John Galarani
Rio de Janeiro/ Brazil
jgalarani@yahoo.com.br
55(21) 96530-3297
www.linkedin.com/in/johngalaraniacomplianceofficeramlftdpr
Fraud Triangle /Fraud Diamond
The fraud triangle is a framework commonly used in auditing to
explain the reason behind an individual's decision to commit fraud.
The fraud triangle describes three components that contribute to an
increased risk of fraud:
(1) opportunity
(2) encouragement and
(3) rationalization.
What is fraud?
The fraud triangle is used to explain the reason behind a fraud.
However, what exactly is fraud?
Fraud is any cunning, deceitful act, in bad faith, with the intention
of harming or deceiving others, or of not fulfilling a certain duty. In other
words, fraud is a deceptive activity used to gain advantage or generate illegal
profit. Furthermore, the illegal act benefits the fraudster and harms other
parties involved.
For example, an employee who pockets money from the company's
cashier is committing fraud.
Below, we discuss the components of the fraud triangle.
The Fraud Triangle – Opportunity
Opportunity refers to circumstances that allow fraud to occur. In
the fraud triangle, it is the only component over which a company has
complete control.
Examples that provide opportunities to commit fraud include:
➢ poor internal controls
Internal controls are processes and procedures implemented to
ensure the integrity of accounting and financial information.
Deficiency of internal control occurs when the designed and
implemented internal control fails, in a timely manner, to prevent, detect
and/or correct misstatements in the financial statements, or there is no such
control
Examples of deficient internal controls, such as the lack of
separation of duties, lack of supervision and lack of documentation of
processes, give rise to opportunities for fraud.
➢ Tone at the top
Tone at the top refers to senior management and the board's
commitment to being ethical, showing integrity and being honest – poor tone
from key members results in a company more susceptible to fraud.
➢ Inadequate accounting policies
Accounting policies refer to how financial statement items are
recorded. Bad (inappropriate) accounting policies can provide an opportunity
for employees to manipulate numbers.
The Fraud Triangle – Incentive
Incentive, alternatively called pressure, refers to an employee's
mindset towards committing fraud. Examples of things that provide
incentives to commit fraud include:
Bonuses based on a financial metric
Common financial metrics used to evaluate performance of an
employee are revenues and net profit.
Bonuses based on a financial metric create pressure for
employees not to meet goals, which in turn can cause them to commit fraud
to achieve the goal.
Investor and analyst expectations
The need to meet or exceed investor and analyst expectations
to ensure that stock prices are maintained or increased can create pressure to
commit fraud.
personal incentives
Personal incentives can include wanting to earn more money,
the need to pay personal bills, a gambling addiction, etc.
Fraud Triangle - Rationalization
Rationalization refers to an individual's justification for
committing fraud.
Examples of common rationalizations that fraudsters use include:
✓ "They treated me wrong"
An individual may be spiteful of their manager or employer and
believe that committing fraud is a way to get revenge.
✓ "Top management is doing it too"
Bad tone at the top can cause an individual to follow in the
footsteps of those higher up in the corporate hierarchy.
✓ "There is no other solution"
An individual may believe that they can lose everything (for
example, lose a job) unless they commit fraud.
According to the new diamond theory of fraud - even if a
fraudster has a strong motive (pressure), opportunity and justification
(rationalization) there are chances that the fraudster will not commit fraud if
there is no "capacity".
Capacity here means – Fraudster's position in that
organization, – intelligence and certain knowledge needed to commit fraud,
coerce others into fraudulent activity, etc.
Corporate fraud is a major concern that can have a devastating
impact on an organization's revenue, reputation and even continuity.
Therefore, companies must take vigilant measures to address, combat and
mitigate the risk of fraud in their organization.
Rio de Janeiro, October 27, 2023.
JOHN GALARANI
COMPLIANCE OFFICER, AML / CFT, LGPD.