How History Sheds Light on the Limits of Fraud Prevention

The common law of fraudulent misrepresentation, whether in tort or contract, balances the alleged fraudster’s intentional deception against the victim’s unjustified reliance. The law does not reward the victim who should have known better than to trust the fraudster’s representations. But why perform this balancing? Why not just focus on the wrongdoer’s intent and ignore the gullibility or implicit complicity of the victim? A wrong is a wrong, after all.

In a new paper, I argue that an answer may be found in the very long history of fraud, and the concomitantly long history of fraud prevention.

While we may imagine that fraud is a modern phenomenon enabled by complex financial systems, the corporate structure, and modern capitalism, fraud is, in fact, an eternal feature of human society. We only get three chapters into the Bible before the serpent deceives Adam and Eve into eating the fruit of the forbidden tree. The Code of Hammurabi from the 18th century B.C.E. details such frauds as selling stolen goods as legitimate, agents cheating their principals, and deceiving a barber into marking someone as a slave for sale who was not a slave for sale. And already in the 4th century B.C.E., an Athenian court was hearing a case of marine insurance fraud of essentially the same type as is likely being perpetrated somewhere on the high seas right now.

Just as fraud has been omnipresent, so have efforts to combat fraud. Transactional parties and governments have for centuries played a cat and mouse game with fraudsters in the form of regulation, reputation policing, public and private verification intermediaries, public service information to warn people about current scams, moral training, and court enforcement of legal doctrines of misrepresentation. These fraud prevention mechanisms may help lessen fraud, but they have never eliminated it.

This is where the balancing element comes in. In the marketplace, stamping out fraud entirely would mean removing trust from transactions. But trust is efficient. When some, perhaps most, people trade honestly, it often makes more sense to trust rather than to verify, despite knowing that on occasion such trust will be rewarded with deception. Otherwise, traders must frequently pay the cost of verification that would be unnecessary.

Similarly, the cost of excess regulation weighs on the honest as well as the dishonest, while the enforcement of regulations is never perfectly effective. As such, although governments have for centuries felt it necessary to regulate the market to curb fraud, history suggests that this regulation often followed a pattern: Pass regulations, outsource enforcement, and ultimately arrive at a modus vivendi with the transgressors in which minor chiseling is ignored or commuted into a tax and enforcement resources are reserved for more serious wrongdoing. (To the extent that the current Department of Justice enforcement pattern focuses on prosecuting small cheats rather than going after big frauds, as a new article suggests, this would subvert the historical pattern.)[1]

If we cannot eliminate fraud, then how should we keep fraud in check to support commercial trust while not overburdening trade with needless or ineffective verification and regulation? As I suggest in my article:

The best governments and individuals can do is find the point at which the risk of fraud and the cost of fraud prevention balance each other out. That point never represents zero fraud. Call it the Hand Formula of fraud: if the cost of fraud prevention exceeds the probability of fraud and the harm caused by the fraud, then it is better to trust rather than to pay for prevention. Just as tort law recognizes that we cannot expect to live in a world without risk, so this practical balancing of fraud prevention and fraud tolerance recognizes we cannot expect to live in a world in which no one cheats.[2]


[1] Stephanie Didwania, Regressive White-Collar Crime, 97 Southern California Law Review (forthcoming) (arguing in the abstract that the “government prosecutes an enormous number of people for financial crimes and that these prosecutions disproportionately target the least advantaged U.S. residents for low-level offenses.”).

[2] Emily Kadens, The Persistent Limits of Fraud Prevention in Historical Perspective, 118 Nw. U. L. Rev. 167, 191-92  (2023).

This post comes to us from Professor Emily Kadens at Northwestern University School of Law. It is based on her recent article, “The Persistent Limits of Fraud Prevention in Historical Perspective,” available here.

1 Comment

  1. Peggy Oestreich

    I don’t think w’ll get trust back in anything for a long time. Shame we can’t turn back the clock. 🙏

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