Not every type of fraud has a clear victim. Sometimes, the person whose identity is being used in fraudulent activities is just as involved as the person actually committing the illicit actions. This type of scheme is called second-party fraud, and the victim in this scenario is typically the organization or institution where the fraudulent activity takes place.
What is Second-Party Fraud?
Second-party fraud occurs when an individual allows another person or entity to use their personal information to engage in fraudulent activities. Oftentimes, this includes sharing their identity data or bank account information so the other party can open an account, make financial transactions, or engage in other activities without exposing their true identity.
Second-Party Fraud vs. First and Third-Party Fraud
Second-party fraud is distinctly different from other types of fraud, which influences how organizations can detect and prevent it. As a reminder, the other main categories of fraud include:
- First-Party Fraud: Occurs when an individual purposefully misrepresents their income, financial data, employment, or other personal information to deceive financial institutions or other entities. The goal is typically to obtain services or products under false pretenses.
- Third-Party Fraud: Also known as identity theft, this type of fraud has a clear victim whose identity is stolen by a malicious actor. The thief will use the stolen information to shield their own identity, often using it to open up new accounts or secure credit or loans without the person’s knowledge.
To reiterate, with second-party fraud, the person allowing their personal information to be used in fraudulent activities is complicit in the act and can face legal consequences. Even if they are not the person who carries out the actions, they can be found liable for losses and damages.
What Is the Purpose of Second-Party Fraud?
It can be puzzling to understand why a person would willingly allow their identity to be used to carry out illicit activities. Just like any other type of fraud, there are a few motivating factors that can cause a person to engage in this behavior. The following are some of the most common incidents where second-party fraud occurs:
- Money laundering: Second-party fraud is often seen in money laundering schemes, where a person will allow a criminal enterprise to use their bank account to transfer money and complete transactions to make the funds appear more legitimate. In such cases, the person likely receives some sort of compensation for lending out their information or bank account access.
- Chargeback scams: Chargeback schemes can also leverage second-party fraud tactics, where a person supplies their payment information to a fraudster, allowing them to make large purchases on a device or network that has no association to the person. Then, the person whose information was used can approach the merchant or card issuer and refute the charges, claiming fraud. In this case, the individual might recoup their funds fully, and they can share the purchased items with the fraudster either directly or by reselling them and splitting the proceeds.
- Fraudulent financial products: Second-party fraud isn’t always nefarious in nature, though that doesn’t make it legal. A person may allow a family member or friend to use their information to secure a loan or other financial product they couldn’t qualify for on their own. Though this might seem innocent, it is still a form of fraud and can lead to serious consequences for all involved parties.
Even still, there are cases where a person may not be aware of the fraudster’s true intentions with their information. This is often seen among family members, with older relatives often being targeted. They may provide a younger relative with their personal information to help them open up a new account or credit card, though they might be unaware that their family member is also using it themselves to make unauthorized purchases or transfers without their knowledge.
Risks of Second-Party Fraud
The ripple effects of second-party fraud can be widespread, often impacting businesses and financial institutions rather than individual victims, like with other types of fraud. Here are some of the top risks to organizations with second-party fraud:
Financial Loss
The primary risk for organizations is that it can result in serious financial losses. The longer the scheme goes undetected, the greater the potential impact. For instance, the chargeback scheme we highlighted above creates a direct financial impact on both merchants and financial institutions. Even though chargebacks exist to help protect consumers from fraudulent transactions, these policies can be misused to exploit institutions through second-party fraud.
Legal Consequences
If regulators discover a financial institution does not have the appropriate controls and policies in place to meet anti-money laundering (AML) laws and other regulations (which would mitigate the risk of second-party fraud), the organization could face legal ramifications like penalties and fines.
Difficult to Detect
Because the individuals allowing their information to be used by fraudsters are directly involved in these schemes, it can be difficult to track down exactly who the person behind the scenes is. As a result, second-party fraud can endure for a meaningful amount of time before a business fully gets to the bottom of what’s going on. This is only becoming more challenging as technology advances and helps fraudsters become more sophisticated with their tactics.
How to Detect Second-Party Fraud
It’s important for organizations, especially financial institutions, to be aware of second-party fraud and know how to effectively detect it to avoid being involved in crimes like money laundering and other illegal schemes.
Fraudsters’ tactics continue to grow more sophisticated by the day. However, the following are some of the best practices and expert suggestions for organizations to enhance second-party fraud detection:
- Flag unusual account activity: A merchant should monitor user account behavior and have methods to flag suspicious activities like unusual devices or locations during login, large transactions, or address changes. Even if the authorized account holder is not directly involved, it can still help mitigate any type of fraudulent activity that might be underway by temporarily freezing flagged accounts.
- Employee training and awareness: Especially with financial products, educate and inform employees on how to spot suspicious behaviors that could indicate second-party fraud. Any inconsistencies in new account applications, requests for unusually large transfers, or an uptick in transaction volumes could be a red flag.
- Regular audits: It can be worthwhile to conduct regular audits and reviews of financial records and operational processes to detect any irregularities and identify potential fraud indicators.