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Stress and Addiction May Lead to Fraud in the Legal Community

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STRESS AND ADDICTION MAY LEAD TO FRAUD
IN THE LEGAL COMMUNITY
BY MICHAEL ROSTEN, CPA, CFE, AND JASON WILEY, ESQ.
Stress and addiction are among the main triggers of fraudulent behavior within an organization. These pressures often make people cross an ethical line and engage in illegal behavior. Those in high-stress jobs in the legal field may have a heightened susceptibility to occupational fraud schemes ranging from altering cash receipts and cash disbursements cycles, to the victimization of the trust accounts for which they have fiduciary responsibility.
According to the most recent Report to the Nations on Occupational Fraud and Abuse from the Association of Certified Fraud Examiners (2012 Global Fraud Survey), reported cases of fraud within the professional services industries, which includes law firms, increased more than 40 percent between 2010 and 2012.1 Attorneys can be susceptible to fraudulent activities due to stress from practicing law and dealing with emotional and physical demands from clients, family and the courts, especially when coupled with a perceived need to “numb out” the pressures with substance abuse.2 Add in the fact that the risks of problem and pathological gambling doubles within 50 miles of a gambling facility3 and the risk of fraud is intensified for law firms in Nevada. But how can the pressure of stress and possible addictions lead someone down the path to fraud? In most instances, a variety of common conditions may lead to fraudulent activities, as illustrated by the fraud triangle, on the right. The fraud triangle is now commonly-accepted in the fraud investigation and financial professions, but originated from Donald R. Cressey’s hypothesis:
Trusted persons become trust violators when they conceive of themselves as having a financial problem that is nonshareable, are aware this problem can be secretly resolved by violation of the position of financial trust and are able to apply to their own conduct in that situation verbalizations that enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.4
Fraud Triangle
Based on the fraud triangle, three circumstances must be present when fraudulent conduct occurs: pressure, opportunity and rationalization. Pressure: Motivates a fraudster to commit an illegal act. Typically, the individual has a financial problem he or she is unable to solve by legitimate means. Oftentimes, the underlying problem arises from stress and/or addiction-related issues such as alcoholism, gambling addiction, health issues or loss of employment. Opportunity: Represents the method a fraudster uses to commit an illegal act. By violating his or her position of trust, the financial problem can conceivably be solved with a low perceived risk of detection. Frequently, either a breakdown or void in internal controls, such as incompatible job duties or lack of oversight, allows the fraudster to misappropriate
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incoming funds, misdirect payments or implement other fraud schemes and to conceal those activities from others. Rationalization: After committing a fraudulent act, the fraudster will typically attempt to distance him or herself from his act(s) by advancing excuses that characterize the behavior as acceptable or justifiable. Common excuses include: • I am underpaid and underappreciated; and therefore, was entitled to the ill-gotten funds. • I was only borrowing, and would have eventually repaid the funds taken (had I not gotten caught).
Fighting Fraud with Internal Controls
Minimizing opportunities available to potential fraudsters is the most commonly accepted method with which organizations combat the risk of fraudulent conduct, because said organizations are usually not able to meaningfully address the underlying personal financial problems or the fraudster’s ability to rationalize their behavior. In the 2012 Global Fraud Study, all internal controls were associated with a reduction in losses, indicating the importance thereof. From an effectiveness perspective, formal management review, employee support programs and hotlines were correlated with the greatest decreases in financial losses. However, external financial statement audits, the most commonly implemented control, showed the least impact on losses suffered.5 Lawyer assistance programs (LAP) may be of help in addressing issues beyond an organization’s purview, such as underlying personal financial problems and the more subjective area of rationalization. (Nevada lawyers may contact Lawyers Concerned for Lawyers at (866) 866-3211). Armed with an overview of the fraud triangle, managers, owners and other responsible parties should be on alert for behavioral traits typically exhibited by fraudsters that serve as warning signs. According to the 2012 Global Fraud Survey, the most common indications (red flags) of fraudulent activity are:6 • Living beyond means; • Financial difficulties (perhaps caused by living beyond means); • Unusually close association with vendor/ supplier/customer; • Control issues, unwilling to share duties; • Divorce/family problems; • Wheeler-dealer attitude; • Irritability, suspiciousness, or defensiveness; and • Addiction problems.
Brestal spent more than $1 million of company funds to pay personal gambling expenses. Brestal’s actions went unnoticed for a lengthy period of time because he was solely responsible for the management of the law firm’s finances and did not share the company’s financial information with its other partners. After the firm experienced financial difficulties, resulting in attorney and staff lay-offs and voluntary pay cuts, Brestal’s partners requested a forensic audit of the firm’s finances. During said audit, Brestal’s actions were uncovered. However, as noted, discovery of Brestal’s conduct did not occur until after others had lost their jobs or agreed to a reduction in salary. In a matter where an attorney “lost all reason,” stress was cited as the catalyst for the attorney’s fraudulent acts against his law firm, resulting in a criminal conviction and a prison sentence. Christopher Grierson, a partner at Hogan Lovells, pleaded guilty to four counts of fraud related to a travel expense scam wherein Grierson bilked his law firm of nearly $2 million. Grierson, who regularly worked 3,500 hours a year, experienced financial difficulties after spending lavishly in order to relieve stress. After borrowing on a series of bank loans, reaching the borrowing limit on a number credit cards and refinancing his primary residence to effectively double the amount owed on his mortgage, Grierson was still unable to meet certain financial obligations. In 2008, Grierson began falsifying travel expenses in order to satisfy outstanding debts. As a senior member of
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Behavioral Red Flags
Examples of Fraud Occurring in Law Firms and the Repercussions Therefrom
Oftentimes, an attorney’s fraudulent acts brought on by addiction not only negatively impact that individual, but also the attorneys’ colleagues and law firm. Earlier this year, a suburban Chicago law firm sued a former name partner, William Brestal, alleging
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STRESS AND ADDICTION MAY LEAD TO FRAUD IN THE LEGAL COMMUNITY
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the firm, Grierson was able to authorize his own expenses, oftentimes charging said expenses against dormant client accounts. Grierson continued the fraud for three years before an internal audit uncovered the nefarious acts. In both examples, an employee of a law firm, when left unsupervised and without a system of checks and balances, was able to manipulate the law firm’s internal accounting procedures to perpetuate a fraud to feed that attorney’s stress and addiction debts. It was only after millions of dollars were misappropriated and, in the case of the actions of Brestal, colleagues lost their jobs and/or agreed to decreased pay, that the fraud was ascertained.
• Be aware of the common red flags that may be indicative of fraudulent behavior. • Small firms are particularly vulnerable to fraud, since they have fewer resources and segregation of duties is more difficult. Due to these challenges, owners and partners should become more active in oversight and monitoring, and focus anti-fraud controls on the highest risk areas.
Awareness – The Key to Prevention and Detection
How Can Law Firms Avoid Fraud?
The 2012 Global Fraud Study offers the following recommendations to minimize risk of occupational fraud:7 • Provide a means for individuals to report suspicious activity, such as hotlines for employees and vendors. • Don’t rely on external audits for detecting fraud. They are usually ineffective, with a reported detection rate of only 3 percent.
An awareness of the common schemes perpetrated by fraudsters is key to prevention and detection. Accordingly, in this section, we have researched and summarized the most common schemes from the 2012 Global Fraud Study. Based thereon, for professional service firms, the top five fraud schemes based upon the 2012 Global Fraud Study, gauged by the number of reported cases, were:8 o Billing: Schemes where a payment is issued by submitting invoices for fictitious goods or services, inflated invoices or invoices for personal purchases.* o Check Tampering: Schemes where funds are intercepted by forging or altering a check drawn on an organization’s bank account.* o Expense Reimbursements: Schemes where there is a claim for reimbursement of fictitious or inflated business expenses.* o Skimming: Any scheme where cash is stolen before it is recorded on the organization’s books and records. o Bribery or conflicts of interest: Schemes where there is violation of a duty owed to another, in order to gain a direct or indirect financial benefit. * For these three fraud schemes, there should be internal supporting documents; however, for the two other schemes the supporting documents will usually be external to the organization. To counter the increased fraud risks for Nevada law firms, organizations should take proactive steps to incorporate the following as standard policies and procedures: o Conduct an internal control assessment, to identify incompatible functions and areas of high fraud risk without compensating or insufficient controls; o Rank risks by department and individual, based upon perceived capabilities, to further identify those areas of greatest risk; o Implement active oversight and monitoring of selected functions and areas by owners or managers;
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o Implement a hotline for reporting fraud, suspicious conduct or breaches of policies and procedures. Those familiar with the inner-workings of an organization, whether internal or external, are usually the first to recognize when something is amiss; • Conduct internal fraud awareness training seminars; and • Be aware of the standard red flags, as possible indications of fraudulent conduct. Stress and addiction can negatively impact a law practice if not kept in check through these internal control procedures. A Certified Fraud Examiner can help conduct a fraud check-up for any organization to identify red flags and potential opportunities for fraud.
6 2012 Global Fraud Study, Association of Certified Fraud Examiners, p. 57. 7 2012 Global Fraud Study, Association of Certified Fraud Examiners, p. 5. 8 2012 Global Fraud Study, Association of Certified Fraud Examiners, pp. 10, 12 & 30.
MIKE ROSTEN is a principal at Piercy Bowler Taylor & Kern CPAs and Business Advisors. He can be reached at mrosten@pbtk.com or (702) 384-1120.
1 2012 Global Fraud Study, Association of Certified Fraud Examiners, p. 28. 2 Problem Gambling and the Law, an information and resource guide, Nevada Council on Problem Gambling, p. 16. 3 National Gambling Impact Study Commission Report, Chapter 4 on Problem and Pathological Gambling, p. 4-4. 4 Cressey, Donald R., Other People’s Money (Montclair: Patterson Smith, 1973), p.30. 5 2012 Global Fraud Study, Association of Certified Fraud Examiners, p. 36.
JASON WILEY is a shareholder at Kolesar & Leatham. He can be reached at jwiley@klnevada.com or (702) 362-7800.
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