Weathering Human Nature's Storms: Is Your Internal Control System Intact?

FROM THE RESOURCE GUIDE

Michael "Bret" Hood, CFE

Retired FBI Special Agent and Director of
21st Century Learning & Consulting

If you see a weather forecast that a blizzard or big storm is coming, you would most likely rush to stock up on food, water and other necessities. Similarly, if you knew fraudsters were targeting your organization, you would no doubt try to anticipate their actions and prepare accordingly.

Although most organizations have an intricate set of internal controls designed to deter and prevent fraud, every day you read about someone — either within or outside an organization — who found a way to circumvent internal controls. One of the hardest gaps to account for when assessing controls is the unpredictable human element. One good place to start prevention efforts as they relate to employees is to understand the root causes of dishonesty.

Duke University Professor Dan Ariely has spent years researching dishonesty and explained, “There’s an intuitive theory that there are good people and bad people, but that masks the real way dishonesty works.” What Ariely’s research has shown is that dishonesty is part of human nature, which means that everyone is capable of it.

Ariely created an honesty test where participants were asked to complete 20 difficult math equations with $1 being awarded for each correct answer. The task would be simple if the participants had enough time, but Ariely gave them only five minutes. When time expired, participants were instructed to count their correct answers before shredding their answer sheets. The participants were then paid by a proctor based on the number they reported. Would you be honest in this situation?

On average, participants reported solving six questions correctly, but in reality, they answered four. How did Ariely’s team know this? It seems the shredder was modified to destroy only the margins of the answer sheet. Out of 40,000 people tested, only 20 participants shot for the moon and claimed to solve all 20 equations, which cost the experiment $400. However, a much larger group of 28,000 people inflated their score only by a few points, which might strike some as less dishonest, but it ended up costing the experiment much more than the blatant liars — totaling more than $50,000 versus the blatant liars’ $400. Ariely refers to this dishonesty as the fudge factor because participants couldn’t rationalize the theft of large dollar amounts, but could easily rationalize stealing just a few dollars.

This first rationalization in fraud is extremely important, as it has a disparate impact on the brain. Once you lie, your brain undergoes change. “Whenever a person lies for personal gain, the amygdala produces a negative feeling that helps curb that act,” said Ariely. “But the more often a person lies, the more the response fades, leading to a slippery slope that may encourage an escalation of dishonest behavior.”

In order to combat the fudge factor, Ariely suggests using explicit codes of conduct. “Clear rules eliminate flexibility. The idea of a general 'do the right thing at the right time' policy may sound appealing, but it melts the moment self-justification comes into play.” Your brain quickly justifies the first step down the slippery slope, which then allows you to take a second step. “Doctors who received industry payments were two to three times as likely to prescribe brandname drugs at exceptionally high rates as others in their specialty.” If these doctors had clear direction, they may have been able to avoid the conflict of interest completely or by finding it harder to rationalize the additional costs passed on to their patients.

Organizational culture also plays a pivotal role in the risk environment. When Ariely asked people to recall the Ten Commandments before taking the previously referenced honesty test, no one cheated. Executives whose actions and words speak to a moral code continually
remind employees of their own morality, which reduces fraud. Co-workers also offer cues to organizational behavior. When Ariely introduced an “outgroup member” that was a known rival, obvious cheating by the rival had no effect on the other participants. When honest behavior is an accepted part of your organizational culture, you experience increased pressure to conform to the established norms.

What should concern fraud examiners, however, is one of Ariely’s other findings. When students were offered a cash substitute, in the form of redeemable tokens, the cheating rate doubled. Debit and credit cards, as well as electronic currencies are dominant in today’s economy. These electronic transactions, in effect, are the same as Ariely’s redeemable tokens in that people can easily rationalize cheating because of the perception that real money is not involved.

Just as the most well-prepared house in a storm could suffer damage if one unknown hole in the roof isn’t protected, even companies with comprehensive fraud prevention plans could fall victim to fraud if they don’t understand the motivation and psychology of fraudsters. Don’t let your organization be left out in the cold. 

Find more resources, products and events about keeping your internal controls intact in the latest ACFE Resource Guide.