FRAUD TRIANGLE

The Fraud Triangle framework helps us to understand the background of this particular fraud
scheme. The Fraud Triangle is a model developed by Dr. Donald Cressey, a criminologist whose research
focused on fraudsters. According to Dr. Cressey, there were three factors that were present when an
ordinary person committed fraud: Pressure, Opportunity and Rationalization. “Pressure” to make a person
commit fraud or an insider turn against his own company is the aspect of the fraud triangle that motivates
the crime in the first place. In many cases, it is a financial problem of a personal or professional nature or
just greed that underlies the pressure. Next, an “opportunity” needs to be present. The individual needs to
have access to information or other resources of value, and perceive that, if illegally exploited, there is little
risk of being caught. The fear and perception of risk is further lowered by the fact that the root cause of the
pressure is non-sharable – risking his social status may be as big of a risk as the crime itself. Rationalization
is the last leg of the Fraud Triangle. Most insiders that turn against their organization are first time offenders
without any criminal record, and they do not perceive themselves as criminals. Rather, they see themselves
caught in bad circumstances that they are trying to resolve. Rationalizations may include, “I’ll pay the money
back”, “They will never miss the funds”, or “They don’t pay me enough.”
All three conditions (i.e., pressure, opportunity and rationalization) must be present in varying
degrees in order for fraud to occur. A financially strapped employee is not going to commit fraud if the
opportunity is not available, or if the risk of getting caught is too high. Similarly, a person who perceives an
opportunity to misrepresent financial statements and has the incentive to commit the fraud is unlikely to do
so if he or she cannot rationalize the fraud. However, the more pressure a person feels to commit fraud,
the easier he or she can justify it.
Regarding the first element, Bernard Madoff’s incentive was simply a desire to maintain the
lucrative lifestyle to which he had become accustomed or just a “lure of greed”. Besides, Madoff faced the
pressure of maintaining the reputation and profit of the firm. Madoff was struggling to generate sufficient
profits to cover returns for investors that required him to repay early investors with new investors’ money.
Walter (2011) explains that in the eighties Madoff said he saw consistent returns of 15%-20%....a time when
the DJIA went from 800 to 2,722 from 1980 to its peak before the crash of 1987 (a growth rate of about
15% compounded a year). So Madoff could have invested in an index fund and done as well as anyone.
But the sell-off associated with the crash (redemptions) and the slow recovery (low returns) put pressure
on Madoff. That’s when Madoff borrowed from investor capital to pay out redeeming investors and began
falsifying results showing big returns. Those returns became the advertising he needed to get more
investors/victims.
With regard to the second element, ‘opportunity’, it seems clear that Madoff took advantage of his
position as head of the company, which gave him more chance to commit a crime without being questioned.
Madoff had enough management power and authority to design the level of internal control and corporate
governance in such an advantageous way for himself. Firstly, it is obvious that the typical segregation of
duties in Madoff’s hedge fund was missing. Normally funds require a segregation of duty between the
investment manager, the broker and the custodian. In Madoff’s case, there was no segregation of duty. He
was all three. He looked after the money, made the investment decisions and brokered the deals (Simon
2017). Secondly, the corporate governance of BMIS had all the key players being the Madoffs with his
brother as the chief compliance officer, his nephew as the director of administration, his sons as directors,
his niece as the general counsel and rules compliance attorney. Thirdly, Madoff approved of and insisted
on using a solo auditor. The auditing company that Madoff hired was Friehling & Horowitz, a firm consisting
of only three employees and one office, and was extremely small despite the scale and scope of BMIS’s
activities.
Last but not the least, the rationalization element should be taken into account in order to analyze
Madoff’s fraudulent acts. Firstly, Madoff rationalized that “it was their fault for trusting me”. From his point
of view, the banks and funds that he tricked should have known that there were some problems with the
scheme because they were financial professionals. Secondly, he argued that his victims were rich and none
of them would face poverty after losing their investment. In reality, not everyone was trapped by Madoff’s
hedge fund and the investors who lost were the players joining the game at the very last second. Thirdly,
Madoff tried to justify his fraudulent engagement by persuading himself that the market was rigged anyway
so if he had not done that, others would. There is no room for investors to earn profits from the market
without bearing any risk of being tricked.
Other rationalizations that are stated in the article “The Atlantic” by John Hudson (Feb 28, 2011),
where Madoff rationalized that he tried to give their money back but his friends wouldn’t take it back. He
said that, “Everybody said, 'No, you can't do that. You can't send me my money back. I've been a friend of
yours, or a client, for years' … I couldn't tell them I would have been doing them a favor.” So he had no
choice.
As can be seen, it became clear that the existence of Madoff’s fraud was the eventual end result
of all the financial incentives, perceived opportunities and defensive rationalizations described above.
REFERENCES:

 Malicious insider psychology – when pressure builds up in the Fraud Triangle

Available at: https://www.computerworld.com/article/2845934/security0/malicious-insider-
psychology-when-pressure-builds-up-in-the-fraud-triangle.html
 Bernard Madoff Is The Fraud Triangle
Available at: https://www.forbes.com/sites/walterpavlo/2011/03/01/bernard-madoff-is-the-fraud-
triangle/#35c884676cad
 Lessons from Madoff
Available at: http://www.lotusamity.com/events/accountingshenanigans/madoff-lessons/
 Bernard Madoff: The key players
https://www.telegraph.co.uk/business/0/bernard-madoff-key-players/
 https://en.wikipedia.org/wiki/Madoff_investment_scandal
 Madoff's Most Astounding Rationalizations
https://www.theatlantic.com/business/archive/2011/02/madoff-s-most-astounding-
rationalizations/342080/