An integrative approach to situational crime prevention models of fraud : synthesising offender characteristics and corporate environment into a unified theoretical model to understand corporate fraud

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An Integrative Approach to Situational Crime Prevention Models of Fraud

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Synthesising Offender Characteristics and Corporate Environment into a Unified Theoretical Model to Understand Corporate Fraud

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Supervisor: Dr. Mijke Rhemtulla Student ID: 10004368

Word count (abstract): 120 Word count (text): 6,635

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Table of Contents

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Table of Contents

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Abstract

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Introduction

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Psychological Characteristics of Fraudsters

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Personality Correlates of Fraud

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Motives of the Fraudster

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The Corporate Environment

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The Non-Control Factor

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Leadership Structures

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Conflictive Norms

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Integrative Models of Fraud

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Conclusions and Discussion

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Abstract

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Despite the consensus about the dramatic impact of fraud, academic research has not yet attempted to synthesise two distinct aspects of fraud. This paper focused on corporate fraud and investigated offender characteristics and corporate environment. It appeared that the propensity to defraud consists of the personality traits narcissism, extraversion and conscientiousness. On the corporation side, the indifference towards warning systems and the discrepancy between internal and external norms have been identified as potential causes of fraud. Both sides of corporate fraud were incorporated into a unified theoretical interaction model. Built on Situational Crime Prevention theory this conceptual model unifies the propensity to defraud and situational causes of fraud. Challenges for fraud research and implications of the new model are discussed.


Introduction

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In 2012, the ‘rogue trader’ Kweku Adoboli, a UBS -employed trader, was found guilty of fraud in 1

several cases for a total financial loss of 1.4 billion pound sterling (Walker, 2014). Adoboli used his detailed knowledge of the European trading regulations to make use of temporal gaps in the trading system that allowed him to trade money from not yet confirmed transactions and cover these

transactions with faked accounts and bookings (BBC, 2012). These unauthorised transactions led to such an immense loss that it was the chief prosecutor who stated that he “was a gamble or two from destroying Switzerland's largest bank for his own benefit” (BBC, 2012). This paper aims to

illuminate the psychological identifiers of fraudsters and the external factors that facilitate corporate fraud.

A report issued by Applied Research & Consulting LLC (2013) details that 80% of Americans have received a potentially fraudulent business offer and 11% of Americans have lost significant amounts of money to fraud. White-collar crime and fraud in specific appear not very representative of a typical crime for two main reasons. First, it usually does not imply violent acts against victims which makes the act of fraud less attention-grabbing. Second, in order to be discovered as such, corporate fraud needs to have reached a certain severity and a great number of victims. Whereas each case of armed robbery is noticed and probably reported by the victim, corporate fraud is much more likely to remain unreported and unnoticed by the victims. However, fraud is a gigantic

problem. 2

To set the impact of corporate fraud into perspective, a comparison between the figures from ‘the rogue trader’s’ case and the average haul of a bank robbery, £20,330.50 (Reilly, Rickman, & Witt, 2012), shows that Mr Adoboli would have needed a total of 68,800 successful bank robberies to equal the loss. The sixty-eight thousand successful bank robberies, given an estimated success rate of 66% (Reilly et al., 2012; Timmer, 2012), would equal the astonishing number of 105,000 bank robberies. Comparing these figures to the true number of annual bank robberies in the UK in 2011 (66; Lee, 2013), it would have taken Mr Aboboli 1,600 stressful and busy years on average to attain the monetary loss he caused in a single year.

UBS is short for Union Bank of Switzerland and is considered Switzerland’s biggest bank with a revenue in

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Despite the severe consequences of fraud, in academic literature no attempt has been made to synthesise offender-based approaches and external factors of fraud. Research that focused on

offender variables has provided insights about the psychological characteristics of fraudsters but has mainly neglected the corporate environment. In contrast, approaches from accounting research that examined the corporate environment left the individual variables aside. Without bridging the gap between those two aspects of fraud, no model can be developed to grasp fraud in its entirety. Without a unifying approach to fraud corporations and law enforcement do not have the tools at their disposal they would need to counter fraud. This paper aims to bring both lines of research together. My ultimate aim is to establish the theoretical causes of corporate fraud and synthesise these causes into an empirically testable unified theoretical model. The resulting model will enable researchers, law enforcement and corporations to identify the steps leading to fraud and to intervene at early stages. Ideally, this paper could be an impetus for future research toward a more holistic approach to corporate fraud.

I will adopt an attempt by Buell (2014) to sketch the features of fraud: “[To] commit fraud is to do a usually innocuous act […] with a prohibited state of mind, namely, the specific intent to defraud the counterparty” (Buell, 2014, p. 841). The UK Fraud Act 2006 handles a more succinct definition. According to this definition there are three ways of committing fraud: fraud by false representation, fraud by failing to disclose information, and fraud by abuse of position (NFA, 2013). Within this paper I will limit the scope to corporate fraud which, despite its many sub-groups, I want to define liberally as fraud embedded in a legitimate business. According to the NFA 3

typology this definition of corporate fraud can be described as fraud by abuse of position. The ‘rogue trader’ Mr Adoboli worked in a bank whose day-to-day business was not fraud but proper investment banking and it was his expert knowledge that made him exploit the opportunity to commit fraud. To understand such cases of fraud, academic literature intersects without finding common ground in one theoretical framework.

It is no wonder that is consensus among fraud researchers and authors “that the total financial cost of this kind of crime far exceeds that of street crime; the likelihood of being a victim of white collar crime is far greater than the likelihood of being a victim of a serious street crime; and every bit as devastating to one’s quality of life as street crime” (Friedrichs, 2007, cited in Perri, 2011, p.

It is important to demarcate between this kind of fraud and cases like the US securities fraudster Bernard

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218). Moreover, researchers have come to the conclusion that “in terms of the number of its victims and the devastating impact on its victim, [fraud] ranks right up there among even the most heinous violent street crimes imaginable” (Pleyte, 2003, cited in Perri, 2011, p.219). The consensus about the impact of fraud, however, does not mean that there is an overarching theoretical model that incorporates the offender variables and the corporate factors of fraud.

I will propose a theoretical framework building on situational crime prevention theory (SCP; Clarke, 2012). SCP states that the opportunity is the main cause of crime, so that criminally pre-disposed people are more likely to and will commit more offences in an environment with many opportunities to commit crime, but more importantly, that people without criminal pre-disposition might be tempted to commit crime when the opportunity is right. According to basic SCP, reducing the opportunity reduces the crime (Clarke, 2012; Bouhana, 2013). Applied to the high-profile example used in this introduction, the sloppy trading regulations in the bank represent the opportunity in an SCP sense, and according to this reasoning taking away the opportunity would make fraud less likely. The SCP framework does not, however, explicitly allow for a role of offender characteristics but puts all emphasis on situational factors. Concerning fraud, there is evidence that psychological variables do play an important role (e.g., Alalehto, 2003; Simpson, 2003; Perri, 2011).

In this paper, I will put equal emphasis on the situational, corporate factors of fraud and the psychological variables of the fraudster. The difference between this framework and basic SCP is that there is a moderating effect. In specific, the effect of offender characteristics on fraud is moderated by situational variables (Figure 1). For the course of this paper, I hypothesise that once there are opportunities for fraud, the psychological characteristics of the potential offender become more important than in isolation. This interaction is of vital importance for this paper because it underlines the importance of the situation but also appreciates the multifaceted nature of fraud. In order to derive a unified model of fraud that incorporates these two theoretical constructs, three questions will lead through this paper. First, are some people more likely to commit fraud? Second, what is it that makes a corporation fraud-friendly? And thirdly, how do offender variables interact with aspects related to the corporate environment? The first part of this paper deals with the offender characteristics and aims to identify psychological red-flags. In the second part, the corporate environment will be scrutinised with a focus on the second main question, and subsequently, the third part proposes a synthesis of these findings. The overarching SCP-based

model is developed in more detail with the very specific parts identified earlier. Finally, this paper will be accompanied by a concrete research proposal aiming to investigate the proposed model.

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Psychological Characteristics of Fraudsters

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The overall aim of the paper is to synthesise the offender and external factors around fraud into a unified model. Therefore it is of crucial interest to identify variables or collections of variables that can discriminate between fraudsters and non-fraudsters. The question whether some individuals are more likely to engage in fraud than others is the starting point of this first part. In particular, adding the psychological variables of the offender is an essential part of the hypothesised theoretical

Situation

Offender

Crime

Figure 1. The hypothesised framework of this paper. Situational variables and offender variables have a main effect

framework of this paper. Within this first part, the offender variables that are investigated to differentiate between fraudsters and non-fraudsters are sub-divided into two categories, namely, personality correlates and motives.

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Personality Correlates of Fraud

One of the earliest attempts to incorporate the concept of personality into research on fraud-related crimes was undertaken by Alalehto (2003). Based on a qualitative research methodology, Alalehto investigated this facet with a unique interviewing technique called “intimate informant

interviewing” that allowed for firsthand insights into the white-collar offender. Her sample consisted of 128 businessmen in Sweden who reported on suspicious business transactions and potentially criminal behaviour of their close colleagues. In semi-structured interview sessions, it appeared that of the 128 colleagues, 55 could be considered as having committed a white-collar crime. More importantly, when asked to rank their colleagues on personality dimensions the

businessmen ranked their criminal colleagues higher on extraversion and neuroticism, and lower on agreeableness. Alalehto concluded that these personality traits contribute to a person’s likelihood of committing fraud.

Alalehto’s findings suggests that personality variables of fraudsters differ from those of non-fraudsters. The results, however, are not conclusive for two reasons. First, she did not test her findings for statistical significance, a fact she ascribes to the small sample size. Second, at least two severe confounds are at play for she relies on subjective reports of colleagues and has no means to verify their statements, and because her sample is not homogenous as she resorts to businessmen from three different industries in Sweden. So it is possible that there are some industries that are more prone to fraud than others and it is not clear which type of business Alalehto’s findings apply to. Nevertheless, Alalehto was the first to set out against the mainstream thinking that white-collar crime is unaffected by personality and she paved the way for more sophisticated research

methodologies.

Blickle, Schlegel, Fassbender, and Klein (2006) adopted a quantitative methodology and examined a range of demographic and personality measures with a sample of 76 convicted high-level white-collar criminals and a comparison sample of 150 business managers. Measures included the personality dimensions narcissism and conscientiousness and hedonic lifestyle. Even though the authors are not explicit about the items they used, elements of narcissism range from need for

admiration and manipulativeness to arrogance and a lack of empathy (adopted from the Five-Factor Narcissism Inventory, Glover, Miller, Lynam, Crego, & Widiger, 2012). Conscientiousness

consisted of items measuring “striving for competence, order, […] self-discipline” (Blickle et al., 2006, p. 224). They used the Schwartz definition of hedonism defining high hedonism scores as participants’ defining goal to seek “pleasure or sensuous gratification for oneself” (Schwartz, 2012, p.8). Their research revealed that white-collar criminals scored significantly higher on hedonic lifestyle tendencies than non-criminal business managers, and showed stronger narcissistic tendencies. Furthermore, contrary to the authors’ hypothesis, conscientiousness was considerably higher in criminals than in non-criminals.

It was especially the conscientiousness-finding that initially surprised the authors. An

explanation could be the skills one needs to become a white-collar criminal. Blickle et al. (2006) reason that rising through the ranks to top-level management positions requires extensive training and technical proficiency. Acquiring such capabilities presumes a high level of persistence and precise work, both aspects that are included in the conscientiousness measure. This finding is supported by Bresser (1978, cited Blickle et al., 2006). Having acquired specialist skills and insider knowledge, the offender perceives the risk of the offence as relatively low and feels safe to defraud. In other words, without a high level of conscientiousness no specialist skills can be acquired and without such skills the potential offender not only will not reach management positions but will neither feel confident enough to really defraud. It is particularly important to refer to this finding against the background of the hypothesised framework. It is not conscientiousness alone that makes a person a fraudster but it is the interaction of high conscientiousness and a fraud-friendly

environment. I will discuss this in part three.

It can be concluded that Blickle et al. (2006) found quantitative evidence for psychological correlates of white-collar crime. They suggest that the fraudster tends to be more narcissistic and disguises himself as more conscientious than his colleagues. Nevertheless, they were also able to isolate lifestyle elements that discriminate fraudsters from non-fraudsters. Whereas personality correlates are unobservable constructs that might remain unobserved, a hedonic lifestyle is

observable and concrete. If one were to translate the Schwartz definition of hedonism (2012) into a corresponding lifestyle, a hedonic person can be described as attaching great value to expensive material things and eager to display status symbols. The fraudster, in other words, attaches greater value to pleasurable leisure activities and above all, sees fulfilment of his own pleasures and

well-being as primary goal. Summarising the findings from Blickle et al. (2006) it appears as though the white-collar criminal is a conscientious someone who now wants it all and cannot resist a

temptation to fulfil his extravagant lifestyle.

So far, the personality section has identified narcissism and conscientiousness as personality correlates of fraud. Also, it was possible to find a manifest variable that transcends the unobservable nature of personality, namely hedonic lifestyle. Next I will discuss the role of motives. It is

worthwhile to adopt a cautionary note by Canter and Youngs (2009) who wrote that motives are only then of interest once they allow for inferences to the offender. It is unclear whether motives are of any help at all as Canter and Youngs suggest that they may merely function as a narrative for a chain of events that we cannot explain. If, however, motivations for a crime are considered in a broader sense of relating causally to the offence, it is imperative to examine them.

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Motives of the Fraudster

Bhattacharya and Marshall (2012) investigated whether money functions as a motive for fraud. Financial record would be a motive of great value because its nature could be established relatively easily compared to rather unobservable personality traits. Bhattacharya and Marshall scrutinised financial records of 52 top-rank employees convicted for fraud. The rationale of their research was that if fraud is an economically rational crime, those fraudsters who have a poorer financial record would engage in more fraud than fraudsters from the richer stratum. This is because assuming a cost-benefits analysis, the costs of potentially being caught are lower for the poorer fraudsters than for the richer ones. Their analysis revealed that once they controlled for possible confounds like business size and growth potential, most cases of fraud in their sample were found in the richer top-management group. Thus from a purely economic cost-benefit perspective, money does not appear to be the primary goal behind corporate fraud. What remains concerns the question why a top-rank manager from richer stratum would engage in fraud.

When it is not a rational cost-benefit analysis that drives the fraudster, another explanation could be the fear of losing. One perspective that focuses on potential losses in contrast to gains, is the fear-of-falling hypothesis as put forward by Piquero (2012). Contrary to the assumption that greed functions as overlying motivation, the fear-of-falling hypothesis states that it is not the prospect of gaining money but rather the fear of losing some of the money, wealth or status the fraudster has worked so hard for. Piquero measured intentions to commit fraud depending on an experimentally

induced fear-of-falling. She presented participants with one of two scenarios describing a family father whose children attend a private school and whose family is about to set off for their annual vacation. The father has been promoted and is about to meet with competitors to discuss future product pricing. In the fear-of-falling scenario, participants read an additional passage making explicit the thoughts of the father who was described as worrying about declining sales which would consequently change the family’s expensive lifestyle. As solution to the fathers problem, it is described that he could engage in price-fixing with the competing company. The control group did not read about the father’s worries. Piquero’s dependent measure were self-reports about the likelihood to endorse in fraudulent behaviour like price-fixing (“What is the chance that you would act as the manager did under these circumstances?”, p. 368).

The results suggest an unexpected inverse relationship, that is those with an induced fear-of-falling indicated less intention to engage in fraud than those with without fear-of-fear-of-falling, a finding Piquero attributes to the “reminder role” of the fear-of-falling. Instead of provoking fraud, it reminds participants that much is at stake. The findings of Bhattacharya and Marshall (2012) and Piquero (2012) suggest that neither monetary gain nor the fear of losing status or money are causes of fraud. It can be concluded that both the financial record and the fear-of-falling motive are of indirect use only. The value of these findings is that if it were financial cost-benefit reasoning or the fear-of-falling, the two investigations discussed above would have indicated that. But they did not. In this sense, money as a critical distinguishing feature can be ruled out.

The studies mentioned in this part provide a number of variables that differentiate between fraudsters and non-criminals. So are some people more likely to commit fraud? Yes, in particular, extraversion, narcissism and conscientiousness have been identified as personality traits that are higher in fraudsters. Moreover, a hedonic lifestyle appears to be more prominent in fraudsters than in non-criminals. Concerning motives, there was no evidence that monetary motivations played a role, neither in terms of potential gain nor in terms of losing what one has earned. The next part will discuss the corporate environment of fraud and provide the missing parts of a unified model. The conceptual model, its details, preceding models, as well as implications for the SCP framework are the focus of part three.

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The Corporate Environment

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Whereas the first part of this paper elaborated on the offender side of corporate fraud, the question guiding this following part is what makes a business especially fraud-friendly? In line with the hypothesised framework of this paper, it can be expected that the corporation affected by fraud plays a significant part in the emergence of fraud. At the end of this part, I will summarise the main findings in order to transfer them to a unified model that incorporates and synthesises findings from both main parts of this paper.

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The Non-Control Factor

Holtfreter (2005) provided valuable insights into the structure that characterises businesses affected by fraud. She investigated a sample of 1,142 businesses reports by certified fraud examiners. Overall, 84% of the investigated businesses fit the definition of corporate fraud and it appeared that these companies were significantly smaller in size compared to companies affected by other types of fraud. Moreover, corporate fraud was more common in businesses that were not publicly traded and corporate fraud was not detected by anonymous reporting systems and remained concealed even with internal audits as a control mechanism in place.

On the one hand, these findings can be explained by the very nature of corporate fraud because an anonymous or internal control system is exactly what the successful fraudster has circumvented. In other words, the fraudster would not have been successful in committing the fraud if he were so amateurish to leave obvious traces. On the other hand, this does not answer why the control systems and background checks failed since all companies had several control structures in place, be it anonymous reporting, internal audits or external audits. Albrecht (2003, cited in Holtfreter, 2005) states that it is not a lack of a control mechanism that is the problem but the fact that all control layers are ignored and overridden. For example, when external audit firms point out that there may be some irregularities or when the internal audit raises concern about an employee’s business transactions, no one in the responsible positions reacts accordingly. It is not only the potential fraudster who ignores control structures but a generally accepted behaviour which, in the end, makes it facilitates fraud. In the following I will refer to the existence of a high degree of ignorance and indifference towards control structures as non-control factor (adopted from Albrecht, 2003, cited in Holtfreter, 2005).

Interestingly, this non-control factor was also at play in the UBS trading scandal. In fact, the Financial Conduct Authority fined UBS 30 million pounds for not responding correctly to the warning systems (Kollewe, 2014). One interpretation of the failure of control mechanisms is that businesses just fail to detect the warning signals, but what the verdict in the UK implies is that not acting upon warning signals may be the norm.

What the findings by Holtfreter (2005) and the UBS verdict evoke is a discussion about the ethical climate that dominates businesses. A paper by Shin (2012) dove into this issue. In his large scale study with more than two hundred CEOs and 6000 employees, Shin administered

questionnaires to compare the CEOs’ self-ratings of ethical leadership (e.g., “I make fair and balanced decisions”, p.305) with employee ratings of the actual, perceived ethical climate (e.g., “In this company, people are expected to strictly follow legal or professional standards”, p.305). It appeared that employees’ and CEOs’ perception of ethical climate did not contradict each other. Shin’s study (2012) confirms Holtfreter’s (2005) findings which suggested that it might that whole businesses affected by fraud are in fact characterised by a non-ethical climate altogether. This emphasises that it is more promising and interesting to re-direct the focus away from some rotten apples to the entire business’ culture.

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Leadership Structures

An investigation by Soltani (2014) shed light on the ethical corporate culture in a comparative analysis of American and European corporate fraud scandals. The framework Soltani relied on was the concept of an ethical climate as a composite consisting of ethical culture (i.e., “those aspects that stimulate ethical conduct”, according to Trevino & Weaver, 2003, cited in Soltani, 2014, p. 254), tone at the top management (i.e., “the manner in which the company’s board of directors […] and CEO perceive their responsibilities in setting the tone of an organization”, p.255) and ethical leadership (i.e., demonstration of proper business conduct through personal actions). His analysis revealed that six cases of gigantic corporate fraud resemble each other on these dimensions. Among the key findings of this in-depth comparative case study is the fact that ethical misconduct reached further than just top-level management so that the multinational businesses as a whole were characterised by poor ethical conduct. Soltani further identified intensely hierarchical structures in those companies with “strong egoism, power abuse, and influential and authoritative position of CEOs” (2014, p. 264). The latter is amplified by the detail that these patterns were particularly

problematic when the company was run by a clan-like leadership structure. Such a leadership resulted in abuse of position and employees’ feelings to oblige which in turn can be conceived of as a facilitator of the non-control factor. Also, decisions were made based on interpersonal relations and in these structures doubtful transactions were never question because one felt part of the company, part of the family. In other words, the obstacles for high-ranked employees to commit fraud were low to begin with and fraud was unlikely to be reported nor detected.

Moreover, Soltani points out that the CEOs’ style showed signs of demonstrating dominance by taking extremely risky business decisions. Concerning the top-management’s role to define the business’ culture, it becomes evident that it was mostly a lack of appropriate leadership that led to the scandals and facilitated corporate fraud at large scale. Literally all control mechanisms and board functions in these multinationals failed, which led Schwartz, Dunfee and Kline (2005) to describe the boards as “sleepy-eyed sentries” (cited in Soltani, 2014, p. 265). This investigation strengthens the findings from Holtfreter (2005) that even though control structures were in place, it is not the controlling mechanisms themselves that need to be called into question but the concrete implementation, realisation and commitment to such schemes. To conclude so far, it appears that

cohesive management structures and CEO malpractice and failure to set the right tone promote a

non-control culture which then indirectly tolerates cases of corporate fraud.

A study by Gabbioneta, Greenwood, Mazzola and Minoja (2013) has taken the investigation of the ethical climate of corporations in cases of illegality a step further. The Parmalat scandal is an example of large-scale fraud by the heads of the corporation - Calisto Tanzi, CEO and Fausto Tonna, CFO - who were jailed for “systematic and creatively planned accounting

misrepresentation” (p.484). This extensive research work and the 10-year long longitudinal design of their study offers an unequaled level of detail of the gigantic corporate fraud within the Italian Parmalat company - a former multinational dairy producer. Applying a multitude of methods and sources, they found that the company kept on focusing on growth strategies despite being aware of severe monetary losses and shortcomings. Conveying an image of strength and risk-taking

behaviour in the top-level management is what Soltani (2014) found in his comparative study as well. Most importantly, it became evident that, again, it were “regulatory loopholes” (Gabbioneta et al., 2013, p. 495) that were the main facilitator of this fraud case. Unsurprisingly there were several layers of control structures but they did not function as they should have and each loophole in internal as well as external audits was exploited. The description of the Parmalat case contains

striking similarities to the company-wide non-control factor that was identified as facilitator of fraud in studies by Holtfreter (2005) and Soltani (2014). As a reminder, recent court cases in the UK (Kollewe, 2014) suggest that prosecutors are not so willing to accept the innocent role of the

company after all. So maybe it is an orchestrated phenomenon. A perspective that zooms in on this idea is the neo-institutional theory.

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Conflictive Norms

Monahan and Quinn (2006) put forward the neo-institutional approach to organisational deviance. They argue that organisational misconduct is rooted in the process of decoupling - described as deliberate ignorance of rules intended to guide proper business practice. In their paper they examined organisational decoupling in the long lasting fraud in the US Architecture Intern Development Program which was marked by false representation of work and duties, deliberate mis-reporting of working hours, and forgery of signatures. The decoupling in this case is that the true purpose of the programme to equip young architects with experience and skills is literally and practically decoupled from reality.

In their study, Monahan and Quinn found symptoms of deviance within organisations.

Specifically they identified discrepant norms, that is a discrepancy between external expectations and internal ought-to-be standards. An example is the conflict between the intern programme’s true purpose and external expectations: the programme is intended as supervised preparation for

professional work for young architects but at the same time, the market competition is fierce and the supervisors, all senior architects, need to generate profit. Even though they should concentrate on guidance and support, external norms forbid time-consuming supervision. Soltani (2014) and Gabbioneta et al. (2013) reported that fraudulent behaviour can be seen as a strategy to conform to external expectations. In order to accommodate the conflicting situation both top-level management and low-level employees or interns resort to fraud. The parallel with corporate fraud is that external expectations do not match the proper business one ought to conduct. For example, working in a typical white-collar crime sector like investment banking, the expectation is typically to generate profit for the bank while best-practice norms tell the banker to be of professional service to his clients. The pressure dictated by the market is so high that fraud like Kweku Adoboli's can be seen as a way to comply with external expectations.

My aim in this part of the paper has been to review the characteristics and features that are particularly noticeable in companies where fraud was an issue. Together with the findings from part one, now the relevant variables for a unified model are in place. In particular, the two main

candidate variables are the existence of a non-control factor, rooted in an ethical climate where the ignorance of proper business guidelines is accepted and tolerated, and conflicting internal and external norms. To a lesser degree, clan-like top-level management behaviour, cohesive top departments and close bonds between company management and external sources, were related to fraud. How the key variables interact with the offender variables is the topic of the next part.

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Integrative Models of Fraud

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In the first two parts of this paper, I have established candidate variable concerning, respectively, psychological offender variables and corporate characteristics. In the remainder of this paper, I will synthesise these findings into a model to provide a framework of fraud that exceeds the situation-as-cause perspective that is advocated by proponents of SCP.

There are two reasons to adjust the original SCP model. First, this theoretical approach focuses merely on the situation in which the crime takes place. Second, the original model has not been applied to the growing problem of fraud. I extend the basic SCP approach by including the offender in the model, that is I hypothesise an interaction between offender characteristics and situational variables. Moreover, this new theoretical framework is hypothesised to deal with the problem of fraud in specific. Centring around the interaction between offender variables and corporate characteristics, in the following, the findings from part one and two are incorporated into a single model. Table 1 recapitulates the identified variables.

Offender Characteristics Corporate Environment

Extraversion Conflictive norms

Narcissism Non-control structure

Concientiousness Clan-like leadership

Hedonic lifestyle Cohesive top-management

I will focus on the most prominent of these variables in order to keep this first attempt to

formulate a fraud-specific interaction model of SCP simple. When it comes to developing a unified model based on these variables, three logical steps are needed to derive the final interaction model. I will now discuss and elaborate on each of these steps. Basic situational crime prevention theory does not explicitly assume a relationship between the criminal act and offender characteristics but states that the situation is the main cause of crime. In terms of structural models, SCP implies that there is a main effect of the situational variables on crime but neither a main effect of offender characteristics nor an interaction between these two aspects. Applied to fraud-relevant situational variables, this model assumes that conflictive norms and a non-control factor are direct causes of fraudulent behaviour without taking into account any psychological offender variables. Figure 2 shows how this would look graphically.

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Figure 2. The basic SCP model with a main effect of non-control factor and conflictive norms (situational variables).

Conflictive Norms Non-control Factor

Propensity to defraud

Fraudulent behaviour

Extraversion Narcissism Conscientiousness Hedonic lifestyle

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The next logical step which builds on basic SCP, is a model that adds a second main effect, namely that of offender characteristics which I will refer to as Propensity to defraud. Theoretically speaking, this means that conflictive norms and the non-control factor are direct causes of fraud. Adding the second main effect implies that a person with high extraversion, narcissism,

conscientiousness, and hedonic lifestyle (i.e., a person with a high propensity to defraud) is more likely to display fraudulent behaviour than a person without high traits on these variables.

Importantly, these two aspects are considered to be independent from one another, that is they do not interact. In other words, regardless of the situational variables, a person with a high propensity to defraud is equally likely to commit fraud in each possible corporate environment. Likewise, every person in a corporation characterised by a non-control factor and conflictive norms is equally likely to commit fraud. The relationships are represented graphically in Figure 3.

Figure 3. The main effects model with a main effect of non-control factor and conflictive norms (situational factors)

and a main effect of propensity to defraud (offender characteristics). Conflictive Norms

Non-control Factor

Propensity to defraud

Fraudulent behaviour

Extraversion Narcissism Conscientiousness Hedonic lifestyle

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Suchlike a model represents existing literature that focuses on only one of both sides of fraud - offender or corporation. This model states that both cause fraud regardless of the other. As this model stands between the basic SCP and an interaction model, I will call this model the main effects

model. Although it is imaginable that there are relationships within each component, for the scope

of this paper I will not propose any sub-models. For example, it might be possible that the variable propensity to defraud explains the shared variance of its four psychological components, or that the role of conscientiousness needs to be reconsidered so it functions as an additional mediator of situational influences. Likewise, conflictive norms could in fact be a cause of the non-control factor. However, the variables of both main components - offender and situation - are allowed to covary because such a specification of the components is out of the scope of this paper. For the offender side, I will treat the propensity to defraud as a formative factor consisting of the weighted sum of the four variables extraversion, narcissism, conscientiousness and hedonic lifestyle.

As a last logical step, the main effects model is extended by adding the interaction between situation and offender. On a theoretical basis, adding this interaction means that the propensity to defraud is moderated by the situational variables, so that the effect of the propensity to defraud varies depending on the situational variables. Figure 4 shows the hypothesised interaction model. All of the corporate environment variables have a main effect on fraudulent behaviour and until here, this is exactly how basic SCP would approach fraud. But when we add the offender to the model and take into account the findings from the literature, the offender variables have a direct effect on fraudulent behaviour as well and interact with the situational causes, that is they are moderated by the corporate characteristics. Concretely this means that psychological characteristics make a person even more likely to commit fraud when the situation provides many opportunities for fraud.

In this part, I have derived a new model that extends the basic SCP approach. The steps involved in this procedure all have their pitfalls and one must be careful not to propose main effects or interactions without any indications in the literature. However, building on recent findings about offender characteristics and corporate environment that are related to fraud, I was able to

hypothesise a new framework of fraud. One of the next logical steps is to test the interaction SCP model. The accompanying research proposal describes two experiments that aim to validate the model against empirical data. In the last section of this paper, I will summarise the conclusions briefly and discuss directions for future research.

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Figure 4. The interaction model with a significant interaction between the two situational variables and propensity to

defraud, a main effect of situational variables, and a main effect of propensity to defraud. Conflictive Norms

Non-control Factor

Propensity to defraud

Fraudulent behaviour

Extraversion Narcissism Conscientiousness Hedonic lifestyle

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Conclusions and Discussion

The global aim of this paper was to address the gap in existing academic literature where the fraudster and the corporation affected by fraud are conceived of as two isolated elements. Without an integrative modelling approach, the core understanding of fraud will not exceed these isles of knowledge. Specifically, for the offender side it was possible to highlight variables that demarcate between the fraudster and non-fraudster. The personality traits narcissism, extraversion and conscientiousness as well as hedonic lifestyle tendencies stood out. For all four variables, higher trait levels were found in fraudster compared to non-criminals. It appeared that on the corporate side the existence of a non-control factor, discrepancies between external and internal company norms, cohesion on top-management levels as well as clan-like leadership styles were related to fraud.

As broad theoretical starting point, situational crime prevention theory was re-formulated. Starting with the basic SCP model and adjusting this approach stepwise culminated in the SCP interaction model of fraud. This model hypothesises that the situational variables conflictive norms and non-control-factor, and likewise the formative factor propensity to defraud, have a main effect on fraud. Importantly, the situational variables are hypothesised to moderate the effect of the propensity to commit fraud. This implies that personality characteristics that facilitate fraud have a direct effect on fraud and are activated even more once there is an opportunity to defraud.

As I have proposed a new model of fraud, it is important to point out some of the challenges that researchers face when testing this model. First, there is a significant proportion of fraud that is never reported. Corporations as well as individuals are reluctant to announce their being a victim of fraud due to fear of image loss and embarrassment. Some corporations reason that reporting fraud would not have made the fraud undone. This accumulates to estimates of under-reporting rates of 60% (Applied Research & Consulting LLC, 2013). Second, the prevalence is very low, a fact that at first sight seems contradictory to the sizeable impact fraud has. Whereas there are few instances where one person kills a thousand others, in the case of fraud, it is much more likely that a single offender affects thousands of victims. In the famous case of the US securities fraudster Bernard Madoff, one individual alone was responsible for financial loss of 20 billion US dollars including numerous instances where whole retirement schemes were lost (Perri, 2011). The third obstacle is the availability of reliable data from corporations. Simpson (2013) discusses this problem by pointing out that theoretical approaches concentrating on dynamics within corporations such as the

centrality of actors, the relationships of different actors within a business, and the contagious

spreading of fraud, are limited because sensitive data is mostly protected by privacy agreements and not accessible to researchers.

Future research should be explicit in tackling these problems. For instance, MacCullum, Wegener, Uchino and Fabrigar (1993) discuss remedies of inconclusive causal relationships. In cooperation with companies and businesses, fraud research should be based on authentic data that allow for reliable analyses of the dynamics within corporations, in specific, within the

top-management structures. Furthermore, as an experimental design is difficult, it is necessary to make use of multiple methodologies. Correlational research as set out in this paper should be enriched with research from laboratory settings which manipulate specific elements of fraud. Finally, a way to circumvent the problem of experimental designs in actual corporations is longitudinal research. Building on approaches described in this paper, longitudinal research could examine a larger sample of corporations on the same factors and see how differences in these factors relate to fraud.

Dynamics that are observed over time allow for much stronger causal conclusions than mere snapshot correlations. Concerning the issues that were discussed briefly in the previous part of the paper, future research should be directed at the sub-models within both the offender and the corporate component. For now, it is not clear whether the scaling of the offender variables is justified or should better be modified to a sub-model. The same holds true for the corporate

environment for it is imaginable that there are causal relationships within this component. Another line of research should focus on feedback-loops in the model because it remains an open question how successful fraud at one time reinforces successful fraud at another time and how this affects the relationships hypothesised in the model.

What this paper has put across is that there is an urgent need for integrative models on fraud because it cannot be understood without incorporating multiple facets. Unified theoretical models will not prevent all rogue traders from committing fraud but will lead to an understanding of the emergence of fraud. This can, in the end, put the tools to make fraud more difficult in the hands of corporations and law enforcement.

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