The Fraud Triangle and the Financial Services Industry

A member of the Center for Ethics Advisory Board recently sent me an excellent link to a TED talk on the Fraud Triangle on YouTube. While the Fraud Triangle is well-known concept in the accounting industry, I have not seen it used to describe acts of fraud in the financial services industry and I thought it would be interesting to take a closer look. What I discovered is that looking at the Fraud Triangle as an explanatory tool can help to account for the incidences of fraud in our industry that many practitioners and commentators have witnessed.

Donald Cressey, a criminologist, identified the concept of the Fraud Triangle while doing research on prisoners serving time for white-collar offenses in the 1940s.  While financial markets and financial products have evolved since the 1940s, it is clear that Cressey’s concept is still relevant (after all, human nature does not seem change much).

Cressey’s Fraud Triangle has, unsurprisingly, three components:

  • Pressure
  • Opportunity
  • Rationalization

Let’s talk about each leg of the stool and see how they can inform our understanding of fraud in financial services industry.


Cressey’s original article referred to financial pressure that is generated from what he refers to as ‘non-sharable’ problem.  Steven Dellaportas provides a good definition of what this means:

“A non-sharable problem occurs when an individual is confronted with a problem or personal crisis and is unable to share their problem with friends or colleagues because of the shame the offender associates with the behaviour, and the consequently effects of legal or social sanctions when the behavior is discovered. Financial distress, loss of status, admission of fault or poor judgment, have the potential to create a non-shareable problems begetting an individual to secretly resolve their problems by stealing to avoid losing face.” (Dellaportas, 2013, p. 30)

The first point to note that is that whether a problem is deemed, ‘non-sharable’ is relative to a certain person. There are some people who would feel comfortable and sharing their financial or business troubles with their spouse or other family members or confessing their feelings of inadequacy to a friend or religious figure.  When we bring other people into the picture, ‘non-sharable’ problems, become ‘shared’ or at least ‘witnessed’ – at which point it is possible to seek input from others regarding possible solutions.

The financial services industry, particularly in some aspects, places tremendous pressure on people to be productive. Success is often solely defined in terms of ‘hitting the numbers’ and individual achievement (or lack of achievement) is often very public. There are some people who find this sort of pressure tremendously motivating and translate it into a drive to produce excellent value to their organization, excellent service to their clients and handsome benefits for themselves and their families.

But not everyone thrives under such pressure, and this is true even if they did at one time or even if they believe that they do thrive. While they are willing to reap the benefits of success, they desperately fear the consequences of failure. They are unwilling to accept or remain stoic in the face of their lack of achievement. This can constitute a ‘non-sharable’ problem as they struggle with ‘losing face’ in front of their colleagues and friends.  Often, their identity is so wrapped in their professional success that they have little to fall back on when this identity is under threat.

Many academics writing on the Fraud Triangle focus their attention on individuals working for large corporations or operating as an external auditor. But I think an argument could be made that a different sort of pressure applies to individual producers in the financial services industry.  Unless you are the member of a C-Suite, pressure is not usually the direct result of your failure to perform.  The accountant at Arthur Anderson who was pressed to collude in the financial shenanigans at Enron was not responsible for Enron’s failed business strategy; but the individual selling unsuitable products or recruiting unsuitable individuals to meet production goals is trying to cover-up a personal failure to perform. The great strength of the financial services industry is its rewards for individual success, but this can create tremendous pressure, pressure that falls solely on the individual.


Cressey’s original article focused on opportunity, which is defined as the perception that a control weakness is present and the likelihood of being caught is remote (Dorminey et. al. 2012, p. 558).

Financial services practitioners have an excess of opportunity to commit fraudulent acts, both towards the organization and towards their clients.  Steven Dellaportas, an accounting professor in Australia, wrote a fascinating article on a research project he did where he interviewed several accountants who were currently in prison for various white-collar crimes. He concludes that these professionals relied on the trust of their clients (whether individuals or organizations) as well as their superior technical knowledge to perpetrate corrupt acts. In finance literature,  the ‘agency problem’ refers to a situation in which individuals lack the knowledge to assess whether their principals are acting in their best interests.  The ‘agency problem’ wherever there is an asymmetry of knowledge between the parties; it is found in the legal profession, the medical profession and the engineering profession, to name a few.  I once had a friend who somehow got a job teaching Latin to a group of high-school students. Unbeknownst to them, his Latin was not as advanced as he led them to believe and he was only a day ahead of them in the textbook. But, as is often the case, in hiring an expert, we don’t know what they don’t know. Of course, the consequences are significantly more severe when you are receiving bad legal or financial advice then when you are receiving an incomplete explanation of the Latin gerundive. Moreover, people often trust their expert advisor simply because they picked him or her.  We all want to believe that we are good judges of character and have confidence in our abilities to select the right experts.  Finally, financial services practitioners actually often handle money (whether in physical or virtual form). It is these three factors; knowledge asymmetry, client trust and proximity of money that can increase the opportunities for financial services professionals to commit fraud.


The last leg of Cressey’s stool focused on rationalizations. The basic idea is that most people have a lot invested in the idea of themselves as an ethical person. But, this self-concept becomes hard to maintain when I am performing a corrupt act.  The way to resolve this tension is through rationalizations, that is, people who commit fraud need to find a way to mitigate the corruptness of their own actions.

In an interesting article, Anand et al. (2005) describe three categories of rationalizations:

  • Denial of Responsibility
  • Denial on Injury
  • Denial of Victim

Anand and his co-authors define denial of responsibility as follows:

“Denial of responsibility is a rationalizing tactic where individuals convince themselves that they are participating in corrupt acts because of circumstances – they have no real choice. The circumstances may involve a coercive system, dire financial straits, peer pressure, ‘everyone does it’ reasoning and so on.” (Anand et. al, 2005, p. 11)

The idea that motivates this type of rationalization since I was somehow compelled to perform these actions, they were not fully free. Therefore I cannot be held morally (or legally) responsible for them. This idea is reflected in the criminal code as well, people often receive a diminished or mitigated sentence for crimes of passion.

And of course, there is a long continuum of what we can call ‘fully autonomous actions’, defined as those actions that are free from any outside influence and completely coerced actions, defined as those actions in which your actions are physically compelled against your will. However, most of the time, the argument offered by the rationalizers simply does not hold weight. While there may have been some pressure involved, it usually is incorrect to say that the individual involved had no choice.

And this leads us to an important point about rationalizations, they do not need to be particularly good arguments, they merely need to be good enough to resolve the cognitive dissonance.  This is one of the reasons that rationalizations often seem so flimsy when exposed to public view.

Denial of Injury

Denial of injury essentially refers to the idea that if no one was harmed by an action, then the action isn’t really wrong. I talked about this in an earlier blog post under the ‘no harm, no foul’ rule and made the case it was inadequate as an ethical standard. First, simply because you cannot immediately identify the harm does not mean that no harm has occurred or that no harm will occur.   Second, if you believe that sort of actions you take affect the development of your moral character, as we talked about in this recent blog post, then corrupt or vicious actions can amount to profoundly harmful consequences for yourself.

As researchers on the fraud triangle point out, this rationalization is often used when employees engage in corrupt actions against their organization. In the financial services industry, an example may be the ‘gaming’ of incentive contests in order to receive the rewards without providing the intended value to the organization. The employee may reason that no one is really harmed by his action, since, “one more plane ticket certainly won’t bankrupt the company.”

Denial of Victim

This rationalization is different than denial of injury, but they are closely related. The driving idea behind “denial of victim” rationalizations is that while the action may be wrong when directed at certain individuals, it is perfectly appropriate when directed at other individuals. So, for example, while it would be wrong to steal from a peasant, it is morally acceptable (and even praise-worthy) to steal from the rich, as in the Robin Hood mythology.  In this example, the wealthy individuals whose property was the subject of Robin Hood’s raids were not understood as victims – and therefore, no harm was done.

The ‘denial of victim’ cluster of rationalizations can take multiple forms, as in the Robin Hood example, in which members of the nobility were not seen as victims because they were not seriously harmed by the by the small deprivation of the good, small relative to the vast extent of their wealth. Another a second form is that people are not victims because they somehow deserve the treatment they get because of a previous bad act. For example, many people believed that it was not wrong to illegally downloading music because they reason that they are just paying back injustice for injustice given the sky-high prices for legally sold CDs and DVDs.  Additionally, perpetrators may deny people are victims because of a personal characteristic of the victim group. In this case, perpetrators of unjust acts reason that their victims were careless or greedy, stupid or naïve, and therefore, deserve the injustice they receive.  As researchers note, this belief (which originally operates only as rationalization) over time can come to be firmly embraced by the perpetrator making it easier to continue to perform corrupt actions.

The take-away is that, according to the model of the Fraud Triangle, there are several factors within the financial services industry that may increase the instances of fraud that make fraud more likely:

  • The inherent pressure of the sales-environment as well as the compensation structure in the financial services industry may increase the instances of ‘unshareable problems’, and as we will discuss in the next post, the hyper-competitive environment in many financial services field offices can make it difficult for people to share their problems with their leaders, thus rendering ‘shareable problems’ into ‘unshareable ones’.
  • Like accountants and other professionals, the knowledge asymmetry between practitioners and their clients as well as the level of trust most clients have in their financial advisors, coupled with the ready access to money, creates more opportunity for financial services professionals than may be found in other industries. While financial services companies strive for rigorous internal controls, their effectiveness may be diminished by the lack of geographical proximity.
  • Finally, it is easy to see ripe opportunities for rationalization at two different levels; client relationships and organization. Organizational relationships always have the potential to be fraught with mistrust – and these feelings (and misunderstandings) can be exacerbated when the home office of the organization is located at a geographical distance.

We have taken the important step of thinking about the factors that may exacerbate the likelihood of fraud in our industry. In the next post, we will look at ways this fraud can be prevented.

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