The Psychology of Fraud 101
Avant Advisory Group | June 27, 2018
The attention-getting article is titled: “17-Year Sentence for West Palm Beach Eye Doctor in $73 million Medicare Fraud Case.” Dr. Salomon Melgen was convicted of 67 crimes involving healthcare fraud for persuading elderly patients to undergo excruciating treatments they didn’t need for diseases they didn’t have. Dr. Melgen became the highest-paid Medicare doctor by rendering unnecessary care to his elderly patient population who trusted him.
Beyond the financial fraud that was bad enough, the medical tests were agonizing. Melgen unabashedly billed Medicare for procedures he claimed were performed on the artificial eyes of one-eyed patients as if they were real. Usually performed over several minutes, he completed the tests in seconds, making them useless as a diagnostic tool. The list of inappropriate billing and examples of patient mistreatment are many, but you get the point.
Why would a seemingly well-to-do physician turn to fraud? What possesses a person to commit such acts?
These three basic circumstances lead to the commission of fraud as depicted by the “Fraud Triangle” below:
Financial Pressure: The upper-left leg of the triangle represents financial pressure. This is what creates the motivation or incentive for the fraudulent act. The individual often has some “perceived unshareable financial problem,” so he begins to consider committing a fraudulent act. For instance, he might steal to conceal and support a drug problem, pay off debts, or acquire expensive cars or houses. Changes in financial circumstances such as divorce or chronic family illness can also create a financial incentive. Greed is oftentimes the driving influence.
Opportunity: The bottom leg is opportunity, which defines the method by which the fraudulent act can be committed. The person must see some way he can use or abuse his position of trust to solve his financial problem with a low perceived risk of getting caught. The opportunity to commit fraud can arise from various circumstances such as:
- Weak internal controls.
- No separation of duties.
- No rotation of tasks.
- Lack of enforcement or monitoring.
Rationalization: The last leg represents rationalization. That means the person committing fraud sees himself as a normal, honest person who is trapped in a bad situation. Thus, the perpetrator of fraud justifies his fraud to himself. Common rationalizations include (but are not limited to) the following:
- “I was only borrowing the money.”
- “I was entitled to the money.”
- “I was underpaid.”
- “I have been wronged.”
- “There is no other way.”
The Fraud Triangle has been further refined as it applies to senior corporate executives with similar and complementary observations. The Executive Fraud Triangle recognizes those attributes of greed, pride, and entitlement which “surround” the executive:
- Greed: Executives want money, position, title, authority, perks, services, etc.
- Pride: Executives think they’re better, smarter, more skilled, or superior.
- Entitled: Executives feel as though they deserve money, position, title, authority, perks, services, etc.”
In the article discussed above, the story is compounded by a lifestyle of wealth, excess, and power. Dr. Melgen abused his position of trust, thinking he wouldn’t be caught. In terms of financial pressure, Dr. Melgen was greedy – seeking what seemed like no limits to wealth and power. He had the opportunity because his patients placed their unquestioning trust in him. He owned his own practice, and as the physician in ultimate control of what goes on the billing sheet, an opportunity was clear. We can only guess at his rationalization which might range from “I deserve it” to “I’m only borrowing it.” Consistent with the executive fraud triangle, we see evidence of greed, pride, and entitlement. If you were an investor in Dr. Melgen’s practice, his problems would be your problems!
Avant Advisory Group professionals have uncovered many instances in which a person of trust – the owner or key executives with his hand in the cookie jar or worse. He or she sees an opportunity and seems never satisfied regardless of how much money or power. Surprisingly, many if not most frauds, are detected from a tip. We receive so many calls to come in and look around because “something does not seem right,” or because someone said or saw something.
Sometimes “the numbers just don’t add up.” It can be an isolated incident or the cash balances may not match up to the reported profitability. It can be inappropriately capitalizing expenses into inventory or the expensing of capital expenditures. Or it can be the intended manipulation of reported sales and the transfer of cash balances into a non-core business entity. Today, the challenges are greater, as are the pressures to meet targeted numbers. And sometimes, management makes a judgment call on how to report the numbers in the current period hoping to catch up sometime in the future. No matter the source of the discrepancy, the accounting needs to be corrected and the results viewed in the proper perspective.
By practicing with Big Four CPA audit firms over the years, we have obtained deep and broad accounting and audit experience. And it is experience supplemented by countless forensic, fraud and corporate examinations performed on behalf of private equity firms, hedge funds, family offices, banks, corporate boards of directors and audit committees, law firms, and other stakeholders. As a result, we are superbly equipped with deep technical knowledge and practical skills necessary to perform cost efficient forensic, fraud, and corporate internal investigations. This makes us effective in contributing to strong dispute resolution strategies and advisory opinions.
Further, this financial forensic expertise provides our consultants with an additional perspective beyond those experienced in or performing only traditional financial audits or due diligence. In fact, as part of performing routine quality of earnings engagements and assessments of portfolio companies, we have identified questionable and even fraudulent accounting and reporting issues.
So if your “numbers just don’t add up,” give us a call and we will help put your mind at rest by bringing you answers that you can trust.