(To be formally presented later this year, 2021)
Consider the following three situations:
1. In the operations department of an injection molding business, the manager notes a significant uptick in the costs of electricity due to a recent weather event. This pushes the fixed costs for manufacturing up 12%. The plant manager calls the manager in to discuss this expense and the plans for it because they are triggering a larger financial alarm.
2. A teenager breaks up with the first serious girlfriend. In the teenager’s mind, they have been dating forever and to be “dumped” preoccupies the mind incessantly. They had a favorite path in the local park. Recently, the city invests in upgrades in the park – and there is a communications campaign to celebrate the upgrades and to get people in the community to the park. Everywhere the teenager turns, there are reminders of the girlfriend.
3. The Deputy Police Chief of a mid-sized municipality, upon completion of an investigation into a check kiting fraud in the public works department, recommends the employee be prosecuted. The city manager and the personnel director disagree with the recommendation, noting the theft is not worth the cost of bringing charges.
What if anything do these very different situations have to do with each other? My proposition is they tie with a very central concept of accounting and financial risk: Materiality.
When I first took an interest in white collar crime, an important question came to me from the world of accounting and law enforcement: “Why do they do it?” While exploring this in the context of municipal government, I discovered I had a question for the accounting profession: “Just what do you mean by materiality?” (My B4G partner and friend, CPA Vic Hartman, explains the concept as determining whether the receiver of financial information is affected in decision-making based on the information received.)
The Fraudster’s Mind: Out-thinking the Financial Materiality Controls
Because a central part of my work with leaders is advising municipalities, I took particular interest in bringing the understanding of fraud into the thinking of the city leadership. In a workshop, an experienced fraud investigating accountant noted a particular scam she had seen through the years. One cynical set of fraudsters would discover the limits of financial materiality, defraud up to that limit, and then move on and work multiple communities. These clever criminals, knowing it was more expensive to prosecute then it was to recover the money, had quite a gold vein to mine. They knew the limits of financial materiality would protect them.
What struck all of us listening to this experienced CPA, was that the type of person she described was a criminal. And what struck me was that psychologically, their actions still had materiality. They MATTERED! An easy way to remember, I thought, was “Their actions matter to reality.” And they certainly matter in relating to the personality and character of the person and the victims. They had psychological materiality.”
Not financially material, BUT still a crime, so it is:
Therefore, I believe it makes sense to bring this dynamic into the awareness of the accounting world. To work with definition of a familiar term with the profession in such a way that perhaps we could raise their awareness and prevent more frauds. Could we find a way to track and prevent these scoundrels from being hired? Maybe not, but we certainly now had new language to drive home the importance of understanding the mind of the fraudster. In particular, the fact that they know what they are doing (there is no mental illness), they still broke the law, and as in many cases of fraud, the accounting rules are being used against the profession.
The Bottom Line on Psychological Materiality: The Mind MATTERS
The individual that moves from community to community, stealing while knowing the financial materiality limits, is even more of a predator than the typical fraudster whose thefts are more expensive.
Let’s close the logic here. Please go back and reread the introductory cases and consider what is discussed here regarding financial and psychological materiality and risk.
In this new light of financial and psychological materiality you will note that the first case is financially material, the second case is psychologically material, and the final case is only psychologically material.
Although each crime may not be financially material to the organization, the actions are psychologically material to the larger community.
BEHAVIORAL FORENSICS GROUPTM LLC
The Behavioral Forensics GroupTM LLC is a team of professionals with vast experience in detecting fraud, understanding why it occurs, and in recommending steps to mitigate fraud incidence within the corporate workplace, particularly within higher-level (and therefore more costly to the enterprise) executives. The fields of investigation, organizational psychiatry, accounting and behavioral forensics, and law enforcement are represented within the Behavioral Forensics GroupTM LLC. Acting in synergy to help organizations prevent, find, and/or reduce fraud, B4GTM is a premier, pioneering practice in this field.
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