About Board and Fraud

Board and Fraud is a blog that aims to bring a practical approach to issues facing the board of directors and the audit committee specifically in the area of governance, risk management, compliance, and internal audit, with a strong focus on fraud, ethics, and internal controls.

Putting the Freud in Fraud – Part One

When fighting fraud, many ignore the human element, and that’s a mistake. While we can’t get into the mind of the white-collar criminal, we can take a closer look at high-profile individuals who have perpetrated massive fraud at corporations and instances of fraud identified in practice, as well as some research, to help us identify a pattern of similar behavioral elements common to white-collar crooks and cultural elements common to their environments.

Anti-fraud programs that consider the behavioral and environmental factors common among white-collar crooks and their environments are more likely to deter bad behavior or detect it promptly.

Following are some “key elements” often associated with individuals who are more likely than others to commit fraud.

Next week I will lay out the settings in which fraud is more likely to occur.

The presence in a company of any single element is not enough to indicate fraud. But the combination – any combination – of these elements increases the risk of fraud.


Behavioral Elements

Individuals who exhibit or have a combination of the following social characteristics might be more likely than others to stray from the straight and narrow. Detecting fraud is further complicated because many of these behavioral elements are the same ones that tend to make executives successful.


Lack of a Moral Compass

Former UBS investment banker Igor Poteroba received a 22-month jail term after pleading guilty to insider-trading charges. The banker told the judge before sentencing, “I made some very bad mistakes and made some very bad decisions. I lost my moral compass.”

All organizations must rely to some extent on individuals’ moral compasses to guide behavior in the workplace. F. Clark Power, in the book “Moral Education: A Handbook,” explains that the term “moral compass” is often used as a synonym for conscience. Without a conscience, an individual might not have the ability to determine right from wrong.

Crazy Eddie’s Sam Antar, who I have spent a lot of time with, explains, “Criminals typically compensate in their outward personality for any lack of morals.” He says this duplicity can make detecting someone’s lack of a moral compass difficult unless there is a pattern of questionable personal behavior.

A pattern of questionable personal lifestyle choices – in areas such as spending or salacious conduct, for example – can indicate an individual’s willingness to lie or otherwise demonstrate a lack of scruples. As much as corporations would like to maintain a separation between the personal and professional lives of their employees, the two are linked when it comes to unethical actions on the business front.

Troubling Friends, Family, and Relationships.

As Warren Buffett has observed, “There’s seldom just one cockroach in the kitchen.”

Trouble tends to attract trouble. For assistance with committing crime, fraudsters often look for people who share the same social background or ambitions or are gullible and easily manipulated. Scott Green, in his book “Sarbanes-Oxley and the Board of Directors: Techniques and Best Practices for Corporate Governance,” noted, “Those who are willing to commit fraud recruit from the corporate employee pool weak or needy personalities and go to lengths to reward and protect them.”



I teach that “Fraud is not about obstruction; it is about deception, deflection, and distraction…”

Deception and cover-up are the hallmarks of white-collar crime. White-collar criminals know that people live on the hope of a better financial future, and their goal is to feed people’s hope with spin and lies. The white-collar criminal hopes that no one will verify what he says. Even if people do attempt to verify the criminal’s information, their skepticism about his answers might be offset by their high level of comfort with him – so they accept deceptive answers as factual.

Warning signs include individuals avoiding face-to-face conversations or overly relying on email or other electronic ways to communicate – they might be shy, or they might be trying to hide dishonest behavior by maintaining distance.

Alternatively, individuals might use a disarming personality to prevent others from detecting nefarious activities. Their charm and ability to “sell you” can draw in the listener and lead to trust.

A working paper by the Rock Center for Corporate Governance at Stanford University found that words contain deception clues.

Researchers studied the words of executives at companies that later had to restate earnings, a frequent occurrence after fraud detection. Identifying some key indicators of deception, the researchers found that lying executives tend to:

  • Disavow ownership by using words like “the company” or “the team” when talking about their company. They avoid saying, “I.”
  • Emphasize extreme positive emotions, using words such as “fantastic” instead of merely “good” or “solid” to mask a mediocre underlying performance.
  • Answer questions indirectly with short, prepared statements to deal quickly with deceit areas and then redirect the conversation.img_7982-1


After an interview with the incarcerated former CEO of Enron, Jeffrey Skilling, Dr. Archelle Georgiou summed up the man in a Fortune magazine article:

Was he arrogant? Yes. But that’s not a surprise. After all, arrogance springs from the same well of confidence that led him to the big chair at Enron.”

To perpetrate fraud, an individual needs the confidence to pull it off. When that confidence and pride approach true arrogance, it might indicate an employee has what it takes to commit a crime. Excessive arrogance – an attitude of superiority and entitlement on the part of an employee who believes that corporate policies and procedures simply do not personally apply – should be checked and redirected.


Cleverness and Creativity

Businesses commonly seek out innovative and creative people. These same traits, though, have long been associated with dishonesty and unethical behavior. The link between creativity and moral laxness was the subject of a recent working paper released by Harvard Business School, which found that creativity might be a predictor of dishonest behavior.

Creative people are motivated to think outside the box and are well-suited to change – two characteristics that also allow them to reinterpret their behavior and rationalize their moral transgressions. Thus, having on the payroll smart, savvy, and creative individuals with widespread access to corporate information can compound the risk of fraud. While companies need highly creative people, appropriate controls must be in place to keep creativity flowing in a positive direction.

I welcome your thoughts and comments. Click here for Part Two!

Remember – White Collar Criminals are profiling you, and you should be doing the same! Properly designed internal controls can help.


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