• Colin Doyle CFO

Moral equilibrium: Charitable donations and other good deeds might be indicators of fraud

Whether it’s by giving your time, money or other resource, how would you rate your generosity on a scale of 1 to 10 if 1 represents little or no generosity, and 10 represents being generous almost all the time?

Now that you have your number, can you recall an act of kindness you performed in the past week? Can you also recall a time in the past week when you had the chance to do something generous for a family member, friend or even a stranger but chose not to? Considering these new memories, would you maintain your same generosity rating, or would you now change your figure? Is it possible that deciding to show or withhold generosity could have an impact on whether you or someone else would commit fraud?

Moral equilibrium is a psychological phenomenon that’s best described as a behavioral mental accounting ledger, according to the writings of Robert Prentice, J.D., professor in the McCombs School of Business at the University of Texas at Austin (UT). Do something good and add a point to your positive column. Do something bad and add a point to your negative column. Making decisions every day adds or subtracts points to either column in your mental ledger. Your brain will naturally seek equilibrium between the two columns, which can lead to positive or negative behaviors — though you might not always be conscious of how these decisions affect you. Problems can arise when your ledger becomes unbalanced.

If you’re like most people, you likely believe that you’re an inherently good person. While that might be true in most instances, the brain has cognitive limitations. Recall a time when you said something you regretted to a loved one, friend or colleague. Your moral equilibrium became unbalanced, which created a conscious or unconscious need to return to equilibrium. Chances are that you either apologized to the offended person or had a conversation (with another person or in your head) rationalizing your behavior by determining that the offended party did something to justify the harsh comment. Whether you realized it or not, such a conversation would’ve helped to restore your moral equilibrium.

On any given day, you’ll experience conflicts between what you should do and what you want to do. This inner conflict — often referred to as cognitive dissonance — can be a source of great stress. Your brain will automatically seek to resolve the issue causing dissonance as a means of eliminating the stress. Deciding whether or not to commit fraud against an individual or employer can be a source of cognitive dissonance. How a fraudster decides to resolve their cognitive dissonance can depend on when they decide.

“When it comes time to make a decision, our thoughts are dominated by … how we want to behave; thoughts of how we should behave disappear,” according to the book, Blind Spots: Why We Fail to Do What’s Right and What to Do About It, by Max H. Bazerman & Ann E. Tenbrunsel (Princeton University Press, 2012, page 67). If a fraudster chooses to follow through with the intent to deceive, their moral equilibrium will be unbalanced, which will compel them to seek equilibrium. Their subsequent action(s) to restore equilibrium could be a significant red flag indicator for a fraud examiner.

Moral compensation and moral licensing

Fraud examiners should understand two components of moral equilibrium when assessing red flags of fraud: moral compensation and moral licensing. Moral compensation refers to instances when you don’t act within your ethical and behavioral norms, which causes conscious or subconscious compulsions to seek out some action or behavior to offset the violation. Moral licensing is the exact opposite — you’ve first committed the good deed, which then gives you license to deviate from your ethical norms because you’ve established yourself as a good person through previous acts or behaviors of generosity and kindness. In both instances, moral equilibrium is restored, which allows you to maintain your positive self-image.

A danger of moral licensing is believing that doing something generous gives you a hall pass to do something incredibly selfish. “Any act and any thought that you consider to be ‘good’ can license a subsequent ‘bad’ behavior because we feel that we deserve a reward for being so righteous,” writes Agota Bialobzeskyte in her article, Moral Licensing: How Being Good Can Make You Bad, in Pick The Brain, Aug. 18, 2012.

This is shown in a study conducted by Nina Mazar and Chen-Bo Zhong. (See Do Green Products Make Us Better People? by Mazar and Zhong, University of Toronto, Psychological Science, 2010.) The study showed that the behaviors of customers who purchased environmentally sustainable products (green products) differed substantially from those who were simply exposed to green products.

“... [W]e find that mere exposure to green products and the purchase of them lead to markedly different behavioral consequences,” the abstract in the study explains. “In line with the halo associated with green consumerism, people act more altruistically after mere exposure to green than conventional products. However, people act less altruistically and are more likely to cheat and steal after purchasing green products as opposed to conventional products.” By “going green,” moral equilibrium inadvertently allowed people, who were acting and behaving with honorable intent, to succumb to a desire or need that they perceived to be dishonorable.

“That’s the sort of devious thing about moral licensing,” says Prentice in a UT Ethics Unwrapped video. “It’s oftentimes a completely subconscious process. We don’t even realize we are doing it. We don’t realize that we’re giving ourselves license not to live up to our own traditional standards.” (See In It To Win: Jack & Moral Equilibrium, by Robert Prentice, University of Texas McCombs School of Business, 2018.)

Fraudsters, after they’ve done something they perceive to be honorable, can more easily mentally offset their illegal and illicit activity by using moral licensing. This, in turn, allows them to relieve the cognitive dissonance associated with committing fraud. The fraudster can operate their scheme more proficiently without the stress caused by cognitive dissonance.

The scientific research for moral compensation is similar. Normally, you’d feel some level of guilt after doing something you know is wrong — either consciously or subconsciously. You then might do something to reestablish your moral equilibrium and alleviate the guilt associated with the moral indiscretion.

In a study conducted by Heather C. Renetzky of Macalester College, each participant was asked to recall from the past a moral transgression or a neutral memory. They rated their guilt and then made a compensatory monetary charitable donation. The findings showed that participants who were primed to think about perceived negative events in their lives were eager to make up for their previous moral transgressions with donations. “Guilt was lower after the compensatory task, particularly for participants who had recalled a transgression suggesting that compensatory behavior can mitigate guilt,” the study explains. (See Guilt and Moral Compensation: Relational or Self-Presentational? by Heather C. Renetzky, Psychology Honors Projects, Macalester College, May 1, 2015.) Once again, fraudsters can assuage the discomfort of cognitive dissonance by taking an action that’s perceived as good and restoring their moral equilibrium.

Using moral equilibrium to indicate fraud

On some level, fraudsters know they’ve done something wrong or are about to, and most will have to find some way to restore moral equilibrium. This is where attentive fraud examiners might be able to proactively and reactively identify fraudulent activity. Surprisingly, good deeds might be a way for fraud examiners to identify rationalization attempts by fraudsters.

When fraudsters donate time and money to charity, they receive multiple benefits. Not only do charities offer the chance to network with other donors, fraudsters also are able to obtain reputational benefits from association with charitable work. Still, the psychological benefits related to moral equilibrium might be more important. Whether fraudsters feel morally compensated (after the fraudulent acts) or moral licensing (before the fraudulent acts), the cognitive relief that accompanies such work could be invaluable to them.

Certainly, this idea of moral equilibrium doesn’t suggest that everyone who donates to charity is a fraudster. But this type of information, along with other supporting evidence, could help assess whether a person is conducting or is capable of fraudulent behavior.

Bernie Madoff, during the life of his Ponzi scheme, made multiple donations to charity and even established a charitable foundation in his name. In the middle of the Enron fraud, founder Ken Lay helped raise millions of dollars for the Houston United Way and the United Negro College Fund, among many other charitable causes. (See Anatomy of a Fall: Keys to Success Left Ken Lay Open to Disaster, by Bryan Gruley & Rebecca Smith, The Wall Street Journal, April 26, 2002.)

Enron’s then-CEO Jeffrey Skilling allegedly gave $86,000 to Junior Achievement’s Houston chapter. John Rigas, one of the founders of Adelphia Communications Corporation, and his son, Michael, the then-chief operating officer of the company, made a $2 million pledge to the National Cable Television Center and Museum before they were arrested for fraud and bank fraud charges. (See Corporate Scandals Tainting Donations, by Arian Eunjung Cha, The Washington Post, Sept. 25, 2002.)

David Mobley, a convicted hedge fund manager, gave a $1.9 million donation to a Naples, Florida, church to establish a homeless shelter just before the collapse of his Ponzi scheme. (See Hedge fund swindler Mobley of Stadium Naples era could be returned to prison, by Aisling Swift, Sept. 24, 2012, Naples Daily News.)

Each of these fraudsters used charitable donations to help them reestablish moral equilibrium at some point in the timeline of their scheme.

Jack Abramoff, a former lobbyist during the Bush administration and convicted fraudster, made conscious and unconscious decisions in moral licensing, so he could try to achieve moral equilibrium. “People who are able to give away money often feel very good about themselves doing it,” says Abramoff in the University of Texas Ethics Unwrapped video. “For me, unfortunately, that good feeling helped to decrease my capacity to analyze what I was doing. And I think as you go through life, you do things and forget about them and you try to look back and say, well, I was a saint, I was good, everything I did was good, everything I thought was good.” Abramoff was convicted in 2006 and sentenced to six years in federal prison after he pleaded guilty to mail fraud, tax evasion and conspiracy to bribe public officials. He served 3½ years.

Abramoff and many other convicted fraudsters have set up speaking businesses after their release from prison to earn money and warn others to avoid such behaviors. They probably went on the speaking circuit because they couldn’t find employment after their convictions but also to morally compensate.

Andrew Fastow was the chief financial officer for Enron Corporation. Since his fraud conviction and release from prison, Fastow has participated in interviews and given speeches at conferences (including ACFE events) about his involvement in Enron’s fraud.

Fastow talks about why he gives speeches, offering a glimpse into how moral compensation operates. “First of all, let me say I’m here because I’m guilty,” Fastow said at the 2013 ACFE Global Fraud Conference. “I caused immeasurable damage. ... I can never repair that. But I try, by doing these presentations, especially by meeting with students or directors, to help them understand why I did the things I did, how I went down that path, and how they might think about things so they also don’t make the mistakes I made.” (See The Confessions of Andy Fastow, by Peter Elkind, Fortune, July 1, 2013. The ACFE doesn’t compensate convicted fraudsters.)

Fastow is compensating for his previous aberrant behavior so he can restore equilibrium and his positive self-image by telling his story to students and other business professionals to educate and possibly prevent others from making similar mistakes.

Restoring moral equilibrium is almost essential to rationalization process

Moral equilibrium is about being able to rationalize behaviors — both good and bad. Each employee in an organization is keeping their mental scorecard of right versus wrong. There’s no objective way for a fraud examiner to monitor each employee’s moral ledger, so fraud can occur no matter what internal controls are in place. However, an attentive fraud examiner could proactively look for situations where people are potentially perceiving a moral equilibrium surplus or deficit. Instances of moral licensing and moral compensation could include employees who complain or talk about voluntarily staying late at the office, complain about or offer to do extra work for no additional pay, plus those who maintain the perception that they were unjustly denied a raise or promotion they believe they deserved.

For example, Walter Pavlo was a senior manager for MCI WorldCom. He was convicted of money laundering, obstruction of justice and wire fraud. In an interview Pavlo gave to the Institute of Chartered Secretaries & Administrators’ (ICSA) Governance Institute, he described his motivation and rationalization for committing fraud both on behalf of MCI WorldCom and himself. “The company kept rewarding me; they liked me,” he explains. “Which made me resent them even more, because I did not like who I was! The more that I cooked the books on their behalf, the more that I wanted to do it for myself.” (See Walt Pavlo: Daylight Fraud, by Henry Ker, ICSA Governance Institute, Nov. 7, 2017.)

Though MCI WorldCom had rewarded Pavlo, his mental scorecard was in a deficit because he knew he was doing wrong. This caused Pavlo to face significant cognitive dissonance. He personally benefited from the money he stole, but Pavlo was able to restore moral equilibrium by creating the narrative that he was the good guy by taking money from people who were more unethical than him. It probably didn’t take much for Pavlo’s brain to rationalize what he was doing as he described himself. “You are not an evil person, one that gets up every morning thinking: ‘I just cannot wait to commit a crime.’ That person is a unicorn. I doubt they even exist.” (See Walt Pavlo: Daylight Fraud, by Henry Ker, ICSA Governance Institute, Nov. 7, 2017.)

No fraud examiner can ever completely predict how employees will perceive workplace situations, but Pavlo’s comments illustrate how certain deeds and events in the workplace can easily lead to moral licensing and moral compensation.

How generous is too generous?

Charitable donations and good deeds are generally recognized as positives. However, these gestures sometimes can be part of a psychological process to license and compensate for aberrant behaviors. A fraud examiner who’s aware of the potential psychological ramifications of these deeds might be able to proactively interdict fraud schemes and mitigate losses of these schemes. The axiom of “it’s better to give than to receive” takes on an entirely different meaning when it comes to moral equilibrium.

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