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Informing the Fraud Triangle: Insights from Differential Association Theory
Mark Lokanan Ph.D
Keywords: Fraud triangle; Differential Association Theory; Accounting; Sub-culture
Abstract : The fraud triangle (FT) has been criticized by scholars and practitioners for not being thorough enough to include every occurrence of fraud. However, not every case of fraud can follow the FT and the problem might have been one of interpretation. The purpose of this paper is to lend support to the fraud triangle (FT) by expanding on the understanding of differential
association theory (DAT). Sutherland’s work on DAT is a major source to inform our understanding of the FT. The return to his work is intended as a clarification of what Sutherland actually says with respect to the FT and a critical assessment of how far his work can be regarded as being authoritative. To accomplish this task, the paper provides anecdotal evidence from three high-profile accounting fraud cases – Livent, WorldCom, and Enron. The findings reveal that the concepts and propositions of DAT do have the potential to expand our understanding of the FT concepts. DAT seeks to explain the content and process of corporate accounting fraud via sub- culture and specific techniques in which criminal behaviour is learned. Practically, the paper contributes to a wider body of literature that expounds on the value to further develop fraud theories to inform fraud detection and prevention.
Introduction
During the last two decades, the world was shocked by a series of high profile accounting frauds that sent the accounting profession into turmoil (Clikeman, 2009; Lokanan, 2015). These frauds not only ripped through the very fabric of corporate America, but also tarnished the image of the accounting profession (Agrawal and Cooper, 2017; O’Connell, 2004, Soltani, 2014). To make sense of it all, some academic commentators have tried to explain the etiology of the frauds through normative theoretical constructs that posit the practice as common place within the industry (see Gray, Frieder, Clark, 2005: 5; Ball, 2009: 278; Lee, 2011: 757-759). Others argued that the frauds were an aberration from the norm and that they represented acts of dishonesty, rather than systematic failure (Demski 2002; Power 2013; Davis and Peasch, 2013; Lokanan, 2015; Sikka, 2015 ). Concerned about the erosion of ethical standards within the accounting profession, both the American Institute of Certified Public Accountants (AICPA) and the Association for Certified Fraud Examiners (ACFE) turned to Cressey’s (1953) work on the fraud triangle (“FT”) for potential explanations of the frauds (O’Connell, 2004; Donegan and Ganon, 2008 ; Huber, 2017; Lokanan, 2015). Cressey (1953) first introduced the FT’s decomposition in his book Other People’s Money. Cressey’s FT consists of three elements: perceived pressure, perceived opportunity, and rationalization, all of which must be present in order for a crime to be committed (Cressey, 1953: 30). Support for the FT comes from audit professionals and standard setters, who argue that investigators who analyze financial statements will be able to quantify the incentive (as in inflated revenue or overstated net income) that led to the fraud; assess the opportunity to commit the fraud with reference to weak or the absence of adequate internal controls; and, the
sociopathic fraudster^1 who feels entitled (Dorminey et al., 2010: 20). All a sociopath or predator seeks is opportunity; he or she does not need pressure or rationalization to commit the fraud (pp. 20 - 21). Perhaps the issue is not with the FT itself, but how it was synthesized, interpreted and applied.
In recent U.S. court cases^2 , the interpretation of the FT was put to the test. In Haupt v. Heaps , the developer claimed that the CEO of the company that hired him fraudulently bought his stock back at an artificially lower price because the company was represented as being in danger of collapsing. The developer lost at trial and appealed the case. In the appeal, the developer reasoned that the trial court erred by excluding his expert testimony on the FT that the conduct of the defendant was consistent with the three elements of the FT. The appeals court agreed with the trial court that: “Research into the case law by counsel for the parties and the [c]ourt has failed to locate even a single case in which the fraud triangles theory has been adopted as a reliable scientific method in any court of law” ( Haupt v. Heaps , 2005, para. 31). The evidence provided by the expert on the FT was rejected because the court felt that it was more prejudicial than probative (Gill, 2017).
In Travis v. State Farm Fire & Cas, Jennifer Davis-Travis and Jon-Michael Travis (collectively the Travises) sued State Farm because it denied their claim for losses sustained in a fire. In its defense, State Farm claimed that the Travises commit fraud by concealing and misrepresented important facts in their claim. State Farm through the testimony of an expert characterize the Travises as individuals with significant incentive and pressure to commit fraud, and that they possess attitudes and characteristics that allow them to rationalize the fraud (Gill, 2017). The trial judge in a brilliant analysis excluded the expert testimony on the grounds that the FT as a scientific theory is still untested and does not have a known rate of error or objective control associated with its application. The judge further notes that the application of the FT is mostly base on professional judgment rather than hard science.
(^1) See Snakes in Suits: When Psychopaths Go to Work for an excellent account on the presence of people with psychopathic traits in the workplace. The authors claim that about three to four percent of people in senior position have psychopathic traits. 2 See Haupt v. Heaps , 131 P.3d 252 (2005); Travis v. State Farm Fire & Cas. Co. , 2005 U.S. Dist. LEXIS 49957; Kremsky v. Kremsky , 2017 U.S. Dist. LEXIS 22794.
In a more recent case, Kremsky v. Kremsky , the issue of allowing expert testimony to employ the FT to speculate on an individual’s mental state was put to the test. In Kremsky, an uncle sued his nephew for breach of fiduciary duty and fraud against the said uncle. The uncle sought the testimony of a financial expert who testified that the nephew exhibit traits that satisfy the elements of the FT and had the motive to commit fraud (Gill, 2017). The court rightfully dismissed the testimony citing that the expert testimony is base on subjective belief, which amount to speculation about the frail morality of the nephew. The judge further noted that no case was cited where an expert touting the FT has been permitted to speculate on an individual’s motive to commit fraud.
In these cases, testimonies that relied on the FT was deemed “unreliable” (Gill, 2017, para. 26). The issue lies with expert witnesses referring to the FT as a “theory” rather than a framework to guide their practice. As such, the testimonies were seen as more prejudicial than probative (para. 36). By referring to the FT as a scientific theory, the analysis presented in these court cases were flawed because it shows that the knowledge obtained from Cressey’s (1953) work was misinterpreted with respect to the very basic of the FT. It is these contentions that jeopardise the AICPA’s efforts (as set out in standard, SAS No. 99) to focus the identification of fraud-risk factors on the components of the FT that work against the successful detection of fraud (see AICPA, 2002, Para. 7).
The purpose of this essay is to lend support to the FT by expanding on the understanding of differential association theory (DAT). Sutherland’s works (1937, 1939, and 1947) on DAT are major sources to inform our understanding of the FT. The return to his work is intended as a clarification of what Sutherland actually meant with respect to the FT and a critical assessment on how far his work can be regarded as being authoritative. Cressey, who as mentioned earlier is attributed with setting the foundation of the FT, was a protégé of Sutherland (the architect of DAT) (Albrecht, 2014; Gill, 2017). As such, DAT and the FT do not sit at opposite ends of a continuum. It may be that when the FT was synthesized, it failed to capture the key postulates of DAT, which was instrumental in forming the three legs of the FT. Whilst not explicit, the FT is embedded in DAT and is therefore not an entirely distinct concept, particularly the link between neutralization and corporate culture e.g. “my boss told me to do it” (Albrecht, 2014).
AICPA, 2002: Para. 5; Farber, 2005: 542). Corporate accounting fraud includes intentional financial misrepresentations (e.g., overstating revenue and understating expenses) and misappropriations of assets (e.g., theft of inventory) (AICPA, 2002). It does not automatically follow that corporate accounting frauds are committed by members of the accounting profession. There is little doubt that professional accountants^3 may have contributed in varying degree in some of these frauds (or not desisted from participating), but the frauds were usually orchestrated by someone other than the accountant - typically the CEO and equivalent individuals.^4
The remainder of this paper is structured according to the following format. I begin with a brief description of three high profile corporate accounting fraud cases – Livent, Enron, and WorldCom to articulate the concepts of DAT and the FT. Next, I briefly outline the principles of DAT, by focusing on the main ideas and postulates attributed to the theory. I then present a literature review of occupational fraud, to better articulate the relationship between the FT and DAT. The literature review is then followed by an analysis of the conceptual critiques of DAT. Next, I present and discuss some anecdotal evidence from Livent, Enron, and WorldCom to explore DAT and inform our understanding of the FT. In order to explain how learning fraudulent behaviour takes place in the course of the individual’s occupation, particular emphasis is given to the power of managerial influence and learning techniques encountered in the workplace. I then summarize the conclusion that highlights areas for future research.
The Origins of DAT and Corresponding Literature
(^3) Professional accountants are individuals who have been certified by a professional accounting body such as the United States’ (U.S.) Certified Public Accountants (“CPA”) and Canada’s Chartered Professional Accountant (“CPA”), and are held accountable by these bodies for their conduct. 4 While distinguishing between corporate accounting frauds and audit failure is a complex explanatory phenomenon, the two of them should not be confused. Audit failure is when an auditor fails in his or her audit responsibility to detect an irregularity that should have been detected, for which the auditor and or company have paid the ultimate price.
In his seminal work, Sutherland’s (1937) White Collar Crime advanced a general theory of differential association to explain the offending patterns of corporations and other white-collar offenders. Differential association is a learning theory of crime and can be used to explain the motivational factors that lead white-collar workers to a life of crime and deviance. The theory has two main postulates: the process by which criminal behavior is learned, and the content that the individual learned from the process (Sutherland, 1947). Developed in the 1930s, differential association is a theory that purports to show criminal behavior as a learned construct. Sutherland (1937) argues that criminal behavior is learned via interaction and association with deviant groups. An individual becomes delinquent because s/he associates with other delinquents and learns how to commit crimes. “If a person associates with more groups that define criminal behavior [as] more acceptable than groups that define criminal behavior as unacceptable, the person will probably engage in criminal behavior” (Popple and Leighninger, 1996: 331). Central to Sutherland’s claim is that criminal behavior is learned “because of an excess of definitions favorable to violation of law over definitions unfavorable to violation of law” (Sutherland and Cressey, 1980: 75). When viewed in this manner, “deviance, like conforming behavior, is seen as a product of [the] socialization” process (Calhoun, Light, and Keller, 1989: 176).
In his book The Professional Thief (1937), Sutherland defined the process where white-collar crime is learned through differential association among group members. According to Sutherland, a person can become a professional thief only if he is trained by those who are already professionals. It is ridiculous to imagine an amateur deciding to become a pickpocket, con man, penny-weighter (jewelry thief), or shake man (extortioner) without professional guidance. He knows nothing of the racket, its techniques or operations, and he can[not] learn these things out of books” (1937: 21).
Sutherland reinforced this process in his 1939 preliminary version of differential association, and argued that criminal behavior is learned through social interaction and association with peer groups (Sutherland, 1939). The final version of DAT was presented by Sutherland in the form of nine postulates found in the 4th^ edition of his textbook Principles of Criminology (Sutherland,
Central to Cressey’s (1953) hypothesis, is the non-shareable problem that has a financial need associated with it. What constitutes a non-shareable financial need is wholly in the eyes of the occupational offender (p. 35). An individual may lose money in a betting shop and s/he might not see the loss as a non-shareable financial problem. Another individual who experiences the same amount of loss might define the problem as one which must be kept secret, i.e., non- shareable. Likewise a corporation may be experiencing financial stress, which must be shared with its shareholders and creditors, while another corporation experiencing similar financial stress may construe these problems as non-shareable (p. 35). The non-sharable problem is driven by a financial need that can be solved by theft of cash or other assets.
The presence of a non-sharable problem alone will not lead to fraud. The non-sharable financial need creates the motive for the crime to occur, but the employee needs to weigh out the opportunity for committing the crime without being detected by authorities. Cressey (1953) noted that there are two general opportunities to commit a crime: general information and technical skills. General information is where the employee has access to information that allows him or her to commit fraud. For example, a banking official might be privy to access codes and passwords to the bank’s internal controls. Technical skills are the individual’s ability to commit the act. For example, a banker may have the knowledge to use dormant accounts to his or her advantage or to withhold deposits. Individuals who have a non-shareable financial problem and are equipped with the general information and technical skills to correct the problem, will apply them and engage in criminal behaviour.
Cressey (1953) then went on to describe the rationalization component that is significant for a violation to occur. Rationalization, Cressey (1953) noted, is where the individual justifies the crime to make it more acceptable. It is argued that rationalization of the crime occurs long before the fraudster commits the act. Rationalization is part of the motivation for the crime. The fraudster usually rationalizes the crime by seeing it as non-criminal; justifying the act to make it seem more acceptable; and, as part of a general responsibility for which he or she is not accountable. These rationalization techniques are necessary for the individual to internalize and maintain the concept as a trusted person.
Other pioneers in researching occupational fraud are Albrecht, Howe, and Romney (1984). Albrecht and his colleagues believe that fraud is difficult to predict because of the absence of a reliable profile of the occupational fraudster (also see Dorminey et al., 2010: 19). To address this problem, they came up with the fraud scale. They proposed that the likelihood of fraud occurring can be assessed by using a fraud scale that encompasses the pressure, opportunity, and the individual’s personality integrity (Albrecht et al., 1984: 5). In many ways, Albrecht et al., (1984) model was similar to Cressey’s (1953) FT, in that they both came up with two elements that are common in fraud causation: opportunity and pressure. As noted earlier, pressure and opportunity are components of the FT, but Albrecht and company substituted rationalization for personality integrity as the third component of the fraud scale (Albrecht et al., 1984: 5-6). Albrecht and his colleagues’ fraud scale is more applicable to financial statement fraud, where the pressure (falling profits) and the opportunity (weak internal controls) to commit the fraud are more observable (Dorminey et al., 2010: 19-20). When pressure and opportunity are high and personality integrity is low, occupational fraud is much more likely to occur (Albrecht et al., 1984: 6).
Less synonymous with the other studies cited so far is Hollinger and Clark’s (1983) work on employee theft. Unlike Cressey (1953) and Albrecht et al., (1984) studies, Hollinger and Clark concluded that “employees steal primarily as a result of workplace conditions, and that the true cost of the problem is vastly understated” (Hollinger and Clark, 1983: 6). Hollinger and Clark did mention however, that there are five separated, but interrelated hypothesis that are significant in understanding occupational fraud. The first is external economic pressure, such as the non- sharable financial pressure described by Cressey (1953). The second hypothesis is that contemporary employees, especially the younger ones, are not as hard working as past generations. The third hypothesis is that every employee can be tempted to steal from their employer. This premise follows a Hobbesian reasoning and posits that people by their very nature, are greedy and dishonest. The fourth hypothesis is that most employees steal from their employers because of job dissatisfaction. The fifth hypothesis is that theft occurs because of the broadly shared formal and informal structure of the organization. Central to this hypothesis is that group norms, whether good or bad, become standard conduct within the organization.
influence fraud occurrence, detection and prevention. Rezaee’s (2002; 2005) works strengthened the pressure and opportunity legs of the FT and show how their interaction with other factors may increase the likelihood of fraud.
Wolfe and Hermanson (2004) introduced a fourth component, “capability”, to the FT and in so doing, transformed it to a “Fraud Diamond”. The Fraud Diamond extends the FT to incorporate the individual’s capability, i.e., the role that personality and behavioural traits play, given the presence of pressure, opportunity, and rationalization in fraud. According to Wolfe and Hermanson, opportunity opens the doorway to fraud, and incentive [i.e. pressure] and rationalization can draw a person toward it. But the person must have the capability to recognize the open doorway as an opportunity and to take advantage of it by walking through, not just once, but time and time again (2004: para. 6).
Accordingly, the critical question is, “Who could turn an opportunity for fraud into reality?” Wolfe and Hermanson (2004) suggests that there are four observable traits that must be considered for committing fraud: (1) The person’s position or function within the organization; (2) the person capacity to understand and exploit internal control weaknesses; (3) the confidence (ego) that s/he will not be detected, and if detected, s/he will talk her/himself out of it; (4) capability to deal with the stress committed within an otherwise decent and trustworthy person when s/he commits bad acts; and (5) the capability to lie effectively and consistently (Wolfe and Hermanson, 2004: para. 10-14). Wolfe and Hermanson’s (2004) fraud diamond gives consideration to the fraudster’s capacity to evaluate how the internal control system lends itself to manipulation to perpetuate the fraud. In this context, the fraud diamond modified the opportunity leg of the FT by limiting it to individuals who have the necessary capabilities to commit the fraud.
Choo and Tan (2007) explain corporate executive fraud by relating the FT to Albrecht el al. (2004) “Broken Trust” theory (“BTT”). Choo and Tan (2007) illustrated how Albrecht et al. (2004) combined the FT’s concepts, agency and stewardship theories to develop the BTT to explain corporate executive fraud (Choo and Tan, 2007: 206). Choo and Tan (2007) then drew from sociologists Messner and Rosenfeld’s (1994) work to describe the American Dream Theory
(“ADT”) of crime. Choo and Tan (2007) used the ADT to complement the FT and Albrecht el al. (2004) BTT. Their rationale was to address two significant limitations in the BTT: first, was that agency and stewardship theories mostly analysed executive behaviour in stable environments, but not in companies involved in fraud. As such, agency and stewardship theories’ assumptions that they can address fraudulent behaviour in both fraud and non-fraud companies was weak, because there is little evidence to support the theories’ assessment of executive behaviours from companies involved in fraud. Second, and perhaps a much more serious limitation was that the BTT related well to the Pressure and Opportunity legs of the FT, but not the Rationalization leg. To address these limitation and better understand corporate executive fraud, Choo and Tan related the three key features of the ADT (intense emphasis on monetary success, corporate executives exploit/disregard for regulatory controls, and corporate executives justify/rationalize fraudulent behaviour) with the three variables of the FT’s concept (Pressure, Opportunity, and Rationalization)” (Choo and Tan, 2007: 2009).
More recently, Ramamoorti, Morrison, and Koletar (2009) proposed a useful conceptual approach call the A-B-C Model to analyse fraud. Ramamoorti et al. (2009) hypothesized that fraud occurs either because of an individual criminal’s calculated/intentional betrayal of trust, a duo or team of “bad boys” who push ethical envelopes, and/or an organizational/social/national culture of passivity, indifference or accommodation that is tantamount to condoning such behaviours (p. 2). Ramamoorti and his colleagues referred to their model as the bad A pple, bad B ushel, or bad C rop Syndrome: the so-called ABCs of white collar crime. The bad apple is the individual, the bad bushel addresses group influence in fraud, and the bad crop refers to the generational/cultural/societal antecedents that influence the fraud (p.7). While we have seen our fair share of bad apples and bad bushel in some of the more recent accounting scandals, it is the bad crop metaphor that perhaps has more of an impact on fraud theory. The bad crop component suggests that for white-collar crime to occur there must be some moral deficiency at the top of the organization, a problem that is also pervasive throughout the organization and society in general (Dorminey et al., 2012: 559).
Another model to capture the motivation (pressure) of the fraudster was suggested in the acronym M.I.C.E (Krancher, Riley, and Wells, 2010: 205). “MICE” which represents M oney,
explain the causes of fraud, the FT as adopted by both the AICPA and ACFE, cannot be seen as the only valid model to explain all occurrences of fraud.
Having reviewed these studies, what does it tells us about occupational fraud? Well, in many ways, it seems as if Cressey (1953) was on to something with his FT’s concept. More often than not, we come back to the three elements of the FT, with very few exceptions. Albrecht et al., (1984) and Hollinger and Clark (1983) have extended our knowledge of the detection of occupational fraud; but, fundamentally, we are back to where Cressey (1953) left us many years ago. Recall that with Cressey’s (1953) FT, employees are motivated to commit occupational fraud because they face a non-shareable financial problem, which if known, will threaten their status (Albrecht, 2014). It then follows that the perpetrator engages in illegal conduct only if s/he perceives that there is an opportunity to fix the non-shareable financial problem that can be rationalized without getting caught.
An Analysis of the Conceptual Critique of DAT Cultural Deviance Critique
Many of the criticisms that are leveled against DAT come from control theorists (Hirschi, 1969; Kornhauser, 1978; Gottfredson and Hirshi, 1990). These criticisms take two forms: the cultural deviance critique; and the motivation of criminal behaviour. Control theorists’ critiques against cultural deviance theories are now widely known amongst criminologists as the cultural deviance critiques. Central to the cultural deviance critique of DAT is that “man has no nature, socialization is perfectly successful, and cultural variability is unlimited” (Kornhauser, 1978: 34). Control theorists’ critique of the quintessential representation of cultural deviance theories (i.e., DAT) surrounds the “logical adequacy” of their underlying assumptions (Costello, 1997). From this viewpoint, cultural deviance theories (namely DAT) “are problematic in a logical sense because one can derive from them a set of incoherent assumptions that leave nothing left to explain” (Kalkhoff, 2002: para. 7). The central premise of these assumptions are that DAT cannot explain individual differences; it is doomed to apply only to group differences in crime that rest on the adherence of a criminal or deviant subculture (Akers, 2009: 91).
Control theorists have been harshly criticized for their caricature of DAT (Matsueda 1988; Bernard and Snipes 1996; Akers, 2009). Control theorists’ adversaries argue that the cultural deviance critique of DAT can be seen as a “gross misrepresentation” with “misconceptions and oversimplifications” (Matsueda 1988: 293: Akers, 2009: 91). DAT is explicitly designed to account for individual variations in crime, not just group differences (Akers, 2009: 91). As can be seen in Table 1-1, Sutherland’s propositions clearly make the distinction between individual behaviour and differential social organizations as a theory of group differences (see Sutherland, 1947: 6). DAT “posit[s] individual deviance as coming from the person’s holding definitions favourable to norm-violating acts that are shaped by relatively greater exposure to deviance than to conventional normative definition” (Akers, 2009: 93). Therefore, the extreme case in which an individual’s deviance is based entirely on his or her having been socialized solely in, and having completely internalized the dictates of, a deviant subculture without contact with conventional society is consistent with differential association theory (p. 93).
But DAT does not propose that everyone socialized within the same subculture will conform to the norm, nor does it propose that there is no possibility that individuals will violate group norms (p. 93). It is not the amount of exposure to deviant groups that matters, but the ratio of association with deviant groups that provides the key to understanding Sutherland’s explanation of criminogenic behaviour (Gill, 2017). Therefore, the defining characteristics attributed to DAT from control theorists only apply if one limits their scope to the most extreme cases (p. 93).
Motivation for Criminal Behaviour
The cultural deviance critique depicts the differential association process in criminal behaviour as one in which the internalization of definition favourable to crime (1) requires the individual to behave in violation of conventional norms, and (2) provides the motivation for criminal behaviour (Akers, 2009: 96; also see Coleman, 1987: 15). Hirschi the chief architect behind this position notes that “[t]heories in the cultural deviance tradition suggest that in committing his acts the delinquent is living up to the norms of his culture. These theories usually suggest the
When looked at in this context, DAT runs counter to the cultural deviance critique that the exposure to definitions favourable to crime will motivate individuals to commit crime. Rather, it reiterates the central principle of DAT which states that, “when persons become criminal, they do so because of contacts with criminal patterns and also because of isolation from anti-criminal patterns” (Sutherland, 1947: 76).
The on-going debate between proponents of these two branches reveals some useful insights surrounding the FT concepts. As mentioned earlier, the FT has been criticised for being an inaccurate descriptor of the motivations of fraud (Gill, 2017; Lokanan, 2015; Morales et al., 2014); its inability to address collusive behaviour (Dorminey et al., 2010); and the observability of rationalization elements of fraud (Murphy, 2012). However, as is evident from the forgoing literature review and the conceptual critiques, DAT informs our knowledge on the decision- making process that the fraudster used when determining the pressure, opportunity, and internalization of the rationalization elements to commit fraud. In so doing, DAT provides useful insights that aid our understanding of the FT concepts.
Methodology The Case Study Approach to Fraud
Cooper and Morgan (2008) advocate the case study approach to study accounting phenomena. According to Cooper and Morgan (2008), case studies can enhance research and help understand complex accounting issues (p. 165). To better understand the relevance of the FT, the analysis is informed by anecdotal evidence from three high-profile cases of corporate accounting frauds. Livent, WorldCom and Enron are among the worst corporate accounting frauds to have occurred over the last decade-and-a-half. While these cases can be considered exceptional, I argue that the cases should not be viewed as being exceptional in nature. Rather, cases such as Livent, WorldCom and Enron can provide useful insights to strengthen existing theories and inform practices (see Cooper and Morgan, 2008). Indeed, it is often with the help of “extreme cases,” that a better understanding of some of the basic mechanisms that are of general relevance are understood; a phenomenon that can be difficult to discern in “average” cases, where these mechanisms are less transparent (Stolowy, Messner, Jeanjean, and Baker, 2013: 13). In a similar
manner, Livent, WorldCom and Enron, can be used to provide valuable insights on accounting fraud and open up new areas for research.
I am well aware that anecdotal evidence can be considered a constraint and seen as weak evidence without empirical validation. However, this paper is written to provoke thoughts and gain new insights on the behavioral and social characteristics considered in assessing fraud risks. It is expected that this line of inquiry will ideally lead to empirical research that is highlighted in the conclusion. Cases such as Enron and WorldCom are well known to a world audience. Consequently, one may rightfully expect readers to possess basic knowledge of these cases. However, the same cannot be said for localized cases such as Livent. Without a background to this case, it may leave readers ‘wanting’. As such, a brief description of the cases could prove useful.
Case 1: Livent
The Live Entertainment Corporation of Canada Inc. (“Livent”) was a Toronto based company that produced live theatrical entertainment, at its own theatres in Toronto, Vancouver, and New York. Livent’s productions include Show Boat , The Phantom of the Opera , Joseph and the Amazing Technicolor Dreamcoat , Ragtime and Kiss of the Spider. Led by co-founders Garth Drabinsky (“Drabinsky”) and Myron Gottlieb (“Gottlieb”), Livent was considered the second- largest theatre chain in North America at the time of its collapse in 2001. The Livent’s fraud was described by the United States Securities and Exchange Commissions (SEC) as “pervasive and multi-faceted,” and defrauded shareholders of more than $500 million Canadian dollars. Two features of the Livent fraud were particularly disturbing to SEC’s officials. First, Livent’s accounting and IT staff were instructed by senior management to create a computer software program that would allow them to manipulate their books and mask the real numbers from auditors (SEC, 1999). The second troubling feature was the manner in which Livent’s management team and accountants planned and carried out the fraud (Knaap and Knaap, 2009; Lokanan, 2014). Livent had a very aggressive growth-oriented management team who worked with the accountants to artificially inflate invoices, understate expenses in order to fraudulently inflate earnings, and inflate revenue through “revenue-generating” agreements to meet quarterly
