Article by David Glusman, Advisory Services Partner and Michael Molder, Advisory Services Senior Manager, "Reading the Semaphore of the Red Flags of Fraud," Featured in The Legal Intelligencer

Excerpt:

For centuries, ships have signaled messages of distress to each other through colored flags arranged in specific positions. Your business may be sending you signals of distress, including catastrophic employee dishonesty. If you can read the signs, you can head off disaster, but first you need to be able to recognize the red flags of fraud.

In his 1973 book, “Other People’s Money,” Donald R. Cressey wrote, “Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.” His analysis led to the development of the fraud triangle: pressure (or motivation), opportunity and rationalization. Like a stool absent one of these legs, most frauds will collapse.

Pressure

Motivation to commit fraud is typically financial need. It can arise from illicit activities, such as an addiction or extramarital affair. Or it can come from perfectly normal needs, such as a spouse’s job loss, costs of caring for an ill or aging family member, or fear of investor response to adverse financial reports. Some of the red flags of pressure to commit fraud are:

• Employees living beyond their means: A common indication that an employee is under pressure to commit fraud is a lifestyle that is inconsistent with official compensation. While there are many alternative explanations (inheritance, asset sales, spouse promotions or bonuses, etc.), a clerical employee driving a luxury car or wearing expensive jewelry is an indication of possible fraud.
• Unexpected family disruption: Showing an interest in staff personal situations such as changes in marital status or a family member’s illness is part of the social contract. We spend a lot of time with our co-workers, and empathy for these types of family disruptions can help make the workplace a more productive environment. At the same time, it provides insight into financial pressures that can lead to fraud.
• Indicia of addictive behavior: Addicts tend to follow certain behavior patterns, regardless of the nature of the addiction. As discussed in “What Are Addictive Behaviors?” (www.indiana.edu/~engs/hints/addictiveb.html), addicts obsess about the object of their addiction, become irritable and depressed when prevented from pursuing in their addiction, and demonstrate low self-esteem. These types of behavior can manifest in the workplace. Problematic as some addictions can be, even if the addiction does not impair function in the workplace, it can impose significant financial obligations on the addict, which, in turn, pressures the addict to steal to support the habit.

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