Fraud happens: a primer on lying, cheating, and stealing.

• Author: Hayes, Arthur A., Jr.
• Position: Fraud detection in government organizations

Pointers to help educate managers about the real risks in the organization and how to detect fraud.

During many conversations with auditors and in training programs, the author has come to believe that the "practice" of public accountancy, particularly relative to auditing, is grounded on experience. Education and training are essential to a mastery of the basic concepts of the. profession, but seasoned judgment is based on experience. Yet, auditors are not gaining much real life, first-hand experience in auditing for fraud. The author's informal survey of participants at presentations and courses on fraud indicates that less than 5 percent acknowledge ever having conducted a fraud audit or otherwise having had experience with fraud.

This article draws on the author's long experience in auditing and teaching to capture a few of his basic concepts about fraud. It is not an exhaustive treatise on the subject, but it may give the reader a new perspective on fraud and a practical frame of reference for detecting fraud. These concepts are presented to give the auditor every advantage possible in the battle against fraud and the persons who perpetrate it.

How Does Fraud Happen;

Many frauds begin as honest mistakes--nothing more, nothing less. What happens when an employee makes a mistake and does not get caught? A brand new employee, for example, is assigned the responsibility of making daily deposits. The employee makes the deposit for the first few days with no problems, then one day forgets to do it. After waking up in a cold sweat in the middle of the night, the employee races into the office the next morning to find the bank bag. It is all still there. Feeling unsteady about the matter, the employee goes to the boss and confesses. What is the boss' reaction? "That's okay, don't worry about it."

The situation reveals a slackness in the system, an indifference to good controls, an opportunity. Maybe at first the employee might just hold some of the deposits for a while to see how the system reacts, not spending the money so as to be able to turn it in as an oversight if caught. Eventually, and it will not take very long, the employee gets tired of just practicing and starts keeping some of the money, realizing that things are such a mess that it probably will be possible to stall any questions long enough to cover the theft. The above scenario is generally true--fraud happens.

To be able to detect fraud, one must have insight into the actions and the techniques of the frauder. It does not take a genius to steal. Most of the fraudulent situations that the author has investigated were relatively easy-to-understand and easy-to-perpetrate schemes. There are three types of people in the world.

* Those who would not steal anything. One could leave $1,000 on a table, unattended, and if these people came across the money, they would not only not steal it but would be so terrified that this money was just lying there that they would rush out to find someone in authority to take charge of the money. This group is extremely small and getting smaller. Such persons can be thought of as "corruption impaired."

* Those who will steal if the circumstances are right. Such people, coming across the $1,000 would count the money, look around and assess the risk of being stopped with the money or being seen leaving the room, considering whether the location is a place where they are known, or whether, if stopped on the way out, it would be possible to say they were on the way to turn it in. The most important question these people would have is "Who's money is this? If it is public funds, who is going to get personally upset about the theft of public funds? No one." The greater the amount of money, the more risk these people may be willing to take. This is a large category of persons often called "opportunists."

* Predators. These persons are at the other extreme of the continuum: they may have started as opportunists, but then they could not stop. When they are found stealing, these people frequently are found to have a long history of stealing. The author calls these people "gifted."

Fraud happens because almost anyone can move to the opportunist level. Internal, personal factors, such as an acute need of money--due perhaps to sickness or other unfortunate circumstances or personal problems, such as dysfunctional relationships or addictions--combine with situational factors--unguarded money, for example--to grease the skids for them.

Under the right circumstances, anyone can become gifted. And, as personal needs become greater, perpetrators will be motivated to overcome greater and greater hurdles in their quest for payday. Even if the organization has a fairly well-designed internal control structure, the truly motivated criminal will find ways to attack it

The author frequently invites participants in fraud seminars to take the true or false self-administered test shown in Exhibit 1, the Pretest for Fraud Potential. He interprets a score of more than seven trues to indicate that the test taker is probably approaching the gifted category. This test was developed after many years of studying frauders, particularly talking with them after they had admitted their actions. The point is, frauders are people just like any others encountered in a government office or private enterprise.

[Exhibit 1 OMITTED]

Disincentives for Finding Fraud

Auditors do not adequately detect fraud. Most people, whether auditors or not, desire not to be required personally to find fraud because they are uncomfortable accusing someone of dishonesty. They prefer to depersonalize matters: It is easier to talk about "weak internal...