How Does Cognitive Bias Hinder Fraud Examiner Decisions?

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Financier Bernie Madoff was a high-profile executive who owned Bernard L. Madoff Investment Securities LLC. The one-time Nasdaq chairman was highly respected and well-liked in the business community, with an incredibly successful record of earning strong returns for his clients. Unfortunately, Madoff used his expertise and relationships to perpetrate the largest Ponzi scheme in history, defrauding thousands of investors of billions of dollars.

In contrast, Harry Markopolos was a little-known trader who became aware of Madoff’s fraud scheme and tried to whistleblow with repeated reports to the Securities and Exchange Commission over an extended number of years. However, his detailed reports never led to a formal investigation that might have ended the massive fraud sooner. Unlike Madoff, Markopolos was socially awkward and lacked Madoff’s glamour and outsized business reputation. Still, why would SEC officials seemingly ignore the repeated tips from Markopolos?

According to Culverhouse’s Dr. Todd DeZoort, part of the problem could be that SEC officials were affected by source reliability bias, or the tendency to evaluate evidence based on the perceived credibility of the source. In fact, if you have ever heard someone say, “consider the source,” you may have witnessed source reliability bias.

In “The Effects of Cognitive Bias on Fraud Examiner Judgments and Decisions,” published in the December 2022 issue of the Journal of Forensic Accounting Research, DeZoort, along with collaborators Rich Brody, Gaurav Gupta, and Bret Hood, evaluated the ways that cognitive biases–unconscious errors in thinking–can hinder fraud examiners’ judgment and decision making. The researchers described 11 distinct biases and provided real-life examples based on their experiences to show how each bias can undermine anti-fraud professionals’ performance. Finally, they presented ways for practitioners to reduce bias.

“Human beings are not capable of being completely objective when making judgments and decisions,” DeZoort said, “but we can take definitive steps to identify, understand, and manage the common cognitive biases that can impact our attitudes, intentions, and behavior.”

In early August, the paper received the 2023 Best Research Paper Award from the American Accounting Association’s Forensic Accounting Section at the AAA’s Annual Meeting in Denver.

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