The Fraud Diamond: Use of Investigative Due Diligence to Identify the “Capability Element of Fraud”

Most of us are aware of the business scandals and failures in recent years and how occupational fraud and abuse were common themes to these failures. In addition, many fraud professionals are familiar with the Fraud Triangle, which discusses the three common elements that are often present in fraud schemes.⁽¹⁾ However, the existence of these three elements alone does not necessarily suggest fraud will occur. Often unrecognized and unnoticed is the fundamental reasoning for the fraudulent activity – the element of the human mind and individual behaviors (i.e. the wrongdoer’s “capability” to commit the fraud).

This article will discuss the capability element of fraud, address how an experienced fraud professional can assist a company in assessing this element and explain why such assistance will benefit business owners.

Creating the Fraud Diamond – the “Capability Element of Fraud”

As acknowledged by Grace Duffield and Peter Grabosky, in their book The Psychology of Fraud,⁽²⁾ behavioral scientists have yet been able to identify a psychological characteristic that serves as a valid and reliable marker of the propensity of an individual to commit fraudulent activities. Nevertheless, research has shown that individuals with certain characteristics and personality traits will increase the likelihood for fraud to occur.

Explained in their article “The Fraud Diamond: Considering the Four Elements of Fraud,” David Wolfe and Dana Hermanson have incorporated a fourth element, capability, into the fraud triangle; thus, transforming the well-known fraud triangle, into the fraud diamond.⁽³⁾ The article states that an individual’s personality traits and capability have a direct impact on the probability of fraud.

As stated by Wolfe and Hermanson: “Opportunity opens the doorway to fraud, and incentive [i.e. pressure] and rationalization can draw a person toward it. But the person must have the capability to recognize the open doorway as an opportunity and to take advantage of it by walking through, not just once, but time and time again.⁽⁴⁾

Below is a summary of the six traits, associated with the capability element, that Wolfe and Hermanson believe are essential in the personality of the fraudster.

1. Positioning: The person’s position or function within the organization may provide the ability to create or exploit an opportunity for fraud. A person in a position of authority has more influence over particular situations or the environment.
2. Intelligence and creativity: The fraudster is smart enough to understand and exploit internal control weaknesses and to use position, function, or authorized access to the greatest advantage.
3. Ego: The individual must have a strong ego and great confidence he will not be detected. The common personality types include someone who is driven to succeed at all costs, self-absorbed, self-confident, and often narcissistic. According to the Diagnostic and Statistical Manual of Mental Disorders,⁽⁵⁾ narcissistic personality disorder is a pervasive pattern of grandiosity, a need for admiration and a lack of empathy for others. Individuals with this disorder believe they are superior or unique, and they are likely to have inflated views of their own accomplishments and abilities.
4. Coercion: A fraudster can coerce others to commit or conceal fraud. An individual with a persuasive personality can more successfully convince others to go along with the fraud or look the other way.
5. Deceit: Successful fraud requires effective and consistent lies. In order to avoid detection, the individual must be able to lie convincingly, and must keep track of the overall story.
6. Stress: The individual must be able to control their stress, as committing the fraudulent act and keeping it concealed can be extremely stressful.

Investigative Due Diligence as a Fraud Prevention Tool:

Assessing the capability element and the six common traits through the performance of Investigative Due Diligence will assist in the prevention and detection of fraudulent activity within your company. Investigative due diligence has evolved as a vital intelligence discipline that is both distinct from and uniquely complementary to traditional legal and accounting due diligence inquiries.

Investigative due diligence comprises information, intelligence, insight and access. It explores issues and pursues lines of inquiry well beyond the information found in ledger books and contract clauses. Its application focuses on in-depth background investigation, vulnerability assessment, corporate personality and business intelligence gathering. The knowledge that is gained from these inquiries may identify issues and information that provide insight as to the capability element described above.

Essential elements of investigative due diligence:
The three classic elements of investigative due diligence are business and media database research; public records searches; and direct contact with government industry, personal and confidential sources. Regardless of whether the investigation is conducted nationally or internationally, access to these sources is essential, and the information and intelligence they provide is invaluable.

If the right investigator is retained preventative measures can be simple:
As recent headlines and stories have shown, individuals that have committed fraud can be superb self-promoters whose conduct can range from simple exaggeration to omission, deception and misrepresentation, all the way to outright fraud and criminality. Since their goal is to entice fraudulent activity, the standard operating procedure is to accentuate the positive and downplay the negative.

Thus, the investigator must have excellent sources and know who to talk with, know what to look for, where to look, how to look, and when to stop looking. In addition to his or her competence in public records and online research, the investigator must also be able to:

• conduct in-depth interviews;
• evaluate the credibility of witnesses and statements
• develop leads and make connections; and
• tap into industry and government resources.

Trusted confidential sources can provide important information about managerial expertise, business reputation and personal style, information that may not be otherwise available. These same sources may also provide leads to undisclosed negative information such as a criminal history, a bankruptcy, unpaid business taxes, or undesirable employees, contracts or partners. An analysis of this information may provide necessary insight into those individual traits that comprise the capability element of the Fraud Diamond. Further, an investigator who has experience interviewing suspects, and possesses a probing, inquisitive and perceptive nature is key to the success of the due diligence investigation.

Thus, the more experience and resources your investigator has at his or her disposal, the more effectively and efficiently the investigative due diligence process will be in identifying a suspected fraudster’s capability of committing, and potential commission, of occupational fraud.

Retaining an Investigator Can Benefit Your Bottom Line:

Many business owners are quick to dismiss the idea that their business could be a victim of occupational fraud. They feel that they are too small or that their employees would never commit fraud, or at least to the extent of those cases portrayed in the media.

Based on a fraud survey in the 2010 Report to the Nation,⁽⁶⁾ small organizations — those with fewer than 100 employees — suffered the greatest percentage of the frauds in the 2010 study, accounting for more than 30% of the victim organizations. However, the variation between size categories is relatively small, with 23% of victims having between 100 and 999 employees, 26% having 1,000 to 9,999 employees and 21% having more than 10,000 employees. The median losses per incident ranged from $155,000 for the small businesses, $200,000 for those with 100 to 999 employees, $139,000 for those having 1,000 to 9,999 and $164,000 for companies with over 10,000 employees. These findings indicate that all businesses, large and small, are susceptible to fraud. Although these are meaningful numbers, research has shown that much fraud goes undetected or the period of the fraudulent activity is unknown. This makes it nearly impossible to quantify the actual costs of fraud on businesses, and thus magnifies the importance of conducting appropriate levels of investigation should suspicion of fraud exist.

Retaining a fraud professional who is experienced and skilled at performing investigative due diligence can help your company identify critical information that will help management make appropriate decisions to avoid or assist in cutting off the ongoing commission of an occupational fraud.

1. The three common elements are: (i) Opportunity (conditions that exist in an organization which facilitate the wrongdoer’s commission of the fraud – i.e. improper segregation of duties); (ii) Pressure (external forces that push the wrongdoer towards committing the fraud – i.e. maintaining a lavish standard of living; and (iii) Rationalization (the wrongdoer’s justification of their fraud – i.e. the attitude that the “company owes” the fraudster).
2. GRACE DUFFIELD & PETER GRABOSKY, THE PSYCHOLOGY OF FRAUD, (Austrailian Institute of Criminology, 2001).
3. David Wolfe & Dana Hermanson, The Fraud Diamond: Considering the Four Elements of Fraud, THE CPA JOURNAL ONLINE, Dec. 2004, http://www.nysscpa.org/cpajournal/2004/1204/essentials/p38.htm.
4. Id.
5. Published by the American Psychiatric Association.
6. Published by the Association of Certified Fraud Examiners at http://www.acfe.com.