Most of us possess a high level of personal integrity that precludes us from considering the temptation of accepting the opportunity to commit fraud. Unfortunately, a good number of people do succumb to the lure of fraud. The frauds these unscrupulous individuals perpetrate can be extremely devastating. Fraud takes many shapes. It can occur internally or externally. The criminal activity at the heart of the financial crisis was subprime loan frauds, mortgage fraud, corporate fraud and investment fraud (Ponzi schemes). Other significant financial frauds include insider trading, bankruptcy fraud, credit card fraud, embezzlement, check fraud, loan fraud, and identity theft and fraud. The success of these schemes, usually hinges on the ability to safely launder the proceeds of the illicit acts.
There is an important nexus between fraud and money laundering. Any discussion regarding fraud should include money laundering. To succeed, fraudsters must have a mechanism to legitimize their ill-gotten gains. Laundering the proceeds of fraud provides an air of authenticity and more importantly, immediate access to the funds. Although the various types of fraud contain different characteristics and warning signs, they are all contingent on five common elements: Integrity; Opportunity; Incentive, motivation or pressure; Rationalization or attitude; and Capability.
The starting point is individual integrity. Does a person have the integrity to resist opportunity? If yes, fraud is an afterthought. If a person’s integrity is compromised, it’s usually because pressure and rationalization lead that individual to give into the enticement of opportunity. Opportunity is the driving factor. Without opportunity, a fraud scheme cannot succeed. Likewise, if an individual’s integrity is influenced by pressure and rationalization, and the opportunity presents itself, unless the individual possesses the capacity to commit the fraud, the scheme will not succeed. The capacity represents the combination of being in a position to commit the fraudulent act(s) and having the skill sets necessary to carry the fraud off.
The first step toward thinking like a fraudster is to understand how the five elements or fraud traits fit together to influence the bad guy. I introduced the idea of the fraud continuum in the early 1980s, when I taught fraud awareness classes. The fraud continuum is the intersection between integrity and opportunity. The point of intersection of the two lines of the continuum creates four quadrants. The vertical line represents opportunity. The bottom of the line affords limited opportunity, while the top of the line represents a high level of opportunity. The vertical line represents integrity. Limited integrity is on the far left side of the line and high integrity to the far right. The lower right quadrant represents where integrity is high and opportunity low. This is where people are least likely to engage in fraud. The upper left side of the quadrant is where opportunity is high and integrity low. This is where people are most likely to commit fraud. The other two quadrants represent moderate risk. This is where the combination of pressure, rationalization and capability most influence an individual’s integrity.
The fraud triangle was introduced by Donald Cressey in 1973. The triangle consisted of three factors: opportunity, pressure and rationalization. These factors were long believed to be why individuals committed fraud. Opportunity is the chance to commit fraud. Pressure or incentive represents the motivation, and is usually driven by financial demands. Rationalization is the self-justification making the fraudulent act acceptable. The fraud diamond was introduced by David T. Wolfe and Dana R. Hermanson in 2004. Basically, they added a fourth dimension to the fraud triangle. Their reasoning was that unless a fraudster possessed the capability to commit a fraud, opportunity, pressure and rationalization by themselves were not enough to succeed. Capability required being in the right position at the right time and possessing the needed skill sets to perpetrate the fraud.
Once you understand how to think like a bad guy, you can better position yourself to identify and investigate fraud schemes by breaking down spin and deception. Understanding the crime problem is the first step toward conducting a successful investigation. Good fraudsters usually have an exit strategy. When they realize their scheme has been, or will be, detected in the immediate future, they put their exit strategy in place. With that in mind, from an investigative stand point, you must have an end game. You don’t want to see a fraudster disappear and abscond with the proceeds of their criminal activity. There are two prominent end games. One has a private sector focus, the other, a public sector focus. On the private sector side, the end game is to prevent or minimize monetary losses and reputational risk. On the public sector side, it is to seek prosecution, recover illicit proceeds and assets through forfeiture, and/or bring enforcement actions. Both end games could carry significant consequences. In either event, understanding how the bad guys think and taking preemptive steps to stop them makes the end game easier to handle.
For more information about frauds and scams, contact DML Associates.
Dennis M. Lormel
DML Associates, LLC