Rationalization and Concealment

Signs of Ethical Deterioration

The 21^st century has brought not only the worst pandemic in over 100 years, but also an alarming deterioration in ethical culture. We see examples of this in the types of fraud being perpetrated, as well as in the behavior of elected officials, athletes, business owners, and wealthy parents of students. Where is this trend headed, and can it be reversed? In this article, the authors discuss how perpetrators rationalize, how financial fraud is concealed, and ways to combat fraudulent behavior.

The 21^st century has brought not only the worst pandemic in over 100 years, but also an alarming deterioration in ethical culture. We see examples of this in the types of fraud being perpetrated, as well as in the behavior of elected officials, athletes, business owners, and wealthy parents of students. Where is this trend headed, and can it be reversed?

            As illustrated in the famous Fraud Triangle, three familiar factors lead to fraud:

• Perceived unshareable financial need (i.e., pressure)
• Perceived opportunity
• Rationalization[1]

Today’s socioeconomic climate has uplifted rationalization as a key factor toward motivating fraud. There is an extreme disparity in income and wealth between the middle class and the top 1%. For example, Jeff Bezos’s net worth has grown from about $12.6 billion in 2010[2] to $198 billion in 2021.[3] Meanwhile, the federal minimum wage in the U.S. has remained at $7.25 during that same timespan. Because of this inequality, the masses are now beginning to believe that unethical acts like cybercrimes against corporations are justified.

Along with the rationalization, the authors propose a fourth element that is becoming pervasive in modern-day frauds: concealment. In many fraud cases, the embezzler is savvy enough to cover his or her tracks. Typically, this is accomplished through bookkeeping manipulation and a weak internal control environment, creating a fertile landscape for fraudulent conduct. When management or those in charge of governance are not watching, mischief is more likely to take place.

Concealment enables the fraudster to keep a fraudulent scheme undetected for a longer period. Sometimes the concealment is so well crafted the fraud is never discovered.

One clever technique of the fraudster is to steal relatively small amounts year after year. In a prolonged scheme, this technique results in financial trends staying within an acceptable range so they will not be questioned. Should the business owners or outside consultants perform trend analyses, the steady rate of theft would make the trends appear less variable; therefore, less likely to lead to internal review or external forensic investigation.

Management and those in charge of governance play an important and unique role in helping prevent fraud. They must actively monitor financial activity or create a perception that they are monitoring. If fraudsters perceive they are not being monitored, they will become increasingly more brazen in their attempts to defraud the entity. Those in charge of governance have a fiduciary responsibility to do their jobs and, in certain situations, if they are not diligent in that role, they could be held liable for the consequences of fraud.

Two Case Studies about Monitoring

A very large, multinational corporation had an administrative assistant who was suspected of stealing through falsification of her expense reports. She had realized that the required protocol of getting a superior to sign-off on her monthly expense reimbursement report was easy to achieve, since her supervisor was always too busy to take the time to review the underlying support for the charges. The employee took advantage of this lack of monitoring and charged numerous personal expenses to the company for years. After the employee quit and relocated to another state, the company noticed something peculiar in their records. Our firm was engaged to conduct a forensic investigation, including interviewing employees. As part of our procedures, we examined the business records, compiled documents, and tabulated the totality of her fraud. We delivered the report to the local District Attorney, who accepted the case. The former employee was extradited to New York and pled guilty to the crimes.

When company executives were asked by my firm why they invested time and money to pursue criminal charges against the employee, they responded that they wanted to send a message to their entire workforce that not only would such abusive acts not be tolerated, but they would also be prosecuted. This created a perception throughout the workplace that employees were being closely monitored, which effectively became a part of their preventive controls.

In another case, our firm was engaged to review the internal controls of a local church parish. We received a tour of the parish including the offices, sanctuary, and room where the offertory was counted after Sunday masses.

The priest told us that due to some “contribution shrinkage” the parish had installed, at great expense, a concealed, closed-circuit monitoring system to record activity in the room. The church discovered how the shrinkage took place and rectified the situation. We explained to the priest that the parish simply should have put a sign on the door advising that the room was being monitored by closed-circuit security cameras. The sign would have created the illusion of monitoring. This solution would have been a preventative control as opposed to a detective control and would have saved the parish the time and money of installing a monitoring system.

Cyberattacks are another form of concealed fraud. These thieves find surreptitious ways to enter computer systems, seize control, and demand ransom money (usually in the form of cryptocurrency) to restore the victim’s access to systems and files.

In cases where an embezzler is caught red-handed, the defendant’s attorney often produces statements written by family members, friends, and clergy testifying as to the redeeming qualities of the person with sentiments such as: “He is a good person who did a bad thing.” Such requests for leniency ignore the impact on victims. Is the victim satisfied when the judge is lenient with the sentence? Or does the victim lose faith in the justice system?

Are these types of fraud examples of erosion of ethics on the part of the wrongdoers? Has organized crime become less organized but much more serious or white collar oriented? Instead of one crime family wiping out a handful of key members of a rival family (certainly terrible), cyber-criminals take down utility infrastructure and cripple major businesses.

One notable and prodigious cyberattack recently occurred in May 2021. The Colonial Pipeline Company, which operates one of the largest petroleum pipelines in the United States, fell victim to a ransomware attack by a criminal hacker group called DarkSide. Because of the attack, Colonial shut down its pipeline for several days. Colonial provides nearly half of the East Coast’s fuel supply. This led to panic-buying of gasoline and significant price spikes in some states. Colonial paid DarkSide approximately $4.4 million in Bitcoin to resolve the ransomware attack. The FBI was able to recover more than half of the monies paid to the cyber-criminals.[4]

Clearly, we may not be far from the day when an even larger utility infrastructure is held hostage or Wall Street is shut down for a week or more.

Government counter-terrorism agencies are getting better at catching crooks who commit such nefarious crimes, and cryptocurrency may become more easily traced due to new legislation, but, until then, we remain vulnerable to attack.

Perhaps one solution is for nations to present a united front and pool resources to deter and detect criminal behavior. But would it be more effective if the world redoubled its efforts to educate and guide young minds to think more ethically and responsibly? Just as reversing the impact of climate change cannot be accomplished if only a few nations alter their ways, crime knows no border. A one-world view of crime management may be the only way through this growing problem.

After the high-profile frauds of the late 1990s and early 2000s, the U.S. Government responded by passing the Sarbanes-Oxley (SOX) Act of 2002, which in many ways worked to legislate corporate governance and, in turn, ethics at the highest levels of corporate America. However, almost 20 years later, fraud still exists in large, publicly traded corporations and research has been mixed on whether SOX has reduced securities fraud. With legislation as big as SOX was, it should not be a surprise that progress has been made in some areas and not so much in others.

Corporate ethics and governance are not very different from personal ethics. Personal ethics is a subject that should be taught in all schools; starting in grade school. The consequences of ethical breaches, both personal and societal, should be clearly spelled out and considered. If we educate young minds on the importance of shared responsibility for change, then change is possible. If we slack off on this effort, then unethical behavior will be seen repeatedly.

People who should be role models are constantly caught in a myriad of scandals, bringing ethics front and center onto the tabloid front pages. New York just lost a governor over charges of sexual harassment and abuse who was already under investigation for misrepresenting nursing home COVID-19 deaths to make his administration’s COVID-19 response look more successful. We have seen all kinds of cheating in professional baseball, football, and in the Olympics. What are these role models teaching the next generation? That cheating or winning at any price is OK if the goal is accomplished? We need to teach kids it is not OK, no matter the goal. Cutting corners is not the answer, even if the desired result is achieved and justified.

We cannot reasonably expect our children to act more ethically than we do. The same principle applies to employees and corporate leaders. Employees look to management to discern what is acceptable or unacceptable behavior. Therefore the “tone-at-the-top” is very important.

Teaching ethics has a long and varied path in North America going back to the 17^th century. When schools were founded in the new world, an education in moral principles was the primary concern. The Puritans of New England believed the moral code was found only in the Bible. In colonial times, the value of a moral education was similarly taken for granted, and its importance filled the writings of the founding fathers. In the 1800s Abraham Lincoln and Horace Mann strongly advocated for moral education. The teachers who were hired and trained were expected to teach and advance a moral code for each school.

In the 20^th century, the population in North America saw an infusion of diversity from other nations. Such expansion also led to a new mix of diverse religious beliefs that differed from the Protestant beliefs dominant in the nation and in schools. This new diversity brought a shift in who should be responsible for a child’s moral education. By the 1960s, the nation’s moral conscience was changing rapidly, and many people believed it was not the role of the public education system to teach values and morals, but rather that of the family and the religious institutions to which people belonged.

In the last part of the 20^th century, many schools avoided the third rail of teaching ethics altogether. During that same period, achievement scores declined, discipline and behavior problems increased, and many people accused teachers of teaching secular humanism.[5] While there is not necessarily a cause-and-effect relationship between the two, the two happened simultaneously.

In the early part of this century, business saw unprecedented and ever-increasing corporate fraud,[6] and as mentioned above, the Sarbanes-Oxley Act of 2002 was enacted. Business schools and professional associations recognized it was time to start talking overtly about ethics and requiring their students and professionals to take ethics classes to complete their degree or maintain their professional certification or license.

Corporations also have begun to prioritize ethics through the recent development of environmental, social, and governance (ESG) reporting. These new reporting standards provide guidance on how businesses can disclose how they benefit society beyond financial profit. Examples of ESG reporting metrics include energy usage and conservation, diversity efforts, and ethics and anti-corruption.[7] As of July 2020, 90% of corporations in the S&P 500 have provided ESG reporting to shareholders.[8] Fraud has not gone away, but ethics is certainly now part of the conversation at most major business schools, professional associations, and corporations.

With the rise of polarized politics and disinformation (from both sides of the political spectrum), we see three rationalizations at play: (1) winning at all costs is OK, (2) my view is the only correct view, and (3) if that person can say something that everyone knows is not true, then I can say untruths as well. These beliefs have continued to deteriorate the moral fabric of this country.

There is a concept in social psychology research called “behavioral contagion.” Behavioral contagion is the tendency to repeat a behavior after seeing how other people behave. Someone might think, “If a leader or a boss is acting belligerently and brashly, it must be all right for me to act in the same way.” With the continued boorish public discourse, how are we ever going to teach our next generations that acting this way is not acceptable or responsible and that we should treat others with respect even if they do not hold our views?[9] 

There is gray everywhere in everyday ethical conundrums. The lines are blurred, rationalization flourishes, and fraud is ever more likely. For this trend to reverse, society needs to reemphasize the benefits of ethical behavior and the pitfalls of rationalization. People justifying the means to the end is going to further polarize us as a society. We need to call out the rationalization of untruths and misinformation when we see it and get back to meeting at a middle ground of honesty and mutual trust.

 

[1] The Fraud Triangle (2021), Association of Certified Fraud Examiners. Date retrieved; July 15, 2021: https://www.acfe.com/fraud-triangle.aspx

[2] Jeff Bezos Through the Ages: The World’s Richest Person in Photos, Forbes. October 1, 2019: https://www.forbes.com/sites/hayleycuccinello/2019/10/01/jeff-bezos-forbes-400-photos/?sh=89153d87d18f

[3] Bloomberg Billionaires Index, Bloomberg. Date retrieved; August 31, 2021: https://www.bloomberg.com/billionaires/?sref=RYeRFDzU

[4] https://www.vox.com/recode/22428774/ransomeware-pipeline-colonial-darkside-gas-prices

[5] Moral Education, A Brief History of Moral Education, The Return of Character Education, Current Approaches to Moral Education, https://education.stateuniversity.com/pages/2246/Moral-Education.html

[6] The year 2001 saw a record number of US federal securities class action litigation filings with 498 cases. This was a 138% increase from the number of cases filed in 1999, which was 209 filings. https://securities.stanford.edu/charts.html

[7] ESG Reporting Guide 2.0 – A Support Resource for Companies, NASDAQ, 2019-ESG-Reporting-Guide.pdf (nasdaq.com)

[8] Why Is ESG Reporting Important? https://sphera.com/glossary/what-is-esg-reporting-and-why-is-it-important/

[9] Behavioral Contagion, Psychology Research and Reference, http://psychology.iresearchnet.com/social-psychology/control/behavioral-contagion/

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Eric Kreuter, PhD, CPA, CGMA, CFE, CBA, MAFF, is a Managing Director at CBIZ Marks Paneth and was an Adjunct Professor in the Graduate Finance Program at Manhattanville College in Purchase, NY where he taught Forensic Accounting. He previously served as an Associate Professor at Mercy College in Dobbs Ferry, NY, where he taught graduate classes in Human Resource Management. He also served as a volunteer at the Bedford Hills Correctional Facility and the Taconic Correctional Facility in Bedford Hills, NY. He is a Counselor at St, Christopher’s Inn located in Garrison, NY.

Dr. Kreuter can be contacted at (212) 201-3117 or by e-mail to ekreuter@markspaneth.com.

Scott M. Brenner, MBA, CPA, CFE, is a Managing Director at CBIZ Marks Paneth, where he provides attest, accounting, and advisory services to both for-profit and not-for-profit organizations. To this role, he brings more than 30 years of experience in the manufacturing, government, and nonprofit industries. He also advises privately held business owners on tax planning strategies and the use of pensions as tax-savings tools.

Prior to joining Marks Paneth, Mr. Brenner was the Managing Partner of Dylewsky, Goldberg & Brenner, LLC – a Connecticut-based, full-service accounting, tax and advisory firm that combined with Marks Paneth in 2017.

Mr. Brenner has taught at the collegiate level for over 25 years. As an adjunct instructor at Fairfield University, where he recently won a university-wide “Adjunct of the Year” award, he has developed and taught several courses covering topics ranging from computerized accounting systems, business software applications, nonprofit and governmental accounting, and financial accounting. He has led courses for Fortune 500 companies and national trade conferences and has spearheaded a project to teach college students financial literacy. In addition, Mr. Brenner is a member of an international committee dedicated to helping reshape the way Jesuit universities teach business courses throughout the world, a joint effort of the IAJBS (International Association of Jesuit Business Schools), IAJU (International Association of Jesuit Universities) and CJBE (Colleagues in Jesuit Business Education).

Mr. Brenner can be contacted at (914) 409-4955 or by e-mail to sbrenner@markspaneth.com.

Andre Castillo, CPA, ABV, CFE, MBA, is a Supervisor in the Financial Advisory Services group at CBIZ Marks Paneth. He provides services related to forensic accounting, litigation consulting, economic damages, internal control reviews, and fraud investigations for his clients. Prior to joining CBIZ Marks Paneth, Andre started his career at KPMG LLP providing audit services to public companies in the sports and entertainment industry and the consumer products industry. He holds a BA in Economics from Boston College and an MBA/MS in Accounting from Northeastern University.

Mr. Castillo can be contacted at (914) 909-4932 or by e-mail to acastillo@markspaneth.com.