The article has been written by Pravin Kumar Ray, a 3rd Year Law student at Sarsuna Law College, Kolkata

Business fraud is a broad term. It can refer to crimes committed by high-ranking employees in a business, or it can describe attacks committed against the businesses themselves. At the end of the day, business fraud almost always involves someone stealing money from someone else under the guise of business dealings. Business fraud is simply the intent or the act of misrepresentation – scammers lying about themselves or their actions and services – to cause a gain or loss.

With limited resources and in tough economic conditions, small and medium-sized enterprises (SMEs) tend to think more about innovation, growth, and survival rather than due diligence, internet controls, and risk management. These can often seem expensive, hard work, and involve a lot of paperwork. But this approach leaves SMEs particularly vulnerable to fraud, with many owners and managers unaware of the risks their businesses face. Corporate fraud is considered a white-collar crime.

It’s important to recognize that fraud can come from anywhere, including:

• staff members
• customers
• suppliers
• third parties, unconnected to the business

This kind of business fraud is designed to give an advantage to the perpetrating individual or company. Corporate fraud schemes go beyond the scope of an employee’s stated position and are marked by their complexity and economic impact on the business, other employees, and outside parties. It’s widely considered that there are three main factors for fraud – motivation, opportunity, and lack of surveillance.

Shell corporations are legitimate, legal entities that do not possess actual assets or run business operations. Shell companies include multiple layers of companies that have been created for the purpose of diverting money or for money laundering. Shell companies are non-traded corporations, meaning that they are not listed on any stock exchanges for buying and selling by investors. This is a company that exists only on paper and has no office and no employees. 

TYPES OF BUSINESS FRAUD

1. Ponzi schemes A Ponzi scheme is an investment fraud that generates returns for earlier investors with money taken from later investors. In this type of fraud, the clients are promised huge profits with little to no risk. The focus of the fraudster companies is on attracting new clients whose investments are then used to pay off earlier investors. Once the flow of money by way of investments from new clients stops, the whole scheme falls apart.
2. Pyramid schemes Also known as a chain referral scheme; a pyramid scheme is a fraudulent business model wherein members are recruited with their payments tied to their ability to enroll new members. As the membership expands, there comes a point where further recruitment becomes impossible which consequently makes the whole thing unsustainable. A pyramid scheme might appear as legitimate multi-level marketing (MLM) practice. But the scheme involves no legitimate sales as the earlier investors are paid from the funds received from new investors. There is no product sold and there are no true profits.
3. Tax fraud refers to the falsification of tax returns in order to evade the payment of tax to the government. For example, claiming false deductions by classifying personal expenditure as business expenditure or non-disclosure of income. When you pay less tax than what is due by hiding or understating or false reporting of your income, you are committing tax fraud.
4. Payroll fraud can manifest in a variety of ways. An employee could lie about their productivity, sales, or hours worked to get higher pay. Some may request a pay advance without any intention of paying it back. Others may even take it a step further by enlisting a co-worker to manipulate their attendance records by clocking in and out for them. Payroll fraud disproportionately affects small businesses because they are less likely to have anti-fraud measures and systems.
5. Invoice Fraud Scheme This type of fraud happens when the fraudster (often an employee in sales or accounting) creates fake invoices to steal money from the business. This could mean invoicing for products and services that were never bought, creating a fake supplier/shell company to funnel the money to, or awarding over-inflated contracts to personal friends and family.

FTX 

Launched as a trading platform for crypto investors in May 2019, with Bankman-Fried as its majority owner. Known universally now as SBF, Sam Bankman-Fried and Gary Wang had previously opened a hedge fund with a friend, Gary Wang called Alameda Research LLC. In late 2022, the U.S. Securities and Exchange Commission accused SBF of defrauding his companies’ investors by steering money from FTX into Alameda Research between 2019 and 2022. SBF and company executives allegedly used the cash to purchase homes in the Bahamas, invest in other companies and fund favored political causes. When crypto assets took a precipitous plunge in 2022, the cash spigot went dry at both FTX and Alameda – with the latter owing FTX customers about $8 billion, according to the Commodity Futures Trading Commission – and federal prosecutors stepped in to issue fraud charges. By November, FTX and Alameda went bankrupt, and SBF was arrested.

THERANOS 

Initially heralded as an innovative healthcare company, Theranos opened for business in 2003, with 19-year-old founder Elizabeth Holmes at the helm and a commitment to making the common blood test more efficient, more accurate, and much faster. Flush with $700 million in equity investments, Theranos was valued at $10 billion by 2014. By 2015, however, the company’s highly touted automated compact testing device was exposed as unworkable by medical testing professionals. Soon after, federal and state regulators filed fraud charges against the company. Crushed under the weight of legal costs, Theranos dissolved in 2018. 

WIRE CARD

One of the more recent corporate fraud cases is that of Wire card, a payment transfer and processing company in Germany. In early 2020, accounting auditors discovered a whopping $2 billion discrepancy between the company’s books and the actual money it held.

Like many corporate fraud schemes, Wire card’s cooking its books had apparently been going on for several years before it was detected. Wire card was forced to declare bankruptcy, and its CEO was arrested by German authorities.

ILLEGAL BUSINESS ACTIVITIES

With the advent of LPG (Liberalization, Privatization, and Globalization) the world has escalated more and more deeply in terms of business and commercial success. Every now and then, we get to know a new startup or industry being established and the existing ones stepping up their overall production, distribution, and profit-making capacities. As every coin has 2 sides, so is the case with the business world. The growth and development we generally measure accounts from legal business.

The underground economy also called the shadow economy, transaction of goods or services not reported to the government and therefore beyond the reach of tax collectors and regulators. The term may refer either to illegal activities or to ordinarily legal activities performed without the securing of required licenses and payment of taxes. Examples of legal activities in the underground economy include unreported income from self-employment or barter. Illegal activities include drug dealing, trade in stolen goods, smuggling, illegal gambling, fraud, Human Trafficking, etc.

Unreported economic activity tends to occur when excessive taxes, regulations, price controls, or state monopolies interfere with market exchanges. Failure to recognize or enforce private property rights and contractual agreements may also encourage underground economic activities. Measurement of the underground economy is difficult because, by definition, its activities are not included in any government records. Its size may be extrapolated from sample surveys and tax audits or estimated from national accounting and labor statistics. Because the underground economy is sensitive to fluctuations in global and national economies, its size is subject to change, growing in times of recession, for example, or shrinking in response to increased penalties for tax evasion.

Drugs The world’s top illicit business. The trafficking of cocaine, marijuana, heroin, and other drugs has continued despite the expensive efforts of the world government. This is a massive industry and political problem, financing violent groups like the Taliban and drug cartels that currently threaten the stability of important countries like Afghanistan and Mexico. The amount of money at stake in the global drug trade can at best be estimated in the neighborhood of maybe $300 billion, according to the United Nations Office on Drugs and Crime.

Illicit Arms Trafficking It’s impossible to even guess the total size of the illicit arms market. It is also often hard to determine when the trafficking of small arms becomes an illegal act. Still, the trade in illicit arms fuels civil wars and worries counterterrorism officials, especially when it comes to loose nukes. Regions like Central Africa are saturated with illicit weapons and illicit arms smuggled out of the U.S. are increasingly exacerbating criminal activity in Mexico.

Cause of Fraudulent and Illegal Business

1. Greed– good old-fashioned human nature intervenes when an individual, or group of individuals, sees a chance to make a fast buck’. A good example is those cases where people ‘adjust’ their expense claims upwards.
2. Lack of transparency – complex financial transactions that are difficult to understand are an ideal method to hide fraud. The Barings fraud was perpetrated by the use of an accounting ‘dump account’ that no one understood.
3. Poor management information – where a company’s management information system does not produce results that are timely, accurate, sufficiently detailed, and relevant; the warning signals of fraud, such as ongoing theft from the bank account, can be obscured.
4. Excessively generous performance bonus payments – the more generous the bonus, when coupled with a demanding target; the more temptation there is to manipulate results, such as year-end sales figures, to reach that target.
5. Non-independent internal audit department – where an organization’s internal audit department is not independent, e.g., where it does not report to a truly independent audit committee but to the Finance Director, the more likely that when there are signals that fraud is occurring the more likely they will be ignored. It is indeed interesting to note that Cynthia Cooper (Head of Internal Audit at WorldCom) had to bypass her boss (the CFO) and go directly to the audit committee to report the discovery of the capital expenditure fraud.
6. Lack of clear moral direction from senior management – leadership comes from the top. Where the senior management indulges themselves in ‘semi corrupt’ behavior, e.g. adjusting their expense claims upwards, others will follow adopting the well-worn mantra ‘everyone’s at it’.
7. Excessively complex organizational structure – designed to obfuscate the revenue streams; and so, hide reality from third parties, such as the Internal Revenue Service. Enron, with its complex off-balance sheet structure and transactions, is a textbook example of this.
8. Poor accounting controls– where the accounting controls, such as a monthly reconciliation of the bank account, lapse the signals that a fraud has occurred will be missed.

BIBLIOGRAPHY

• https://corporatefinanceinstitute.com/
• https://www.met.police.uk/
• https://www.forbes.com/
• https://dimitrainternational.com/

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