by Rabon, Don
In Shakespeare’s King Henry VI, part II, act III, scene I, we learn, “by wicked means to frame our sovereign’s fall. Smooth runs the water where the brook is deep.” The brook was indeed deep, and sovereigns, whether considered as money or people, did, with a certainty, fall. Alex’s undertakings to frame, and thus control, that fall were there, hidden just below the surface.
As we plunge below the surface to plumb the depths, we are mindful that fraud is a human construct. Humans—in this case Alex—are motivated toward gain and more emphatically away from pain. Alex has, at this point, already undertaken drastic steps for the first dynamic—gain—and will in time take action regarding the latter—the avoidance of pain.
THOUGHTS, COMMENTS AND ANALYSIS
What are your impressions, to this point, with regard to this circumstance?
Exactly what do you know?
What is it that you know that you don’t know?
What questions would you ask in order to know?
What steps would you take in order to know?
Points to Ponder
In contrasting the elements in the “Complaint For Permanent Injunction And For Other Relief Case 1:07-cv-00306, filed September 24, 2007” with Alex’s words at his sentencing:
And it was never my intent to lose anyone’s money or divert anyone’s money or scheme anyone out of anything.
What are your initial impressions from the comparison?
Is it conceivable that someone could machinate these complexities while having no intent to lose, divert or scheme?
What could possibly be Alex’s plan once the injunction was published, yet all the while, he was continuing to deceive the federal authorities?
Why would he view his continued deception as his best option?
If actions do speak louder than words, to which of the two is it most advantageous to attend?
What questions would you pose to Alex at this point?
Content – Context Application
Former Controller of Luxury Car Dealership Accused of Embezzling
A former controller of a luxury car dealership was charged in a federal indictment for embezzling approximately $285,000. The charges involved making and possessing forged securities with the intent to deceive. The indictment indicated the former controller had issued over 130 company commercial checks to a variety of entities and individuals. He then would deposit the checks into bank accounts that were controlled by him. He was accused of forging the endorsements on the back of the checks in order to make the deposits.
What similar mindsets might there be as demonstrated by the actions of Alex and the controller?
Is there, in your mind, a difference in defrauding an organization as opposed to defrauding an individual?
Why or why not?
What questions would you pose to this individual?
CHAPTER THREE
ALEX AND THE FRAUD TRIANGLE
THREE ATOMS TO FORM WATER –
THREE REQUIREMENTS TO FORM FRAUD
Water, water, every where,
And all the boards did shrink;
Water, water, every where,
Nor any drop to drink.
The Rime of the Ancient Mariner
—SAMUEL TAYLOR COLERIDGE
NAVIGATION POINT AND HEADING The chemical formula for water is H2O. A molecule of water is comprised of two hydrogen atoms and one oxygen atom. The atoms are connected by a type of chemical bonding that involves the sharing of pairs of electrons (Wikipedia.org). Fraud is also comprised of three components. These components must, in like fashion, be bonded or connected. In the case of fraud, the connections involve the circumstances in a person’s life, the latitude in which they have to operate and their adaptive cognitions. How does an individual’s (in this case, Alex) life-changing circumstances come down to a diagram? Paddle on and let’s see.
THE FRAUD TRIANGLE
In the 1950s, criminologist Donald R. Cressey presented what has classically become known as “the fraud triangle.” He theorized that for the commission of fraud to take place, three components must be in place:
Pressure/motive
Opportunity
Rationalization
His proposal has stood the test of time and is very much a part of fraud investigative applications today. Various entities have applied the terminology over time to a multitude of circumstances. One of the most salient, fraud-related issues, at the time of this writing, involves teachers and educational administrators manipulating the end of grade test scores by providing the answers to the students in advance or changing the students’ incorrect answers after the fact. But, the concept is still the same. Once an incentive (economic, moral or societal) is attached to an outcome, two of the three fraud-related elements are subsequently in play. In the teacher–administrator case, the incentive is economic.
At this point, we have an overview of the topography of this financial water system. Let’s endeavor to find the source of a specific tributary—Alex’s debilitating stock trading activities and subsequent false financial reports. This undertaking involves a four-year tributary that systematically evaporated resources that belonged to others.
Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit
First, an explanation of the “Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit” will assist in our understanding of the relationship of the fraud triangle, the actions which Alex had undertaken and their downstream consequences:
NOTE: What is SAS 99?
“Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit, commonly abbreviated as SAS 99, is an auditing statement issued by the Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) in October 2002. The original exposure draft was distributed in February 2002. SAS 99, which supersedes SAS 82, was issued partly in response to recent accounting scandals at Enron, WorldCom, Adelphia, and Tyco. The standard incorporates recommendations from various contributors including the International Auditing & Assurance Standards Board. SAS 99 became effective for audits of financial statements for periods beginning on or after December 15, 2002” (Wikipedia.org).
NOTE: How does SAS 99 describe fraud?
“SAS 99 defines fraud as an intentional act that results in a material misstatement in financial statements. There are two types of fraud considered: misstatements arising from fraudulent financial reporting (eg. falsification of accounting records) and misstatements arising from misappropriation of assets (eg. theft of assets or fraudulent expenditures”).
Note: How does SAS describe the fraud triangle?
“The standard describes the fraud triangle. Generally, the three ‘fraud triangle’ conditions are present when fraud occurs
First, there is an incentive or pressure that provides a reason to commit fraud.
Second, there is an opportunity for fraud to be perpetrated (eg. absence of controls, ineffective controls, or the ability of management to override controls.)
Third, the individuals committing the fraud possess an attitude that enables them to rationalize the fraud” (Wikipedia.org).
In our application of the fraud triangle, opportunity is located at the top of the triangle. Pressure/motive is placed at the left base of the triangle. Rationalization is found at the right base of the triangle. And while the elements of the triangle are not limited to fraud, they certainly find application in this circumstance.
ELEMENT ONE: OPPORTUNITY
We will resume our examination of Alex’s continuing actions, at this point, with the most obvious of the fraud triangle elements—opportunity. Clearly Alex had the opportunity to commit the fraud all along. As the transcript from his testimony at Noel’s trial indicates:
&
nbsp; “As Bryan was becoming more involved with Titan Composites, and he actually moved his office out of the CEP offices to become involved with Titan at their offices, I had to take a more day-to-day role in the business in terms of overseeing the staff and making some of the decisions necessary for operating the business.”
“Opportunity” can be defined as, “a situation or condition favorable for attainment of a goal” (Dictionary.com). Within the business functions of Certified Estate Planners, Alex’s operational responsibilities were replete with opportunities for the commission of fraud. The opportunities did not suddenly make themselves available. They had always been there. Our reading of the “Complaint For Permanent Injunction And For Other Relief” serves to underscore the plethora of opportunities. At some point, as we will learn from his own words, Alex took advantage of those opportunities. A most critical component of our examination is not whether or not the opportunities were available to enable him to commit the fraud, but rather, that he ultimately did commit the fraud.
Within any organization, there are opportunities for fraudulent undertakings. Ranging from taking a number two lead pencil to selling national security secrets, if an individual’s goal is to divert assets to himself there will exist “a situation or condition favorable for attainment of a goal.” An individual may work in an organization for ten years and never engage in an illegal act. But on day one of the eleventh year, circumstances can change and the same individual utilizes an opportunity that had been there all along. What happened in Alex’s life that released the fraudster that had, seemingly, lain dormant to that point?
Two of the salient, fraud triangle elements—pressure/motive and rationalization—provide a most intriguing focus of our inquiry to understand his behavior.
Element Two: Pressure/Motive
First, let us define some terms:
“Pressure” is defined as “a moral force that compels” (Dictionary.com).
“Moral force” is defined as “an efficient incentive” (thefreedictionary.com).
“Motive” is defined as “something that causes a person to act in a certain way, do a certain thing” (Dictionary.com).
If we combine the three definitions, to conceptualize pressure/motive, as it relates to fraud, we can develop an operational definition along the line of “an effective incentive that compels a person to behave in a manner consistent with the intention of committing fraud.”
The pressure/motive element, as it related to Alex, came forth as he gave testimony during Noel’s trial. At this ford in the stream, we will focus on the fraudulent activities related to his stock trading. Alex’s stock trading endeavors did not meet with a positive outcome—he was losing significant amounts of money. As the transcript of Alex’s testimony reveals:
Q. Now, when this stock trading program began to be offered in mid 2002 to CEP clients, how was the trading going?
A. The trading went well until about May or June, and then the trading was not so good after that.
Q. May and June of when?
A. May or June of 2002.
Q. And when you say after June of 2002 it wasn’t going so well, what’s that mean?
A. It means that losses were being generated. There were some gains that were being generated, but there were more losses that were generated than gains.
Q. So overall, after the summer of 2002, in a given quarter, were the trades net positive or net negative?
A. In most instances they were net negative.
Q. Did you tell the clients about that?
A. No, I did not.
Q. What do you mean by that?
A. The clients did not know that their funds were losing money.
Q. After the midsummer of 2002.
A. Correct.
Q. Well, weren’t you keeping clients updated on how their accounts were doing?
A. Yes.
Q. Well, how were clients being kept up to date?
A. They were being kept up to date via quarterly statements that would be sent out.
Q. Sent out how?
A. Sent out via the Postal Service.
Q. And who was preparing those client reports?
A. I was preparing figures for them, and then they were put into a presentable format by Heather Noel.
Q. And let’s take the third quarter of 2002. Was the trading in the third quarter of 2002 a net gain or a net loss?
A. The trading would have been a net loss during that point.
Q. Did you send out client reports showing a loss?
A. No, I did not.
Q. Why not?
A. At that point I hoped that the trading system would turn around and right itself at some point.
Q. Well, why couldn’t you tell clients that there had been a loss and just tell them to hang on?
A. I was also not telling Bryan Noel during that time. I was scared to death of the consequences of that getting out to any clients or to him.
Q. Well, what were you concerned would happen if you told Mr. Noel?
A. He’s not a man that takes bad news very well, so I was concerned that he might be extremely irritated with such news and that ultimately clients might want to pull their funds out.
Q. Were you concerned about losing your job?
A. I was concerned about that as well.
Q. So just to be clear, at least beginning the third Quarter of 2002, your Pinnacle trading program is losing money.
A. Yes, it is.
Q. And you’re lying to clients about that.
A. Yes, I am.
Q. And you’re lying to Mr. Noel about that.
A. Yes, I am.
Q. And you’re sending false account statements out in the mail.
A. Yes.
Q. At that point, this fraud that you’re perpetrating, are you doing that by yourself or with someone else?
A. At that point that was by myself.
Keep in mind that pressure/motive is idiosyncratic. A circumstance (stock results flowing into the negative column at an increasing volume) that may, for one individual, be no more than a “bump in the road of life,” may be, for another, perceived as a catastrophic event. According to Alex, the following were the increasingly emerging dynamics:
Reduction of funds due to his stock trading activities
Fear of telling clients lest they withdraw their money
Fear of telling his partner
The possibility of the loss of his position served as the catalyst (pressure/motive) to set in motion his willingness to falsify the quarterly reports
Changing circumstances can serve to reveal a different nature (side) of an individual—a nature of the individual having lain dormant to that point.
Sir Francis Bacon (1561–1626) was a prolific and insightful writer. He was a man ahead of his time. One of Bacon’s treatises, “Of Nature in Men,” is worth our review and application to Alex:
“Like as it was with AEsop’s damsel, turned from a cat to a woman, who sat very demutely at the board’s end, till a mouse ran before her. Therefore, let a man either avoid the occasion altogether; or put himself often to it, that he may be little moved with it. A man’s nature is best perceived in privateness, for there is no affectation; in passion, for that putteth a man out of his precepts; and in a new case or experiment, for there custom leaveth him.”
Hundreds of years before Dr. Donald Cressey put forth his theory with regard to the fraud triangle, Bacon had addressed the pressure/motive element most succinctly. In the above quote, Bacon is telling us that circumstances (pressure/motive) “putteth a man out of his precepts”—meaning that circumstances, especially new circumstances (consistent losses in the stock market for example), can serve to reveal a dimension of the person that had heretofore not been made manifest. Pressure/motive does not create a fraudster but
rather reveals the fraudster that has been within all along. It is interesting to note that, after falling into debt, Bacon himself was convicted of taking bribes. Apparently, for Bacon, debt did indeed “put him out of his precepts.” Oh well.
In Robert Louis Stevenson’s (1850–1894) The Strange Case of Dr. Jekyll and Mr. Hyde, Doctor Jekyll provides a telling account of his transformation and actions. Within the narrative, he reveals:
“The drug had no discriminating action; it was neither diabolical nor divine; it but shook the doors of the prisonhouse of my disposition; and like the captives of Philippi, that which stood within ran forth. At that time my virtue slumbered; my evil, kept awake by ambition, was alert and swift to seize the occasion; and the thing that was projected was Edward Hyde. Hence, although I had now two characters as well as two appearances, one was wholly evil, and the other was still the old Henry Jekyll, that incongruous compound of whose reformation and improvement I had already learned to despair. The movement was thus wholly toward the worse.”
The drug did not turn Doctor Jekyll into the evil being into which he transformed; rather, it released the being that was waiting patiently all along in the anteroom of his heart.
With my profound apologies to Mr. Stephenson, let’s take license to make a couple of wording modifications in his account, as if the character were Alex, and not Doctor Jekyll, to illustrate our point:
“The losses (that) were being generated had no discriminating action; it was neither diabolical nor divine; it but shook the doors of the prisonhouse of my disposition; and like the captives of Philippi, that which stood within ran forth. At that time my virtue slumbered; my evil, kept awake by ambition, was alert and swift to seize the opportunity; and the thing that was projected was Alex Klosek the fraudster. Hence, although I had now two characters as well as two appearances, one was wholly evil, and the other was still the old Alex Klosek, that incongruous compound of whose reformation and improvement I had already learned to despair. The movement was thus wholly toward the worse.”