We Need to Change Our View of Trust
—We need to do it now and we need to do it on a permanent basis—
In the time it takes you to read this article I want to change your view of trust. Why? In the hundreds of investigations that I have done, in many different countries and cultures, I can say without hesitation and unequivocally that misplaced trust, and the basis upon which it is given, is the single most significant reason why more financial fraud does not get detected on a more timely basis. Change your view of trust and you will become much better at performing your control and audit responsibilities. It’s really that simple.
BACK IN THE DAY…BEFORE SARBANES-OXLEY
I began my accounting and auditing career in the early 1980s. It was a different time. The industry was self-regulated and while I don’t purport to speak for the entire accounting and auditing industry, we ran our business with the idea that we could carry out our mandate, that of assessing the accuracy, completeness and validity of transactions and balances and still have a very close relationship with our clients. And we could do all this without impairing our independence. Life was good. Consulting services were beginning to surface as a very bright light in our industry. We knew we were the smartest and most independent external financial experts permitted access to public companies. Through the process of performing our audit and tax functions we grew to learn a great deal about our clients. It seemed a natural extension of our business objectives to extend our reach inside corporate America and use that knowledge to suggest other services to the boards that hired us for required audit and tax services. Our Code of Ethics and Independence requirements would ensure that any consulting services we performed would not impair our judgment required under attest functions. It certainly made perfect sense at the time, but events and circumstances have a way of creeping up on us and shattering our view of the world. Enron and WorldCom was our awakening. But I’m getting a little ahead of myself.
My awakening came a lot earlier than Enron and WorldCom. In the early years of my career as an auditor, before becoming a forensic accounting investigator, I liked to say that I followed my mother’s advice to trust others unless there was good reason to mistrust. I had no notion that a criminal would ever cross my path or do serious financial harm to a company I was auditing. I was naïve. Fortunately, not so naïve that I abandoned common sense and allowed the controller for a new public company audit client to defraud me into trusting his representations without verification. Worse yet, he was a former colleague of mine who had resigned to take a position at this client. Did I trust him? Of course I did. And, I was excited to have this opportunity to work with him in his new position. I was soon to find out trust alone is not a sufficient basis to perform the duties of an auditor under GAAS. It was a lesson that changed my life and my career. The experience of detecting and investigating this fraud caused me to start the forensic accounting practice in the Indianapolis office of Coopers & Lybrand, one of the predecessor firms of PricewaterhouseCoopers.
I will often tell auditors attending my seminars that I was fortunate to have been defrauded by someone I trusted early in my auditing career. I say “fortunate” because those who have been touched by fraud become better fraud detectors. Their trust has been violated, and if they survive the experience and live to audit again, they learn the most valuable lesson of all. And that is this: while the overwhelming majority of people we encounter in the course of performing the work of an auditor, both internal and external, are honest people, there are those who would use those trusted relationships to perpetrate their devious deeds upon unwitting investors, bankers, the public, and yes, auditors to advantage their own criminal acts.
Since that experience, I have performed hundreds of investigations in many different countries and cultures; I have come to learn something about those who became targets of my investigations and I can tell you this about them. Most of the corporate criminals who would perpetrate their crimes do so without any intent to harm anyone. Most of these white-collar criminals are truly sorry for the fact that their actions have caused many innocent people, investors and employees, to lose significant portions of their net worth, their jobs and careers, pensions, healthcare coverage and in the end, their self-respect. Most of these fraudsters are not really bad people in their heart of hearts. Most are actually otherwise good people. But what one needs to understand is that sometimes, under the right circumstances, good people can do some very bad things.
Some might wonder how it comes to pass that someone who is a solid, hard-working and well-meaning person can come to turn to the dark side. Once you understand what goes on in the mind of the fraudster, it’s not difficult to understand why they choose to do what they do. So let’s have a look and see how these folks become criminals.
THE FRAUD TRIANGLE
It takes three ingredients for a crime to be committed and all three must be present. The first of these is Need. We all have needs. For most of us they could pertain to money, promotion or recognition. But for some it’s just a need for socialization. They just want to be known and admired: being recognized at the annual meeting as the only unit manager who made budgeted revenue targets each month throughout the year. No extra bonus, just the recognition is enough motivation to do the crime.
Next is Opportunity. They must have sufficient opportunity to be in a position in the organization to do something inappropriate: do a favor for their boss; or have access to overlapping control responsibilities such as Cash and Accounts Payable to perpetrate a false vendor fraud.
The last ingredient, and likely most significant, is Rationalization. The ability to rationalize the crime or deceitful act gives the fraudster his or her reasonable justification to do something they believe is the right thing to do. For some, the ability to rationalize their crimes becomes an artform. “Well, the company is having a down year, or at least that’s what they tell us. But I still see others getting compensation and perks that I’m not. I deserve this, and I’m going to get what I deserve. I owe it to my family.” And with that, the dirty deed is done. Or, the rationalization could come in the form of helping others. “Bob, we made a prediction to the Street that we would show positive earnings this quarter. If we fail to accomplish this they will kill us. We’ll likely have to close the PA division and put 60 people out of work. Do you want that on your conscience?” Or, there’s the not a big deal rationalization—“Look, that sale to GE puts us over the top. I know it came in three days after quarter’s end but it’s not like it didn’t happen. It’s a real sale. We just need to move it up a few days.” Such an argument could be compelling were it not for the fact that it would be illegal. However, some would cave to this rationalization and falsify the sale date. That’s how it’s done.
Need, Opportunity and Rationalization: the three ingredients present in all crimes. But I’m sure that you are an honest person and would never succumb to the vagaries of illegal acts. Really? Ok, just for demonstration purposes imagine yourself driving your car on an interstate highway. You have a Need: you need to get somewhere fast. You have an Opportunity: you are in the car alone. Your foot is on the gas pedal, and there are no cops in sight. All you have to do is Rationalize doing something wrong: breaking the law. “Well now hold on there,” you say. “Exceeding the speed limit isn’t really breaking a law….is it? Isn’t it more like a traffic ordinance? And surely that would not rise to the level of a law. Even if it does, laws were meant to protect people, and I don’t know about you but when I drive at 55 mph on an interstate highway, I get sleepy. With me being sleepy and behind the wheel of a 4,000 lb vehicle that is not a safe situation. So to comply with the spirit of the law, I need to speed up to ensure that I remain alert thereby keeping others safe.” Oh, and lastly, “I only speed when it is absolutely necessary.”
And there you have it. You have just acted upon your Need, given your Opportunity and Rationalized breaking the law. Silly example? Maybe. But it has been my experience that the people who steal millions of dollars from others, or book entries they know they shouldn’t, will rationalize their crimes the exact same way. Imagine how other seemingly good, hard-working and well-meaning fellow employees, trusted vendors and corporate and civic leaders, working in a very complex world, can sometimes find a way to act upon their needs in a way that takes advantage of their positions allowing them to rationalize crimes. It happens every day.
TRUST BUT VERIFY
So how do you protect yourself from these types of people? Just don’t trust anybody? Here’s how, and it’s quite simple. To borrow the phrase once heard from President Ronald Regan when he was negotiating the missile defense treaty with Mikhail Gorbachev in the mid-1980s: “Trust but Verify”. He was essentially saying to the Russian Premier that we need to trust each other, as the world’s only two superpowers, but we need to verify missile warhead numbers, trajectories, payloads, and locations. This periodic verification will become the basis for our trust. “Trust but Verify.”
Unfortunately, many people truly believe that they can ascertain the honesty and integrity of someone just based upon their interactions with them. What they do not understand is that while most people are honest and fair-dealing, there are those like Bernard Madoff, Robert Stanford and Barry Minkow, to name a few of the more notable perps, true cons. Did you know that the term Con is derived from the word confidence? They gain one’s confidence, and they are very, very good at it. The only way to tell the cons from the honest people is to “Trust but Verify”. This is such an important concept that I compel every auditor to take this pledge: “I will never again assess the accuracy, completeness and validity of any transaction or balance based upon my perception of the honesty and integrity of the person who either created it or approved it, without sufficient verification.” Quite frankly, that’s the only way to assure you are getting what you expect.
Now, some might say that is too harsh to go through life and treat others like that in every instance. To them I would say they do not have to utilize this approach in every instance. For example, on a personal level, if a couple might want to trust their 16 year old will have the family car parked safely in the garage on Saturday night by 10 pm while they are headed out of town, without verifying that they will actually do that, is totally up to them. Knock yourself out. As the father of two boys, I would not recommend that approach, but it’s a personal decision and you and your family will suffer any consequences for failure to obey, personally. But when you are acting in a fiduciary capacity, such as performing an attest function for an audit committee, trust without verification is, quite frankly, someone not doing his or her job.
A CONVERSATION WITH A MASTER CON
Some time ago I was out west giving a speech at an ACFE Conference and had an opportunity to spend some time with another presenter. Barry Minkow had recently been paroled after serving seven years of his prison sentence and had presented the keynote speech. My firm had actually been hired to act as a monitor over his revenue generating activities during his parole term verifying that a certain percentage of his fees would go to the victim’s compensation fund, some $29 million. It might take Barry quite a while to pay that off! In the course of our conversation I could see why he was such a great Con. Very smooth, likable and overly attentive to every word I said. One might even say that he is a great “people person”, an essential requirement to pull the Con. I told Barry I wished I could put him in front of my seminar audiences so they could see for themselves how easy it would be to be Conned. We laughed as that would not be possible, but instead I asked if he could give me some advice for them, especially for the auditors.
He immediately and graciously agreed and here is the advice he gave me to pass on to you. He said “Tom, tell them that trust without verification is a luxury that auditors cannot afford to do in performing their responsibilities. Companies don’t hire auditors to be human lie-detectors. They hire them to verify in accordance with their professional standards. That’s their job. Tell them to do their jobs. If they fail in that endeavor, remind them that Barry Minkow did not invent the Con and if they choose to trust without verification, they may be dealing with a guy just like me.”
It was great advice, I thanked him, and I am passing it on to you. I encourage you to take it. To change your view of trust: do it now and do it on a permanent basis. You owe it to the profession, you owe it to you clients and quite frankly, you owe it to yourself.
 For the full account of this fraud investigation, see Thomas W. Golden, Steven L. Skalak, Mona M. Clayton, A Guide To Forensic Accounting Investigation (New York: John Wiley & Sons 2006) 96-99
 The Association of Certified Fraud Examiners (ACFE) is the world’s largest anti-fraud organization and premier provider of anti-fraud training and education. Together with more than 80,000 members, the ACFE is reducing business fraud world-wide and inspiring public confidence in the integrity and objectivity within the profession. Find them at www.ACFE.com