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What is Fraud?

Updated on May 5, 2010

Fraud is an intentional deception whereby the person or persons deceived are deprived of money, property, or other advantage. Generally, fraud involves the intentional misrepresentation of a material fact, resulting in damage to the victim. So defined, fraud may form the basis of a civil action for damages or of a criminal prosecution. Even where the intention to deceive is absent, it may still be possible for a contract to be nullified if it involves misrepresentation. To protect against the possibility of deception, certain modern statutes require the affirmative disclosure, in sales or loan agreements, of relevant information, the omission of which may give rise to liability.

Because of the continual development of ingenious new schemes to defraud, it is not possible to give a definition that will cover all cases. In general, to constitute fraud, there must have been misrepresentation of a fact that is pertinent to a transaction, and the victim must have entered into the transaction in reliance on that misrepresentation. As a rule, the willful expression of an erroneous opinion does not constitute a fraudulent misrepresentation. This may not be so, however, when the parties involved stand in a special relationship of trust and confidence-members of the same family, attorney and client, or principal and agent—a relationship in which one person may justifiably rely on the opinions of the other. Similarly, where one of the parties has special knowledge of the subject matter of a transaction, his intentional expression of an incorrect opinion may be considered a fraud, such as the opinion of an expert jeweler as to the value of a diamond. On the other hand, a seller may exaggerate the value of his product, so long as he is not specific. Statements that a product is the "best in America" or "will last a lifetime" are mere "puffing", and under the law reasonable men are not considered to be taken in by this kind of assertion.

Although fraud is often perpetrated by means of actual statements that misrepresent facts, deception that constitutes fraud can be practiced by concealment, by half-truths calculated to deceive, or tricks or devices that mislead the victim. Also, a statement made recklessly without knowing its truth or falsity may, if false, constitute a fraud.

Common Types of Fraud

There are so many different types of fraudulent schemes that it would be impossible to enumerate them all. One of the most common types of fraud is embezzlement, where a person lawfully entrusted with another's money takes it for his own use and attempts, through false entries in the records of the rightful owner, to conceal the fact that the money is missing. Another common type of fraudulent scheme is the signing of someone else's name to a check that is then cashed on the basis of false identity. This constitutes forgery. It is also considered wrongful to give someone else a check drawn on one s own account when one knows that there are insufficient funds in the account. In addition, it is fraud to procure a signature to a contract by willfully misrepresenting the contents of the document to be signed.

In many jurisdictions it is considered fraud to obtain goods or services, such as food or lodging, without intent to pay. It is fraud for an insolvent person to obtain goods on credit and to conceal his insolvency from the seller. The use of forged or stolen credit cards has also become a prevalent type of fraudulent practice.

Other common types of fraud include obtaining insurance policies based on false representations of material matters—such as the state of one's health in obtaining life insurance, or one's prior driving record in obtaining automobile accident insurance. Also connected with insurance is the misrepresentation of burglary or fire losses in order to collect either for property that was not lost, or an amount in excess of the value of the property lost. In real estate transactions false statements as to the nature of the vendor's title, description of the property or other basic aspects of the property may constitute fraud. There have also been numerous instances of fraud in the sale of securities of corporations, where such matters as the assets of the corporation have been misrepresented. In the second half of the 20th century, with the development of photo-offset equipment, counterfeiters have issued bogus bonds, a form of fraud insofar as they are sold as real bonds.

Other business frauds include issuing negotiable warehouse receipts for nonexistent property and falsifying corporate financial statements in order to obtain credit.

Investment Schemes

Besides the more obvious frauds, many types of schemes have been devised to cheat the unwary. A classic scheme was that of Charles Ponzi. Ponzi began with less than $150 of his own capital. He claimed that, by taking advantage of the excessive differences in the rates of exchange after World War I, he could buy and sell international postal reply coupons in different countries and thereby earn a quick 100$ on his money. He offered to let others share if they would lend him money and sold those who did notes payable within 90 days and bearing 50% interest. Ponzi never did buy the coupons. Instead he built up confidence by paying the earlier notes back in full (with the 50% interest and often within 45 days) out of funds from the sale of more notes. From December 1919 to August 1920, when a bankruptcy petition was filed against him, Ponzi received upwards of $9 million. After being exposed, he was sentenced to serve five years in a federal prison.

Borderline Practices

There are many other types of practice that technically may not be fraud, but might mislead even reasonably sophisticated people. For example, it was discovered that the publishers of two investment advisory services were purchasing securities for their own accounts shortly before recommending those securities for purchase by investors. Shortly after each service report was distributed the price of the recommended stock showed an increase (as investors presumably followed the recommendations) and the publishers then sold their shares at a profit. The misleading feature of this practice was that the advisers failed to disclose to subscribers that they owned the securities involved. The U. S. Supreme Court has held in SEC v. Capital Gains Bureau (1963) that an injunction could be issued to require a registered investment adviser to disclose such a practice. The injunction would be obtained in accordance with the Investment Advisers Act of 1940, which forbids certain practices by investment advisers and gives the Securities and Exchange Commission (SEC) powers of enforcement.

Consumer Frauds

In selling goods to consumers, some unreliable firms utilize misleading methods to trick buyers into purchasing items they often do not want. Some of these practices go so far as to amount to fraud. One practice that has become prevalent is chain-referral selling. Potential customers for fairly expensive consumer goods are told that they can obtain the goods for almost nothing merely by furnishing names of other possible customers. The idea is that the victims agree to purchase the goods and pay the full price, but with the understanding that they will receive "commissions" on sales to those persons whom they have referred, and that those commissions will be sufficient to offset the sales price. What constitutes the misrepresentation is the implication that the referrals will yield commissions sufficient to offset the cost of the goods purchased.

Another type of consumer fraud is the "bait-and-switch" technique. A merchant advertises a product, which he has no intention of selling, at a very low price, either to lure potential customers to his store or else to gain an invitation for his salesmen to call. The item advertised is disparaged by the salesman, who instead attempts to get the customer to buy a more expensive product.

Some unscrupulous repair shops entice customers to leave television sets or automobiles by advertising that they will perform certain work at an extremely low cost. Although the work is performed as advertised, the customer is, in addition, charged for a series of unneeded repairs that are also made.

Still another type of consumer fraud is the "fear-sell" scheme, in which a salesman induces the owner of an item to believe that it is in such a bad state of repair that it is dangerous. The victim is then sold a replacement. One furnace company sold many furnaces through salesmen who claimed that potential customers' furnaces were dangerous, and who sometimes went so far as to dismantle those furnaces and then refuse to reassemble them.

Other Types of Fraudulent Schemes

Other types of fraudulent schemes include the collection of money for nonexistent charities or religious organizations, the selling by unscrupulous persons of useless remedies for such afflictions as cancer and arthritis, and the giving of advice, allegedly derived from spirits or deceased persons, by fake spiritual mediums. One practice that brazenly capitalizes on grief is the presentation of inflated bills, including charges for services never received, by some unreliable undertakers who count on the fact that the grief-stricken recipient will pay the bill without verifying it.

Some land promoters, taking advantage of the goodwill built up by many reputable land developers, attempt to sell lots without showing the land to potential purchasers. Some less-than-scrupulous promoters give the impression, either by mail or face-to-face-selling, that the land they offer is part of a nearly developed, or rapidly developing, community. Many of the representations made may not, in and of themselves, be false, but a large proportion of them are extremely misleading. Taken together, they convey a false image of the extent to which the land is developed.

When fraudulent schemes are perpetrated through the use of the U.S. mails, they may constitute the federal offense of mail fraud.

In certain circumstances, fraud may be grounds for the annulment of a marriage. To constitute such a ground, the fraud would have to involve an intentional misrepresentation of a fact that goes to the heart of the marriage relationship, and the misrepresentation would have to have resulted in the procurement of consent to the marriage. The types of misrepresentations that would give rise to an annulment of a marriage are far more limited than those that might serve to invalidate an ordinary contract. Generally, where one party conceals an intent at the time of the marriage not to have children and then persists in adhering to that intent after the marriage, the marriage can be annulled. But the law differs from state to state, and there is conflict on some issues: for example, whether concealing the fact of a prior marriage, or promising to go through with a second ceremony of a religious nature, without actually intending to do so, are the types of fraud that can result in an annulment.


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