What drives management fraud and how to effectively tackle it

04 August 2021 Consultancy.in 5 min. read

Fraud comes with a hefty price tag for organisations across India, with management fraud one of the most potentially harmful forms for businesses and society. A new report by MBG Corporate Services takes a look at why leaders entice themselves into illicit conduct, and what other leaders can do to tackle the risk. 

According to the report by MBG Corporate Services (MBG), the typical large organisation in India loses 5 percent of its revenue to fraud each year (sourced from the Association of Certified Fraud Examiners). Fraud can come in all shapes and sizes, from theft of cash, procurement fraud and payroll fraud, to asset misappropriation, tweaking financial accounts and theft of intellectual property, among other. 

One such type – management fraud – can have pervasive and wide-reaching effects, impacting shareholders, employees, the communities in which firms work, and society at large. Although managers are estimated to be at the source of less than one fifth of all fraud cases, their involvement does on average lead to (by far) the largest damages for their organisations. 

The Fraud Triangle for Management

Key drivers of management fraud

In its report, MBG’s authors introduce the concept of the ‘Fraud Triangle’ to outline the why behind fraud by CxO’s and (senior) managers. At the core of this concept is the notion that managers have power and authority, which makes it easier for them to commit certain types of fraud, and perhaps more importantly, make sure that their conduct is concealed or kept top-secret among a small group of fellow offenders. 

The drivers are fraud are:

Greed is at the top of the Fraud Triangle. Despite an already privileged (financial) position, the executive is hungry for more, and uses his position and related authority to take more than what is stated in his contract. 

Pride is one of the supporting legs of the Fraud Triangle. Executives that have too much pride or an inflated sense of superiority, might think they are better, smarter, more skilled as compared to others. They can get lured into illegal conduct – and typically won't allow anyone to question their decisions. 

The last leg of the Fraud Triangle is entitlement. Executives feel they deserve anything they could possibly want – money, fame, high bonuses. They also believe that they should get these things because they “deserve” them. This level of selfishness can lead to all sorts of slimy decisions and behaviour. 

How leaders conduct fraud

So how do managers conduct fraud? According to MBG’s paper, these are the most common types:

  • Override internal controls
  • Mis-usage of company funds for personal profiteering
  • Siphoning of funds for unrelated business purposes
  • Preferential selection of business suppliers
  • Hiring of related parties or associates at excessive remuneration
  • False representation to auditors
  • Concealment of financial information
  • Misreporting of financial statements
  • Falsification of documents

Because fraud inherently involves efforts of concealment, many of such cases will never be detected by organisations or regulators. “Some behaviours are fraudulent, while others represent an abuse of power. Mostly, the executive can get away with fraud because he is the top of the authority pile; the authorisation usually goes unchallenged or those that dare to question are simply removed from their role/position,” says Abhijeet Sharma, Chief Operating Officer at MBG. 

Tackling management fraud

Tackling management fraud is by no means an easy task. Sharma: “They are difficult to detect, complex in their design, time taking to comprehend, extremely difficult to prosecute and cumbersome to obtain convictions because of the various alternatives measures available to senior executives to cover their tracks.”

The key in doing so, according to MBG’s report, is by taking an integral approach to risk management and governance. This includes: 

Robust internal controls
Having a formal system of fraud detection in place is the fundament. “Businesses should care about internal controls to protect their assets and reduce the risk of frauds,” states Sharma. A coordinated effort is required, with internal controls in departments/processes aligning to the overall corporate governance model. 

Effective risk management
“No matter how small or big the company is, risk management is for many valid reasons an essential part of detecting, and resolving management fraud,” says Sharma. 

As with any change or form of conduct, leadership is expected to lead the way. “Management’s commitment to implementing internal controls and how well they follow the compliance controls framework sends a strong signal to all employees about the importance of internal controls, fraud prevention and accurate financial reporting.” 

In similar fashion, leaders are expected to assume responsibility: “Management shares a large quantum of responsibility for the prevention and detection of frauds wherein an environment of corporate governance protects the interest of all stakeholders,” explains Sharma. This extends to their own personal behaviour – as they are expected to demonstrate ethical and responsible leadership. 

Background audits
In high risk areas, background audits are needed on individuals, entities and/or third-party suppliers to identify any corrupt practice executed in past or in the current. Such background verification procedures have a proven track record as a share of wrongdoers are repeat offenders. 

The role of people and culture is an often undervalued part of successfully combatting fraud. Sharma: “Companies must strive to develop an organisational culture that encourages reporting of policy violations and frauds, thereby protecting the whistle blowers. With an effective whistle blower hotline, a strong vigil mechanism gets created as an entity level control, thereby making it reasonably difficult to commit frauds in any organisation.”