Of the following, the best definition of a scheme is:

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, that 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 it 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. 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. 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.

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