Occupational fraud continues to wreak havoc on businesses around the globe, with annual losses for the typical organization estimated by the Association of Certified Fraud Examiners at 5% of revenues. Fraud experts have long suggested that the presence of three conditions, known as the “fraud triangle,” greatly increases the likelihood that an organization will be defrauded. And, over the years, some have suggested additions to the triangle.

Classic shape

The classic fraud triangle, as conceived by criminologist Donald Cressey, consists of:

Pressure. A perpetrator generally experiences some type of personal pressure that motivates the fraud — for example, pressure to maintain a high standard of living, pay off debt from credit cards, medical bills or gambling.

Rationalization. Perpetrators must be able to mentally justify their fraudulent conduct. They might tell themselves that they’ll pay back the money before anyone misses it, or reason that:

• They’re underpaid and deserve the stolen funds,
• Their employers can afford the financial loss,
• They’ll lose everything (or someone) if they don’t commit fraud,
• “Everybody does it”, or
• No other solution or help is available for their problems.

Most employees who commit fraud are first-time offenders who don’t view themselves as criminals but as honest people caught up by circumstances beyond their control. By rationalizing, perpetrators overcome ethical barriers that generally guide their conduct.

Opportunity. Without opportunity, even motivated and rationalizing would-be perpetrators can’t commit fraud. Occupational thieves exploit perceived opportunities that they believe will allow them to go undetected. Poor internal controls, weak management oversight and ineffective or nonexistent audits all create opportunities for fraud. Note that the opportunity leg represents the best avenue for preventing fraud because it’s within an organization’s control.

New dimensions

Since Cressey’s original fraud configuration, other experts have proposed expanding the conceptual framework to account for societal influences, integrity, arrogance, competence, personal greed and employee disenfranchisement. But perhaps the most widely supported addition is what’s being called capability — the fourth leg of the “fraud diamond.”

Not every employee with motivation, rationalization and opportunity commits fraud. Some people, the theory goes, have a mindset that makes them more able to commit ethics violations or break laws without experiencing the guilt or stress that might afflict others. Capability comprises a range of considerations, including position, intellectual capability, confidence, resilience to stress and guilt, and ability to coerce and cajole others.

Yet another modified theory, called the MICE (Money, Ideology, Coercion and Ego) model shares similar considerations with the fraud diamond. MICE retains the original three sides of the fraud triangle but shares the opportunity leg with a second triangle that also has sides for criminal mindset and arrogance.

Fraud perpetrators with characteristics matching the original motivation/rationalization/ opportunity triangle are categorized as “accidental fraudsters” who wouldn’t commit fraud in the absence of motivation. Those on the side of the criminal mindset/arrogance/opportunity triangle are deemed predators, or pathological fraud perpetrators. These individuals require only opportunity.

Red flags not proof

It’s important to remember that the presence of the conditions discussed above doesn’t constitute proof that fraud has been committed — or that an individual will commit fraud. Rather, the fraud triangle and its variants are designed to help organizations identify risk and understand the importance of eliminating the perceived opportunity to commit fraud. All of your clients should conduct a review of their organization’s system of internal accounting controls at least annually to mitigate the risk of employee fraud. If one of your clients suspects a specific fraud event might actually have occurred, consider engaging a forensic accounting expert to conduct a thorough investigation.

For more information, please contact Kevin Walker, CPA, Partner.