System View of Fraud — Introduction
[Note: This article is 1st in the series of overall Fraud Analytics & Fraud Detection and Prevention strategy.]
“Our ability to manufacture fraud now exceeds our ability to detect it.”
~ Al Pacino, Simone ( 2002 )
So what is fraud? Going by the word meaning ( Cambridge Dictionary ), Fraud is — the crime of getting money by deceiving people. However, a better and more generic explanation is done by Investopedia as below:
Fraud is an intentionally deceptive action designed to provide the perpetrator with an unlawful gain or to deny a right to a victim.
Core takeaways from the above definition:
- Fraud is intentional — An act of fraud is not by chance but is well planned and organised.
- Fraud is deceptive — The act of fraud is deceiving. It is a concealment or distortion of truth to result into misleading outcome or cheating.
- Fraud has a perpetrator — Fraud is never accidental. As it is always intentional, there is always a perpetrator behind the act — in form of an individual, group or an organisation.
- Fraud has a victim — An act of successful fraud results into illegal/unethical gain for the perpetrator. This gain is at someone’s expense and an intended victim ( person, business or organisation) pays for it; more often in monetary terms. Fraud is a social phenomenon.
- Fraud is unlawful — An act of fraud is illegal. Most governments have laws that criminalize fraud.
Types of Fraud
Fraud comes in many forms and types, and happens in many different settings. Below is non-exhaustive list of fraud categories based on frequency of occurrence and the monetary impact:
The above list is just the tip of iceberg. There are various other frauds like phishing, insurance fraud, healthcare fraud, chargeback fraud, tax evasion, plagiarism that are very common.
The Fraud Triangle
So why does fraud happen? This is best depicted with so called Fraud Triangle.
This above framework outlines three components that contribute to the risk of fraud : 1) Incentive, 2) Opportunity, and 3) Rationalization.
- Incentive is the main motivation for fraud to happen. This can be a personal incentive wanting to make more money or an external pressure or fear that can force to commit the fraud.
- Opportunity is about circumstances that allow fraud to happen. Fraudulent activity can be a possibility only when there is an opportunity for an individual to perform an unauthorized activity in a concealed or hidden manner.
- Rationalization is about an individual’s justification for doing a fraud. This is why a fraudster do not shy away from committing a fraud and think of it as acceptable.
Cost of fraud
As mentioned above, fraud is a social phenomenon; i.e, the gain for the fraudsters comes at the expense of victims.
- As per 2019 report from www.crowe.com, fraud costs the global economy over US$5 Trillion, each year.
- As per an early report by www.acfe.com, a typical organization loses over 5% of its revenue to fraud each year.
- As per www.lexology.com report, fraudulent insurance claims costs an estimated $40 to $80 billion per year in the U.S. alone.
The above numbers do indicate the impact of fraud and importance for any organization to fight and prevent fraud as their strategy.
Fighting fraud
The problems of fraud is obvious for any organization or business dealing with external transactions or wherever money is involved, directly or indirectly. This is also a unique challenge because fraud as a problem space is dynamic and is ever evolving. Businesses consider this as a paramount problem to solve because a denial for this problem or wrong approach to handle fraud risks can lead to broken customer trust for the product & business brand along with regulatory compliance issues.
At a high level, fraud management strategy can be broken into following 3 areas:
A comprehensive anti-fraud solution requires all the above components of the framework. In general, the fraud solutions evolves from manual auditing based systems to full fledged automated decision support systems. Most of the enterprise solutions ( built as dedicated stand alone anti-fraud solution or a solution built inside existing business ) evolve and provide hybrid model of fraud management solutions, where decisions & enforcements can be automated as much as possible to prevent and contain the fraud, but also have a manual review or override method as 100% false-positives or false-negatives can never be guaranteed.
( In future articles, I will cover the system & design approach of all 3 components in details. Stay tuned & suggest in comment if there is anything specific you would be interested to know.)
To put it together
Fraud & risk management is vast area and core part of building Trust & Safety within any business & enterprise. With evolving tech space, more digital transactions and open marketplaces, the types and frequency of fraud is increased many folds. It is never too early to plan and build a fraud management strategy.
With technological evolution in big data, machine learning & data science, fraud analytic & intelligence has become a possibility.
References & credits:
- Fraud Analytics using descriptive, predictive, and social network techniques [ Book ]
- https://corporatefinanceinstitute.com/resources/knowledge/accounting/fraud-triangle/
- https://towardsdatascience.com/fraud-detection-unsupervised-anomaly-detection-df43d81fce67
- Handbook of Statistical Analysis and Data Mining Applications [ Book ]
