Ten Reasons Frauds Occur

In my roles as Head of Internal Audit and International Forensic Co-ordinator, in both Philips and De Beers, I have had many years of experience investigating frauds. Based on this experience I have put together my personal “top ten” list of reasons why frauds occur.

1. Greed - good old fashioned human nature intervenes when an individual, or group of individuals, sees a chance to make “a fast buck”. A good example being those cases where people “adjust” their expense claims upwards.

2. Lack of transparency - complex financial transactions that are difficult to understand are an ideal method to hide a fraud. The Barings fraud was perpetrated by use of an accounting “dump account” that no one understood.

3. Poor management information – where a company’s management information system does not produce results that are timely, accurate, sufficiently detailed and relevant; the warning signals of a fraud, such as ongoing theft from the bank account, can be obscured.

4. Excessively generous performance bonus payments – the more generous the bonus, when coupled to a demanding target; the more temptation there is to manipulate results, such as year end sales figures, to reach that target.

5. Non independent internal audit department – where an organisation’s internal audit department is not independent, eg the where it does not report to a truly independent audit committee but to the Finance Director, the more likely that when there are signals that a fraud is occurring the more likely they will be ignored. It is indeed interesting to note that Cynthia Cooper (Head of Internal Audit at WorldCom) had to bypass her boss (the CFO) and go directly to the audit committee to report the discovery of the capital expenditure fraud.

6. Lack of clear moral direction from senior management – leadership comes from the top. Where the senior management indulge themselves in “semi corrupt” behaviour, eg adjusting their expense claims upwards, others will follow adopting the well worn mantra “everyone’s at it”.

7. Excessively complex organisational structure - designed to obfuscate the revenue streams; and so hide reality from third parties, such as the Internal Revenue Service. Enron, with its complex off balance sheet structure and transactions, is a textbook example of this.

8. Poor accounting controls– where the accounting controls, such as a monthly reconciliation of the bank account, are lapse the signals that a fraud has occurred will be missed.

9. Arrogance – some people believe that they are better than “the system”, and that they can get away anything. The late Robert Maxwell (of the Mirror Group) plundered his company pension scheme, arrogantly assuming that since he was chairman of the company he could get away with it; he almost did!

10. Complacency – I have met many a manager who has an almost childlike faith, based in part on the “old boy” network, in the probity of their colleagues; believing that fraud “is not the sort of thing that could happen here”. Others will, and do, take advantage of that trust.

My simple advice is, if you think that a fraud may be happening then fear the worst; because it probably is.