• author: The Finance Storyteller

Understanding the Fraud Triangle: Common Roots of Tax Evasion, Crime Novels, and Corporate Scandals

Welcome to the "Finance Storyteller" series! In today's video, we will explore the common roots of tax evasion, crime novels, and corporate scandals. There is a concept underlying all three of these that comes from the world of auditing and internal controls: the fraud triangle.

The Three Elements of the Fraud Triangle

The fraud triangle consists of three elements that often work together to facilitate fraudulent behavior:

  1. Incentive or pressure: The first element of the fraud triangle is the incentive or pressure to commit fraud. For example, if an individual has secret gambling debts, they might feel pressure to steal or cheat to cover their losses.

  2. Opportunity: The second element of the fraud triangle is opportunity. This refers to situations where there is a lack of controls or oversight, making it easier to commit fraud. For instance, if no one is counting the money in the safe, an individual might see an opportunity to steal some of it.

  3. Attitude or rationalization: The third element of the fraud triangle is attitude or rationalization. This refers to the individual's ability to justify their fraudulent behavior. They might tell themselves a story to convince themselves that it is okay to commit fraud, such as feeling that they are entitled to the money or are not being paid enough.

Unfortunately, humans are great at justifying their actions, and so this kind of self-delusion can be a significant problem.

Addressing the Fraud Triangle

After a major scandal like the Panama Papers, there is often a public outcry for more laws and regulations to prevent fraud. One way to decrease the opportunity for fraud is to implement better controls. The same thing happened after the Enron and Worldcom scandals, and the result was the implementation of the Sarbanes-Oxley Act.

However, it is important to take a balanced approach and avoid "control obesity," where regulations become so strict that it becomes impossible to run a company. Therefore, it is essential to work towards changing the pressure and incentives that might lead to fraud. One significant step forward would be to create more alignment in tax rates and regimes, which might decrease the incentive for tax evasion.

However, greed is a common human trait, and there will always be individuals who push legal boundaries with new tricks and schemes. Therefore, it would be best to work towards changing people's attitudes and rationalization towards fraud, as this would be a more fundamental and longer-term solution.

Changing Attitudes

One potential solution to reducing fraud is to implement a mandatory philosophy and ethics course for individuals in senior leadership positions. Such courses would focus on doing the right things and doing things right. Studying moral philosophy can help individuals understand how to make ethical choices and act appropriately in different circumstances.

Here are four significant philosophers to know:

  1. Aristotle: The Greek philosopher who inquired into a moral code of conduct for good living.
  2. Jeremy Bentham and John Stuart Mill: Philosophers who judged actions by their outcomes.
  3. Immanuel Kant: One of the most influential Enlightenment philosophers, who designed a moral framework based on principles.

Thank you for watching this video. If you enjoyed it, please subscribe to my YouTube channel for more videos coming soon!

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