Skip to content

Prevent Fraud in Business with the Fraud Triangle

James Ratley talks about how to prevent fraud in business.

Can you guess the reason the majority of businesses fail? If you guessed “economic downturn” or “poor business decisions,” those are good guesses – but they’re wrong. The majority of businesses fail because of fraud. And many managers and owners don’t realize the problem until the checks start bouncing. If you don’t have systems to watch for it or it’s not a concern, fraud could spell the end for your business.


See Finding Small Business Fraud with James Ratley for a complete transcript of the Easy Prey podcast episode.

James “Jim” Ratley started his career as a Dallas police officer, where he got a solid background in investigative techniques and interrogation. After fifteen years of police work, he left the force and went to work at a financial investigation firm with a man named Joseph Wells. Joe had an idea for something called a Certified Fraud Examiner, where people could get certified as financial fraud investigators. The response was overwhelming, and Joe and Jim founded the Association of Certified Fraud Examiners. After moving from Program Director to President to CEO of the association, Jim retired in 2018 after thirty years investigating and helping others to investigate fraud.

The Association of Certified Fraud Examiners

When the Association of Certified Fraud Examiners (ACFE) started, Jim and Joe had no members and five employees. They printed 20,000 letters on a desktop printer and stuffed and mailed them all themselves. The response was so enthusiastic, within weeks the post office had to bring them mail in boxes.

Shortly after they started, two men in suits showed up at the office. They were FBI agents. Someone had reported the ACFE for being fraudulent. Jim brought the agents in and showed them what the ACFE was doing. Both of those agents became Certified Fraud Examiners.

The program has been an overwhelming success. Today, ACFE has almost 100,000 members from more than 155 countries. When it first started, there was no information on fraud. Jim went to the University of Texas library, and it had only two books on fraud – both of which only said that fraud was bad and something should be done about it. Neither had any advice for what to actually do. ACFE stepped in and created a great resource.

Fraud in Business is a Huge Problem

One of the things that ACFE does is the Report to the Nations. This is a biannual study that looks at fraud data from all over the world and provides a wealth of data. And these reports contain some shocking facts that illustrate why it’s so important to prevent fraud in business. Some examples of these facts: The average business loses 5% of their revenue to fraud, and statistically, six out of every ten people you hire will steal from you.

The average organization loses 5% of their gross revenue to fraud.

James Ratley

At the time of the first Report to the Nations, businesspeople wouldn’t say fraud. Most accounting organizations just called it “irregularities.” ACFE put fraud on the map and took it from the back room to the boardroom. Over half of frauds happen because people ignored the internal controls meant to prevent fraud. And small businesses are twice as likely to be victims, to the point where over half of all business failures are a direct result of fraud.

51% of business failures are a direct result of fraud.

James Ratley

Fraud is a massive problem, and we shouldn’t ignore it. But you can also prevent fraud in business very cheaply. One organization Jim worked with had a massive fraud problem and dealt with it by creating a fraud squad. They put photos of the fraud squad members in the company newsletter, provided a number to reach them, and told employees that they could call the number to report fraud. Just doing that reduced fraud by about half.

The Psychology of Fraud in Business

People will steal to the limit of what they can. Jim was once doing a class for an auditor’s office, and the class started talking about what counted as stealing. If you’re working for a company and take home a ream of paper, is that theft? Jim’s answer was not only is that theft, but if you’ll steal paper, you’ll steal a million dollars if given the opportunity. The only reason you haven’t stolen that much is because you haven’t had an opportunity.

There are no small frauds, only frauds that have not had time to reach maturity.

James Ratley

People that steal often tell themselves that they deserve it. Jim very seldom finds someone who admits they stole. We perceive ourselves as we intend to be, which may not necessarily be how we are. The biggest thing you can do to prevent fraud in business is stop sweeping it under the rug. Stop being afraid to talk about it. Create the perception of detection – let your employees know that you’re on the watch for it. Have an anti-fraud program. This won’t be a problem for your honest employees. Just like non-smokers don’t complain about smokers having to go outside to smoke even when it’s cold or raining, and in fact are often happy about not having smoke in their space, non-fraudsters won’t complain that you have programs in place to prevent fraud.

The first thing that people have to do to reduce the level of fraud is quit being afraid to say the word fraud.

James Ratley

The Fraud Triangle

You may remember the fire triangle from when you were in school – for a fire to start, you need heat, a flammable material, and oxygen. Without all three of those, there’s no fire. Similarly, with fraud in business, there is a “fraud triangle.” In order to steal, the three elements of the fraud triangle have to come together.

The three sides of the fraud triangle are financial need, opportunity, and the ability to rationalize. Everybody has financial need at some time or another. Most employees have an opportunity to steal something at some point. But the ability to rationalize it is the key. People don’t want to see themselves as thieves. They have to have some way to look at themselves as deserving it in some way, or they can’t rationalize it to themselves.

The three sides of the fraud triangle illustrate ways to prevent fraud in your business.

The fraud triangle provides a guideline to prevent fraud in your business. If you can reduce the three sides of the triangle, you can prevent a lot of fraud.

Reducing Financial Need

Without paying employees more, there are not a lot of options to reduce financial need. Jim is a big fan of employee care programs. At ACFE, they have over a hundred employees, many of them young. And they have a policy that if you need help, you come to them. The organization has paid for a number of root canals and bought a number of tires and car batteries. They want to help their employees.

An employee care program gives employees somewhere to turn to. Many people have parents, siblings, or friends they can turn to in times of need, but some don’t. It’s the responsibility of the corporation to step up and help the employee. ACFE doesn’t make the employee pay back the assistance – they already don’t have the money to pay for it, making them pay it back won’t help.

These programs also make the employee realize it’s a good place to work. Any business, especially a small business where the owner and/or manager knows the employees personally, should step up to help when an employee is in dire straits. Not only does this prevent fraud in business by lowering the financial incentive, having your boss or company go out of their way to help you lowers your ability to rationalize a theft, as well.

Reducing Opportunity

To prevent fraud in business, you need to limit the opportunity employees have to commit fraud. That means creating the perception of detection, or fostering the idea that the company is watching and you’ll get caught if you try to steal. A lot of things go into that.

One of those is your managers. Many managers want to be friends with employees and won’t be confrontational. But a manager should be a manager first. A manager’s obligation is to the company first, and their job is to know what the employees are doing, know what their jobs are, and make sure they’re doing them well. Managers who want to be friends with the employees first is not doing their job. It’s essential to have a strong management environment – and if you have to train your managers, then train them!

Training is also part of creating the perception of detection. If you train your employees about fraud, what it looks like, and how to report it, they understand that it’s something that you’re monitoring. They have the opportunity to report fraud if they see it – and they know that other people could report them if they try it.

Opportunity for Asset Misappropriation

Another part of preventing fraud in business by reducing opportunity is actually putting checks and monitoring in place. About 80% of fraud is asset misappropriation, which is a fancy term for just stealing money. The best way to prevent that is to have the person keeping the records of an asset be different from the person controlling that asset. This is why small businesses are often more vulnerable – they frequently don’t have enough employees to separate the control and record-keeping.

80% of the fraud you encounter is going to be asset misappropriation.

James Ratley

Doctors and dentists make excellent victims for fraud because they often don’t want to run a business. They just want to do their medical or dentistry things. So generally they hire one person to run the business side of the office. If that person decides to start writing checks for themselves, it’s easy for them to do. And the doctor or dentist often doesn’t know until their own checks start bouncing.

Controls are important because the people committing fraud in business are often the top performers or the ones everyone likes. The longer an employee has been with the company, the more opportunities they have to steal. And if the internal controls aren’t there, that gives them even more opportunity.

An Example of Opportunity and Preventing Fraud in Business

Initiatives like having an independent inventory team and preventing people doing the receiving from doing any shipping are great in creating the perception of detection. Employees know you’re serious about limiting opportunity for fraud. They also pick up on it if you have those initiatives to prevent fraud in business and then stop doing them.

Jim once taught a seminar for a company that had about a dozen clerks who collected cash for people to pay their utility bills. In the past, the company was really diligent in doing surprise cash counts to make sure nobody was stealing. But during the seminar, one employee brought up that the new director stopped the surprise cash counts and asked why they would do that. Before Jim could answer, the new direct spoke up and said it was because they weren’t catching enough errors to pay for themselves. Six months later, Jim got a call from the company saying the employees were robbing them blind.

It didn’t take those employees more than a week to figure out that the surprise cash counts had gone away. That opened up a huge opportunity to commit fraud. For those employees who had financial need and could rationalize it to themselves, stopping the surprise cash counts completed the fraud triangle and they started stealing.

Reducing Rationalization

The third way to prevent fraud in business is to reduce rationalization. You can do this through education, explaining, and giving people a means to report it if they see it. The most common thing companies do is provide a hotline for people to report fraud anonymously. It’s important to give them a means and a method to turn fraud in. The goal is not to live in fear, but to educate people, explain why, and let them know that you want the company to be healthy for everyone.

Most employees want to report fraud. If you’re working hard, Jim isn’t, and Jim is stealing, you’re not going to be happy about it. If you have training to recognize it and a way to report it, you will.

Some people aren’t going to like the methods you use. One of the things ACFE did was implementing internet monitoring software to see what employees were doing. But they didn’t turn it on until after an all-hands meeting where they explained what they were doing and why. They weren’t trying to stop employees from checking their personal email, just make the company better. The first person they had to call about their internet use was their IT Director. In five days, he spent ten hours looking at eBay. Many people didn’t care about this change because they spent their day doing their job, and normally they wouldn’t say anything unless someone spent six or eight hours a week goofing off online. They eventually had to terminate the IT Director because he couldn’t stay off eBay.

Prevent Fraud in Business by Watching for Financial Fraud and Corruption

The vast majority of fraud is asset misappropriation. But the rest is financial statement fraud and corruption, or taking kickbacks. Every company should have a policy limiting what purchasing agents can accept in gifts. Vendors have expense accounts that they can use to buy gifts for purchasing agents, and this could become a problem.

If a sales representative goes to a purchasing department and says, “Here’s $10,000, and we want you to approve every invoice we send you,” it’s great if they take the deal. But if they don’t, not only do the salespeople lose that business, they’re probably going to jail. But if they give the purchasing agents gifts, they’re just as obligated to the company, and there’s nothing fishy to report. And it doesn’t have to be $10,000 worth of golf trips and steak dinners. Small gifts often do the job just as well.

Financial statement fraud is another place where businesses can lose a lot of money. A lot of this fraud is done by senior managers. That’s what happened with Enron. Even if you have auditors in your company, it can be hard for them to challenge senior managers. To be effective, auditors need to be completely independent. Boards of directors should also be educated on fraud.

To prevent fraud in business, you have to be proactive.

We can prevent fraud in business is through education. But it’s hard to convince companies to spend money on a negative. Companies don’t want to hear negative information and ignore it when they can. That’s human nature. But it’s our responsibility to look. We have to go back to the fraud triangle and take away opportunity and ability to rationalize where we can.

The hardest part [of fraud prevention] is convincing someone that they need to spend the time and the money to educate their people.

James Ratley

Don’t Overlook Fraud

Jim once investigated fraud for a construction company where the purchasing people falsified the strength test on concrete. He knew for sure it was fraud, but couldn’t find the kickback. He went through everything he could think of, but didn’t see anything. Finally, while talking with the secretary, she asked if he’d checked the travel log. When he did, he found the purchasing people taking a corporate jet to a hunting lodge. That was the kickback.

As a manager or auditor, it’s essential to never judge people by your standards. Many people think that if you’re going to commit fraud, someone would have to pay you a lot. But you would be surprised by how small of an incentive some people need to commit fraud. It could be as small as a weekend at a hunting lodge.

You’d be surprised how cheaply somebody will sell their souls to the devil.

James Ratley

Most of the business failures due to fraud are because companies buy stuff from vendors that they don’t need. Look at your bank statements, look at your vendors, and let employees know you’re looking. If you see something that looks unusual, look at it more. Most of the time it’s not going to be anything. But sometimes it’s the thread that unravels the entire fraud. Owners and managers need to be involved and active to prevent fraud in businesses.

Learn more about the Association of Certified Fraud Examiners at acfe.com.

Related Articles

All
  • All
  • Easy Prey Podcast
  • General Topics
  • Home Computing
  • IP Addresses
  • Networking Basics: Learn How Networks Work
  • Online Privacy
  • Online Safety
  • Uncategorized
Michael Lyborg talks about the promises and risks of business automation.

Business Automation is Great – But Some Things Should Be Left to Humans

As we see an increase in cyberattacks, it’s more important than ever for companies to be able…

[Read More]
How to Spot Fake Emails.

How to Spot Fake Emails and Avoid Danger

The good news is that you don’t have to become a cybersecurity pro to protect yourself from...

[Read More]
Introducing the Brick

The Brick Turns Off Distracting Apps, Makes Your Life Less Distracted

Here are some details. Brick is a combined software and hardware app that helps temporarily “remove” distracting...

[Read More]
Howard Goodman talks about cybersecurity and business.

Education and Communication are Key to Business Cybersecurity

The landscape of both technology and cyber threats is constantly changing. That means that cybersecurity and business…

[Read More]
Money Lender “Dave”

Money Lender “Dave” is In Hot Water with the FTC and DOJ. Scam or False Advertising?

Money-lender Dave does the one thing that all scammers do: It lied to its target through its...

[Read More]
Christiaan Brand talks about passkey security and why it's the future of authentication.

Passkey Security is the Future of Account Access

Phishing and account breaches have been a problem for years, and it’s not going away. In fact,…

[Read More]