical acts find
themselves wandering off their
moral course.
Interestingly, the ways in which
such ethical lapses occur generally
fall within several broad and
recognizable categories; including
the following ..
50

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
1.

Rationalization: Justification that a

person provides for his/her
actions.
What Im doing is okay because
.
Frauds are about lies, and the
lying starts with lying to yourself
--- Its okay because
Well talk much more about this
51

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
2.

Recall Walt
Pavlo again.
Ive heard
the phrase,
feasting on
envy;
wanting
stuff, but
not willing
to work
hard to get
it.

Instant Gratification: A desire for

wealth without patience to earn it
honestly.

People might become overwhelmed by a

financial need or desire and being
accustomed to instant gratification in other
aspects of his/her life turn to white collar
crime as a means of instantly gaining
wealth, rather than taking the traditional
route involving hard work and
perseverance.
52

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
3.
Psychopat
hs fit here.

Disregard for Authority of Rules:

When someone lacks respect for
authority or believes that the
rules are unreasonable,
purposeless, or not valuable,
he/she might be inclined to
disregard authority figures and
the rules they are tasked to
enforce.
53

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
4.

BIG Giant
Ego
Hypothesi
s

Being Overly Optimistic: Often

creates a sense that one is
invulnerable and incapable of
failure (hubris).

This is
why many
frauds
start out
as a
trickle and
end up a
waterfall.

Sometimes an individual thinks

he/she is smarter or better that
his/her peers and therefore can get
away with fraud.
Can also be bred out of situational or
environmental factors (steal54$5 and

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
5.
Again,
psychopat
hs fit here.

Entitlement: General belief that

the world owes me something
or I deserve it.

This is a powerful motivator for fraud.

Some business leaders convince
themselves that they are entitled to
live a certain lifestyle by virtue of
their positions.
55

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
5.

Entitlement:

Per The Declaration of Independence,

We hold these truths to be selfevident, that all men are created
equal, that they are endowed by their
Creator with certain unalienable
Rights, that among these are Life,
Liberty and the pursuit of Happiness.

Notice that you are entitled to life and

liberty.
56
And to pursue happiness --- not

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
6.

Lack of Remorse: Often manifests

itself in fraudsters as a disregard
for the consequences of their
actions, even when they know
theyve done something wrong
and caused harm to others.

May be due to personality disorders

(psychopathy --- next class).
57

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
6.

Lack of Remorse:

Or, people who just dont give a sh*t

--- they simply dont care if they
cause harm to others or their
employing organization --- they think
their personal needs or desires are
more important than anyone elses
and therefore, they experience no
regret when they hurt others out of
selfishness.
58

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
7.

8.

Peer or Financial Pressure: People view

this pressure as a problem they have
to solve no matter the method
Inadequate Fear of Punishment:
Punishment will never completely deter
crime, but fraudsters often lack the
fear of punishment that most people
feel and may not know the penalty for
the fraud they are considering.

So, companies should communicate (loudly)

the policy for handling frauds. 59

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
9.

Egoism: Refers to arrogance and

narcissism (defn: excessive
concern for oneself without
exaggerated feelings of selfimportance).

In fraudsters, egoism is often a blend

of arrogance, pride, and narcissism
that fuels a persons desire to commit
a crime.

Often viewed as a challenge to

60 beat the

10 Critical Thinking Errors

of Unethical Behavior (ACFE
course)
10.

Diffusion of Harm: Fraudster

believes that the fraud affecting a
large group does not harm any
one person much, if at all.

Pump-and-Dump schemes and Ponzi

schemes are examples of frauds
frequently used by fraudsters who
hold the belief that the diffusion of
harm minimizes the severity.
61

WHY DID THEY DO IT?

Generally, the following 4 factors

compel people to commit fraud:
1.
2.
3.
4.

Personality
External pressures
Personal situation
Corporate culture

62

Common Motivations for

Fraud

Greed (among the most common reason

given for why people commit corporate fraud
ACFE report)

Sense of entitlement
Desire for power/ego
Need
Challenge
Fear
Anger
Personality disorders

63

End of Research and Other

Information on Fraud Sidebar.

64

Sociology and Criminology

Psychologists and sociologists

have tried to understand the inner
workings of people who commit
white-collar crime.

Old theories tried to link white-collar

criminals to biological and
psychological flaws associated with
the lower classes and social misfits.
(The prevalent theories relating to
common criminals.)
65

Sociology and Criminology

Edwin Sutherland (White Collar Crime,

1939) argued that an individuals
personality has no relevance to a
propensity to commit white-collar crime.

Economic crimes originate from the

situations and social bonds within an
organization (process of differential
association) --- its more a learned
behavior.
In addition, he noted that economic crime
encompasses upper-class, socially welladjusted people.
66

Sociology and Criminology

Others suggested that financial

fraud is an inevitable feature of
capitalism, in which the culture of
competition promotes and justifies
the pursuit of material self-interest,
often at the expense of others and
even in violation of the law. (I think
this is crap. Its not capitalism per
se; its that people are weasels,
period --- see next slide.)
67

Sociology and Criminology

People cheat under socialist

regimes & communist regimes &
theocratic regimes, etc. --- its all
about diverting resources from
others to yourself.
Egypts Mubarak (ousted
president, Feb. 2011) is estimated
to be worth $70 billion and
believed he diverted more than
68

Sociology and Criminology

Nature

Nurtur
e

Research concludes that two factors

should be considered in analyzing the
psychology and personality of
fraudsters:

The biological qualities of an individual,

which vary widely and influence behavior,
including social behavior.
The social qualities that are derived from
and in turn shape how the individual deals
with other people.
69

Sociology and Criminology

So, three general types of fraudster

have been observed:

Calculating criminals who want to

compete and to assert themselves.
Situation-dependent criminals who are
desperate to save themselves, their
families, or their companies from
catastrophe.
Power brokers who are highly placed
corporate criminals.
Psychopaths reside in this
category.
70

Calculating Criminals

Calculating criminals are predators.

Tend to be repeat offenders.
Higher-than-average intelligence.
Relatively well educated.
Usually begin their careers in crime
later in life than other criminals.
Risk takers.
Lack feelings of anxiety or empathy.
71

Calculating Criminals

Predators

Develop considerable skills and

make a career of deceiving
people (as though it were just
another career track to follow).
Are dangerous and cause great
harm.
Once in place, are hard to detect.
See Case 1, Bob Davies; p.

49/27

72

Calculating Criminals

Fraud deterrence and detection

controls are often robust enough to
stop other types of white-collar
criminals, but they may not stop
the predator.
The best defense against predators
is a thorough background check
before hiring --- since they tend to
be repeat offenders. (Key element of
an anitfraud program.)

73

Situation-Dependent
Criminals

The vast majority of white-collar

criminals are not predators, they
are ordinary people who commit
crimes without the intent to harm
others.
Characterized as the more
common, run-of-the-mill, gardenvariety offenders that account for
the bulk of fraud --- not the Bernie
74

Situation-Dependent
Criminals

They look like us!

Typical White-Collar Criminal (ACFE):

Recall
ACFE
stats on
fraudster
s

Older (> 30 years)

55% male, 45% female
An appearance of a stable family situation
Above-average (postgrad) education
Less likely to have a criminal record
Good psychological health
Position of trust
Detailed knowledge of accounting systems and their
weaknesses
Prior accounting experience
75

Situation-Dependent
Criminals

People often display disbelief

regarding these criminals when
discussing a fraud.

Oh, no, it couldnt be Anne. Shes

been with us for 20 years. Shes
always assisting others with their
duties. Shes pleasant and rarely
takes time off. My wife and I have
been to her home. Our daughters are
on the same soccer team.
76

Situation-Dependent
Criminals

Victims may believe that what

she or he knows, or thinks she
or he knows, about a
fraudsters character
eliminates him/her from the list
of suspects of fraud . . . . . . .

77

Situation-Dependent
Criminals
. . . . . However, fraud examiners
know that:
Its NOT the case that nice
people are white-collar
criminals,
Rather, most white-collar
criminals give the
appearance of being nice
people.
78

Power Brokers

Power brokers show characteristics

of predators and Situationdependent criminals, but they are
different enough to deserve a
category all their own.
Its the combination of predator
characteristics and the
circumstances of their positions
that lead these people to commit
79

Power Brokers

These highly-placed criminals are the

ones that cause us to ask the question:
How could this respected business
leader have been so deluded as to
believe that he could usurp the financial
resources of their company to line their
own pockets and deceive so many
people?
It ties into the Big Giant Ego
Hypothesis.
80

No Intent to Harm

Generally speaking, situation-dependent

criminals carry out their frauds with no
intention to do any harm.
It is critical to an understanding of the
psychology of such people to accept
this key point: most of them carry out
their frauds with no intention to doing
any harm, and they believe they
are able to convince themselves
that what they are doing is not
wrong.
81

Case 3: Middle Mgr.

Middle mgr. gets laid-off, he was making

$85,000, unemployed for 14 months,
eventually found a lower paying job,
daughter gets hurt and needs plastic
surgery (not covered by insurance),
mother-in-law gets sick and has to move
in (and he must add another room to
the house), and his wife is pregnant

HUGE Pressure.
82

Case 3: Middle Mgr.

Under this duress, many people

may find that their customary
ethical behavior may seem beside
the point when criminal
opportunities seemingly provide
solutions to complex personal
problems.
What would you do?
83

No Intent to Harm

These people may convince

themselves that

They are doing it for the good of the

company, or
They deserve the spoils they seize
because they rationalize their crimes
as immaterial, innocent, or deserved
but not wrong.

Many frauds start out as a trickle

and end up a waterfall (start small,
end big).
84

Six Basic Forms of

Rationalization for Fraudulent
Behavior
Case 4

1.

2.

Case 1
Case 3
Case 2
Case 4

3.
4.
5.
6.

I only borrowed it --- I was going to put

it back.
Its a grey area and my action is
acceptable.
Everyone is doing it.
I deserve it.
I need it.
Its not for me, its for others (the
company, the stockholders, my family,
etc.).
85

Six Basic Forms of

Rationalization for Fraudulent
Behavior

Burn the 6 forms of rationalizations

into your brain.
If you go into fraud investigation,
you will see these 6
rationalizations over & over again!

86

CASE 4: Foundation Fraud

Exec. Director of a foundation charged

personal expenses to the foundation
(school books, car repair, groceries,
flight to Miami for her and her family,
etc.).
The Board and others were confused,
puzzled, shocked, surprised, blah, blah.
Were these clerical errors,
misunderstandings, or the work of a
weasel?
87

CASE 4: Foundation Fraud

Eventually, the FAIs uncovered

unauthorized expenditures of at
least $90,000 (including private
school tuition for the Exec.
Directors kids).
Now, that the weasel has been
identified, whats next?
88

The Next Step in the FAI

Once a fraudster has been

identified, FAIs should next*:

Look for additional schemes

Look for coconspirators
Look to see what the targets have
touched and test those areas

* From the ACFEs Fraud Examiners Manual.

If they are willing to cheat in Area
A, theyll probably cheat in Area B.

89

CASE 4: Foundation Fraud

So, now the FAIs thought about

what the Exec. Director touches
and the other possibilities for
fraud.
They learned she was involved in
fund raising --- so now they have to
examine incoming donations.

This can be very difficult since any

fraud would probably be an off-thebook fraud (the donors might only
90
be know to her).

CASE 4: Foundation Fraud

How would you get a handle on

donations converted to the Exec.
Directors private use?

In general --- you need to connect her to

situations where she could be in personal
contact with donors.
Analyze her expense reports and correlate
with churches, etc. near hotels she stayed
at, etc.*

Call churches and use an audit pretense to ask

about donations to the foundation.

For each church, etc. where she might have

* See next made
slide. an appeal for money, look91for a

CASE 4: Foundation Fraud

The FAIs found something. A

church in Dallas had given the
Exec. Director a donation of
$10,000.

The FAIs had the church send them a

copy of the check (front and back).
The check had no endorsement, but it
did have the Exec. Directors personal
account number. Gotcha!

With one, there are probably more.

92

CASE 4: Foundation Fraud

Weasels arent necessarily that smart.

She should have left those items off her
expense report - weasels are often also
little piggies --- submit an expense for
hotel & food, say $500, steal $10,000;
set nailed; get zero + jail time --- OR,
forget the hotel & food (dont submit),
steal $10,000; get away with it; net
$9,500 + NO jail time. Which option do
you prefer?
93

CASE 4: Foundation Fraud

The Board was stunned and not

ready to take the matter to the
prosecutor.

There has to be a reasonable

explanation for the allegations, some
Board members said. (Yea, the Exec.
Dir. is a weasel.)
Plus, they were worried about adverse
publicity if the information went
public.
94

CASE 4: Foundation Fraud

The next step is to prepare for an

admission-seeking interview in an
attempt to get the Exec. Dir. to
admit to the thefts.
She did confess and rationalized as
follows:

I only borrowed the money and had

every intention of paying it back.
(See Rationalization #1 earlier.)
95

CASE 4: Foundation Fraud

She did confess and rationalized as

follows:

She needed to circulate in high

society to solicit donations from wellto-do people, so she needed to live
the lifestyle, including having her kids
attend the same private school as the
wealthy peoples kids.

She believed her taking only a little to

these
wrong.
Rationalization meet
#6: Its
not needs
for me,was
its not
for the
96
Foundation.

Rationalization

You must understand how

rationalizations underlie white-collar
crime.
Rationalization cuts right to the heart of
the psychology of the fraudster: The
ability of fraudsters to convince
themselves that what they are doing is
acceptable enables otherwise good
people to do stupid things.
We all engage in rationalizations daily (a
97
form of lying to yourself).

Rationalization

Rationalization starts
with a lie --- a lie to
yourself!

98

Rationalization

Its important that you contemplate

potential rationalizations when you
examine transactions --- what would
allow someone to steal X or misreport Y,
even though they appear to be a
regular person?
Later well see that understanding the
perps rationalization is important to
doing a successful admission-seeking
interview.
99

Rationalization-a recent
example

People are searching for a villain

relating to the subprime meltdown.
Angelo Mozilo, founder and CEO of
Countrywide Financial, the largest
U.S. mortgage lender and the
source of so many of the bad home
loans that have gummed up the
global financial system, has been
identified as a potential villain.
100

Rationalization-a recent
example
Countrywides easy underwriting culture
invited nothing short of business
suicide: an astonishing 7.2% of its
mortgages were delinquent, while
foreclosures more that doubled in a
year.
Mozilo pocketed nearly $400 million in
the past 6 years, and took $115 million
when
Bank
of America
purchased
At 9/12/11
BoA was
in deep
financial trouble
(reducing
its workforce
by 30,000) and some link the problems to
Countrywide.

its acquisition of Countrywide.

101

Rationalization-a recent
example*

Mozilos response: We have

provided over 25 million families
with an opportunity to have a
home of their own, to build equity,
and to utilize that equity to have
the best life possible in our great
country.

See, its not for me, its for you --rationalization #6.

* Business Week, 2/4/2008, p. 77 & CNNMoney.com,

3/7/2008

102

Understand the Mind of

the Fraudster

The more auditors understand why

criminals do what they do, the better
prepared they may be to determine the
evidence required to uncover fraud.
Professional skepticism, a focus on the
fact that smart people may do dumb
things, and a focus on the conditions
under which white-collar criminals may
act will help auditors uncover fraud.
103

Conclusion

Keep in mind, when designing controls

and when auditing, Locks on doors
keep out honest people.

Predators often circumvent controls --- they

actively seek to get into a locked house.

The best fraud deterrence mechanism is

simple: Create the expectation in your
organization that wrongdoers will be
caught and that punishment will be
swift and commensurate with the
offense.

The emphasis on expectation is 104

important.

Conclusion

People must believe they

will be penalized --- S3
Swift
Sure
Severe

105