Review of Elements of Fraud

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1 Review of Elements of Fraud Elements of Fraud It is critical to understand that there are several elements of fraud. Each type of fraud includes these elements, and all these specific elements must be present in the act for the act to be considered a fraud. Fraud is an intentional act. It is not an accident or error. One of the common arguments used in fraud cases is that there was no intent, and therefore, no fraud. Fraud perpetrators will claim it was an accident or error. A major portion of the fraud investigation will be gathering evidence to support the position that the alleged fraudulent act was intentional. Intent is the most critical element and the most difficult to prove. One may look for manipulations of documents and other evidence that indicate the intent. Innocent people will not generally destroy and or conceal evidence required for investigation. It may be possible to cover up mistakes, but much of fraud deals with concealment. This is where the study of prior cases and the study of red flags, audit, investigation tools, and techniques will become very useful. One must understand that as a fraud examiner, one does not determine guilt or innocence. That is the role of the courts. Albrecht (2006) lists seven common elements of fraud including the following: a representation about a material fact which is false intentionally or recklessly so which is believed acted upon by the victim to the victim's damage The ACFE Fraud Examination manual (2009) identifies the following principal categories of fraud or white-collar crime: misrepresentation of material facts concealment of material facts bribery conflicts of interest theft of money or property theft of trade secrets or intellectual property breach of fiduciary duty statutory offense Misrepresentation of Material Facts The term fraud is often associated with misrepresentation of material

2 facts. Misrepresentation cases can be prosecuted criminally or civilly. This will include charges of false statements, false claims, mail and wire fraud, and so on. The key element is that there is a deliberate false statement to induce the victim to exchange money or property. The element of proof of misrepresentation must include the following: a material false statement kowledge of its falsity reliance on the false statement by the victim damage suffered In a civil case, it may be required that the victim relied on the false statements and suffered loss (Association of Certified Fraud Examiners, 2009). False representation and misrepresentation may not be the same for a fraud case. A sales person may give opinions and speculation statements that will not be classified as fraud. If a car sales person says a car will provide many enjoyable years of pleasure, and the car falls apart the next week, this may not necessarily be considered a fraud; however, if the sales person says the car has only 10,000 miles, but it had 50,000 miles, this would be a material fact that is not true. Contactors who perform services may be sued for breach of contract when they fail to perform according to the contract. They would not be prosecuted under fraud unless there was intent not to perform the services. The prosecution or plaintiff must prove that false statements made were intentional and part of a deliberate scheme to defraud. Fraud is not accidental; there must be intent to misrepresent facts. Prosecutors must prove reckless false statement made with disregards for truth or falsity. Concealment of Material Facts When a defendant has a duty to disclose a material fact and does not disclose this information, this would be considered a concealment of material facts. The element of proof of concealment must include the following (Association of Certified Fraud Examiners, 2009): The defendant had knowledge of a material fact. The defendant had a duty to disclose and failed to do so. with the intent to mislead or deceive the other party The prosecution or plaintiff must prove that the concealed fact was material. There would not be a liability if the withheld information would not have affected the other party (Association of Certified Fraud Examiners, 2009). There may be a case for negligent failure to discover and/or disclose material facts. This would not be a fraud charge, and the penalties would be less severe.

3 Bribery Bribery includes corruption of public officials or private individuals to gain an advantage. Payments are made to influence or entice someone for personal favors and business advantages. These generally include kickback and bid-rigging schemes. The element of bribery includes the following: giving or receiving something of value to influence an official act The valuables may include cash or money, as well as nondirect cash benefits, such as lavish gifts and entertainment, payment of travel and lodging expenses, payment of credit card bills, promises of future employment, and interests in businesses. The key is that intent must be present to influence or to be influenced (Association of Certified Fraud Examiners, 2009). Bribery schemes can be difficult to prove. It may be possible to prove lesser charges, such as illegal gratuities. This would exclude the element of influence. The elements of proof for an illegal gratuity include the following: giving or receiving a thing of value for or because of an official act Note: Influence is required for this charge. Commercial bribery would include the following elements: giving or receiving a thing of value to influence a business decision without the knowledge or consent of the principal Extortion is generally the flip side of a bribery case. Extortion is the obtaining of property from another unlawfully. A demand for a bribe or kickback may constitute extortion. The person making the bribe may claim they were forced to make the payment and attempt to use extortion defense. Though most states will not accept this defense, it is used in New York in some situations. An extortion case is often the flip side of a bribery case. Extortion is defined as the obtaining of property from another with the other party's consent having been induced by wrongful use of actual or threatened force or fear. Fear might include the apprehension of possible economic damage or loss. A demand for a bribe or kickback also might constitute extortion. In most states and the federal system, extortion is not a defense to bribery. That is, a person who makes a bribe payment upon demand of the recipient still is culpable for bribery. In New York, however, extortion may be a defense in certain circumstances (Association of Certified Fraud Examiners, 2009).

4 Conflict of Interest Conflict of interest includes opposing interest of individuals or individuals and organizations. Conflict of interest elements include the following (Association of Certified Fraud Examiners, 2009): an agent taking an interest in a transaction that is adverse to the principal without full and timely disclosure to and approval by the principal An agent owes a duty of loyalty to another. These would include the following: officer directors employees of a corporation public officials trustees brokers independent contractors attorneys accountants Theft of money or property Theft of money or property includes misrepresentation fraud as theft by deception or larceny by trick. Examples include embezzlement, larceny, and misappropriation of trade secrets and proprietary information. Embezzlement Embezzlement is theft of money or property by a person to whom it has been lawfully entrusted. Although it is not technically called a theft, it includes deceitfully secreting assets that were entrusted with the perpetrator. The elements of embezzlement include (Association of Certified Fraud Examiners, 2009): the defendant took or converted without the knowledge or consent of the owner money or property of another that was entrusted to the defendant Embezzlement is different from larceny. Larceny Larceny is the unlawful taking of money or property of another with the intent to convert it or deprive the owner of its use or possession. The key difference between larceny and embezzlement is that the defendant never has lawful possession of the

5 property in a larceny whereas an embezzler has possession of the property through his or her position. A worker may take goods out of a warehouse without the owner's consent and sell them to a competitor. This would be larceny. A worker in the production line who works on the goods (this is possession) may also take the goods without the owner's consent and sell them to a competitor. This is embezzlement. In fact, the employee may be charged with multiple fraud counts such as fraud, larceny, embezzlement, conversion, and breach of duties. The elements of larceny typically include the following (Association of Certified Fraud Examiners, 2009): unlawful taking or carrying away without the consent of the owner with the intent to permanently deprive the owner of its use or possession Theft of Trade Secrets Trade secret includes secret formulas and processes, as well as proprietary information including customer and price lists, sales and cost figures, business plans, or other confidential information that is valuable value to the business and would harm the company if disclosed. The elements of a typical theft of trade secret include the following (Association of Certified Fraud Examiners, 2009): that a party possessed information of value to the business that was treated confidentially that the defendant took or used by breach of an agreement or confidential relationship Breach of Fiduciary Duty A fiduciary is someone who acts for and on behalf of another in a relationship of trust. These include officers, directors, high-level employees, agents and brokers, and so forth. The principal fiduciary duties are loyalty and care. Duty of Loyalty The employee/agent should act solely in the best interest of the employer/principal and be free of any self-dealing, conflicts of interest, or other potential abuse of the principal for personal advantage. Embezzlements, thefts, acceptance of kickbacks, and conflicts of interest also violate the duty of loyalty. A breach of duty of loyalty is easier to prove than fraud. The plaintiff must show that the defendant occupied a position of trust or fiduciary relationship and has benefited personally (Association of Certified Fraud Examiners,

6 2009). Duty of Care An agent must use prudence with skill and attention exercised by people in similar positions. Agents who act carelessly or recklessly may be responsible for damages resulting in loss to the corporate shareholders or other principals; however, normal business errors and acts of judgments made in good faith, free of self dealing and conflict of interest, may not be deemed fraud (Association of Certified Fraud Examiners, 2009). Statutory offense There are many statutory offenses that may be prosecuted as fraud. The two sources of substantive law are the following: Statutes by the federal or state legislatures and related regulations of administrative bodies Common law Criminal law is statutory. Civil actions can be either statutory or common law. References Association of Certified Fraud Examiners. (2009). Fraud examiners manual. Austin, TX: author.