Occupational fraud is a risk faced by businesses of every shape and size and the financial and reputational damage can be significant. Fortunately, there is a tool that can help you understand why people commit fraud so you can tackle it head on: the fraud triangle. This guide explains the theory behind the fraud triangle and how you can use it to implement fraud prevention measures.
What Is the Fraud Triangle?
The fraud triangle is a tool used by anti-fraud professionals to explain the conditions that drive occupational fraud. It is made up of three components: motivation, opportunity, and rationalization.
The theory behind the fraud triangle is that fraud doesn’t occur out of nowhere. There are factors in the workplace and broader environment that can increase the risk that a person will be tempted into committing fraud. Understanding these factors can help a business take preventative measures and implement internal controls.
Who Commits Fraud?
Research shows only 4% of fraudsters have a prior fraud conviction and 86% have never been punished or lost a job because of a fraud-related violation. This makes it difficult for companies to screen for potential fraudsters in the hiring process.
In addition, fraud experts say that most people are tempted to commit fraud in certain circumstances. This phenomenon is explained by the 10-80-10 rule, according to which:
- 10% of people would never commit occupational fraud
- 10% of people actively seek opportunities to steal from their employer
- 80% might commit fraud if they have motivation, opportunity, and justification
The fraud triangle helps businesses to understand the 80% of their employees who have the potential to engage in fraudulent behavior and create an environment that reduces that risk.
Let’s dive a little deeper into each of the three components of the fraud triangle.
Motivation
A person who commits fraud is often under some form of pressure – or perceived pressure. It could be a personal financial problem, such as gambling, substance abuse, or medical bills, or a work-related pressure, such as challenging sales targets, investor expectations, or a round of layoffs.
Motivation can also come from the broader environment. For example, an interest rate rise or stock market crash could put employees under financial pressure and make them consider where they could get more money.
Social psychology tells us that a desire for status and recognition can be just as powerful a motivator as a desperate need for cash. For example, an employee overlooked for promotion may feel compelled to steal from their employer to protect their social status.
Opportunity
The risk of fraud increases when there is a perceived opportunity. If an organization has inadequate checks and balances in place or a weakness in security processes, this could make an employee feel that they can commit fraud easily without getting caught.
The risk of fraud increases, for example, when a company is short-staffed and doesn’t have the manpower for the usual scrutiny of financial statements.
Rationalization
Even with an opportunity and a motive, a person may resist the temptation to commit fraud if they cannot justify their behavior. However, many fraudsters reason that committing fraud is fair, just, or reasonable. Common rationales include:
- “I deserve it”. Employees may feel the company deserves to be punished or owes them something because they have been undervalued or underpaid.
- “It’s a victimless crime.” Fraudsters may reason that there is no harm in taking other people’s money if it will go unnoticed or be reimbursed through insurance.
- “Everyone’s doing it – including my boss.” If occupational fraud is widespread in an organization or industry or seen to be condoned by management, it can become normalized. An individual may feel it is only fair if they get a piece of the action.
- “It’s nothing to them.” If there is a lot of waste and excess spending, employees may feel that the company’s assets would be better spent on their personal gain.
10 Tips for Preventing Fraud With the Fraud Triangle
Here are some of the measures you can take to tackle the three elements of the fraud triangle and reduce the risk of someone committing fraud in your organization.
1. Get to Know Your Employees
According to one study, 85% of fraudsters display at least one red flag. If you know your staff, you are more likely to be aware when an employee has a sudden change in circumstance or behavior – either of which could indicate an incentive for fraudulent activities. This gives you an opportunity to:
- offer support
- monitor red flags
- resolve workplace grievances
For example, if you learn that an employee has a gambling addiction, you could guide them toward treatment, implement IT solutions to prevent gambling on work devices, and control the employee’s contact with cash.
2. Offer Good Benefits
Benefits like subsidized mental health services, comprehensive health insurance, and paid compassionate leave can ease financial pressure and encourage loyalty, undermining potential motivations for committing fraud.
3. Keep On Top of Cybersecurity
To remove opportunities for fraud, invest in internal controls that limit and track access to digital assets and other funds. Data monitoring and machine learning can help identify patterns and anomalies but even simple measures like multifactor authentication and log-in alerts can make a difference.
4. Don’t Rely on Honesty
Timesheets, expense reimbursement requests, and contractor invoices should all be checked. Limit the number of people with company credit cards, and, where appropriate, separate duties to avoid conflicts of interest e.g. keep purchasing separately from payables. These measures limit opportunities to commit fraud.
5. Tweak and Test Systems
For potential criminals, an unmonitored account, lazy supervisor, or outdated security system is an opportunity. Be sure to test, monitor, and maintain your anti-fraud processes regularly to close every perceived opportunity.
6. Promote Financial Transparency
Show your staff how company money is spent. Be open about major costs and financial challenges. Be especially vocal when reinvesting in the business or employee well-being. If it’s clear that money is not wasted or flowing into the CEO’s pocket, they may have a harder time justifying fraud.
7. Have a Zero Tolerance Approach
If managers openly expense a few extras on a company retreat, it sends a message that it’s okay to commit fraud. If you let small stuff go unnoticed, employees will be better able to rationalize a violation of your financial trust. They may not even realize that certain actions are considered a crime.
8. Invest in HR
A well-run HR department will tackle problems like discrimination, bullying, and labor law breaches, which can easily develop into grievances that can become a rationalization for committing fraud. It can also help by assessing employees to determine if they have any major red flags.
9. Promote Based on Merit
Feeling underappreciated and underpaid is a major incentive for committing fraud. A formal system of performance reviews, clear and fair KPIs, and transparent criteria for performance bonuses are some of the practices that can promote a sense of fairness.
10. Have a Tip-Off System
Employee tips are one of the best ways to pick up on occupational fraud. Make it as easy as possible for your staff to blow the whistle so you can stamp out opportunities for fraud.
Fraud-Proofing With the Fraud Triangle TL;DR
No matter how carefully you screen new hires, many of your employees will be capable of committing fraud – in the right circumstances.
The fraud triangle outlines the key drivers that make people commit fraud: motivation, opportunity, and rationalization. As a business, you can leverage the theory behind the fraud triangle to take proactive steps to minimize the risk of occupational fraud.
Robust internal controls, a fair and supportive work environment, and a zero-tolerance approach are all practical measures that can safeguard your business from the potential financial and reputational harm associated with occupational fraud.