Investment Scams and Frauds

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Investment Scams and Frauds

Although it is easy to read a story about the latest investment scam and shake our heads at the ridiculousness of it all, there is a reason these scams persist: they work. The scammer uses detailed, sophisticated, official-sounding language that is over the heads of most victims. The scammer projects an air of authority, which soothes the fears of the victims. The scammer adds an air of urgency. And many otherwise educated people fall for them. If you don’t know of any such people, perhaps they were too embarrassed to admit they fell for them.

Investment scams come in many forms. Here are some of the bigger ones:

Ponzi Schemes

Similar to a pyramid scheme is a Ponzi scheme, named for Charles Ponzi, who defrauded investors out of millions in the early 1900s. In a Ponzi scheme, the schemer gathers money from a large group of people to allegedly invest it, but instead of investing it, keeps most of it, and pays small "dividends" to the earliest joiners out of the funds of later joiners. These "dividends" give it an air of legitimacy. The scheme collapses when not enough new investors can be found to keep up the payment of dividends.

Not all Ponzi schemes start out that way. As with Bernard Madoff (the biggest Ponzi scheme of all time), what was once a legitimate investment opportunity with high returns eventually became a Ponzi because those high returns could not be sustained. This makes it hard to identify these operations as illegal. What can you do to guard yourself?

• Investigate any investment that makes claims of high returns for low risk or "you can’t lose." Research it online.
• Ask a broker or financial advisor before investing.

Prime Bank Note Fraud and Letter of Credit Fraud

"Prime" bank notes and letters of credit are fake investments in "bank guarantees" (a type of letter of credit) used by large, established banks. Scammers try to convince you that by sending your money to them, you can participate in these notes and receive unusually high returns quickly. In reality, they just steal your money.

Banks do use similar instruments (to ensure payment for goods in trade), but they are not sold or traded on markets. Scammers target not only individuals, but also organizations and associations. They even advertise in mainstream media. Here are some tips for protecting yourself:

• Always be skeptical of any investment claiming a high yield and/or low risk.
• Beware if the promoters are claiming that the investment is secret or confidential or limited to only a few people. Secrecy and exclusivity are common tipoffs to scams.
• Beware if the opportunity is vague about how it works or who is involved. Beware if the promoters rebuff your attempts to understand the investment.
• Verify the investment opportunity by researching it as well as you can. Consult a broker or an investment advisor or an attorney if you can.

Unscrupulous or unlicensed agents and brokers

Just because people are agents or brokers does not mean they always act ethically. Sometimes they can be enticed by scammers into promoting fraudulent investments. Sometimes they don’t even know how these investments work.

People who sell investments must be licensed by their state securities regulator, but not all salespeople actually are. Contact your state securities regulator to find out whether a salesperson—and the investment itself—is actually registered. If you already have a broker, read your statements carefully for any unauthorized trades, unexplained fees, or anything suspicious.

"Pump and Dump" Fraud

This is market manipulation that creates artificial demand for an investment, usually a stock. This artificial demand causes the market price to go up (the "pump"). At some point, the perpetrators sell off the investment (the "dump") and realize a profit. Pump-and-dump schemes are usually promoted in Internet chat rooms, social media, and email lists.

To avoid these scams, find out where the investment is trading, verify any claims, and research the investment itself. If you have an online broker account, you may have access to research on investments.