APPENDIX 4: LIST OF SCHEDULE 1 OFFENCES 270
3.2 EMPLOYEE FRAUD THEORY
According to the ACFE (2014:6) there is a common misconception among many organisations that fraud does not occur within their organisations. Organisations do not believe that their employees would commit fraud against them. KPMG (2011:4) found that senior managers within an organisation are more likely to commit fraud against their employer than other levels of employees. According to Simuyemba (2012:1), the element of entitlement involves people holding the view that those in charge owe them something. Simuyemba (2012:1) cites the example of an employee who expects to be promoted based on the fact of long service in the organisation. The entitlement mentality may not justify the notion that the world owes anybody anything. The reality is that employee fraud is on the increase, causing financial losses to employers. The ACFE (2014:8) reported in its global fraud study that an estimated $3.7 trillion (R44.4 trillion) loss is attributable to employee fraud. The study was premised on 1483 cases of occupational (employee) fraud globally. This is the formal estimation. The informal reality may be substantially more. The ACFE (2014:4) postulate in its report that employee fraud
comprises three types of fraud: asset misappropriation, corruption and financial statement fraud. These types of employee fraud are explained in more detail later in this chapter when the nature of employee fraud is explored. In order to understand what fraud is, one has to establish what elements constitute fraud.
3.2.1 Elements Constituting Fraud
According to Snyman (1987:457), the legal definition of the crime of fraud requires four essential elements to be present in order for it to constitute a crime. The four elements that define fraud are briefly described below in order to provide an understanding of what fraud is.
3.2.1.1 Misrepresentation
Snyman (1987:457) holds that the act by the employee has to involve a distortion or perversion of the truth, commonly referred to as a misrepresentation. The employee has to represent to the employer the existence of certain facts while knowing in his/her mind that these facts do not exist. The employer accepts this representation at the time in good faith on the understanding that the employee will honour his/her commitment. The misrepresentation may be made in writing, verbally or by means of a physical gesture, such as nodding of one’s head. The misrepresentation could be made explicitly or implicitly. It could be made by an omission of relevant facts. For example, had the victim been made aware of this particular essential fact, he would not have acted to his detriment. By implication, this means that an employee who withholds vital information can be regarded as making a misrepresentation to the employer, which results in prejudice.
3.2.1.2 Prejudice
The element of prejudice could be in the form of actual or potential prejudice to the victim.
According to Snyman (1987:459), the potential that the victim is being prejudiced is sufficient in law. In other words, it is not a prerequisite in law for the victim to suffer actual prejudice. It is of no consequence that the fraudulent act was unsuccessful because of it being detected during its commission. It is the “intent” that is the key here (“mala fide”, “dolusmalus”,
“falsum” and “stellionatus”). Whether the victim suffered a loss, or not, is irrelevant, as Snyman expounds (1987:460). The prejudice may be in the form of a financial or proprietary nature.
3.2.1.3 Unlawfulness
The act has to be unlawful. The perpetrator cannot rely on a defence that he/she did not know that the act of misrepresentation was unlawful. Snyman (1987:172) is of the view that the fraudster has to, in principle, know that his/her conduct is forbidden in law. The fraudster may raise the grounds of justification that he/she was acting upon an order or compulsion. Snyman (1987:462) found that the court refused to accept the ground of justification that the accused had acted unlawfully on instruction from his employer when fraud was committed, in the case of Shepard 1967 (4) SA 170 (W) 177-178.
3.2.1.4 Intention
Intention is an essential element that makes up the crime of fraud. The accused should have intended to commit the crime. One cannot negligently commit fraud. According to Snyman (1987:462), the accused should have been aware that he/she was making a false representation at the time. In terms of Section 245 of the Criminal Procedure Act 51 of 1977, an accused on trial for fraud will be deemed to have made the representation while knowing it to have been false, if such is proved in court. The onus rests on the accused to prove otherwise.
There has to be the presence of all four elements in order for the act to be deemed fraud. The Criminal Procedure Act 51 of 1977 currently lists fraud as a crime which is punishable by the State.
The question often asked by employers is “why did my employee do it?”. In attempting to understand this phenomenon, criminologist Donald Cressey (1973:30) suggests that trusted persons violate trust when they have a financial difficulty and are able to conceal their fraudulent conduct and rationalise to themselves that they are entitled to use the funds.
According to Simuyemba (2012:1), this involves employees who have an entitlement mentality. Cressey identifies three factors which facilitate the perpetration of fraud. The factors are pressure (incentive), opportunity and rationalisation. He argues that the fraudster has to be under some pressure to commit the fraud, such as having a gambling habit, drug abuse or greed. Secondly, there has to be a lack of, or weak internal financial controls, which the fraudster exploits in order to create the opportunity to commit and conceal the fraud. Thirdly, fraudsters justify the fraudulent act by convincing themselves that they will repay the money,
or that the money is due to them, for example, by being overlooked for promotion (Cressey, 1973:30).
Wolfe and Hermanson (2004:38) expanded the fraud triangle model and created the “Fraud Diamond Model” by adding a fourth factor. This was the factor of capability. They assert that the individual has to have certain observable traits, for example, the personality, to commit fraud. They postulate that some capability traits are holding an authoritative position, having the capacity to exploit deficient internal controls, being confident of not being caught or having the ability to explain away the fraud and lastly, the ability to deal with the stress of committing fraud. Both the fraud triangle and fraud diamond models are deliberated on below in separate sections of this chapter.
Regular global fraud surveys are conducted by various forensic auditing companies including KPMG, PwC and Deloitte; as well as the ACFE. The objective of these surveys is to provide insight into the nature and extent of employee fraud and how these could be detected and prevented.
PwC (2011:18) found that a total of 56% of perpetrators of fraud were employees of a company. It is evident from this study that the risk of fraud emanates largely from within a company’s own ranks. In view of this finding, this study focused on higher education institutions that were victims of employee fraud, in order to explore the modi operandi used and motives of employees to commit and conceal the fraud. Organisations can prevent fraud from occurring if they are aware what fraud is, who commits it, why and how it is committed and how it is concealed. The ACFE (2012:5) found that the longer a fraudster was employed within an organisation, the greater the value of the loss. This situation is exacerbated when two or more employees collude with each other to defraud their employer. The ACFE (2012:43) asserts that collusion between employees to commit fraud results in greater financial losses than fraudsters working on their own. Fraud involving collusion amongst employees is also difficult to detect as they have the ability to circumvent internal controls and conceal their fraudulent conduct. Considering that preventative internal controls, according to KPMG (2006:8), are designed to assist in the reduction of the risk of fraud, these internal controls are arguably ineffective when employees collude to commit fraud and circumvent these preventive internal controls.
Albrecht and Schmoldt (1988:16) explain that dishonesty and compromised integrity are prevalent in society. The reasons why employees commit fraud against their employers have to be considered. According to Jones and Jing (2011:859), experts agree that the motive for committing fraud is greed for money. Wells (2001:89) concurs that the motive to commit fraud is greed. Albrecht and Schmoldt (1988:111) caution that trustworthy employees are not a control measure. Albrecht and Schmoldt (1988:113) are also of the view that employees commit fraud due to three inclusive factors, namely, pressure, opportunity and rationalisation.
These three factors form the fraud triangle, as explained earlier in this chapter. Thus, understanding the motive and modi operandi of fraudsters will be helpful to organisations in their quest to address the occurrence and impact of employee fraud.
Peterson and Zikmund (2004:30) suggest that employees would be less likely to commit fraud if they were aware that they could get caught; they recommend implementing robust internal controls, the presence of internal auditors, conducting fraud risk assessments, implementation of a fraud hotline and awareness training programmes to staff about fraud risks. Management needs to set a sound ethical tone at the top and lead by example in order to win the hearts and minds of employees in the fight against employee fraud. While incidents of fraud are escalating within South Africa, so too is the cost of the loss to the victim organisations. It is of concern that fraud remains pervasive. Perhaps the assertion by Larson (2006:16), that there is a scarcity of skilled forensic accountants, is indeed a shortcoming in fraud prevention and detection.
It is also likely that employees are aware that they will not be caught out as their organisations lack the relevant skills and expertise to unearth fraudulent conduct. Larson (2006:16) avers that little is being done by tertiary institutions to incorporate forensic accounting concepts into their curricula in order to provide undergraduates with fraud prevention skills. The gap in the curricula of universities could possibly be addressed by creating a partnership between universities and the ACFE. The ACFE (2014) provides an “Anti-Fraud Education Partnership” initiative between itself and universities, whereby the ACFE provides the required resources for the fraud examination course to universities at no cost. The ACFE suggests that this fraud examination course be integrated into the applicable mainstream degree courses offered by universities.
Apart from the actual loss, organisations incur financial costs to have fraud cases investigated and to recover their losses. Laufer (2011:402) argues that a victim organisation may be further prejudiced due to legal costs, negative publicity and poor staff morale resulting from the fraud committed by an employee. Organisations undoubtedly have to spend additional funds for legal fees and costs to institute formal disciplinary procedures against the implicated employee, over and above the direct loss arising from the misappropriated funds.
The Prevention and Combating of Corrupt Activities Act 12 of 2004 was promulgated because the illegal obtaining of personal wealth is considered to be harmful to organisations, the economy, ethical values and the rule of law. Section 34 of this Act also places the onus on persons who are in positions of authority, to report corrupt transactions, inter alia, the offence of fraud involving an amount of R100 000 or more, to any police official. In its attempt to combat fraud and corruption, the government has made management personnel accountable should they not report such cases to the SAPS. The intention of the legislature is to eradicate employee fraud with the assistance of management and the public. Section 29 (1) of the Higher Education Act 101 of 1997 stipulates that a university council should establish committees who will have the delegated authority to carry out certain duties on its behalf. One such committee which is tasked with oversight of audit and risk at a university, is the audit and risk committee (UKZN, 2014:23). According to COSO (2013:148), the role of the audit and risk committee is, inter alia, to ensure oversight over the implementation of adequate and effective systems of internal control to mitigate all risks, including fraud risks by management. Both these Acts should be considered when addressing employee fraud and prevention strategies at universities in KwaZulu-Natal.
In this chapter an analysis is presented of various global fraud surveys that have been conducted by forensic auditing companies such as KPMG and PwC, as well as the ACFE.
Hereunder, the factors of pressure, opportunity and rationalisation are explained in order to obtain enhanced insight into the fraud triangle explained below.