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How Difficult Should It Be to Prove Fraud?

09/06/2012 09:42 am ET | Updated Nov 06, 2012

Throughout the economic crisis a spoken or implied question has been why individuals have not been jailed and transactions rescinded due to "fraud." Behind this question is our legal systems' definition of fraud. This brief comment can only encourage the reader to consider the social and economic issues surrounding the proof of fraud. Volumes have and could be written on this topic. By necessity, what follows is an incomplete list of debatable public policy questions.

The classic common law definition of fraud is an intentionally false statement of material fact that is justifiably relied upon and this reliance causes injury.

"Intent" addresses state of mind, always difficult to determine. Typically a jury determines intent. On the kindergarten playground we learn the difference between accidental and intentional wrongs. As Justice Holmes famously wrote: "Even a dog distinguishes between being stumbled over and being kicked." What would be the implications if proving fraud ignored the state of mind of the actor? Would there be less innovation and economic activity due to fear of the consequences if the transaction produced a loss? Should society punish innocent mistakes? If so, under what circumstances?

What constitutes a "false statement?" This may be debated. What should be the role of projections, opinions, and sales talk (puffery) in the world of business? Who can definitively know the future? Should silence be fraudulent as a general rule? Do we want to obligate a mandatory legal and financial education as a prerequisite to borrowing money to purchase a home? Have you ever attended a closing in which a borrower insisted on reading every word of every document and being educated on the possible implications of each word? How much "personal responsibility" or mandatory "consumer protection" do we want? What are the socially and economically desirable features of "freedom of contract" and a "free market economy?" In many transactions, our legal system requires disclosure in a standardized format of certain facts. Is this desirable?

A "material fact" is one that would influence the decision of a reasonable person. If a lender discloses that a home mortgage payment is "interest only" or has a "balloon payment" is that sufficient or should that lender be required to present information about the undesirable aspects of these terms? Should certain contract provisions be prohibited by law or should it be a matter of personal decision to accept or reject the terms?

"Justifiable reliance" places responsibility on an individual not to ignore what he/she does or should know and not to blindly believe everything that may be stated. A problem is that "trust" in statements and actions is a basic social and economic feature of a smoothly functioning social and economic system. Should individual verification be the rule? Is "buyer beware" without governmental intervention the best policy?

"Injury" traditionally means individual economic loss. Should possible or actual societal losses also be considered? What individuals, if any, should be held accountable for an economic crisis?

Finally, in a large corporate structure, to what extent should senior leadership be responsible for the actions of "rogue" employees? Are there systemic changes that should be mandated, such as the way senior leaders are compensated? Should senior leaders be strictly liable for all actions occurring within the organization? What connection, if any, should there be between the injured individual and the person being held accountable? Again, the question becomes the appropriate balance between governmental controls and individual and corporate freedom of contract and action. What balance produces the greatest good for society, to use utilitarian language?

How difficult should it be to prove fraud?