Fraud Awareness for Small Businesses: First-Party vs. Third-Party Fraud

"The trust of the innocent is the liar’s most useful tool." – Stephen King

Fraud in the business world is not a one-size-fits-all problem. It comes in many forms, but two of the most significant categories are first-party fraud and third-party fraud. Understanding the differences between these types of fraud and how they impact small businesses is essential for protecting your finances, reputation, and long-term success.

What is First-Party vs. Third-Party Fraud?

First-Party Fraud

First-party fraud occurs when a business or individual misrepresents information to gain financial benefits. Unlike other forms of fraud, there is no external fraudster—just someone manipulating the system for their own gain. Common examples include:

• Lying on Loan Applications – Businesses exaggerate revenue, falsify financials, or misrepresent ownership to qualify for financing.

• Friendly Fraud (Chargeback Fraud) – A customer makes a legitimate purchase, then falsely claims fraud to get a refund while keeping the product or service.

• Application Fraud – Businesses create fake entities to apply for multiple loans or lines of credit.

First-party fraud is difficult for lenders and suppliers to detect because it often involves real businesses or individuals who appear trustworthy on paper.

Third-Party Fraud

Third-party fraud occurs when an external actor—someone outside the business—exploits stolen or fake identities to commit fraud. Examples include:

• Identity Theft – Fraudsters use stolen business or personal identities to open accounts, secure loans, or make unauthorized purchases.

• Account Takeover – Hackers gain access to legitimate business accounts and make fraudulent transactions.

• Invoice and Payment Fraud – Scammers impersonate suppliers or employees to trick businesses into sending payments to fraudulent accounts.

Unlike first-party fraud, third-party fraud often involves deception that the business itself is unaware of until it is too late.

The Grey Area Between First-Party and Third-Party Fraud

Despite these clearly defined categories, there is a significant grey area between first-party and third-party fraud.

Blurred Lines in First-Party Fraud

First-party fraud assumes that everyone in a business is a single, unified entity acting together. However, even in small businesses, employees or partners may be unaware of fraudulent actions taken by others. Some individuals may have legitimate authority to act on behalf of the company, while others do not. Additionally, motivations can vary:

• Some may commit fraud for personal gain, such as inflating sales numbers to receive higher bonuses.

• Others may manipulate financials to help the company survive difficult times.

• Some may engage in fraud for a mix of both reasons, trying to boost both their personal standing and the business’s success.

The Grey Area in Third-Party Fraud

Similarly, third-party fraud isn’t always committed by a completely external actor. Fraudsters sometimes rely on "sold" or "borrowed" identities—where a real person or business willingly provides their identity details for fraudulent use.

For example, a fraudster running a traditional stolen identity scam may have access to inside information normally associated with first-party fraud. This gives them an advantage in bypassing traditional security measures. In these cases, the fraudster can combine the deceptive aspects of third-party fraud with the operational knowledge of an insider, making detection even more difficult.

Fraud is Always Evolving

We define these types of fraud to better understand how to protect ourselves, but fraudsters increasingly exploit the grey areas to uncover new opportunities. Be aware of these types of fraud, but remember that these categories are based on what we have seen in the past—not necessarily what can happen in the future. As criminals find new ways to manipulate systems, businesses must stay vigilant and adapt their defenses accordingly.

Red Flags to Watch For

• Inconsistent Financial Documentation – Revenue, expenses, or customer data that don’t match historical trends.

• Suspicious Account Changes – Unexpected changes to payment accounts, logins from unusual locations, or unauthorized transactions.

• Unverified Vendors or Customers – Requests for payment to unknown accounts, rushed financial transactions, or unverifiable business details.

How to Protect Your Business

• Verify Identities – Conduct background checks on employees, vendors, and partners before financial transactions.

• Implement Strong Security Measures – Use multi-factor authentication and encrypted payment systems to protect accounts.

• Monitor Transactions Regularly – Set up alerts for unusual spending patterns or changes in financial behavior.

• Educate Employees – Train staff on recognizing phishing scams, fraudulent invoices, and identity theft risks.

Final Thought:

First-party and third-party fraud are both major threats to small businesses, but knowledge is the best defense. By understanding the risks and implementing preventative measures, you can safeguard your business from financial loss and reputational damage.

Stay tuned for the next post in our Fraud Awareness series, where we’ll discuss Business Email Compromise (BEC) Scams and how they target small businesses.