The Fraud Triangle and Protecting Your Business from Fraud

Video Transcript 

My name is Robert Bonavito, New Jersey forensic accountant. This video is part of a series of videos where I discuss forensic accounting topics for educational purposes only. If this was a litigated matter, I would take a different approach, had different conclusions based on different facts and circumstances.

Today's topic is gonna be fraud. Who commits fraud, and why? And mainly what I'm gonna discuss is called the "Fraud Triangle." And, we can involve in a lot of business fraud and one of the first things we do is we evaluate who in the company would be most likely involve in a fraud. And to do this, we have to know why do employees commit fraud? And you're saying, "Well, there's not that much fraud." If I told you the amount of fraud that happens in the world is over a trillion dollars a year, that's how much money is stolen or misallocated year in, year out.

Now, remember, the gross product in nominal terms for the world is about $71 trillion. That equates 2% or 3%, I think. A trillion dollars is a lot of money. Can you imagine if you open your bank and found a trillion dollars. But, that's what is taken from companies illegally by individuals annually, a trillion dollars. Back in the early 20th century, Donald Cressey invented what's called the Fraud Triangle, it's something we use to this day, and it kinda explains who would steal or why they would steal.

We had a case where there was a bookkeeper or a company rather, and the owner called me, he said, "Bob, I run this manufacturing company for 20 years. Things were going good 10 years ago and lately, I don't understand why I'm not making money. I'm actually borrowing money to make payroll. And for the first time, I have a line of credit and yet we're busy. I just don't understand where the money is going." And so he had us go in there and we went in and we looked at the fraud triangle and I zeroed in at the bookkeeper right away, because we found out that the owner was very busy, he had a very capable bookkeeper.

And when you run a small business and you have somebody who's a very good employee, you rely on them more and more and more and more. And this employee had everything from his signature stamp and basically did all these finances for him, payroll and everything.

So, we went back and we looked at...we did a transaction search and we found that four or five years ago back, he actually paid his American Express bill with the company check. And then, three or four months later he put himself on payroll, gave himself a small raise, and he gave himself a bigger raise, end up doubling his salary. He set up dummy companies where he would transfer the money from the company to these other vendors, who were supposedly vendors but was really his company. He was transferring money to his mother's account and a couple other ways he was stealing money. And the reason we kinda zeroed in actually, it was kinda obvious, three or four people who could've been stealing money.

But by using the fraud triangle, we sat down and we looked at the company charts and we said, "Well, who has the perceived opportunity, who has the perceived pressure, and who can rationalized this?" I would add another part to this triangle and I would call it the diamond because I would add capability to this triangle, because if you have three of these criteria you still can't steal unless you have the capability to steal. And with the bookkeeper, he kinda felt like he owned the company because he was working so much and he did so much, and maybe he was insulted because the boss never gave him big enough raises. And that was his rationalization for stealing. He couldn't make his American Express bill and he stole.

Pressure. He wanted to live above his means. He wanted a nicer car. He wanted to impress his mother. And he wanted to show off in front of his friends. And he had the opportunity because of the business owner, he's busy running the business. So he's scratching his head, like, "Why am I borrowing money to make payroll when we're busier, the sales are up," and the accountants, they would have accountants go in and do the compilations but they weren't looking for fraud like we were. So we were able to prepare reports, quantify the damages, we actually testify, he went to jail. Most of the money wasn't recovered unfortunately because he had very...even though he was stealing money left and right, he didn't have any excess assets.

But here's a case where we have what's called an accidental fraudster. And what that is is someone who stumbles upon it. This guy was not a thief when he came into the company, he became a thief. And probably when he gets out of jail, he will go to another company. If they don't do a background check, he will steal from them. And see, that's when you become a predator. And there are a lot of predators out there and you will never know a predator because they're usually the nicest, it's very difficult to know that you have a predator on hand. When you have a predator, what they do is they seek out weaknesses in internal control. Okay?

An accidental fraudster, they kinda stumble upon it. And they have opportunity, they meet the opportunity, pressure, and have the capability to steal. But, when you get these predators in your company they actually seek out weaknesses in your internal control, extremely dangerous because the number one way to stop people from stealing is in their mind that they think they're gonna get caught. But when you get a predator in your company, and a lot of people get predators, they don't realize they don't do background checks, they don't check them out, they don't have friends who are accountants come in there and just make sure things make sense.

If you have a predator in your company and you give them a signature stamp, and you let them control the payroll and you don't segregate the duties, open your bank statement, don't let them open the bank statement, do the bank work. I know things are tight and you're busy, but if you get a predator in your company they can steal hundreds of thousands of dollars and you will never notice. Because it's not like they do it at once, they do it over a long period of time, we see a lot of this. So be careful with that, make sure you keep control, open your bank statements.

If you hire someone do a background check, if you feel uncomfortable, get a forensic accountant in there to look at it. Because your accountant is not looking for fraud, probably won't find it unless you specifically tell them there's an issue and a lot of times they don't.

So again, the three things that we look for is perceived opportunity, pressure, rationalization, and I would put capability. Because if you don't have, you may have all these three but if you don't have the capability to steal, you don't understand how to steal, you're not gonna be able to do it. There's other things we use, one is called MICE, an acronym, it means Money, Ideology, Coercion, and Ego.

If you look at somebody who's most likely to steal from a company and studies had been done and what it does is it's not the person in the warehouse, it's not someone in the accounts receivable or something like that, it's usually the most educated person. And they usually have access to, you know, like I said, they can actually collude and hide their earnings. It's the person who you'd lease likely think would be stealing is the one who is stealing, as was the case in that one manufacturing company. This guy, they were best friends and he would never think he was stealing but he was. Be careful. And if you have any questions concerning this video, please give me a call. My name is Robert A. Bonavito, New Jersey forensic accountant.