Avoiding Investment Fraud: Don't Get Taken

By Timothy E. Eble © 2007 classactionlitigation.com

A desire to profit has always had appeal to Americans. It is a common characteristic of a capitalist economy and a motivating factor in driving economic success. When a desire to profit turns into Blind greed, however, it is dangerous. It can destroy an individual's net worth, cause desperation, and ruin reputations. Blind greed decisions are made on emotions, not on reason. It is for that reason that many bad investment scams could be avoided if the investor stopped to logically think over the facts before handing over money to a dishonest "investment advisor" or some other individual with a grandiose "plan."

It is a fact that any investments involve a certain degree of risk. So how does an individual avoid being taken in by a fraudulent investment adviser? There are some principles if followed that can minimize the risk of loss to an investor.

A local boy genius with a proven track record of beating the "stuffed suits" on Wall Street by a wide margin is an unlikely scenario. The equities market is driven by institutional and money fund investors who are floating billions of dollars in and out of the market. They don't follow the market; they drive the market. Anyone claiming to beat the market with outstanding returns on a consistent basis deserves investigation before money is put in his trust.

Investors should avoid placing money in any investment that they do not personally understand. An investment advisor with unexplained "investment pools" and trading in futures or investment products that entail high risk or an incomprehensible "smoke and mirrors" explanation should be avoided. If you don't fully understand the mechanics of futures or commodities trading as well as the risk, stay clear of those investments. Do not place money in someone else's hands for investment unless the investments to be made are clear, concise, logical, verifiable and understood. The risk of loss is simply too great.

Be aware of claimed investments in jewelry, art, gems, gold or commodities. Investment in such "hard assets" entails a high degree of risk. The value of commodities, metals, even oil, can dramatically go up, or down. Further, the more diversified any one person claims to be in the commodities market, the less of an expert he can be in any more than one of the investments.

Don't be victimized by your own courtesy. Scam artists will exploit good manners and consideration of their potential victims. Remember that an unknown person who calls you and asks for your money is to be regarded with skepticism if not utter contempt. If a legitimate investment advisor has a proven track record, he doesn't have to call strangers on the phone with a sales pitch. The sales pitch operators are often inept boiler-room operators whose only concern is to con the unsuspecting public. You have no obligation to stay on the phone, be courteous, or even engage in a conversation with unsolicited callers trying to rope you into some "great deal."

You don't need to be polite to people that ignore the registry, and you should feel free to hang up on them without talking to them at all after they identify themselves. Simply hanging-up the phone can save a lot of aggravation.

Steer clear of investments that are being sold for the sole purpose of creating tax losses or avoidance of taxes. These investments have a history or unpopularity with the IRS and are likely to lead to an audit, tax penalties and potential criminal claims. In any investment involving serious tax issues or ramifications, consult a reputable tax lawyer before investing.

Avoid Affinity Fraud. Con artists who share a common community activity with their victims in ethnic, religious, career or community based groups often attempt to get prominent members of a group to trust them by first selling their scam to them. Those people get the promised high "guaranteed" returns and are then used as references when the scam is pitched to other members using the previous investors as references. The early investors may be wildly enthusiastic about the scheme that will ultimately collapse after a sizeable number of other members are taken in. The early investors may be quite loyal to the scam artist and others may be ashamed or embarrassed by losing money and reluctant to turn the scam artist in to authorities. Just because someone belongs to the same church or organization you belong to is no reason to place and undue degree of trust in that person. Ignore the relationship and check them out as if they were strangers.

In deciding whether to invest money with any person, the confidence and assurances of success that person conveys should be ignored. The term "con man" is short for confidence man, i.e., a person who develops a relationship based on trust in order to steal. In fact, any claims of "no risk" or "fast high profits," should instantly raise a serious question about the legitimacy of the investment. Since con men operate on instilling trust or confidence, testimonials of strangers regarding the legitimacy of the investment scheme should be met with a healthy degree of skepticism. If the scheme operating is a Ponzi* scheme the testimonials may be from early investors who were, in fact, paid off with the money of later investors for the sole purpose of luring in more investors.

* A Ponzi scheme is a fraudulent investment operation that promises extraordinary returns to investors from its business and investment operations, but actually pays early investors returns from money invested by subsequent investors. The operation of a Ponzi scheme depends on a constant influx of new money that exceeds the amounts of funds that are withdrawn by the early investors. Thus, from the outside to the early investors, it appears the returns promised are actually being achieved and available for withdrawal. The Ponzi scheme operator can also refer later investors to a group of satisfied early investors for confirmation that the returns promised are actually being achieved and paid, thus reassuring the new victims that their investments are secure.

Recognize the signs of fraudulent investment scammers. The following information from the Washington State Secretary of Financial Institutions represents an excellent summary of the signs of a con artist:

Any deal that sounds too good to be true is probably not true. If anyone approaches an investor with claims that make an investment program sound to good to be true there is probably something wrong with it. Any claim of an investment return that is not consistent with current market conditions and returns should automatically trigger investigation or, at least, further inquiry.

The first place to start that inquiry is at the Securities Investor Protection Corporation website, www.spic.org. SIPC serves to help people whose money, stocks and other securities are stolen by a broker or put at risk when a brokerage fails. If you are considering investing other than in any investment you control yourself, or monitor on a constant basis, investing through a member firm of SIPC provides a degree of protection from theft or misappropriation of funds. Further details about SIPC are available on their website. However, if a securities or investment broker is not a member of SIPC, it should raise a big red flag of increased risk on any deal involving them, or preclude dealing with them at all.

Secondly, on a state level, every state has agencies that assist in determining whether a broker or dealer of securities or investment "opportunity" is legitimate. As stated on the website of the South Carolina Office of the Attorney General Securities Division:
All individual brokers-dealers and brokerage firms that do business in South Carolina must register with the Securities Division. This office licenses and regulates the conduct of brokerage firms and their agents. In addition, the Securities Division has access to a nationwide database of brokers and brokerage firms through the National Association of Securities Dealers (NASD) and can quickly find registration status of brokers anywhere in the United States.

To find out if a firm or individual is registered or is the subject of reportable complaints, contact the [South Carolina] Securities Division at 803-734-9916.
That same website has a list of the top 10 questions a person should ask an investment advisor before investing:
  1. Are you registered with the National Association of Securities Dealers (NASD) and the State of South Carolina? (If they say they are not required to be registered, ask why, then verify this with the Securities Division.)
  2. What is your Central Registration Depository (CRD) number? I want to check your disciplinary and work history with my state regulators
  3. Where are you located? Does your firm have any offices in South Carolina?
  4. How long have you been in the investment or brokerage industry? (You can verify this by calling the Securities Division.)
  5. Is your firm a publicly held corporation with an exchange-listed stock? What symbol? (Most legitimate brokerage firms are listed on major exchanges.)
  6. Would you send me some written information about yourself, your firm and the investments you are trying to sell me? (Beware of handwritten material or "flashy" brochures.)
  7. Are the investments you are trying to sell me registered in the State of South Carolina? (If the salesperson says they are exempt or not required to be registered, ask which specific exemption was granted, then tell them you want to check this with your state regulators.)
  8. Can you guarantee a certain amount or percentage return on my investment? (If the salesperson says "Yes", beware. There is no such thing as a guaranteed investment.)
  9. How many clients do you have in South Carolina/ my community?
  10. Can you give me references in my community who are clients of yours?
The above example is for South Carolina, but you can locate your state agency through the following website which contains a directory for every state in the United States and the provinces of Canada. http://www.nasaa.org/QuickLinks/ContactYourRegulator.cfm

In general, if satisfactory, readily verifiable answers are not provided to all of the questions above, that investment advisor, in my opinion, should be avoided.

If someone is trying to convince an investor to invest in a particular company, information is also available to help access the degree of risk of investing in the company involved.

Federal securities laws in the United States require many public companies to register with the SEC and file annual audited financial reports. These reports may be accessed by the public from the SEC EDGAR database for free. Information about EDGAR and the database is also available.

The National Association of Securities Dealers maintains a database to help investors check the professional background of current and former NASD securities firms and brokers. If an investment advisor is not NASD registered, caution should be exercised in dealing with or providing personal information to him.

Finally, if the investment involves futures trading, an organization exists that may be able to provide some information regarding futures-trading businesses. That group is the National Futures Association. http://www.nfa.futures.org/

As stated on the NFA website: "One of the first things any investor should do before trading futures is conduct a background check on the firms and individuals offering these products."

The above represent a number of basic preventative measures to avoid fraud. If you find yourself victimized by a suspected fraudulent investment advisor or scheme, you should immediately report the situation to the appropriate authorities. If the scheme involves investment or securities sales, the links in this article may help you locate the appropriate office. Among those you may need to contact are the SEC complaint center at www.sec.gov/complaint.shtml. You should also contact your state securities regulatory authority. For addresses and phone numbers of state regulators, refer to the following link for information: http://www.nasaa.org/QuickLinks/ContactYourRegulator.cfm .If criminal fraud is suspected, you may desire to contact the Federal Bureau of Investigation. Also, legal action may be taken either in court or in arbitration proceedings, depending on the situation, which may recover your lost funds. In some cases securities violations may be addressed by class action proceedings in state or federal court. Contact a lawyer competent and experienced in such cases to assist you.

Further information on fraud prevention may be found at the following links:
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