Staying on the Lookout for Fraud - Some Risk Management Advice

Published August 9, 2007

In the last 6 months we have helped two of our client organizations, PSOs in two different provinces, deal with the aftermath of employee theft. For one organization, the outcome was the loss of tens of thousands of dollars, none of which is likely recoverable from the former executive director. For the other organization, the outcome was considerably more upbeat – a business corporation that was unknowingly and innocently drawn into the fraud transaction by the executive director turned around and made a sizable donation back to the PSO. The cloud of fraud rarely has such a silver lining. However, once fraud is perpetrated on an organization, it seldom happens a second time, because of the valuable lessons learned.

We suggest that fraud is more easily understood by examining what is known as the ‘fraud triad’. Fraud is a crime, and the fraud triad is similar to the standard of evidentiary proof that we hear about on TV shows like CSI and Law and Order – motive, method and opportunity. The three elements of the fraud triad are not far removed – they are pressure, opportunity and rationalization:

Pressure refers to the person having some sort of financial need (an illness in the family, an accumulation of debts, an addiction, a divorce, a desire to maintain a certain lifestyle etc.)

Opportunity refers to having an easy ability to commit and conceal the fraud

Rationalization refers to the person having, or developing, a mindset that allows them to justify the fraud (‘I am underpaid anyway’, ‘my employer owes me for all the extra work I have done’, ‘it’s just a temporary thing, I will repay it later’, etc.)

A forensic accountant will tell you that when all three of these ingredients exist, there is a high likelihood that fraud will occur: for sure, we know that fraud seldom occurs in the absence of these things.

By breaking down the fraud factors this way, it is possible to think more clearly about the measures that can be taken to reduce the risk of fraud. For example, the opportunity to commit and conceal fraud arises directly out of the controls that an organization takes, or fails to take, in relation to the management of money or other assets. And while an employer is likely unable to read inside the mind of an employee (thus detecting a certain attitude of rationalization), an observant employer should be generally aware of an employee’s individual circumstances that might lead to pressure.

Possibly the easiest way to prevent fraud is to shut down the opportunity. This can be as simple as developing good systems to authorize and execute financial transactions. Other measures include having the treasurer perform informal audits and internal checks from time to time, having an external book-keeper, and instituting careful physical controls around any large volume cash transactions such as player or club registration, or ticket sales. The same physical controls would apply to large inventories. If the organization regularly makes major purchases such as for team uniforms, it should be standard policy to solicit competitive bids.

Once aware of the fraud triad, it becomes easier to watch for warning signs. One such warning bell is a sudden change in an employee’s circumstances. Also, be wary when financial reports are late, when financial records are incomplete, or when an employee is vague or unclear when responding to direct questions. The same advice applies to treasurers, or other officers who have a role in organizational finances. Lastly, no matter how trusted an employee may be, the Board ultimately has an oversight responsibility and should take steps to ensure controls are in place and enforced.

It is said that in some industries the indicators of fraud are on the rise, in part due to new technologies and declining business ethics. We have certainly seen more sport-related fraud cases recently. We urge sport administrators to trust their intuition when something does not seem right, and to err on the side of caution by investigating further. Remember, risk management is ‘organized common sense’ and some of the most effective risk management measures are those that are intuitively simple and practical.

Originally published: Centre for Sport and Law Newsletter (2007) Vol. 3(3)