Negligence: More Likely Than Fraud .........................................................
U.S. law defines negligenceas acting with deliberate disregard of the conse-
quences of the act. It defines gross negligenceas acting with knowledge of
the fact andwith deliberate disregard of the consequences of the act. The
difference between gross negligence and fraud is that fraud is considered as
acting with intent. Fraud is so difficult to prove that the term is rarely
invoked. Negligence is far easier to prove — and fits in quite well with human
nature’s tendency to drop the ball.
Lack of compliance with regulations such as SOX usually results in charges of
negligence or gross negligence, which leads to fines. Therefore, a company
may receive a SOX-related fine if management doesn’t give a good reason why
they haven’t adopted a code of ethics, forgets to disclose material changes of
information, or is slapdash about financial reporting and internal controls.
The classic example of segregation of duties failure is when an employee can
set up a vendor andmake a payment to a vendor. This scenario provides the
employee with the opportunity to set up a fictitious vendor and pay himself.
An auditor combing through a company’s transactions will see this as a red
alert.
Failure to segregate duties is known as setting the fox to guard the henhouse,
because it provides employees with opportunities for fraud. Because fraud is
hard to prosecute, SoD failures are more likely to lead to fines for negligence,
gross or otherwise.
To mitigate the potential for charges of negligence, a company should segre-
gate the duties, allowing one person to set up the vendor and another to pay
the vendor. If, for practical reasons, the company can’t segregate the duties,
it needs to put in compensating controls, such as having a manager check all
the transactions that the person who does too much enters into the account-
ing system.
Entropy: Errors, Omissions, and Inefficiencies ........................................
Entropy is the tendency for things in general to naturally fall into disorder.
Think of the proliferation of papers on the top of your desk during a busy week.
The same thing can happen in corporate accounting systems. The disorder is
unintentional and it can happen because of bad management, inefficiency, and
just plain not taking the time to rigorously follow an organizational system. No
Chapter 5: Fraud, Negligence, and Entropy 111
