ITS 4450 - Fraud Risk Assessment Tools and Investigation

Chapter 1, The Nature of Fraud, Chapter 2, Why People Commit Fraud

This lesson presents some background material from chapters 1 and 2. Objectives important to this lesson:

  1. What Is fraud?
  2. Types of fraud   
  3. Criminal and civil prosecution
  4. Preparing to be a fraud professional
  5. Fraud-related careers

  6. Why people commit fraud
  7. Who commits fraud
  8. The Fraud Triangle: Element of Pressure, Element of Opportunity, Element of Rationalization
Chapter 1

Photo of Bernie MadoffThe chapter begins with a discussion of the historic investment fraud perpetrated by Bernie Madoff. His crime was reported at the end of 2008, and he was tried and convicted within six months. This time frame is not typical of our court system, but famous people were victims, which may have had something to do with it. The text tells us that there is no reliable estimate of the number of frauds committed. Many may go unreported. Numbers reported by government agencies and insurance companies are likely to be lower than actual numbers.

The text defines physically forcing something from someone else as robbery. This is probably meant to include theft from someone who is not present. It defines fraud as tricking someone out of their assets. The distinction is important. The text quotes another source, expanding on that definition to include "surprise, trickery, cunning, and unfair ways" to gain access to those assets. The word "fraud" can refer to either the crime itself or to the person carrying out the crime. When reading material on this subject, you will have to determine how the word in being used by its context.

Another definition lists several elements of fraud. Fraud is deception that includes the following elements:

  1. A representation
  2. About a material point,
  3. Which is false,
  4. And intentionally or recklessly so,
  5. Which is believed
  6. And acted upon by the victim
  7. To the victim’s damage

Photo of Carlo Charles PonziAs you might imagine, proving that fraud has occurred involves proving each of those points. The text tells us the story of Carlo (Charles) Ponzi, who was made famous by his invention of several variations on pyramid schemes.

In his schemes, he promised a return on investment that was not possible to deliver, but he delivered it to several customers by paying them with the investments of subsequent customers. This made his companies seem legitimate, until the fraud was discovered, at which time he owed more money to the outstanding investors than he had assets to pay. He did this several ways in several states. The kind of scheme that Mr. Madoff carried out was a type of Ponzi scheme.

The text stresses that a fraud depends on each of the elements listed above, but it may most heavily rely on the victim's trust in the operator.

A table on page 10 lists six types of fraud, common perpetrators (hence the slang word "perp"), typical victims, and brief explanations of each type. This list is not exhaustive, which could mean that it won't make you tired, but really means that it does not include all types. Note that the last type is miscellaneous. Review the discussion of several types that appear through page 14. We will discuss some of these in class.

On page 14, the text turns to prosecution of fraud, by criminal prosecution, civil prosecution, or both. The distinction between them is that criminal offenses violate a law about the public good, and civil offenses typically violate laws about private rights, such as the rights of an individual person. Civil prosecution may require a lower threshold of evidence for a conviction. See the comparison table on page 16. See also the discussion of chapter 2 about prosecutions that never take place.

On that same page, the text begins a section discussing seven skill areas in which a fraud investigator should be well trained:

  • analytical skills
  • communication skills
  • technological skills
  • understanding of accounting and business
  • knowledge of laws, privacy, and criminology
  • understanding of two or more languages
  • knowledge of human behavior

The text mentions the Association of Certified Fraud Examiners (ACFE) several times, and will continue to do so. It is a professional organization our author obviously believes in, dedicated to fraud prevention, detection, and deterrence. To be certified, you must meet the requirements listed in the text, which include at least two years of professional experience.

Chapter 2

Chapter 2 begins with the confession of a person who "kited checks", which means passing checks that had no value from one bank to another to give the impression that his accounts had money in them. Wikipedia defines check kiting as "intentionally writing a check for a value greater than the account balance from an account in one bank, then writing a check from another account in another bank, also with non-sufficient funds, with the second check serving to cover the nonexistent funds from the first account". Kiting only works when there is a lag time (also called float time) between the time a check is accepted and the time it is processed. Electronic processing of payments has made this less likely to work. The point of the story is that the person in question may not have understood the legal issues about what he was doing, that it snowballed as he went along, and that he came to the attention of the banks in question when the amounts he owed them were quite large.

A person committing a fraud may believe they have no other choice. This does not excuse it, but it does let us feel sympathy for the person introducing this chapter that we probably did not feel for the person introducing the first chapter. Note the characteristics listed for fraud perpetrators on pages 33 and 34, comparing them to characteristics commonly found in college students (some similarities) and characteristics commonly found in other kinds of offenders (almost no similarities). How do you feel now?

The example case for this chapter is used to introduce the Fraud Triangle: three elements that are typically found in a fraud case.

  • perceived or real pressure - the need to do it
  • perceived opportunity - the way to do it
  • rationalization of the fraud as being acceptable/temporary - the reason it is okay to do it

We can see that the perpetrator in the example case felt the pressure of having little money, a commitment to paying rent, and "oh yeah, a powerful need to eat sometime this month". He saw what he thought was a way to hide his lack of money, and thought that wasn't illegal to do it. Looks like all three elements were there. The text expands its discussion of each element.

  • perceived or real pressures - financial pressure (bills, lifestyle, financial losses), vice pressure (gambling, drug and alcohol abuse, other socially unapproved behaviors), work related pressures (lack of recognition, dissatisfaction, fear of being fired)
  • perceived opportunities - lack of internal controls (several pages are devoted to this one), lack of accountability for one's work, lack of prosecution in many cases, lack of checks and balances in audit trails, belief that the victims will not notice or complain, lack of auditing
  • rationalizations - they owe me, this is a loan that I will pay back, there is no victim here, the money is being used for good purposes, if I don't do this I could lose face or my position

The text offers several examples of frauds carried out in different ways, each illustrating elements of the triangle. It continues with a new concept, that the triangle does not necessarily explain a fraud committed by a group of people. The next idea is fraud recruitment.

The text presents a theory that a person may be recruited into a fraud (or other crime) by someone who has one or more kinds of power over them:

  • reward power - the recruiter offers a reward for cooperation
  • coercive power - the recruiter offers not to impose a punishment if there is cooperation
  • expert power - the recruiter presents his/her detailed knowledge of the system that will be compromised, leading to belief in the fraud's sure success
  • legitimate power - the recruiter presents his/her authority to require cooperation
  • referent power - the recruiter establishes a bond with the recruit, convincing the recruit that cooperation is a natural thing to do

The text offers a graphic (figure 2.7) that illustrates these five power types and the required matching attitudes in the person being recruited. It suggests that we should do something in our organizations to make people more resistant to these kinds of pressure from bosses, friends, coworkers, and strangers.


  1. Begin the reading assignments for the course, weeks 1 and 2.
  2. Complete the assignments and class discussion made in this module.
  3. We will have a discussion about the planned exams in our first class.