What is Fraud?


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Fraud is a deliberate deception to secure unfair or unlawful gain, or to deprive a victim of a legal right. Fraud itself can be a civil wrong (i.e., a fraud victim may sue the fraud perpetrator to avoid the fraud or recover monetary compensation), a criminal wrong (i.e., a fraud perpetrator may be prosecuted and imprisoned by governmental authorities), or it may cause no loss of money, property, or legal right but still be an element of another civil or criminal wrong.

Fraud can take many forms, including:

  • Financial Fraud: This is fraud related to financial transactions, such as securities fraud (manipulating stock prices), credit card fraud, mortgage fraud, or insurance fraud (filing false claims).
  • Identity Theft: This type of fraud involves impersonating another person or entity to steal money or get other benefits.
  • Internet Fraud: This includes a variety of schemes executed via the internet, including phishing (sending fraudulent emails to get personal information), online auction fraud, and scams related to online sales.
  • Corporate Fraud: These are schemes, often complex, that involve large corporations, such as cooking the books to inflate a company’s worth, insider trading, or other manipulative practices that deceive shareholders or regulators.
  • Fraud by False Representation: This type of fraud occurs when a person knowingly or recklessly makes false representation intending to make gain for himself or cause loss to another.

It’s worth noting that for an action to be considered fraudulent, it generally needs to involve deliberate deception. Mistakes, errors, or accidents don’t usually qualify as fraud unless there was an intent to deceive involved.

The penalties for fraud vary widely depending on the nature of the fraud, the amount of money involved, and the jurisdiction in which it occurs. Penalties can include fines, restitution (paying the victim for their loss), and imprisonment.

Example of Fraud

Let’s take a look at a classic example of financial fraud, known as the “Ponzi Scheme,” named after Charles Ponzi who became notorious for using this method in the 1920s.

In a Ponzi scheme, the fraudster recruits investors by promising unusually high returns. The initial investors do see these returns, but not because their investment is generating profits. Instead, the money they ‘earn’ is simply the capital coming in from newer investors.

For instance, let’s say Charles convinces Investor A to invest $1,000 in his venture, promising a 50% return on investment within a month. To fulfill this promise, Charles then convinces Investors B and C to invest $1,000 each. Charles uses $500 from each of B and C’s investment to pay the promised returns to Investor A.

Investor A, seeing that Charles has fulfilled his promise, may decide to reinvest his money. Meanwhile, Investor B and C are told their returns will be available soon. To pay these returns, Charles then needs to bring in even more investors, and so the cycle continues.

It’s worth noting that a Ponzi scheme is not a sustainable business model. It inevitably collapses when the fraudster can’t attract new investors fast enough to pay the promised returns to the earlier investors.

Ponzi schemes are illegal and considered a form of fraud because the profits that investors believe they are earning are merely the results of the fraudster robbing Peter to pay Paul. In the end, most investors lose all the money they placed into the scheme, while the fraudster often walks away with a significant amount of stolen money.

One of the most notorious Ponzi schemes in recent history was run by Bernie Madoff, who defrauded investors out of billions of dollars over several decades before his scheme collapsed in 2008.

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