Question & Answer: Apply the fraud triangle to the Martha Stewart case and identify the system flaws. Specifically, you should apply the…

Expert Answer

Fraud Triangle is a model which is designed to explain the reasoning behind an employee’s decision to commit fraud at the workplace. The three components of fraud triangle are – Opportunity, pressure and rationalization.

Fraud triangle can be applied to Martha Stewart’s case as well.

• Firstly, she is in a special position (she is the chairwomen and chief executive) and had the opportunity for a fraud to be perpetrated.
• Secondly, she has an incentive and is under pressure, which give her a reason to commit fraud.
• Lastly, her attitude and ethical values allowed her to rationalize her dishonest act.

Stewart sold 4,000 shares of ImClone stock, with a tip from her her broker Peter Bacanovic. She sold her shares, a day before the Food and Drug Administration refused to review ImClone System’s cancer drug Erbitux. Stewart lost more than a quarter of her net worth of $650 million, and avoided a loss of $45,673 by selling off those shares. According to her portfolio record in December, 2001, she had more losses than gains, and ImClone was one of few companies has positive gains.

It looked like Stewart might be desperate about the loss and the incentive she had in hand to avoid the loss, she sold off the shares under pressure. However, Stewart could not save herself, and was found guilty not because of her sale of ImClone Stock, but on her public statement of innocence and obstruction of justice.

Stewart had claimed publicly that she sold her stock because of a prearranged sell order. This was found to be false later on. Stewart had made these statements with an intention to deceive purchasers of her company’s stock by increasing the price of the stock. Being a successful business woman, Stewart knew what she was doing was absolutely wrong, but she could not resist lying to protect her image and the image of her company.

Opportunities are the circumstances that will make a person weak to the scenario. Because, opportunities are those that allow a person to take a bold step of carry out the fraudulent actions. Being a CEO of ImClone, Stewart had the opportunity and the position to get certain confidential information from inside. There are records of phone conversations which between the Stewart and Baconovic which indicate that Bacanovic called Martha Stewart’s office on December 27 shortly after Samuel Waksal’s daughter dumped all her shares. Stewart’s stock was sold ten minutes later. This shows that they had a communication and together committed the fraud. They are closely associated and hold a certain position in the organization that gave them the opportunity to access nonpublic information, which they ultimately used it for personal well being and advantage.

Rationalization is the final part of fraud triangle. It is said to be a frame of mind or an ethical character that allows a person to justify his/her dishonest actions. Stewart is a first time offenders with no criminal record as such. Hence she does not view herself as a criminal. Therefore, she tried to rationalize their fraudulent actions with certain reasons which is related to her personal enrichment, paying personal debts, and protecting the company. When Stewart sold her shares and lied about the insider information, she felt her actions were okay because she was protecting her own financial assets and her company.