in order for occupational fraud to occur , three conditions must be met : Pressure , Opportunity and Rationalization .
Elements of the Fraud Triangle
Pressure Justification : The pressure or incentive to commit the crime is the first leg of the Fraud Triangle . Financial issues like debt or the inability to settle household expenses could be plaguing the person . Non-financial incentives can also serve as driving forces behind fraud . At work , there could be pressure to meet targets or a desire to act dishonestly to hide subpar performance .
Opportunity : The second leg of the fraud triangle is the opportunity , also called perceived opportunity . At this point , a person identifies ways to commit fraud with the lowest amount of risk . Windows of opportunity exist for wrong doing when organisations have poor or inadequate internal controls , weak processes and procedures or a lack of physical safeguards that allow fraud to be committed and concealed .
Rationalization : Fraudsters must then convince themselves that their actions are morally justified after determining what drives them and provides them with opportunities to commit fraud . Recall that the majority of first-time offenders consider themselves to be ordinary people in unfortunate circumstances rather than criminals . Compensating for feeling undervalued or underpaid at work is a common example . Additionally , they may persuade themselves that the victim is unaware and will not miss the stolen property , or that they are simply borrowing money from them and will repay it . " It is what I deserve ," " other people are doing it ," and " it does not hurt the organization " are a few examples of mindsets that justify fraud .
The Enron Scandal Viewed In The Lens Of The Fraud Triangle Theory
Background : Founded in 1985 , Enron was a fast-growing energy company that diversified into a number of industries , including communications , electricity , and natural gas . In the 1990s , Enron rose to become the seventh-largest company on the Fortune 500 list and sixth-largest energy company globally . However as more and more people decided that Enron was a wise investment , nobody anticipated that the company would file for bankruptcy . The company ' s stock plummeted from USD 90 per share to just USD 0.02 by November 2001 .
Financial Manipulation : The majority of the offenses , including lying to investors and analysts about Enron ' s true financial status , were committed by the company ' s founder Ken Lay and CEO Jeff Skilling . Though they knew that Enron was not doing well , they utilized special-purpose entities ( SPEs ), off-balance-sheet partnerships , to conceal debt and inflate Enron ' s profits . They also allowed external auditors to perform some internal auditor work , which resulted in Enron ' s lax internal control .
Mark-to-Market Accounting : Through the use of mark-to-market accounting , Enron was able to identify the projected profits from certain deals up front rather than over time . This technique was used to conceal losses and inflate profits .
Stock Price and Employee Impact : When the company ' s stock fell drastically , investors including Enron employees who had made large stock investments suffered significant financial losses .
Whistleblower and Investigations : Sherron Watkins , an Enron executive , exposed the fraud by voicing concerns about the company ' s accounting practices . This prompted the US Securities and Exchange Commission ( SEC ) and other authorities to launch investigations .
Bankruptcy and Consequences : Enron filed for bankruptcy in December 2001 , making it one of the biggest bankruptcies in American history at the time . Thousands of jobs were lost as a result of this massive fraud scandal , and employee pension plan losses exceeded USD 2 billion . Concurrently , the scandal caused Arthur Andersen , which was among the top five audit and accounting firms globally at the time , to dissolve .
Legal Proceedings : Criminal charges were brought against a number of Enron executives , including Chairman Kenneth Lay and CEO Jeffrey Skilling . Skilling and Lay were convicted in 2006 of a number of offenses , including conspiracy and securities fraud . However , Lay died before he was sentenced . Afterwards , the appeals process partially overturned Skilling ' s convictions .
Impact on Corporate Governance : Accounting practices came under more scrutiny after the Enron scandal . The scandal also had a significant impact on corporate governance . In an effort to improve corporate accountability and transparency , this state of affairs led to the enactment of the Sarbanes-Oxley Act in 2002 , a federal law that established sweeping auditing and financial regulations for public companies .
Examining the Enron Fraud using the Fraud Triangle
Pressure ( motivation ): The primary driving force behind Enron ' s fraudulent behavior was financial . The business was under tremendous pressure to fulfill financial projections , especially with regard to sustaining growth in the stock price . Executives were incentivized to participate in fraudulent accounting methods in order to present a fictitious picture of financial stability and profitability . The need to preserve employee and investor confidence , safeguard executive compensation linked to stock performance , and prevent the fallout from falling short of market expectations all contributed to this pressure .
Opportunity : The complex corporate structure and financial transactions of Enron offered numerous opportunities for fraudulent actions . Due to a lack of transparency brought about by the use of Special Purpose Entities ( SPEs ) and offbalance-sheet transactions , executives were able to manipulate financial statements without being discovered immediately . It was difficult for outside parties , such as auditors and regulators , to completely understand the scope of Enron ' s fraudulent activities due to the complexity of the company ' s financial arrangements and operations .
Rationalization : People rationalize when they persuade themselves that their dishonest behavior is acceptable or justified . There were various ways that Enron rationalized itself . It ' s possible that executives thought using special entities and accounting loopholes was essential to the company ' s survival and to safeguard the interests of shareholders and workers . Some might have justified their behavior by persuading themselves that they were only reacting to demands from the market and preserving the competitive advantage of the company .