What Is Fraud?
Definition, Types, and Consequences
By JAMES CHEN Updated January 15, 2024
Reviewed by DAVID KINDNESS
Fact checked by TIMOTHY LI
What Is Fraud?
Investopedia / Sydney Saporito
Fraud is an intentionally deceptive action designed to provide the perpetrator
with an unlawful gain or to deny a right to a victim. Types of fraud include tax
fraud, credit card fraud, wire fraud, securities fraud, and bankruptcy fraud.
Fraudulent activity can be carried out by one individual, multiple individuals or
a business firm as a whole.
KEY TAKEAWAYS
Fraud involves deceit with the intention to illegally or unethically gain
at the expense of another.
In finance, fraud can take on many forms including making false
insurance claims, cooking the books, pump & dump schemes, and
identity theft leading to unauthorized purchases.
Fraud costs the economy billions of dollars each and every year, and
those who are caught are subject to fines and jail time.
Fraud Explained
Fraud involves the false representation of facts, whether by intentionally
withholding important information or providing false statements to another
party for the specific purpose of gaining something that may not have been
provided without the deception.
Often, the perpetrator of fraud is aware of information that the intended victim
is not, allowing the perpetrator to deceive the victim. At heart, the individual or
company committing fraud is taking advantage of information asymmetry;
specifically, the resource cost of reviewing and verifying that information can be
significant enough to create a disincentive to fully invest in fraud prevention.
Both states and the federal government have laws that criminalize fraud,
though fraudulent actions may not always result in a criminal trial. Government
prosecutors often have substantial discretion in determining whether a case
should go to trial and may pursue a settlement instead if this will result in a
speedier and less costly resolution. If a fraud case goes to trial, the perpetrator
may be convicted and sent to jail.
Legal Considerations
While the government may decide that a case of fraud can be settled outside of
criminal proceedings, non-governmental parties that claim injury may pursue a
civil case. The victims of fraud may sue the perpetrator to have funds recovered,
or, in a case where no monetary loss occurred, may sue to reestablish the
victim’s rights.
Proving that fraud has taken place requires the perpetrator to have committed
specific acts. First, the perpetrator has to provide a false statement as a material
fact. Second, the perpetrator had to have known that the statement was untrue.
Third, the perpetrator had to have intended to deceive the victim. Fourth, the
victim has to demonstrate that they relied on the false statement. And fifth, the
victim had to have suffered damages as a result of acting on the intentionally
false statement.
Types of Financial Fraud
Common individual mortgage fraud schemes include identity theft and
income/asset falsification, while industry professionals may use appraisal
frauds and air loans to dupe the system. The most common investor mortgage
fraud schemes are different types of property flipping, occupancy fraud, and
the straw buyer scam.
Fraud also occurs in the insurance industry. Thoroughly reviewing an insurance
claim may take so many hours that an insurer may determine that a more
cursory review is warranted considering the size of the claim. Knowing this, an
individual may file a small claim for a loss that didn’t really occur. The insurer
may decide to pay the claim without thoroughly investigating since the claim is
small. In this case, insurance fraud has been conducted.
The Federal Bureau of Investigation (FBI) describes securities fraud as criminal
activity that can include high yield investment fraud, Ponzi schemes, pyramid
schemes, advanced fee schemes, foreign currency fraud, broker embezzlement,
pump-and-dumps, hedge fund related fraud, and late-day trading. [ 1 ] In many
cases, the fraudster seeks to dupe investors through misrepresentation and to
manipulate financial markets in some way. These crimes are characterized by
providing false or misleading information, withholding key information,
purposefully offering bad advice, and offering or acting on inside information.
Consequences of Financial Fraud
Fraud can have a devastating impact on a business. In 2001, a massive
corporate fraud was uncovered at Enron, a U.S.-based energy company.
Executives used a variety of techniques to disguise the company’s financial
health, including the deliberate obfuscation of revenue and misrepresentation
of earnings. [ 2 ] After the fraud was uncovered, shareholders saw share prices
plummet from around $90 to less than $1 in a little over a year. Company
employees had their equity wiped out and lost their jobs after Enron declared
bankruptcy. The Enron scandal was a major driver behind the regulations found
in the Sarbanes-Oxley Act passed in 2002. [ 3 ]
ARTICLE SOURCES
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