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Corporate Fraud: Overview and Reasons

Oct 26, 2021 5:51 AM 6 min read

The opening bell is going to ring in five seconds and, to be honest with you, we wish it wouldn't.

These were the words said by a CNBC news presenter during the Stock Market Crash of 2008. He was in trepidation due to the avalanche fall of the stock prices during the crash. By March 6th 2009, the Dow Jones Industrial Average (DJIA) had dropped 54% to 6,469 compared to its peak of 14,164 on October 9th 2007, over a span of 17 months, before beginning to recover.

The crucial question is: Why did it happen?

The Genesis of the Great Recession

It is known to us that this was in response to the Housing Market Crash that happened due to people defaulting on their home loans. It caused the bursting of the bubble of over-inflated mortgage-backed securities' (MBS) value that led to the collapse of the Lehman Brothers and massive losses for financial institutions who had bet heavily on it. 

But there is more to the story. This colossal crash was orchestrated obliviously through a wide degree of fraud that was going on under the nose of regulatory authorities. Loans were sanctioned to people with poor credit scores to produce more MBS. These bad loans were kept under MBS that consisted of good loans. The credit agencies still gave high ratings to these securities.

The market took some time to realise the sham that was going on. But when it did, the aftermath was catastrophic for the entire world.

We can see the scale at which financial fraud affects both the affected institutions and us (as the general public or as shareholders). People lost their homes, life savings, and jobs because of the crash around the globe.

The case of the 2008 Financial Crash is one of the numerous examples of fraud that had a substantial impact on the lives of ordinary people.

Let's look at one more such instance of corporate fraud that caused devastating consequences for the company or shareholders, similar to the 2008 financial crash.

Barings Bank

Nick Leeson was a financial trader employed by Barings Bank to run its Singapore trading operations. Leeson earned enormous profits for the bank but he made unauthorized trades to do so. Eventually, his prowess took a toll, and he started making some losses. To hide those losses, Leeson used the bank's 'error accounts'. He was able to exploit it as he was responsible for both making and settling his trades. It was a mistake as it breached the principle of segregation of back-office and front-office duties, which is employed to prevent such abuses.

Leeson kept placing increasingly larger and riskier trades and his losses kept growing to the extent of hundreds of millions of pounds. Eventually, in anticipation of an earthquake in Japan, the market came crashing down like a meteor, and Leeson's losses grew to a gigantic size that was too large to hide. In 1995, Barings Bank discovered the losses to be greater than £800m (£1.36bn or $1.85bn in 2021) that exceeded the bank's available capital and, thus, caused the collapse of one of Britain's oldest banks.

Here, it is evident how a person can single-handedly cause the collapse of a large corporate body if the required anti-fraud measurements are not maintained.

But, why did Nick Leeson do what he did?

What Drives a Fraudster

Research by the Association of Certified Fraud Examiners (ACFE) shows that fraudsters are ordinary people who find themselves in circumstances that encourage them to commit fraud. Every large-scale fraud started on a small-scale wherein he/she couldn't find a way to diminish the fire they created.

(Interesting Fact: According to a statistical analysis conducted on data collected by ACFE, a fraudster is likely to be between 31 and 45, male, well-educated, and have been at the company for at least a year.)

To battle fraud, an organization must know how and why it occurs.

In the 1950s, Donald R. Cressey, a well-known criminologist, developed the Fraud Triangle. This model has three main components - motivation, opportunity, and rationalization.

The motivation of fraud can arise due to the desire for more money, to achieve the unrealistic target set by the company, save themselves from any unforeseen mistake, or in recession to save the company and its employees who have become more like family.

On top of motivation, a fraudster might find themselves at the forefront of an opportunity that can entice them to commit the fraud. It is simply a weakness in the system that a fraudster could exploit. It could be too much autonomous power in an individual's hand due to his rapport in the company or lack of definite division of duties within the organization.

The third side of the triangle is rationalization. Although motivation and opportunity present themselves to the fraudster regularly, it doesn't lead to fraud. For fraud to occur, the fraudster needs to believe that they have a justifiable reason for committing the fraud. It could be that he's only borrowing some money and will pay it back later or a conviction that no one is getting harmed.

To tackle these obstacles, the organizations tend to create hard bordered rules which in most cases of fraud isn't much of help. It can be due to subconscious thought that "rules are made to be broken". Instead, they should focus on creating a consistent set of values that are shared among individuals who consider themselves to be part of the success.

A strong and consistent message that keeps everyone from the organization at the center, rather than away from it, is important. This way an employee can resonate with the message which will likely keep him at the bay of going rogue.

For Nick Leeson, the motivation was to hide his losses, the opportunity was that he had access to both the front door and back door workings, and the rationalization was that he would recover the losses and will put everything back on track.

The next question that arises is how can an organization detect an ongoing fraud?


Detection of Fraud

Every large-scale fraud starts with some microscale steps. For example, Nick Leeson claimed that he stepped into the world of crime when he tried to cover for a junior colleague who had lost £20,000. It is essential to detect fraud when it's at an early stage. The period between the initiation of fraud and its eventual discovery is known as the 'exposure gap'. In this epoch, an organization is consistently incurring losses.

For an organization, whistleblowers are at the forefront of the detection mechanism. An organization should aim to strengthen its whistleblowing hotline. Also, the management should know how to sensitively and fairly deal with the whistleblowers. Most of the time, they would be fearful and nervous to come forward. Therefore, an organization must encourage them and should assure them that their identities will remain concealed.

(Interesting Fact: Three times as many frauds are discovered by tip-off than any other method)

Another method to detect fraud is Surprise Internal Audits. During a regular internal audit, the manager is notified and the focus is rather on the compliance of procedures than on catching wrongdoings. But, surprise internal audits are focused on intercepting activities that are not part of a manager's legitimate activities.

Forensic Data Analysis is another effective way of detecting fraud. Due to emerging technologies, it is now easier to analyze humongous amounts of raw data to detect irregularities in them. Due to these technologies, many organizations are nowadays moving to real-time data analysis instead of end-of-day analysis that results in early fraud detection, additionally, it gives a competitive edge to the organization. 



After a fraud runs its course, the recovery of salvageable assets through various legal means is bound to happen. A fraud opens up many loopholes in the system which is then amended. The stock market fraud of Harshad Mehta resulted in the construction of the National Stock Exchange (NSE). Payments were recorded for purchasing investments in reconciled Bank Receipts and Subsidiary General Ledgers to prevent fraudulent transactions.

While technological innovations bring forward advanced ways to detect fraud, it also equips fraudsters with sophisticated methods to perpetrate fraud seamlessly. So, to hinder a fraudster's efforts, we also must be the eyes of justice and bring forward any illegitimate activity that is or might be taking place.

Let's end with quote by Nassim Nicholas Taleb, an essayist, mathematical statistician, former options trader, risk analyst, and aphorist:

If you see fraud and do not say fraud, you are a fraud.


Written by Harsh Prakash


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