What Is Financial Fraud? Types, Signs, and Reporting

Financial fraud is a deliberate act of deception involving financial transactions for personal gain, characterized by misrepresenting or omitting facts. These illegal acts can target individuals, businesses, or government entities using varied and evolving methods. The scope ranges from individual identity theft to complex corporate schemes that impact the entire economy.

Common Financial Fraud Schemes

Identity Theft

Identity theft is the fraudulent use of a person’s private identifying information, like a Social Security number or bank details, for financial gain. Perpetrators use this data to make unauthorized purchases, open new credit accounts, or take out loans in the victim’s name. The consequences for the victim can include significant financial loss, a damaged credit history, and the difficult process of restoring their good name.

Ponzi and Pyramid Schemes

Ponzi and pyramid schemes are investment frauds luring participants with promises of high returns. A Ponzi scheme pays early investors with capital from new investors, rather than legitimate profits, and collapses when it can’t attract enough new money. A pyramid scheme, on the other hand, is a structure that primarily generates revenue by recruiting new members, who must pay a fee to join, rather than from the sale of actual products or services.

Embezzlement

Embezzlement is the theft of funds placed in one’s trust or belonging to one’s employer. This fraud is committed by an insider, like an employee with access to company finances, who might create “ghost” employees to divert funds. The core of embezzlement is the breach of a fiduciary duty, the legal obligation to act in another’s best financial interests.

Insurance Fraud

Insurance fraud involves deceiving an insurance company for an illegitimate payout. Examples include staging a car accident to claim fake injuries, intentionally damaging property to collect on a homeowner’s policy, or providing false information on an application to get a lower premium rate.

Mortgage Fraud

Mortgage fraud involves misrepresenting information on a loan application to obtain a mortgage that would otherwise be denied. One type is fraud for housing, where a borrower misstates their income to qualify for a home. Another is fraud for profit, which often involves industry professionals colluding to inflate property values and skim profits from fraudulent loans.

Securities Fraud

Securities fraud involves misrepresenting information to investors in the stock market. A common type is insider trading, where an individual uses non-public information to trade a company’s stock. Another is a “pump-and-dump” scheme, where fraudsters inflate a stock’s price with false statements, sell their shares, and leave others with worthless stock.

Corporate Fraud

Corporate fraud is the falsification of financial information by a company’s employees to mislead investors and auditors. This can involve “cooking the books” by manipulating financial data to show inflated earnings or hide debt. This fraud can lead to significant investor losses and the collapse of entire companies.

Recognizing Warning Signs of Fraud

Fraudsters often create a sense of urgency, pressuring you to make a quick decision. They may claim an offer is for a limited time or that you must act now to avoid negative consequences. This tactic prevents you from thinking critically or consulting an advisor.

A major red flag is the guarantee of high returns with little to no risk. All legitimate investments carry some risk, and promises of guaranteed profits are a classic sign of investment scams like Ponzi schemes.

Be cautious of unsolicited offers or requests for personal information via email, phone, or social media. Scammers may ask for your Social Security number or bank details for unexpected offers. Legitimate organizations rarely request this information through unsolicited contact.

Another warning sign is a request to pay fees or taxes upfront to receive a prize or money. This is a feature of advance-fee scams, where a fraudster requires you to pay fees first. The promised money never materializes after you pay.

Pay attention to inconsistencies in documents or communications. Fraudulent materials may have spelling errors, unprofessional formatting, or altered logos. An email from a free webmail service claiming to be from a well-known company is also a significant red flag.

Parties in Financial Fraud

Perpetrators

Perpetrators of financial fraud are either internal or external. Internal perpetrators are individuals within an organization, like employees, who use their access to commit fraud such as embezzlement. External perpetrators are outside actors, from individual scammers to organized crime rings, who use deception and technology for their schemes.

Victims

Victims of financial fraud range from individuals to large institutions. Individual consumers are frequent targets, especially vulnerable populations like the elderly and young adults. Small businesses are also at risk due to fewer internal controls. Large corporations and government entities can also fall victim to complex financial crimes like securities fraud and cyberattacks.

How to Report Financial Fraud

Federal Trade Commission (FTC)

The Federal Trade Commission (FTC) is the primary agency for collecting reports on fraud and identity theft. You can file a report on their website, ReportFraud.ftc.gov. The FTC uses these reports to build cases and shares the information with law enforcement. Be prepared to provide details of the transaction and the suspected fraudster.

Federal Bureau of Investigation (FBI)

For online fraud, file a complaint with the FBI’s Internet Crime Complaint Center (IC3). The IC3 accepts reports on internet crimes like phishing and online investment fraud. The FBI analyzes this information and shares it with law enforcement. Be ready to provide details like website addresses and transaction information.

Local Law Enforcement

Report localized crimes like check fraud or wallet theft to your local police department. A police report is often necessary when disputing fraudulent charges with your bank or credit card company. Have all documentation ready, including receipts and a timeline of events.

Specific Regulatory Agencies

Certain types of fraud should be reported to specific regulatory agencies. Report suspected investment fraud, like a Ponzi scheme, to the U.S. Securities and Exchange Commission (SEC) through its online portal. Tax-related fraud should be reported to the Internal Revenue Service (IRS) by filing an Identity Theft Affidavit (Form 14039).