FUNDAMENTALS OF

FRAUD
TAXONOMIES AND MODELS
IN FRAUD

FRAUD TAXONOMIES
There are different systems for classifying

frauds.
But we will focus on frauds in the financial
statements and business transactions.
There are numerous types of fraud and ways
to categorize fraud.
The key is to find a fraud taxonomy that can
be effectively applied to fraud programs,
investigations and control.

FRAUD TAXONOMIES
1) Consumer and investor frauds
Frauds in a nutshell is intentional deception,

commonly described as lying, cheating, and

stealing.
Fraud can be perpetrated against
customers, creditors, investors, suppliers
etc.

FRAUD TAXONOMIES
2) Criminal and civil fraud
It may be a criminal offense or a civil wrong.
Criminal fraud requires proof of an

intentional deception.
Criminal fraud is a false representation of a
material fact made by one party to another
party with an intent to deceive.
Civil fraud requires that the victim suffers
damages

FRAUD TAXONOMIES
3) Fraud against/for the company
Corporate frauds can be classified into two broad

categories.
Frauds directed against the company
Frauds that benefit the company
E.g. price fixing, corporate tax evasion, violation of
environmental laws, false advertising, short counts
and weights.
Manipulation of the accounting records to overstate
profits for bonuses purposes and stock prices.

FRAUD TAXONOMIES
Frauds for the company are committed

mainly by senior managers who wish to

enhance the financial position or condition of
the company by such ploys as overstating
income, sales, or assets or by understating
expenses.
An intentional misstatement of a financial fact
is made, and expenses can be overstated for
tax purposes

FRAUD TAXONOMIES
Top managers use fraud to deceive

shareholders, creditors and regulatory

authorities.
Similar fraud can be used by middle level
managers to deceive their supervisors
Others are:
Planned bankruptcy
Fraudulent insurance claims
Causing fire to property.

FRAUD TAXONOMIES
4) Internal and external fraud
Corporate or management frauds can be

categorized as internal frauds.

While external frauds include fraud
committed by vendors, suppliers and
contractors who might over bill, double bill
or supply inferior goods
Customers can also take fake damages
Corruption can also be practiced by
outsiders

FRAUD TAXONOMIES
5) Management and non management
Organizational fraud involves senior, middle

and first line managers as well as non

management employees
There may be some notable distinctions
between the means used and motivations
and opportunities the work environment
provide but fraud is found in all levels of the
organization.

FRAUD TAXONOMIES
Note:
Fraud and deception are abstract terms. They

go by many other names as well e.g. they

might be called:
Accounts fabrication
Accounts receivable lapping
Bank fraud
Bid rigging
Cash lapping etc.

Models in fraud
There is a lack of models to explain fraud. You would

not want potential fraudsters to learn how to defeat

your detection strategies.
Fraud data sets and modeling methodologies are
highly kept secrets
There are three general approaches to modeling
fraudulent events
Expert systems
Fuzzy logic systems
Data mining systems-linear models, non-linear
models, neural networks and decision trees.

Models in fraud
Early fraud models employed expert systems to

detect fraudulent events

An expert system is a collection of expert opinions on
a number of decision criteria.
These systems induce rules from the responses of a
group of experts in the field.
These rules can be coordinated into a flow chart
leading to a decision.
The problem with expert systems is that they are
based on subjective inputs that may be contradicting

Models in fraud
Subsequent fraud detection systems used

automated rule induction, based on decision

tree technology and fuzzy logic.
Some of these fraud detection systems are
still being marketed today e.g. iPrevent by
Brighterion
The most comprehensive fraud detection
system were developed by HNC systems and
they include Falcon fraud, credit card fraud
etc. The credit card fraud get the most press
coverage.

 END