Fraud

What Is Fraud?

Fraud is intentional deception made to secure an unfair or unlawful financial gain. In markets and personal finance, it usually involves a person or organization knowingly giving false information, or concealing information that matters, so that another party acts to their detriment. That might mean handing over money or making an investment decision they would not otherwise have made. The key word is intent. An honest mistake, or an investment that simply loses value, is not fraud by itself.

How Fraud Works

Legal definitions vary by jurisdiction, but most fraud claims share several elements: a false statement or concealment of a material fact, knowledge that the statement was false, an intent to get the other party to rely on it, actual reliance, and resulting financial harm. Fraud can be pursued as a crime by prosecutors, as a civil lawsuit by the injured party, or both.

Common forms in investing include:

• Misstating results in company reports, known as financial statement fraud
• Ponzi schemes, where returns to earlier investors are paid from money contributed by newer ones
• Pump and dump schemes, which spread misleading hype to inflate a stock's price before those behind it sell
• Insider trading, which involves trading on confidential information
• False claims about guaranteed returns or credentials

Why It Matters to Investors

Fraud can cause total losses, and recovering money through courts or regulators can take years. Recoveries often cover only part of what was lost. Because of this, many investors pay attention to safeguards that exist to catch fraud. Regulators oversee many financial professionals, companies publish audited financial statements prepared by an independent auditor, and securities laws prohibit misleading statements in many countries.

Safeguards cannot eliminate fraud risk. Common warning signs include promises of unusually high returns with little or no risk, pressure to act quickly, unclear explanations of how returns are generated, and difficulty verifying who is managing the money. Learning how to recognize these patterns is one way investors can understand the risks involved in financial decisions.