The social side of fraud

Research Findings: Fraud survey says ...

This new column provides an outlet for new research into fraud and related studies. The ACFE doesn't necessarily vouch for the methods and results of any research in these columns. This material is food for thought. — ed.

Organizational leaders, fraud examiners and auditors might not fully appreciate the social nature of many fraudulent acts. In fact, many of us think of a fraud perpetrator as a cold, calculating individual — a "bad seed" — who opportunistically takes advantage of internal control weaknesses. Research that we've conducted lends new insights into the social side of fraud. We specifically studied collusion and organizational culture in the perpetration of fraud. Results from both studies provide valuable insights for fraud prevention and detection. 

In our first study, we interviewed convicted fraud perpetrators from three large U.S. federal prisons and found that 37 of 63 (58.7 percent) of interviewees stated that their fraudulent activity directly involved more than one person.¹ As the CFO at the center of a major corporate collapse commented:

No one really acts in isolation on that big of a scale if you really think about it. There might be some desperate acts — and people no doubt have gambling and drug habits and relationship messes — but large-scale fraud is a group of people acting together.

Co-offending relationships vary significantly. We found that co-offending bonds could be categorized in three distinct groupings or archetypes, depending on the primary beneficiary of the fraud (individual versus organization) and nature of the relationship between co-offenders (functional ties in which the purpose is to perpetrate fraud, versus affective ties in which individuals have an emotional attachment).

As Figure 1 below illustrates, the three archetypes of co-offenders identified are as follows:

1. Individual-serving functional bonds, which characterize perpetrators in a relationship bonded together by the view that co-offending offers an efficient way to commit fraud. Here, co-offenders find it in their own individualistic self-interest to cooperate with others. This group could be considered predatory — actively seeking opportunities to commit fraud in line with prevalent views of fraudsters.
2. Organization-serving functional bonds, which characterize those bonded in a fraud in order to enhance the financial position of their organization. A leader, often the CEO, recruits group members. Members rarely seek to commit fraud and often do so after the recruiter cajoles them. This group underscores the importance of workplaces as sites of socialization and points to the criminal aspects of some organizational contexts.
3. Affective bonds, which refer to strong emotional attractions between two or more adults. These bonds are often tied to deep friendships and kinship, which highlights the role of family relationships in the transmission of crimes.

These categories vary substantially in important dimensions as Table 1 (below) reflects. Individual-serving functional bonds are consistent with the instrumental perspective that perpetrators conduct fraud with a view to maximizing efficiency and minimizing risk.

Wide variation existed within this archetype in the duration of the primary bond and the size of the co-offending group. Organization-serving functional bonds rest on a larger workplace affiliation and tend to be associated with larger groups than other archetypes.

Participants cited such factors that influenced their decisions to co-offend as: firm-level patterns of non-compliance, the communal pursuit of "unreasonable goals" that create a climate of pressure and fear, the collective desire to continue rapid growth or arrest decline, as well as company structures that isolate small groups of employees. Finally, fraud perpetrated by co-offenders bonded by affective ties was characterized by smaller groups and long-standing relations.

As these findings suggest, an understanding of fraud prevention requires a more diverse and heterogeneous mix of explanations for committing fraud than just single factors such as greed, need or offender personality. Individuals often don't act independently, seldom arrive at goals independently and their interests aren't wholly selfish — all of which makes finding and prosecuting fraud a formidable challenge. Organizational leaders must first be aware of the role of these social elements in how fraud begins in order to have a chance to prevent or detect fraud.

In our second study, we found that a particular organizational culture is often present when fraud is perpetrated.² We surveyed three groups of individuals, each of whom had a unique view on a fraud that was perpetrated within an organization: 1) individuals who perpetrated a fraud, 2) individuals who investigated a fraud, and 3) individuals who witnessed a fraud within an organization. They were asked to state their level of agreement (1 = strongly disagree to 7 = strongly agree) with the following statements:

1. In this organization, people protect their own interest above other considerations.
2. People are expected to do anything to further the organization's interests.
3. In this organization, people are mostly out for themselves.
4. People are concerned with the organization's interests — to the exclusion of other interests.
5. There is no room for one's own personal morals or ethics in this organization.
6. Work is considered sub-standard only when it hurt the organization's interests.

These statements capture what is known as an "instrumental climate" in which employees prioritize their own or the organization's interests to the exclusion of ethical concerns.

We found that 39 percent of respondents agreed or strongly agreed with these statements when fraud was present. This percentage seems quite high, given that organizational cultures are rarely blamed for fraud. Within this climate, employees often rationalized that others in the organization do the same thing, which implies the group nature of fraud. These findings don't suggest that the presence of an instrumental climate automatically means that fraud is being perpetrated. Rather, they suggest that it constitutes an important red flag for fraud.

How to prevent or detect collusion

The prevalence of co-offending and instrumental climates have important implications for the ways organizational leaders, fraud examiners and auditors think about preventing and detecting fraud. It must begin with awareness of these possibilities.

For example, brainstorming sessions should explicitly include consideration of how groups of individuals can overcome internal controls to perpetrate fraud. Leaders should pay closer attention to areas within an organization at greater risk for collusion. More scrutiny could lead to a greater chance of detecting red flags for fraud. For example, are there any obvious tight-knit groups of employees within those high-risk areas? Additionally, organizations should explicitly include collusion and culture in fraud training for management and employees.

Organizational leaders, fraud examiners and auditors can also use the instrumental climate statements as a diagnostic tool to identify problematic cultures within an entire organization or sub-groups. For example, many organizations administer employee questionnaires to assess employee satisfaction. Many auditors administer surveys to understand how well internal controls are working. Both could incorporate the instrumental climate statements above.

Organizations can increase the effectiveness of the surveys by assuring employee anonymity. If feasible, they can include identifying locations or divisions to assess fraud risk at the lowest possible levels. Strong agreement or significant changes in agreement with these statements over time signify problematic climates or sub-climates. For organizational leaders and fraud examiners, the results could allow them to address problems before fraud begins. For auditors, the results could help identify areas that need additional audit work.

Finally, several other fraud prevention ideas address the social nature of fraud, such as:

• Job rotation policies within a fairly large pool of employees.
• Mandatory holidays with revolving role replacement.
• Surprise audits.
• Emotive content analysis of internal communications.
• Fraud or forensic audits specifically designed to investigate the social infrastructure of an organization.

Not surprisingly, the ACFE's 2014 Report to the Nations found that surprise audits, job rotation and mandatory vacations were associated with significant reductions in median losses from fraud. Yet, many organizations don't commonly implement these anti-fraud controls.

Pamela R. Murphy, Ph.D., CFE, CPA (Illinois), is an associate professor and E. Marie Shantz Fellow in Accounting at Queen's School of Business in Kingston, Ontario, Canada. 

Clinton Free, Ph.D., is an associate professor in the School of Accounting at the University of New South Wales in Darling Point, Australia. 

References

1 See "The Ties that Bind: The Decision to Co-Offend in Fraud," by C. Free and P. Murphy, Contemporary Accounting Research, forthcoming.

2 "Broadening the Fraud Triangle: Instrumental Climate and Fraud," by C. Free and P. Murphy. Working paper.

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