29th October 2017 | Fraud | by Dr Alexander Schuchter

“Trust, but verify” – I can only agree with this to a certain extent. If you conduct too many checks on someone you profess to trust, it will generate mistrust … I’m not sure whether this is really conducive to a positive collaboration. It’s like marriage. If you don’t trust your partner, it’s better not to marry in the first place.”

Statement by a fraudster | personal interview

 

 

When I lead in-company training sessions on forensic subjects, I’m frequently confronted with one question: “Is there a single common denominator for all types of fraud?”

Yes, there is! My answer may seem surprising. But virtually all fraudulent behaviour has one thing in common: a massive breach of trust.

What is fraud? Examples? What triggers fraud?

Definition of fraud

To define fraud, we need to take a look at research. In business management, law and social sciences, the term „fraud“ is frequently used as a synonym for actions which are criminal, fraudulent, deviant, delinquent, unlawful or classed as economic crimes.

The opposite of fraud is legally permissible action and compliance with legal requirements. Managers who act according to the latter principles are regarded as being honourable and possessing business integrity.

Etymology of the Latin word “dolos”

In German, the word used in this context for “fraudulent behaviour” is “dolos”, a Latin word which means “to deceive with intent and act underhandedly”. “Dolos” is occasionally suffixed by the word “malus”, which emphasises the premeditated aspect of the action and distinguishes it from an action committed through negligence.

Audits: “dolos” or merely containing errors?

International standards for internal and external audits make a clear distinction between:

  • fraudulent behaviour and intentional misrepresentation – aka “fraud” – and
  • unintentional errors or non-compliance without intent to deceive – aka “error”.

It is often extremely difficult to prove that someone has acted with malicious intent. As it is not generally acceptable to accuse a person of wilful wrongdoing the moment a legal requirement is violated, audits speak of “irregularities” as an umbrella term.

In internal audits many types of fraudulent behaviour can be observed. External audits, however, differentiate solely between:

  1. fraudulent financial reporting
  2. and misappropriation of assets.

This is due to the respective areas of responsibility to which the auditors are assigned, and their assessment of risk. Public accountants are primarily responsible for checking the annual accounts, whilst the internal auditor has a wider scope of work.

Examples of fraud

When I began writing my doctoral thesis at St. Gallen University (HSG) a decade ago, I thought – somewhat naively, as I now realise – that I could simply inspect the relevant files to learn more about some of the more renowned cases of white collar crime.

But when I entered the court library – my motivation levels as high as the 3m ceiling – and asked to see the file for a particular case, the judge raised an eyebrow. “All the files you see here in these 30m long shelves – they’re all for this one case!” was his reply. This was the moment I realised that such cases are far more complex than crimes of violence.

Internal vs. external fraud

In business practice, I think there is little point in the commonly accepted distinction between “internal” and “external” fraud. Before making this theoretical and abstract distinction, we should be clear about one fact:

Much of the fraudulent behaviour which has come to my knowledge, e.g. corruption and bribery, involves at least one employee and one external accomplice. So fraud is often a mixture of “internal” and “external”.

Examples according to frequency and level of damage

The examples for fraud listed here occur frequently in practice, as I have learned from my experience as a managing director and former Big Four auditor. They result in heavy financial losses. Very few of the cases are ever made public, for fear of damaging the public image of the companies concerned.

In practice, it is meaningful – particularly with regard to risk assessment – to differentiate fraud according to frequency and level of damage.

In my professional experience, I frequently encounter the following types of fraudulent behaviour:

  • bribery, corruption
  • embezzlement, misappropriation, breach of trust, misuse of company property
  • forgery of documents, false identities
  • insider crimes, insider dealing
  • insolvency crimes, fraudulent loans
  • IT- and cyber crimes
  • obtaining credit by false pretences, insurance fraud
  • moonlighting, social crimes
  • social engineering, CEO fraud or fake president fraud
  • customs offences
  • tax evasion
  • blackmail

In comparison, the types of fraud in the following list come less frequently to the public notice. However, these are the crimes which result in the heaviest financial losses and bring consequences in their wake which threaten the very survival of the companies involved:

  • financial statement fraud
  • damage to the company image through fake news
  • product piracy, industrial espionage, trade mark abuse
  • violations against competition law
  • money laundering

Obviously, different types of companies will be affected by the various types of fraud to different degrees. For example, the risk of money laundering is higher in the financial services sector than in other industries.

Tip: Risks are company-specific, individual, and need to be reassessed regularly. One should be particularly mindful, for example, during company restructuring processes. Risks can only ever be recognised if employees have the respective awareness!

Ignorance of the law is no defence

When I drew up the above-listed division according to frequency and level of damage, my focus was solely on the financial losses involved. The list does not take into account personal liability risks, tarnished reputations and the personal consequences for senior executives.

In many of my interviews with managing directors, I realised that the people in charge often don’t realise that they themselves can be deemed culpable if their employees engage in fraud. And ignorance of the law is no defence. The consequences are ruined careers, a loss of prestige, financial penalties, imprisonment, susceptibility to blackmail, estrangement from family etc.

Practical tip: Have you taken all possible measures to ensure your employees do not commit fraud? Have such measures been documented with the required diligence?

The old saying “NOT DOCUMENTED, NOT DONE” applies here! Such documents are taken into account in sentencing – and a court will give you credit for such measures, provided they have actually been implemented!

What triggers fraud?

Why do people commit fraud? Who is the best person to answer this question?! Exactly – fraudsters themselves. Without doubt, only the white collar criminals know the background and the triggers which explain their fraudulent behaviour.

As you may well imagine, a researcher – who is independent and not personally involved in the specific case – will obtain the most honest, and hence the most valuable information by conducting interviews with offenders on a voluntary basis.

Working with one of Europe’s leading universities for business studies, I had the best possible conditions for preparing and evaluating numerous interviews with high-ranking offenders.

Interviewed fraudsters provide insights

It was not until I had conducted several dozen personal interviews and scientific discussions with fraudsters that I was able to recognise recurring patterns for fraud. I’d like to share with you a few glimpses into the worlds of convicted offenders.

Laymen are puzzled, professionals scratch their heads

So-called “experts” who have never or rarely had any serious or independent talks with offenders explain to companies the reasons for fraud – and are often able to make their voices heard! These “expert” consultants bandy around presumptions which have little to do with the reality.

A practical example: It is wrong to presume that fraud is solely triggered by monetary concerns! Particularly when the financial stakes are high. This is one of the most common misconceptions, and can lead you to draw catastrophic conclusions. Consult specialists with proven expertise!

Explanations from business reality

In my interviews with offenders, one of my aims was to investigate the most widespread approach for explaining white collar crime – the “Fraud Triangle”.

This triangle constitutes an essential tool for auditors, compliance specialists, risk managers, forensic experts and other professionals. It says that fraud is committed when the following 3 elements merge:

Fraudsters assess the fraud triangle

The perspective offered by the “Fraud Triangle” is limited. Reality cannot be compressed into 3 elements which explain fraud. In each of my interviews with offenders, I was able to pinpoint roughly 30 themes which prepared the ground for the offence, to lesser or greater degrees.

I’d now like to give you 3 pieces of background information:

  1. Without exception, there has to be opportunity in order for any malicious action to be committed – an opportunity which also has to be taken. To be blunt, no malicious action will be committed if there is no opportunity to do so. Nonetheless, this element alone is not sufficient. Something more is required.
  2. Pressure as a motivating factor is something which offenders frequently describe as a major trigger for committing the offence in question. This is an important insight when it comes to internal investigations or prevention. Taking this as a starting point can be particularly effective.
  3. There’s also news when it comes to rationalisation. Up to now, people assumed that offenders were listening to an inner voice which justified their actions. To my surprise, I found the opposite was the case: a fraud-inhibiting inner voice urged the offenders not to commit the offence – but the inner voice had an “expiry date“. The aim should be never to reach the expiry date. Once the expiry date has been reached, opportunities are grasped. How never to reach the “expiry date” is something I teach in my in-house training courses.

Last but not least

Understanding the motives of the offenders is essential – not only for internal investigations, but also in order to prevent future fraud. It is easier to identify patterns which recur. For prevention, it is decidedly advantageous to understand the approach taken by the offenders.

The Latin word “dolos”, in other words, means “fraudulent”. The companies affected by such crimes often mistakenly explain the white collar crimes as having been triggered by greed. But in reality, the offences can neither be nailed down to a single trigger, nor squeezed into the triangle mould. Understanding the way offenders think and act offers more clarity. Because without profound expertise, the consequences can be severe.

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Dr. Alexander Schuchter

I have been working in forensic since 2008 – but not as a fraudster! As Managing Director of Schuchter Management GmbH, I support executives and companies.

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