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 Two

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 is identify a pattern of similar behavioral elements common to white-collar crooks and cultural elements common to their environments.

In Part One, I opened with the statement, when fighting fraud, many ignore the human element, and that’s a mistake and focused on the Behavioral Elements.

In this writing, I focus on some of the Environmental Elements.

Environmental Elements

The risk of fraud tends to increase when the following characteristics help define an organization.

Weak Tone and Conduct from the Top

The “tone from the top” is a collective message from senior management that enhances the ethical fiber of the organization and the moral backbone of staff members.

Leadership that doesn’t support a rock-hard ethical and moral ideal – and doesn’t lead by example with strong character, evident values, and timely action – can leave the organization exposed to the vagaries of fraudulent behavior.

Good tone from the top does not mean you have an ethical culture or a shared belief of ethics and integrity!

Culture is one of the most significant factors of how employees behave and is the foundation for the governance framework.

The word “culture” is mentioned 124 times in the 2017 COSO Enterprise Risk Management framework because a weak culture that allows undesired behavior to continue can lead to various risks.

Strong cultures understand and build their strategy around core values that are well defined, have a high level of intensity with regard to those values, and believe in organizational objectivity and justice.

According to my good friend Tom Fox, organizational objectivity comes from procedural fairness. This is one of the things that will bring credibility to your fraud risk management and compliance programs.

Notably, in 2017, the Fraud Section of the U.S. Department of Justice published its Evaluation of Corporate Compliance Programs introduces the concept of “conduct from the top,” meaning the government now expects timely action by senior leadership when there are ethical transgressions or outright fraud.

So the bar has been raised, and the expectation is now good tone and timely action or conduct from the top.

Vulnerable Culture

Criminals, who do not think in terms of right or wrong, are unlikely to be impressed by moral constructs, so an ethical corporate culture is unlikely to deter them. A company’s culture, however, can help determine if co-workers are inclined to blow the whistle on crime or if criminal activities are likely to go unreported. Specifically, there might be a concern about a retaliatory strike.

A resolute tone and timely and appropriate conduct from the top helps (emphasis added) to create an ethical culture, which is the foundation of good corporate governance. Regular surveys of employees can help management determine whether the culture of the organization is bedrock or sand.

I developed a culture survey many years that I have used successfully many times. If you are interested in speaking to me about your fraud concerns, need an investigation, governance review, or fraud risk assessment, kindly click here for my contact information.

Loose Link between Ethics and Compensation

Compensation structures that do not include an ethics component might be encouraging the wrong types of behavior. For example, a large pay increase that is tied to unreasonable performance targets may serve as an individual’s rationalization for unethical and excessive risk-taking.

According to a survey on ethics and compensation, two out of three companies do not think about or are unsure of the role of ethics in compensation. Compensation structures have direct social and moral effects on staff. Moreover, executive compensation is a critical corporate governance issue that must be overseen closely. Stock options, profit sharing, bonuses, executive retirement benefits, severance policies, and other perks should be aligned with a corporate commitment to compliance and ethical behavior.

White-collar criminals today often exhibit a blend of personal characteristics similar to the infamous Sam Antar, and they are often assisted by an environment such as Crazy Eddie’s, characterized by clearly flawed ethics and culture.

It is important to note that the existence of any or all of these elements does not necessarily mean fraud is in play. However, it does mean that management needs to have sound or properly designed internal controls to deter bad behavior. Should the controls be overridden, be able to detect patterns of inconsistencies and get at the truth before it’s too late.

In my experience, anti-fraud programs that take into account behavioral and environmental elements are more effective than those that do not. In the fight against fraud, one must be skeptical (click to read about using skepticism as a tool to fight fraud), curious, and courageous enough to ask the tough questions and take the necessary steps to establish the accuracy, correctness, or truthfulness of the information. In other words, trust is a professional hazard, and one must verify, verify, verify to avoid being deceived!

The links within supplement this material and provide additional information that is important in the fight against fraud.

I welcome your thoughts and comments.

Jonathan T. Marks, CPA, CFE

Contact me at jtmarkscpa@gmail.com

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