Few would argue that occupational fraud presents a daunting challenge for organizations. It affects virtually every industry, costs employers vast amounts of time and money, and can do widespread damage. In worst-case scenarios, fraud can decimate the organization's balance sheets and even lead to its demise.
But why is fraudulent activity so pervasive? What motivates employees and executives to commit occupational fraud? Some may think it's driven largely by greed. To others, a lack of adequate internal controls is to blame.
Both of these opinions actually contain an element of truth, but they are far from the complete answer. Greed, for example, is a natural human trait; all human beings are greedy to an extent. And there is no way to measure it, so the amount of greed has no predictive value. Moreover, believing that lack of internal controls causes fraud is wrong on two counts. First, most people won't commit fraud even in the absence of suitable control mechanisms. Second, organizations with solid internal controls still experience fraud.
To grasp the real causes of fraud, internal auditors need to step away from the books and records long enough to examine why people do it; not just how. In short, they must get inside the fraudster's mind. One of the best ways to gain that kind of insight is to speak with those who've actually committed fraudulent acts.
With that in mind, the Association of Certified Fraud Examiners (ACFE) interviewed 10 convicted white-collar criminals last year for a video training program on understanding fraudsters' unique psyche. In their own words, these individuals described why they committed their crimes, shedding light on the real motivations behind occupational wrongdoing. The interviews reveal several key behaviors exhibited by the offenders, offering valuable lessons for internal auditors seeking to better understand the mind of the fraudster.
A Sense of Entitlement
Kenneth Kemp served as controller at a small company when he started having an affair — one that he could not afford. He subsequently began embezzling money by writing checks to himself. Kemp justified his actions by believing he was entitled to the money. He was a high-ranking employee who thought he was being underpaid.
"So my success kind of overshadowed anything [else]," Kemp said. Like many who become addicted to fraud, he got careless. And when he let another employee reconcile the company bank account, she spotted the checks Kemp had written to himself and informed management. In turn, they notified law enforcement and Kemp was prosecuted. He received a probated sentence but didn't learn his lesson very well. He got a better job at a different company as a vice president by falsifying his résumé.
Kemp wasn't there long before he received a promotion, but without the big raise that he felt he deserved. "I got upset so I started cutting checks to myself again to the level I should be compensated at," he said. But auditors uncovered his scheme and Kemp spent nearly a year in jail.
The story of Kemp is not all that unusual. A recent study published in the journal Proceedings of the National Academy of Sciences suggests that people higher on the organizational ladder are more likely to behave unethically. "Elevated wealth status seems to make you want even more, and that increased want leads you to bend the rules or break the rules," lead author Paul Piff observed. The message for internal auditors is a simple one: Don't believe that occupational fraud is always motivated by need.
"I wasn't worried about the internal auditors catching the fraudulent activity that myself or some of my co-workers were involved with," said convicted fraudster Mark Whitacre. "All they would do if they caught a fraud like that would be to go to management." Whitacre shouldn't have been so optimistic; he was caught and served more than eight years in prisonfor embezzling US $9 million from his employer, agricultural giant Archer Daniels Midland Co., where he was a vice-president. But his rosy outlook was aided by the fact that he was high enough in the company to approve his own phony invoices for expense reimbursements. "I didn't have to do any cover-up when I submitted these invoices," he said. "I simply signed them and it got processed." Whitacre is like many other fraud offenders in that, the higher the position in the organization, the greater the losses (see "Position of Perpetrator — Median Loss").
If there is one single trait that stands out in criminals of all persuasions, it is "super optimism." From the bank robber to the bank embezzler, these people have convinced themselves that they won't get caught. This irrational thinking often hastens the offenders' downfall — their excessive confidence leads to lapses in judgment and often careless mistakes that bring about discovery of their misdeeds.
"I wanted to get my kids and my family everything they needed, material-wise; toys, stuffed animals, anything they wanted," said Barry Webne, another convicted fraudster. He also was a controller for a small company, one without an internal auditor. According to the latest ACFE Report to the Nations, companies that are audited have significantly lower losses than those that aren't (see "Median Loss Based on Presence of Anti-fraud Controls"). Webne's scheme was the essence of simplicity: He set up a phony company and directed payments to it, stealing a total of US $1.25 million. The losses were charged to various fictitious expenses.
Part of Webne's rationalization was the belief that his employer didn't provide adequate oversight. "The company I worked for was typical of American companies," he said. "As long as the financial statements were turned in on time, nobody bothered us." Or, said another way, the company made it so easy to steal that they deserved it. He got caught when the company dismissed him as part of a cost-cutting effort. Webne served 63 months in prison.
Rationalization is a common behavior among occupational fraudsters. That's because most of them were raised with the same set of values as most people — stealing is wrong. Hence, they need to call it something else. The rationalization doesn't have to make sense to anyone else; only to them.
Peer or Financial Pressure
One of the most widely publicized financial statement frauds of the early 21st century involved HealthSouth, a medical services provider, and its founder Richard Scrushy. The founder had allegedly instructed his senior executives to overstate revenue to the tune of US $1.6 billion. The founder was criminally tried on 36 counts of fraud in 2004 and found not guilty on all of them, but in 2009 an Alabama judge ruled that Scrushy was civilly responsible for the fraud — where the burden of proof is much lower — and ordered him to pay US $2.87 billion in restitution. Nonetheless, much of the wrongdoing was committed by the chief financial officer (CFO), Aaron Beam, who says he succumbed to the peer and financial pressure exerted by Scrushy to cook the books.
"I did not really talk to Richard or challenge him," Beam said. "I had learned from working with him for four years that he didn't like to be told he couldn't do something; he made it very unpleasant when you challenged him." Although the CFO participated in the early stages of the accounting fraud, he couldn't square his conscience with his conduct and left the company. But his early conduct had been uncovered by federal investigators. Beam confessed and served several months in federal prison.
Conduct like Beam's isn't limited to executives or other financial professionals who receive pressure to overstate company earnings. It also occurs among rank-and-file employees who can't pay their bills. Their financial pressures may stem from gambling losses, substance abuse, poor investments, or the desire to maintain a high standard of living — one that exceeds their means.
"I know I wanted to make a lot of money," said con artist Steve Comisar. "And I figured I am going to take a short cut. I'm going to make some big money."
Unlike most of the fraudsters interviewed, Comisar conned people out of money for a living. He is currently serving his second stint in prison for duping investors in a get-rich-quick scheme. But he shares traits with many other people who commit fraud — whatever they want, they want now.
These types of fraudsters typically display their wealth ostentatiously with expensive clothes, fine automobiles and jewelry, dream vacations, and lavish homes. Dennis Koslowski, the former CEO of Tyco, is a classic corporate example. He was legitimately earning several hundred million dollars a year, but that wasn't enough; he and his CFO, Mark Swartz, were convicted of stealing another US $150 million and are serving long prison sentences. The press had a field day over Koslowski's purchase of a US $4,500 shower curtain and a US $9,000 umbrella stand, all paid with company funds.
Diffusion of Harm
People like Koslowski can justify their actions easily because the company losses from their frauds are spread over many thousands of shareholders; no one person loses a lot. This is called "diffusion of harm," and it is a common thought inside the fraudster's mind. Patrick Kuhse, a former investment broker, exhibited this type of thinking when he helped fleece the State of Oklahoma out of millions of dollars.
One of Kuhse's friends handled investments for the state. "She had 10 different brokerage houses that were going to be doing the buys and sells on behalf of the state," Kuhse recalled. "She would take bids from three of them for a portion of the money." The state employee suggested that Kuhse charge excessive commissions on his stock trades — she would then authorize the commissions, and the two of them would split the ill-gotten gains.
"I didn't have any problem with Oklahoma and what was going on because of the significance of the money that she continued to tell me that she was earning for the state," Kuhse said. "It was, to me, a win-win situation." But when their activities were uncovered Kuhse admitted, "There was over $6 million dollars generated in fraudulent commissions." He was sentenced to four years in prison and ordered to pay restitution.
Lack of Remorse
Justin Paperny was a stockbroker who cheated clients out of millions of dollars. But ultimately, the thefts became so large that he could no longer cover them when clients asked for their money back. Paperny cooperated with the authorities who investigated his fraud, but not because of a guilty conscience.
"I only cooperated because I thought it might keep me out of jail," Paperny said. "I didn't really feel bad. I told the [U.S. Securities and Exchange Commission (SEC)] everything they wanted to hear — the truth."
Whitacre felt much the same way. "I didn't feel guilty about it then because I felt like the company was stealing so much money that mine was miniscule compared to what they were stealing," he said. "It really helped; it took some of the guilt away."
Lack of remorse can be a sign of sociopathic behavior. Sociopaths have a pervasive pattern of disregard for, and violation of, the rights of others.
Inadequate Fear of Punishment
There is a perception, at least in the United States, that white-collar criminals do not receive adequate punishment. In reality, fraudsters have been receiving longer sentences over the last decade. But for first offenders, probation is still common — too common, perhaps. "The first time I was placed on probation, I got no time at all," Comisar said. "In fact, I wished I did because I wouldn't have gone on with knowing what it is like in prison. I just got a slap on the wrist — it didn't deter me at all."
Kenneth Kemp had a similar experience. After embezzling money the first time, he didn't serve any jail time. So he embezzled again. "The laws, because I was a first-time offender, were very easy on me," he admitted.
Lessons for Internal Auditors
motivations behind fraud vary but are often predictable, giving those
charged with helping to prevent fraudulent activity key insight. Audit
practitioners can learn several important lessons, and help spot
wrongdoing, by getting inside the fraudster's mind.
fraudsters may look like ordinary people, they're not. In your
day-to-day responsibilities, listen to more of what is being said by
executives and employees. Don't disregard behavioral red flags if you
come across them.
and records don't commit fraud; people do. The more auditors learn
about fraudsters' thought processes, the better they'll be able to
Elevated company rank does not necessarily equate to honesty. Business leaders are no more honest than anyone else.
internal control, above all others, can make fraud more difficult to
commit: segregation of duties. Those that keep the money shouldn't keep
the books, and vice versa.
people in your organization about how fraudsters think. More fraud is
uncovered through tips and complaints than by all other methods combined
(see "Initial Detection of Occupational Frauds" below). Let others in
the organization be your eyes and ears.
Numerous fraudsters commit their crimes just because they think they can — they're smarter than other people, they know how to beat the system, or they're familiar with the way fraud is investigated. That was the case with Kevin Barnes, who orchestrated a mortgage fraud ring. "I was involved in law enforcement prior to getting into the banking industry," Barnes said. "So I had knowledge of when you look at a file or when they investigate fraud, what it took."
Barnes' scheme collapsed. He pleaded guilty to fraud and conspiracy charges and served five years in prison. But he didn't learn much from the experience. "Always keep ahead of them," Banes said. "You do your due diligence on a regular basis if you are a good fraudster. Today, if I wanted to get back into it, I truly believe that I could beat the system for billions."
Disregard for Authority and Rules
Sam Antar was part of a family conspiracy — the entire clan cheated the U.S. government and investors through its Crazy Eddie electronics chain. Antar was the organization's CFO and the cousin of Eddie Antar, the president and CEO. The fraud they committed is one of the most infamous and outrageous in recent history.
"It's not uncommon, you know, in a small business, that people are paid off the books," Sam Antar said. "Nobody is denying it is illegal. It was more like a casual thing, like an entitlement." The reason the company paid employees off the books, of course, was to avoid payroll taxes.
The family's scheme involved listing Crazy Eddie publicly in an effort to reap untold wealth. But due to a feud among family members, someone informed the SEC that the company had overstated its inventory by approximately US $50 million. Eddie Antar went to prison, and several family members now have criminal records. The family showed a complete disregard for rules and authority. "There was never a morality issue that I can recall," Sam Antar said. "Committing fraud was just like another part of life."
Not all rule-breakers commit fraud, but most fraudsters are rule-breakers — and there are no audit programs to detect this type of behavior. Nonetheless, auditors should realize that if they observe an employee or executive consistently taking shortcuts or trying to "beat the system," they just might be seeing the tip of the iceberg.
Those tasked with helping to detect occupational fraud are bound to be less effective if they believe the numbers will always provide the first clues to wrongdoing; they rarely do. Simply remaining alert to the behaviors commonly exhibited by white-collar criminals will enable better detection of fraud in its early stages — before catastrophic losses occur.