Fraud

DEFINITION of 'Fraud'

An intentionally deceptive action designed to provide the perpetrator with an unlawful gain, or to deny a right to a victim. Fraud can occur in finance, real estate, investment, and insurance. It can be found in the sale of real property, such as land, personal property, such as art and collectibles, as well as intangible property, such as stocks and bonds. Types of fraud include tax fraud, credit card fraud, wire fraud, securities fraud, and bankruptcy fraud.

A fraudulent activity can be carried out by one individual, multiple individuals, or a business firm as a whole.

BREAKING DOWN 'Fraud'

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 as to create a disincentive to fully invest in fraud prevention.

For example, 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. 

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.

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 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.

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.