The Fraud Prevention Pyramid

Financial professionals can face many ethical challenges during their careers, from pressure to bias project estimates to incentives to alter results in order to meet targets. Many individual resources exist to guide financial professionals on their ethical journey, but some may wonder, “How do I pull all of this together? What are the key building blocks to protecting myself from fraud?” In this article, we present a model for building your career-long ability to fend off fraud, which we call the Fraud Prevention Pyramid. This model is based on our research and teaching in fraud and ethics, as well as our professional experiences.

The goal of the Fraud Prevention Pyramid is to help accountants and financial professionals and others to build increasing levels of personal anti-fraud competence that will act as a shield that protects them from pressures and incentives to act unethically.

Equipped with this model and underlying resources, financial professionals will be better prepared for the pressures and incentives that may lie ahead. They also will be able to help bolster their organization’s ethical tone and anti-fraud environment.

The Continuing Fraud Issue

As the biennial surveys from the Association of Certified Fraud Examiners (ACFE) indicate, fraud continues to be a significant societal problem, with annual fraud losses in the trillions of dollars globally. Unfortunately, financial professionals too often succumb to pressures or incentives to commit fraud, making accountants among the leading perpetrators of occupational fraud in the ACFE surveys. Thus, it’s especially important for financial professionals to be prepared to address inappropriate pressures and incentives, especially since occupational fraud perpetrators often are well-educated and first-time offenders.

At the heart of the fraud issue are people (see Dana R. Hermanson, “Fraud and Governance: The Importance of People,” Journal of Forensic Accounting Research, 2021, pp. 313-334), since people are the ones who commit fraud. Understanding people, both yourself and those around you, is critical to addressing the risk of fraud. Likewise, longtime IMA^® (Institute of Management Accountants) contributor Curtis Verschoor articulated the importance of focusing on people and the behavioral aspects of fraud in many of his columns published in Strategic Finance (see Curt Verschoor on Ethics: Timely Columns from Strategic Finance Magazine).

Further, professional ethics and values are at the core of the IMA Management Accounting Competency Framework (see Figure 1). They include three key competencies: professional ethical behavior, recognizing and resolving unethical behavior, and legal and regulatory requirements. Without a solid ethical core, it’s difficult for financial professionals to credibly and consistently create value in their organizations. The Fraud Prevention Pyramid provides a practical model for financial professionals to consider in addressing the IMA Competency Framework in the areas of professional ethical behavior and recognizing and resolving unethical behavior.

Figure 1: IMA Management Accounting Competency Framework

The Fraud Prevention Pyramid

The Fraud Prevention Pyramid is designed to assist financial professionals and others in building a career-long ability to shield themselves from fraud. It contains five increasingly advanced stages of anti-fraud preparation: (1) developing fraud awareness and acumen, (2) understanding fraud ingredients, (3) avoiding common fraud pitfalls, (4) mitigating dark triad traits and pressure, and (5) mastering emotional intelligence (see Figure 2).

Figure 2: The Fraud Prevention Pyramid

1. Developing fraud awareness and acumen. The first step in defending yourself from fraud is to develop fraud awareness and acumen. In other words, it’s critical to start by establishing a foundation of basic fraud knowledge in both occupational fraud and fraudulent financial reporting. The key is to understand the characteristics of typical cases today, so that you appreciate the current fraud landscape. “Fraud Prevention Resources” at the end of this article lists several resources that provide current assessments of occupational fraud and fraudulent financial reporting.

Perhaps the foundational source for current information on occupational fraud is the ACFE’s biennial survey. The most recent report, Occupational Fraud 2022: A Report to the Nations, examines annual fraud losses (about 5% of revenue), fraud methods (largely asset misappropriation), fraud detection (most commonly through tips), types of organizational victims (with the most severe effects in smaller organizations), perpetrator profiles (most often from operations, accounting, upper management, or sales), and case outcomes (both civil and criminal). The ACFE reports provide an excellent overview of occupational fraud, including trends over the years.

In addition, each Big 4 accounting firm publishes periodic fraud-related surveys, with selected recent reports listed in the sidebar. While the surveys differ in their focus, they each provide current information about fraud and fraud-related risks. Deloitte’s Emerging Fraud Risks to Consider: ESG examined fraud risks in the environmental, social, and governance (ESG) arena, while EY’s Global Integrity Report 2022 addressed corporate integrity and pandemic-related challenges. A Triple Threat Across the Americas: 2022 KPMG Fraud Outlook focused on fraud, cyberattacks, and compliance in the Americas, and PwC’s Global Economic Crime and Fraud Survey 2022 examined fraud, corruption, and economic crime globally. Beyond the Big 4 firms, many others provide periodic analyses of fraud cases or fraud risks.

Mitigating the Risk of Common Fraud Schemes: Insights from SEC Enforcement Actions by the Anti-Fraud Collaboration and Financial Statement Fraud: A Review From the Era Surrounding the Financial Crisis by Jaime L. Grandstaff and Lori L. Solsma that appeared in the Journal of Forensic and Investigative Accounting in 2021 examined U.S. Securities & Exchange Commission fraud-related enforcement actions for somewhat different time periods. They collectively highlight the key roles of the CFO and CEO in fraudulent financial reporting cases, as well as the frequency of revenue overstatement frauds and frauds involving technology companies, among other issues.

2. Understanding fraud ingredients. In 2004, David T. Wolfe and Hermanson proposed a now widely cited fraud model, the Fraud Diamond (see Figure 3), which builds on the traditional fraud triangle’s focus on pressure/incentive, opportunity, and rationalization as the ingredients of fraud by adding a fourth element: capability. Capability reflects the skills and personality profile needed to commit fraud: brains, position, ego, immunity to stress, coercion skills, and lying ability. The notion is that it takes someone with the right skills and personality to be able to commit fraud successfully. Subsequent research suggests an enhanced fraud triangle, with capability grouped with rationalization to reflect all of the perpetrator characteristics in one element (see Douglas M. Boyle, F. Todd DeZoort, and Hermanson, “The Effect of Alternative Fraud Model Use on Auditors’ Fraud Risk Judgments,” Journal of Accounting and Public Policy, November-December 2015, pp. 578-596).

Figure 3: The Fraud Diamond

Hermanson’s Journal of Forensic Accounting Research article discussed the development of the Fraud Diamond, highlighting Wolfe’s notion that, “The number one cause of fraud is people.” Simply stated, fraud is, at its heart, a people problem. Therefore, we need to understand people, including ourselves, to address and mitigate fraud. Hermanson surveyed his people-focused research to identify five key human considerations in fraud and corporate governance: skills, signals, relationships, fairness, and persuasion. Each of these provides insights into what makes people “tick” and why some people act unethically.

Using ACFE data on occupational fraud cases, Hermanson, Scot E. Justice, Sridhar Ramamoorti, and Richard A. Riley Jr. examined two different kinds of people who commit fraud: the predator—a repeat offender who goes into an organization looking for fraud opportunities—and the situational fraudster—the first-time offender who comes upon bad times and decides to “borrow” from the organization (“Unique Characteristics of Predator Frauds,” Journal of Forensic Accounting Research, December 2017, pp. A31-A48). The authors identified several differences between predator and situational frauds, including that predators tend to focus on “softer targets” (smaller, private companies) and commit large, quick frauds.

3. Avoiding common fraud pitfalls. In the 2015 Strategic Finance article “Avoiding the Fraud Mind-set,” Douglas M. Boyle, James F. Boyle, and Daniel P. Mahoney discussed eight ways to avoid fraud-enabling thinking and tested these strategies through a survey of accounting faculty. The authors highlighted the following ways to avoid common fraud pitfalls:

1. Develop an ability to recognize your own human tendency toward rationalization.
2. Understand that fraudsters typically are not black-cloaked villains; rather, they are real people.
3. Recognize the psychological costs of “getting away with” fraud as well as the costs of getting caught.
4. Clearly define the specific values that are most important to you in both your personal and future professional lives.
5. Understand the importance of living within your means.
6. Build a trusted network as a means of mitigating nonsharable problems.
7. Understand the importance of maintaining your marketability.
8. Understand that you are an individual of value as reflected in the choices you make in life. Avoid defining your value based on the position/title you hold.

In the 2018 Management Accounting Quarterly article Behavioral Assessment and Modification in Fraud Mitigation Efforts, Boyle, Boyle, and Mahoney built on this analysis by surveying accounting practitioners about the eight strategies above, including their use in mentoring and overseeing others. As with the accounting faculty, practitioners also reported strong support for these strategies as ways to avoid common fraud pitfalls.

Finally, a 2010 Center for Audit Quality report discussed how to deter and detect financial reporting fraud. The report focused on three key strategies for mitigating fraudulent financial reporting:

• A strong, highly ethical tone at the top that permeates the corporate culture (an effective fraud risk management program is a key component of the tone at the top).
• Skepticism, a questioning mindset that strengthens professional objectivity, on the part of all participants in the financial reporting supply chain.
• Strong communication among supply chain participants.

These three strategies also are highly relevant to financial professionals seeking to protect themselves from fraud. Tone at the top is critical to shaping behavior and possibly mitigating pressure, skepticism is fundamental in evaluating information and people’s motives, and communicating with others often helps to identify and resolve inappropriate pressures and incentives.

4. Mitigating dark triad traits and pressure. As Ronald D. Parker, Douglas M. Boyle, and Brian W. Carpenter discussed in their 2020 Strategic Finance article Do Dark Personalities Lurk in Your Company? the dark triad personality traits are narcissism (having a large ego), Machiavellianism (being manipulative), and psychopathy (lacking remorse). The authors encouraged financial professionals to be on the lookout for such personality types in their organizations, as they suggest greater fraud risk. Likewise, Ramamoorti and Barry J. Epstein, in their 2016 article Today’s Fraud Models Lack Personality, encouraged auditors to move beyond the traditional fraud triangle and to be cognizant of dark triad personalities. Ramamoorti and Epstein asserted that for executives with dark triad personalities, the traditional fraud triangle collapses to a single dimension: opportunity. The only issue is whether the person has the opportunity to commit fraud, as pressure and rationalization are irrelevant to dark triad personalities.

In their 2022 article How to Handle Pressure to Act Unethically in Management Accounting Quarterly, Lisa S. Haylon, Carol C. Bishop, Douglas M. Boyle, and Hermanson discussed 10 specific ways to mitigate pressures you may face as a financial professional. The authors presented five strategies for dealing with possible future pressure (preparing yourself for what may come) and five others for dealing with pressure when it happens. Some of these strategies are adapted from the 2015 Strategic Finance article by Boyle, Boyle, and Mahoney discussed above.

To prepare for future pressure, the authors encouraged financial professionals to:

• Plan ahead.
• Practice personal financial responsibility.
• Understand the pressure and people landscapes.
• Work with others to set the right tone.
• Have some advisors.

Once pressure is being applied, the authors suggested:

• Beware of little asks.
• Watch your tendency to be a pleaser.
• Guard against rationalization.
• Explain your role as a professional.
• Articulate the ask and the possible consequences.

Through advance preparation and having a clear strategy when pressure arises, financial professionals can protect themselves.

5. Mastering emotional intelligence (EI). In the 2019 Strategic Finance article Do You Have Emotional Intelligence? Patrick E. O’Brien and Douglas M. Boyle discussed EI and its importance to financial professionals. The authors noted that EI is “a multifaceted concept that breaks down how someone recognizes or perceives emotions, manages them, and uses them to create knowledge or reach goals.” The four components of EI are self-awareness, self-management, social awareness, and relationship management (see Figure 4). The authors surveyed accounting professionals to understand which components are most important at different levels of professional accounting.

Figure 4: Elements of Emotional Intelligence

Source: Patrick E. O’Brien and Douglas M. Boyle, Do You Have Emotional Intelligence? Strategic Finance, June 2019.

While the focus of EI hasn’t historically been on fraud prevention, it’s clear that those who are self-aware, manage their own actions, understand others, and effectively manage relationships are very well positioned to protect themselves from fraud. Fraud is a people issue, and those who understand and can manage themselves and others have precisely the skills needed to address inappropriate pressures and incentives.

Complementing the notion of EI is understanding and developing trust and leadership skills. First, Amanda S. Marcy, Douglas M. Boyle, James F. Boyle, and Mahoney discussed elements of trust in the 2020 Strategic Finance article The Value of Trust using Richard Barrett’s Trust Matrix to highlight elements of both character and competence. The authors surveyed Trust Across America’s Lifetime Achievement Award recipients to understand the relative importance of trust elements. The award recipients collectively pointed to the importance of character (for example, honesty, fairness, authenticity, and caring) in building trust. While trust is no substitute for effective controls, trust can help to establish a healthy tone at the top based on sound character and competence.

Second, in Leadership Skills at Every Career Level, a 2019 article in Strategic Finance, Carpenter, Douglas M. Boyle, James F. Boyle, and Mahoney examined leadership skills. The authors discussed servant leaders, transactional leaders, and transformational leaders, and surveyed professionals regarding various leadership skills that are most important at each level of professional accounting. Many of the specific leadership skills relate to the human nature of fraud, including building trust, having situational awareness, displaying empathy, and anticipating the consequences of actions. Overall, EI, trust, and leadership reflect higher-level competencies that can be very helpful in protecting professionals from fraud.

How to Use the Fraud Prevention Pyramid

The Fraud Prevention Pyramid can be used in various ways. First, from a personal perspective, we encourage readers to carefully reflect and consider where in the pyramid they currently are and then to work toward advancing upward using the resources suggested in the resources sidebar. The knowledge and skills in the pyramid can contribute to a successful and sustainable financial career.

Second, boards and executives can promote the use of the pyramid to help to establish the tone at the top of an organization. By emphasizing protection from fraud and building training or other programs around pyramid content, organizations can help their employees to defend themselves and the organization from fraud.

Finally, we encourage organizations to complement the pyramid with external continuing education programs for financial professionals and others. IMA offers a variety of courses in professional ethics and values, as well as leadership, that reinforce and extend the concepts in the pyramid.

Fraud isn’t going away, but there are ways for financial professionals to protect themselves. We encourage readers to consult the Fraud Prevention Pyramid and related resources to bolster their own fraud defenses, as well as to improve the tone and anti-fraud environment in their organizations.