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Six common myths about fraud; if not debunked, they can obscure the existence of white-collar crime.


If not debunked, they can obscure the existence of white-collar crime.

A solid auditing or accounting background is helpful in uncovering white-collar crime, but it's not the whole answer. Auditors now turn up only about 20% of the frauds detected. Most fraud cases are discovered by accident or are revealed through complaints by co-workers.

Nationally, employees are stealing as much as $120 billion annually, according to estimates from the U.S. Department of Commerce. Data compiled at my professional association headquartered in Austin, Texas, the National Association of Certified Fraud Examiners (NACFE), which specializes in fraud detection and deterrence, show the average bank robbery nets the criminal only about $3,200, but the average bank embezzlement is $125,000. To meet their expanded responsibilities to uncover fraud and control it, CPAs need to know more about it. In particular, they need to debunk these six myths about fraud.


The notion that most people are immune to the temptation to commit fraud is probably the biggest myth of all about financial crimes. Fraud perpetrators come from all walks of life, all economic circumstances and all social classes. The public at large, including CPAs, has trouble coming to grips with a fact of life: Some people lie, cheat and steal. Sociologists suggest the reason is instinctive--to receive rewards or avoid punishment. The greater the promise of reward or the more pervasive the threat of punishment, the higher the motivation for antisocial behavior.

McKinley was about as unlikely a thief as you could find. A CPA and the only son of a Tennessee judge, he had attended the right schools, worked at a large national accounting firm and married well. McKinley eventually went to work for the right bank as chief financial officer, where he proceeded to steal $100,000 or so right under the internal auditor's nose.

In McKinley's case, as in most frauds, it was a combination of three factors: motive, opportunity and a defective set of values. He was in a financial jam and decided to "loan" himself out of it. He simply moved the money he needed to a checking account he controlled and charged it to the bank's expense. It certainly would have been easy enough to find if the internal auditor had suspected the theft because the trail was there.

The late Donald Cressey, a noted criminologist, pioneered the study of embezzlement by interviewing approximately 300 prison inmates in the 1950s. He showed that the fraud perpetrator is normally caught up in a complex web of circumstances. Cressey discovered that nearly all fraud perpetrators have three things in common: a motive, which he defined as being usually a hidden or "unshareable" financial need; a perceived opportunity to commit fraud without being detected (usually caused by weak controls); and an ability to rationalize the theft. This is normally done by calling the theft something else--for example, "borrowing" from the company to get out of a financial bind. Cressey said fraud occurs only when these three factors are present at the same time. Luckily, this does not happen too often.

W. Steven Albrecht, president of the NACFE and an accounting professor at Brigham Young University, noted similar characteristics in a study of 212 fraud cases: The motive is usually financial, the opportunity is there and the person is able to compromise his or her integrity.

Opportunity almost always relates to position. Managers are no more or less honest than the employees--they just have more opportunity to commit bigger thefts. In McKinley's case, it was a common pattern: excessive leverage, marital problems, too much control. Yet had the internal auditor not fallen for the first myth, he might have at least known whom to look at, if not where to look. Considering there are almost countless ways to defeat internal controls, knowing whom to suspect of fraud is critical to its detection.


A second myth about fraud is that it is not material. It may start out that way, but immaterial frauds have a way of turning into material ones. Albrecht states flatly: "There are no immaterial frauds, only ones with insufficient time to grow." In other words, most people who start committing fraud will continue.

That was the situation with Smith, a bookkeeper for a Midwestern lighting company. She needed to help her children financially and began forging checks. Since she did the reconciliation of the account, she simply destroyed the checks when they were returned from the bank. The costs of the thefts were added to inventory. It was very easy. But once she found the way to steal, she literally couldn't stop. It no longer was a need for money; it became a $400,000 compulsion. Smith's fraud was uncovered after she had a nervous breakdown from the continuous pressure of concealing her activities. What started out as the theft of a few hundred dollars to help her kids became a major embezzlement that went undetected for nearly four years.


Another myth about internal crime is that most of it goes undetected. Because fraud by its nature is concealed, sociologists have a difficult time measuring its extent. In its initial stages, most fraud probably does go unnoticed. But as it continues, two things happen. First, the amounts involved get bigger. Second, the perpetrator gets careless about concealing the fraud. That's what happened to McKinley, Smith and countless others. In McKinley's case, instead of concealing the fraud proceeds as he had done so expertly for two years, he foolishly forged a check from a bank vendor and then deposited the proceeds directly into his own checking account.

Criminologists such as Cressey theorize the criminal receives positive reinforcement when the fraud goes undetected. As the fraud continues, the individual becomes more confident in his ability to escape detection. Some describe feeling almost "superhuman."

According to McKinley, "I never gave it a thought. I didn't think I would ever be caught. Looking back, it makes no sense at all. I was totally irrational." This helps explain why those involved, auditors included, are often surprised at the simplicity of the fraud when cases are unraveled.


There are indeed some famous cases of fraud that were so complex no auditor would have been able to uncover them. These cases are the exception, not the rule. The truth is that most clues to fraud do not come from the books but from the perpetrator. In Albrecht's study, he noted that half of frauds are discovered by accident, a third come from co-worker complaints and the rest (about one in five) are discovered by audit. The "accidental" discoveries are usually those that are not well concealed, such as McKinley's conversion of a bank vendor's check.

"Fast Eddie" was president of a small, start-up bank in west Texas during the gogo atmosphere of the oil boom. In Eddie's case, the auditors were the least of his worries. There was no internal auditor, and he was able to limit the independent accountants' work to assistance with the directors' examination rather than a full audit. The last thing he wanted was a hard look at his operation.

When the bank was formed in 1979, Eddie had honorable enough intentions, but it wasn't too long before borrowers were offering him part of their deals if he would make loans. Eddie resisted temptation for about two years. Then, loan by loan, the bank became less important to him and the deals he was making became more important. And, of course, the more kickbacks he took, the more brazen he became.

The regulators examined Eddie's bank about three months before it failed. One of them noticed an unusual deposit in Eddie's checking account and asked him about it. Eddie's explanation seemed logical enough, so the examiner didn't look further. Later he wished he had, because Eddie had run almost all of his ill-gotten gain through his own checking account, in his own bank, in his own name. If the examiner had looked further, he would have discovered over $1 million in deposits to Eddie's checking account. Eddie was making $60,000 a year at the time. Most of his gains were spent on bad business deals.

Most fraud perpetrators commit themselves to obligations they can't meet and then steal to fulfill those obligations. People rarely commit fraud to accumulate wealth. Take the case of Steven, the manager of a retail chain store. He had invested his own money in a convenience store that was draining him financially. Management was aware of his investment.

Steven's auditors from the home office kept looking at the books because it was the chain's least profitable store. Cash receipts balanced, but inventory costs kept rising in relation to sales. They finally decided to close the store. In the postaudit review, one of the auditors noticed the proportion of cash going into the bank. In other stores, half was cash and the rest credit card sales and checks. In Steven's store, only about a third was cash.

After going over the cash receipts several more times, they finally spotted it: Sales returns and allowances were twice what they should have been. Steven had figured out that the home office audited only the deposits, and if they agreed with what went into the bank (which they always did), no further checking was done. Steven was taking $500 a day or so out of the register by simply hitting the refund button.

Before the authorities were contacted, Steven was interviewed and furnished a consent to examine his bank accounts. In Steven's case, there were over 300 cash deposits in a two-year period amounting to nearly $200,000. When the suspect is known, the rest is usually easy.


There are a number of reasons auditors don't detect fraud. Some frauds are well beyond the scope of the audit. Some are too well concealed. Some are too small. But perhaps the greatest reason is that the evidence is not reflected in the financial statements.

Statement on Auditing Standards no. 53, The Auditor's Responsibility to Detect and Report Errors and Irregularities, requires the auditor to assess the risk that errors and irregularities may materially affect the financial statements. And, most important, SAS no. 53 requires the auditor to design the audit engagement so that it provides reasonable assurance of detecting any material fraud.

There are essentially two types of frauds: on-book and off-book. The former consist of typical employee frauds, such as embezzlements, phony expenses and ghost payrolls. Although sometimes difficult to detect, on-book frauds at least have audit trails.

Off-book frauds consist of kickback and bribery schemes, hidden interests and similar offenses. SAS no. 54, Illegal Acts by Clients, defines these frauds as illegal acts and indicates that the auditor should be aware of the possibility that such acts may have occurred. These frauds or illegal acts tend to involve upper levels of management, they involve much larger amounts and they are not normally detected by traditional audit procedures.

Detection of off-book frauds can be a particular problem since they are outside the scope of traditional audits. Documentation of these frauds usually requires extensive experience in interview, interrogation and collection of evidence.

In fraud examination methodology, a profile of a suspect is developed by looking at the high-risk factors of not only the organization but also its personnel.

In the case of Steven, the store auditors knew they had a problem but not who was responsible. A certified fraud examiner interviewed the store employees and quickly determined Steven had outside business interests, one of the more common motivators for internal fraud. Once Steven was developed as a suspect, it became a simple matter to gather evidence of his guilt.

Auditors can learn from this methodology. Those who wish to uncover fraud must be aggressive. They must not be reluctant to ask questions about fraud. All too often, other employees know about or suspect fraud. And all too often, they are afraid to report their suspicions.

Management's role in this regard is to create an environment in which fraud awareness becomes everyone's responsibility and any employee can furnish information without fear of reprisal. Many companies now have developed reward policies for "whistleblowers" and have cut their losses significantly. Auditors should understand that environment in designing their tests.


Criminologists say there are several reasons for punishing criminals. One is retribution to society for the crime. Society is outraged at the criminal act and punishment satisfies the need for retribution. Other reasons include deterrence, both specific and general. Specific deterrence means punishing a particular criminal to keep him or her from committing other crimes. General deterrence means punishing the guilty to serve as a strong message to others.

Sociologists are divided on whether general deterrence works at all. Data suggest that white-collar offenders have the lowest rate of recidivism of all criminals. This is probably because offenders are usually intelligent and, once jailed, think carefully about committing future offenses.

While prosecution appears to reduce individual recidivism, it might not be at all effective in discouraging others. In one limited study conducted by the NACFE, loss data from 300 banks were compared with each bank's policy for prosecuting fraud offenders. There was no statistically significant difference in banks that prosecuted offenders and those that didn't. This surprising result may be due to the nature of the fraud itself: Perpetrators carefully plot their crimes to avoid detection. If Jones is caught committing fraud, Smith's only lesson might be in finding a different way to steal. Smith could decide that Jones was not clever enough.

This doesn't mean that prosecution should not be pursued. But it does mean that an aggressive position on prosecution is not necessarily adequate protection from other fraud.


As the population continues to age, fraud may become the crime of choice. Most criminologists agree that violent crimes and those involving property offenses occur most frequently with young people, specifically with males. Fluctuations in violent crimes relate directly to the number of people in the 18-25 age group. White-collar criminals are older, and more of them are female.

According to Albrecht's study, 40% of all white-collar criminals were female, but only 2% of those who committed violent offenses were women.

The aging of the population coupled with the fact that an increasing number of women commit frauds led criminologist Georgette Bennett to observe that white-collar crimes will increase as the proportion of older people in the population grows. A rising mandatory retirement age also may contribute to future growth in white-collar crime.

If the proportion of frauds grows, then crime prevention must be concentrated in that area. The criminal justice system has long recognized that it is ill-equipped to investigate and prosecute these crimes. The private sector must take up the slack, with the preventive effort starting with the skeptical auditor.

PHOTO : White-collar crime is on the rise, and it's hard to tell who the culprits are. Possibilities are people with motive, opportunity and defective values.

JOSEPH T. WELLS, CPA, CFE, is chairman of the National Association of Certified Fraud Examiners, Austin, Texas. He is a member of the American Institute of CPAs and served on the professional ethics committee of the Austin chapter of the Texas State Society of CPAs.
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Author:Wells, Joseph T.
Publication:Journal of Accountancy
Date:Feb 1, 1990
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