Conduct Risk — The Psychology of Fraud

Have you ever received one of those e-mails where some wealthy individual — for some “heartwarming” reason — wants you to help them transfer a large amount of money in exchange for a commission? If you have, then you were most likely targeted by someone who was looking to make a quick buck by convincing you to give away your credit card information or send a few hundred dollars.

This is just one of the countless ways in which ill-intentioned individuals attempt to commit fraud by exploiting your vulnerabilities.

In broad lines, the MacMillan dictionary defines fraud as the crime of obtaining money from someone by tricking them. Right from the start, this definition provides a clear picture of the underlying elements of fraud. In other words, any act of fraud involves 1) a victim, 2) an offender, 3) a motive, and 4) a strategy.

In a 2014 global report released by The Association of Certified Fraud Examiners (ACFE), fraud is defined as the use of one’s occupation for personal enrichment through the deliberate misuse or application of the employing organization’s resources or assets. As you’ve probably figured out, this second definition is used to describe fraud in the context of organisations and businesses.

In fact, most of the financial losses that result from fraudulent behaviour involve organisations and companies with millions of dollars in revenue. Sadly, as one survey clearly states, fraud is increasing dramatically with the expansion of modern technology and global communication, resulting in substantial losses to the businesses. [1]

In this article,we’re going to discuss the psychology behind fraud and why some fall victim to this type of crime. But first, let’s take a closer look at the inner-workings of fraud.

The Three Factors of Fraud

In an article published by The Australian Institute of Criminology, Grace Duffield, and Peter Grabosky highlight three factors that explain fraud. [2] According to the authors, fraud is possible only when there’s:

1. A supply of motivated offenders;

2. A supply of suitable targets;

3. An absence of capable guardians.

In other words, if there are people who have the means and motivation to commit fraud, people who are susceptible to this form of crime, and no one to take action and prevent this problem, fraud is likely to occur.

Most of us believe that people who commit this sophisticated form of crime are characterised by greed, dishonesty, or even Machiavellianism. While these elements may be part of the offender’s psychological profile, science has yet to confirm the existence of personality traits that can serve as markers of the propensity of an individual to commit fraud. For example, just because some people are greedy or ‘hungry’ for profit, doesn’t mean they’re more likely to commit fraud. Same goes for dishonesty and Machiavellianism.

Nevertheless, some experts believe that by using personality tests, one can determine the trustworthiness of potential employees, and eliminate those who might be inclined to commit fraud given the right situation. [3] Factors such as ‘integrity’ and ‘honesty’ are associated with a lowpredisposition for fraud. In other words, personality traits — though they might not be the most accurate marker for fraud — are currently our best bet.

Unfortunately, no matter how many tests, surveys, or questionnaires experts have at their disposal, there’s no 100% reliable way of telling which person will engage in fraudulent behavior. Maybe the answer lies somewhere else…

But what about financial factors?

It’s obvious that financial strain is one of the reasons why some people resort to such malicious activities. When money’s running thin, andthe opportunity of a quick buck occurs, some people tend to see fraud as a viable and “rational” option.

However, this ‘theory’ fails to explain why individuals with above-average economic status engage in fraudulent behaviour.

But perhaps we should take a closer look at the term ‘financial strain’; a term that can vary in meaning depending on the person. For example, if you possess one luxury home and two sports cars, while your friends have several luxury homes and enough sports cars to fill up a small parking lot, then it’s you who’s in a “difficult” financial situation. In other words, perception is partially responsible for how wealthy we believe ourselves to be.

The desire to accumulate wealth is without a doubt one of the reasons why people engage in fraudulent behavior. Many believe that integrating behavioral sciences into fraud and forensic accounting might help experts gain a better understanding ofthe inner-workings of fraudand prevent such events from destroying the lives of innocent, hard-working individuals. [4]

All and all, the one conclusion that many experts seem to agree on is that fraud represents a mix of personality, environmental, and situational factors.

The Fraud Triangle

To prevent fraud, we must first establish what motivates people to commit this white-collar crime. For that reason, fraud expert Donald Cressey came up with the famous triangle of fraud. This construct was used by experts from across the globe to tackle the fraud epidemic in a structured and efficient manner.

In theory, by understanding the motivation behind fraudulent behaviour, one can then set up preventive measures to diminish the impact of this ever-growing problem. As the name suggests, the triangle of fraud is comprised of three elements that we’re going to discuss briefly.

The first element of the fraud triangle is opportunity. Even if a person has a reason, there must also be an opportunity, which is generated, by the existence of deficient internal control systems. In other words, the offender is encouraged by the alleged probability that the deed will not be detected.

The second element of the fraud triangle is incentive. That can come in the form of financial pressure (as we previously discussed) experienced by the offender, or even greediness. Other incentives that can lead people to fraudulent behaviours are financial difficulties caused by personal problems such as addictions, gambling, and so on.

The third elementof the fraud triangle is rationalisation or the motive behind fraudulent behaviour. The offenders will always try to find a “reasonable” explanation for their actions. For example, they might come up with a detailed and often sentimental explanation to why they’re entitled to a certain amount of money. Explanations such as, “Since the world isn’t fair, why should I play by the rules!?” or “It’s not like the company went bankrupt because of my actions” or “Anyone in my position would have done the same thing” are used by offenders to justify fraud. What’s interesting is that the purpose of these “theories” is to help the offender ‘make peace with himself’ so that it doesn’t feel like he’s committing a crime.

Many experts believe that the key to preventing such unpleasant events is breaking the fraud triangle. But the real question is — HOW? How can companies and average Joes (like you and me) prevent such an elaborate scheme?

It’s obviousthat we can’t eliminate incentives. Wealth and material possessions will always draw people. It’s just human nature. At the same time, no matter how much we try to paint fraud as a profoundly negative action, those who are willing to commit it will always find a way to rationalise it.

The only thing that’s left is opportunity, and this is where most experts believe that authorities should intervene. In other words, we need to give offenders as little opportunities as possible.

Adding the fourth element

Although the fraud triangle has proven to be extremely useful in understanding the reasons behind fraudulent behaviour, one group experts believe it’s not enough.

In a paper published in 2004, David Wolfe and Dana Hermanson introduced an ‘updated’ version of the fraud triangle with one extra element. As the paper clearlystates: The fraud triangle could be enhanced to improve both fraud prevention and detection by considering a fourthelement. In addition to addressing incentive, opportunity, and rationalization, the authors’ four-sided “fraud diamond” also considers an individual’s capability. [5]

If we think about it for a second, adding capability as the fourth element makes perfect sense. Thisrefers to the skills and personal traits one must have to commit fraud.

Depending on the type of fraud, these abilities can range from soft skills and manipulation to computer hacking and data analysis. Sadly, one recent study suggests that audit team members may lack the training necessary to detect and prevent fraud. [6]

Considering that new types of fraud emerge regularly, it’s somewhat understandable why experts find it difficult to keep up the pace.

Nevertheless, adding the fourth element — capability– gives experts the chance to identify potential offenders and take preventive measures.

The Offender

For many offenders, fraud represents a victimless crime. The fact that they rarely interact directly with their victim makes it easier for them not only to commit this crime but also justify it.

In reality, the consequences of fraud can be devastating. By losing their hard-earned money, victims can end up in stressful financial situations, which in turn can cause severe psychological problems.

Imagine waking up one day and realising that your pension fund or your kids’ college fund is completely drained. Or imagine losing a month’s salary because someone has somehow obtained your credit card information.

But regardless of the horrible consequences of this crime, offenders will always find a way to justify their actions. They will still have an explanation that clears away the guild and allows them to sleep peacefully at night.

That’s because people who are willing to commit fraud don’t play by the same rules. Concepts like ‘moral values,’‘empathy,’ or ‘guilt’ mean nothing to them. The only thing that counts is wealth and profit.

In a sense, we could argue that, like any other offenders, those who commit fraud are somewhat antisocial. In other words, they lack the empathy that would show them the real consequences of their actions; they are cruel, cynical and utterly careless towards other peoples’ rights.

Finally, many of the people who commit fraud are experts in manipulation and persuasion. Otherwise they wouldn’t be able to trick their victims and vanish before anyone can realise the motive behind their actions.

The Victim

Most of us go about our daily business without thinking that someone, somewhere might be plotting to steal our money or material possessions. Even when we hear about such tragic events on the news, we somehow end up thinking — “That can’t happen to me.”

We like to believe that this sort of situations can’t happen to us or that we’re too smart to fall victim to such schemes. The bad news is that this is precisely what those who commit fraud what you to think. They want you to be overconfident, cocky, or even careless. Why? Because it makes it easier for them to run their schemes and drain your accounts.

Last year, the National Association of Corporate Directors (NACD) ran a survey to gain a better understanding of why companies are vulnerable to fraud. As the authors state, eighty percent of respondents …felt that failure resulting from poor risk management couldn’t happen to them.

What’s even more interesting is that fifty percent thought it could happen to other companies. To put it differently, the risk of fraud is something we’re all aware of; we just refuse to believe it could happen to us. In short, carelessness is one of the main reasons why some of us fall victim to fraud.

In the end, when it comes to fraud, everyone is a potential target. However, the ones who end up being the victims are those who are careless or naïve enough to believe fraud couldn’t happen to them.

Works Cited

[1]K. Yufeng, L. Chang-Tien, S. Sirwongwattana and H. Yo-Ping, “Survey of fraud detection techniques,” in IEEE International Conference on Networking, Sensing and Control, Taipei, 2004.

[2]G. Duffield and P. Grabosky, “The Psychology of Fraud,” Crime and Criminal Justice, 2001.

[3]P. R. Sackett and M. M. Harris, “HONESTY TESTING FOR PERSONNEL SELECTION: A REVIEW AND CRITIQUE,” Personnel Psychology, vol. 37, no. 2, p. 221–245, 1984.

[4]S. Ramamoorti, “The Psychology and Sociology of Fraud: Integrating the Behavioral Sciences Component Into Fraud and Forensic Accounting Curricula,” Issues in Accounting Education, vol. 23, no. 4, pp. 521–533, 2008.

[5]D. T. Wolfe and D. R. Hermanson, “The Fraud Diamond: Considering the Four Elements of Fraud,” The CPA Journal, vol. 74, no. 12, pp. 38–42, 2004.

[6]D. Dickins and J. T. Reisch, “Enhancing Auditors’ Ability to Identify Opportunities to Commit Fraud: Instructional Resource Cases,” Issues in Accounting Education, vol. 24, no. 4, pp. 1153–1169, 2012.