WHERE ARE THE FRAUD VULNERABILITIES AND

WHY DO THEY OCCUR

As per a recent study by Assocham and Grant Thornton, the most vulnerable
sectors to Fraud in India are:

The increasing adverse effects of Fraud merit it’s further study and the first
step in that study is understanding as to ‘Why do Frauds Happen’ So let
us study some of the principles/theories which shall help us understand as
to why frauds happen.
The most basic of all theories is the Fraud Triangle Theory. The other theories
are merely extension of Fraud Triangle Theory.
2.1 Fraud Triangle
Donald Cressey, a sociologist and criminologist in the 1940s, was one of the
first persons to specialize in the field of understanding fraudsters and why
they do what they do. Cressey wrote "Theft of the Nation," a treatise on
La Cosa Nostra- a hierarchically structured view of the Organizational Crime
and he was widely known for his studies in organized crime. Cressey first
gained public recognition in this field while completing his PhD
dissertation on embezzlers, at Indiana University. Cressey interviewed nearly
200 incarcerated individuals charged with embezzlement. From his research,
Cressey developed "The Fraud Triangle” which was a model he used to
explain what caused some people to become fraudsters by analyzing the
circumstances in which the subjects of his research were drawn into fraud
The fraud triangle, developed by Donald Cressey, is a model for explaining
the factors that cause someone to commit occupational fraud. It consists of
three components which, together, lead to fraudulent behavior:
1. Perceived Pressure
2. Perceived opportunity
3. Rationalization
Study on Forensic Accounting and Fraud Detection

Incentive/ Pressure
Management or other employees may find themselves offered incentives or
placed under pressure to commit fraud. When, for example, remuneration or
advancement is significantly affected by individual, divisional, or company
performance, individuals may have an incentive to manipulate results or to
put pressure on others to do so. Pressure may also come from the unrealistic
expectations of investors, banks, or other sources of finance. Certain risk
factors are usefully considered in the evaluation of whether or not the
organization is at a greater or lesser degree of risk, owing to incentives or
pressures that could potentially lead to material misstatements.
Determining the presence and degree of these pressures or incentives is part
of the auditor’s goal in evaluating the risk that misstatements due to fraud
may have occurred.
Certain risk factors are usefully considered in the evaluation of whether or
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not the organization is at a greater or lesser degree of risk, owing to
incentives or pressures that could potentially lead to material
misstatements.
▪ Financial stability or profitability is threatened by economic, industry, or
entity operating conditions.
▪ Excessive pressure exists for management to meet debt requirements
▪ Personal net worth is materially threatened

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 Where are the Fraud Vulnerabilities and Why do they Occur

Attitudes/ rationalization
Some individuals are more prone than others to commit fraud. Other things
being equal, the propensity to commit fraud depends on people’s ethical
values as well as on their personal circumstances. Ethical behavior is
motivated both by a person’s character and by external factors. External
factors may include job insecurity, such as during a downsizing, or a work
environment that inspires resentment, such as being passed over for
promotion.
Risk factors that fall into this category of rationalization and attitude are
typically the least tangible or measurable, and many are by nature difficult
for an auditor to observe or otherwise ascertain. Fundamentally,
rationalization and attitude are functions of the culture of an organization,
the psychology of those who work in it, and the interaction between the
two—for example, the level of employee loyalty to the company. The wider
business environment must also be considered: hard times in an industry or
in the overall economy may make it easier for some individuals to
rationalize fraud.
A history of violations of laws is known
Little communication and support of the entity’s core values is evident.
Management has a practice of making overly aggressive or unrealistic
forecasts.
Personal financial obligations create pressure to misappropriate assets.
Adverse relationships between management and employees motivate
employees to misappropriate assets.
Disregard for the need to monitor or reduce risk of misappropriating
assets exists.

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 Where are the Fraud Vulnerabilities and Why do they Occur
There is a disregard for internal controls
Some of the commonly given reasons for committing Fraud –
1. Everyone else is doing it
2. I needed the money
3. I meant no harm and did no harm
4. The organization can afford it
5. I was used and needed revenge
6. What I did was entirely right for someone in my position
7. My employer did not compensate me well enough and hence I took
what was due to me
8. Bribery is a norm in this type of business
9. I did it to keep the business afloat
10. It was a loan and I would have repaid it

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Opportunities
Circumstances may exist that create opportunities for management or other
staff to commit fraud. When such opportunities arise, those who might not
otherwise be inclined to behave dishonestly may be tempted to do so. Even
individuals under pressure and susceptible to incentives to perpetrate a fraud
are not a grave threat to an organization unless an opportunity exists for
them to act on their need. An opportunity must exist to commit fraud, and
the fraudster must believe the fraud can be committed with impunity.
Opportunities may also be inherent in the nature, size, or structure of the
business. Certain types of transactions lend themselves more than others to
falsification or manipulation, as do certain kinds of balances or accounts.
There is a presence of large amounts of cash on hand or inventory
items.
There is an inadequate internal control over assets.
Inadequate segregation of duties.
Absence of mandatory job rotation and vacations.
2.2 Fraud Diamond
Wolf and Hermanson (2004) introduced the fraud diamond model where
they presented another view of the factors to fraud. The theory adds fourth
variable “Capability” to the three factor theory of fraud triangle. Wolf and
Hermanson believed many frauds would not have occurred without the right
person with right capabilities implementing the details of the fraud. They
also suggested four observation traits for committing fraud:
Authoritative position or function within the organization.
Capacity to understand and exploit accounting systems and internal
control
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Confidence that he/she will not be detected, or if caught, he/she will
get out of it easily.
Capability to deal with the stress created within and otherwise good
person when he or she commits bad act.
The Fraud Diamond theory states that all these 3 ingredients are essential
but the critical component in turning the fraud opportunity into reality is
“Capability”. The fraudster should have the necessary traits and abilities
to be the right person to pull it off and also the confidence and ego that
he will not be detected or he will be able to talk himself out of trouble if
detected.

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 Where are the Fraud Vulnerabilities and Why do they Occur

2.3 Fraud Pentagon

Cressey’s classic fraud triangle helps to explain many situations, but today’s
fraudster is more independent-minded and armed with more information
and access than were available to perpetrators in the 1950s. In addition, few
would deny there have been significant cultural changes in the past 60
years. The fraud triangle can be expanded further to a Crowe Horwath’s
Fraud Pentagon, where an employee’s competence and arrogance are factored
into the 3 conditions generally present when fraud occurs. The two additional
aspects in the Fraud Pentagon are:
[Link]: It is an extension on the element of opportunity to
include an individual’s ability to override internal controls and to socially
control the situation to his advantage
2. Arrogance (lack of conscience): It is an attitude of superiority and
entitlement or greed on the part of the perpetrator who believes that
company policies and procedures do not apply to him.

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Where are the Fraud Vulnerabilities and Why do they Occur

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2.4 Fraud Scale

This is another theory on Frauds propounded by Steve Albrecht which states -
Situational pressures, perceived opportunities& personal integrity
are the 3 factors that lead to frauds–
When situational pressures & perceived opportunities are high &
personal integrity is low, occupational fraud is much more likely to
happen than when the opposite is true.
It also states that perpetrators hard to profile & fraud difficult to predict.

2.5 Fraud Circle

Another notable theory relating to Fraud is of ‘Fraud Circle’. This theory
recognizes the fact that fraud is Omni-present everywhere and wherever
there will be money there will always be Frauds
2.6 Hollinger Clark Theory
Hollinger and Clark study was based on a total of 12,000 employees of
various organizations. They found that nearly 90% engaged in ‘work place
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deviance’ which included behavior such as gold bricking, workplace
slowdowns, sick time abuses and pilferage. On top of that, an astonishing
one third of employees actually had stolen money or merchandise on job.
The researchers concluded that the most common reason employees
committed fraud had little to do with opportunity, but more with motivation.
The more dissatisfied the employee the more likely he or she was to engage
in criminal behavior. This is described as employees taking wages in kind.

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 Where are the Fraud Vulnerabilities and Why do they Occur

Hollinger and Clark concluded that everyone had a sense of their own
worth, if they believe that they are not being fairly treated or adequately
compensated, statistically the organization is at much higher risk of
employee related frauds.

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Where are the Fraud Vulnerabilities and Why do they Occur

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