What’s the Difference Between First-party and Third-party Fraud?

According to Federal Trade Commission data, in 2023 there were over 1 million cases of identity theft in the United States, resulting in losses in the tens of billions of dollars. Understanding the most common types of fraud is the first step to tackling this problem via effective fraud prevention strategies. The two primary categories of identity fraud are first-party fraud and third-party fraud.

What is first-party fraud?

First-party fraud occurs when an individual deliberately provides false information or misrepresents themselves to obtain goods, services or credit. This type of fraud is typically committed by the person who will ultimately benefit from the deception. First-party fraud is often difficult to detect because the perpetrator is using their own identity, albeit with manipulated or falsified information.

Some common examples of first-party fraud include:

• Application fraud: This involves providing false information on applications for credit, loans or other financial services. For instance, an individual might inflate their income or provide a fake address to qualify for a loan they wouldn't otherwise be eligible for.

• Bust-out fraud: This is when the perpetrator initially establishes a good credit history, only to max out credit lines and disappear without repaying the debts. This type of fraud is particularly challenging to detect because it starts with seemingly legitimate behavior.

• Misuse of accounts: This includes unauthorized use of credit or debit accounts by the accountholder. Examples include maxing out credit cards without intention to repay or disputing legitimate charges to avoid payment.

• Friendly fraud: Often seen in ecommerce, friendly fraud occurs when a legitimate customer makes a purchase and then disputes the charge, claiming it was unauthorized. This can result in chargebacks for the merchant.

What is third-party fraud?

Third-party fraud, on the other hand, involves the use of another person’s identity without their knowledge or consent. This type of fraud is usually perpetrated by identity thieves who steal or purchase stolen personal information with the intention of committing fraud. The victim is typically unaware their personal information has been compromised until after the fraud has occurred.

Examples of third-party fraud include:

• New account fraud: This occurs when a fraudster opens new accounts, such as credit cards, loans or utility services using someone else's personal information like a phone number, email address, Social Security number, or existing credit card or bank account details. This is a form of identity theft that can lead to significant financial and reputational damage for victims (customers and organizations).

• Account takeover (ATO): This entails a fraudster gaining access to a victim's existing accounts, such as banking, email or social media accounts. They may change account details, make unauthorized transactions or use the account to enable further fraudulent activities.

• Synthetic identity fraud: This involves creating a fake identity by combining real and fictitious information. For example, a fraudster might use a real Social Security number (often stolen from a minor or deceased person) along with a fake name and date of birth to create a phony or synthetic identity. This synthetic identity is then used to open accounts and build a credit history, eventually leading to significant financial fraud. Synthetic fraud is particularly challenging to detect because it doesn’t rely entirely on stolen identities and takes time before the victims themselves can detect the fraudulent activity.

• Identity theft: This occurs when an individual’s personal information is unlawfully obtained (by techniques like phishing and social engineering) and used by a third party to commit crimes, such as opening new credit accounts, making unauthorized purchases or engaging in other forms of financial fraud.

What’s the difference between first-party and third-party fraud?

The most significant difference between first- and third-party fraud is the identity of the perpetrator. In first-party fraud, the fraudster is the legitimate accountholder or applicant. In third-party fraud, the fraudster is an external entity who steals or fabricates an identity. First-party fraud often involves deliberate misrepresentation by the individual for financial gain, such as lying on loan applications or committing friendly fraud. Third-party fraud, on the other hand, involves identity theft — which enables the perpetrator to use another person's identity to commit fraud.

How do organizations detect and prevent first-party fraud?

Detecting and preventing first-party fraud is challenging because the fraudulent activity can appear legitimate at first. Advanced identity verification using a combination of sophisticated technologies and tools are essential for better detecting discrepancies in application information. Some effective strategies include:

• Advanced analytics: Organizations use advanced analytics, artificial intelligence and machine learning (AI/ML) algorithms to identify patterns and anomalies that may indicate fraudulent behavior. These tools rapidly analyze vast amounts of data to help detect inconsistencies in application information, transaction histories and spending patterns.
• Identity verification: Implementing robust identity verification processes, which include verifying personal information, income and employment details, can help prevent first-party fraud. This typically includes cross-referencing information with third-party databases and other in-depth digital checks.
• Behavioral biometrics: Behavioral biometrics analyze user behavior, such as typing patterns and navigation habits, to create a unique profile for each user. Any deviation from this profile can trigger alerts for potential fraud.
• Fraud detection software: Specialized fraud detection software can monitor transactions in real time and flag suspicious activities. These systems use various rules and algorithms to better identify potential fraud and prevent it before it occurs.

How do organizations better detect and prevent third-party fraud?

Preventing third-party fraud requires a multilayered approach to identity verification that combines technology, education and vigilance. Here are some effective measures:

• Multi-factor authentication (MFA): Implementing MFA adds an extra layer of security by requiring users to provide multiple forms of verification — such as a one-time passcode (OTP), knowledge-based questions (KBA) or biometric scan — when accessing systems or initiating transactions.
• Identity fraud detection tools: Organizations use advanced identity fraud detection tools that can identify and block suspicious activities in real time. These tools can detect unusual login attempts, new device usage, and changes in user behavior.
• Regular account monitoring: Continuous monitoring of accounts for unusual activity can help detect identity takeover attempts. Alerts can be set up to notify accountholders and security teams of suspicious transactions or changes in account information.
• Synthetic identity fraud detection: Detecting synthetic fraud requires a combination of techniques, including verifying the authenticity of identity components and cross-referencing data with multiple sources. AI/ML algorithms and models can also help identify patterns indicative of synthetic identities.
• Public awareness campaigns: Educating customers about the risks of identity fraud and new fraud schemes, and promoting better security practices like using strong passwords and regularly updating them can help reduce the likelihood of third-party fraud.