Fraud deterrence has gained public recognition and spotlight since the 2002 inception of the Sarbanes-Oxley Act

Sarbanes-Oxley Act

The Sarbanes–Oxley Act of 2002 , also known as the 'Public Company Accounting Reform and Investor Protection Act' and 'Corporate and Auditing Accountability and Responsibility Act' and commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, which...

. Of the many reforms enacted through Sarbanes-Oxley, one major goal was to regain public confidence in the reliability of financial markets in the wake of corporate scandals such as Enron

Enron

Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed approximately 22,000 staff and was one of the world's leading electricity, natural gas, communications, and pulp and paper companies, with...

, WorldCom and Waste Management

Waste Management, Inc

Waste Management, Inc. is a waste management, comprehensive waste, and environmental services company in North America. Founded in 1894, the company is headquartered in Suite 4000 at the First City Tower in Downtown Houston, Texas, in the United States....

. Section 404 of Sarbanes Oxley mandated that public companies have an independent Audit

Audit

The general definition of an audit is an evaluation of a person, organization, system, process, enterprise, project or product. The term most commonly refers to audits in accounting, but similar concepts also exist in project management, quality management, and energy conservation.- Accounting...

 of internal control

Internal control

In accounting and auditing, internal control is defined as a process effected by an organization's structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives. It is a means by which an organization's...

s over financial reporting. In essence, the intent of the U.S. Congress in passing the Sarbanes Oxley Act was attempting to proactively deter financial misrepresentation (Fraud

Fraud

In criminal law, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation...

) in order to ensure more accurate financial reporting to increase investor confidence. This same concept is applied in the discussion of fraud deterrence.

Until recently, fraud deterrence has not been specifically identified under one common definition. While it has been discussed by many authoritative sources such as the American Institute of Certified Public Accountants (AICPA)

American Institute of Certified Public Accountants

Founded in 1887, the American Institute of Certified Public Accountants is the national professional organization of Certified Public Accountants in the United States, with more than 370,000 CPA members in 128 countries in business and industry, public practice, government, education, student...

 Practice Aid Series, “Fraud Detection in a GAAS Audit: SAS No. 99 Implementation Guide,” (explicitly) The Committee of Sponsoring Organizations of the Treadway Commission (COSO)

Committee of Sponsoring Organizations of the Treadway Commission

The Committee of Sponsoring Organizations of the Treadway Commission is a voluntary private-sector organization, established in the United States, dedicated to providing guidance to executive management and governance entities on critical aspects of organizational governance, business ethics,...

, “Internal Control – Integrated Framework,” (implicitly) and the National Association of Certified Valuation Analysts Certified Fraud Deterrence Analyst (CFD) designation (recently merged into the Certified Forensic Financial Analyst (CFFA) designation), an actual definition of the term “fraud deterrence” has been difficult to find.

Definition

“Fraud deterrence is the proactive identification and removal of the causal and enabling factors of fraud.

Fraud deterrence is based on the premise that fraud is not a random occurrence; fraud occurs where the conditions are right for it to occur. Fraud deterrence attacks the root causes and enablers of fraud; this analysis could reveal potential fraud opportunities in the process, but is performed on the premise that improving organizational procedures to reduce or eliminate the causal factors of fraud is the single best defense against fraud. Fraud deterrence involves both short term (procedural) and long term (cultural) initiatives.

Fraud deterrence is not earlier fraud detection, and this is often a confusing point. Fraud detection involves a review of historical transactions to identify indicators of a non-conforming transaction. Deterrence involves an analysis of the conditions and procedures that affect fraud enablers, in essence, looking at what could happen in the future given the process definitions in place, and the people operating that process. Deterrence is a preventive measure – reducing input factors” (Cendrowski, Martin, Petro, The Handbook of Fraud Deterrence).

Analogy

Deterrence is distinct from remediation and detection. An analogy can be drawn in considering unhealthy weight gain and the actions undertaken in response. Identifying the action(s) that deter unhealthy weight gain is the key to understanding fraud deterrence in this analogy.

• Working Out = Remediation
  • A person has already gained weight
  • Lessen the amount of weight gain by working out immediately after noticed gain
  • The longer the weight gain goes unnoticed, the more overweight they will become

• Scale = Early Detection
  • Scale is used to detect weight gain, before it is visibly noticeable
  • Detects nothing unless weight is increasing
  • When the scale reads a higher number, the weight has already been gained

• Removal of Causal Factors = Deterrence
  • Removal of unhealthy food in diet
  • Removal of habits that perpetuate obesity (e.g. inactivity)
  • Increasing awareness of obesity risks (e.g. health classes in primary education)

Fraud Triangle

The causal factors that should be removed to deter fraud (as described above) are best described in the “Fraud Triangle.” This idea was first coined by Donald R. Cressey. The Fraud Triangle describes three factors that are present in every situation of fraud:

1. Motive (or pressure) – the need for committing fraud (need for money, etc.);
2. Rationalization – the mindset of the fraudster that justifies them to commit fraud; and
3. Opportunity – the situation that enables fraud to occur (often when internal controls are weak or nonexistent).

Breaking the Fraud Triangle

Breaking the Fraud Triangle is the key to fraud deterrence. Breaking the Fraud Triangle implies that an organization must remove one of the elements in the fraud triangle in order to reduce the likelihood of fraudulent activities. “Of the three elements, removal of Opportunity is most directly affected by the system of internal controls and generally provides the most actionable route to deterrence of fraud” (Cendrowski, Martin, Petro, The Handbook of Fraud Deterrence).