Investment Fraud: How to Protect Yourself

May 26, 2015

A few years ago a securities analyst, economist, and the owner of the New York Mets walked into a money manager’s office. It sounds like the beginning to a bad joke, but what happened next is anything but. Despite being highly educated and investment savvy, each of the three was eventually defrauded by a Ponzi scheme run by Bernie Madoff. Ultimately the scheme defrauded investors of billions, yes billions, of dollars.  You don’t have to own the New York Mets to be targeted though. Victims of investment fraud transcend all ages, ethnicities, education levels, and socio-economic classes.

If you weren’t nervous about investing before you probably are now. Yet investing is a key component on the path to financial security. How can a person protect themselves against fraud when the most intelligent and diligent investors get duped?

Understand what you're up against 

First the good news. Human beings are naturally skeptical creatures. The bad news is that fraudsters are well aware of this fact too. It is no coincidence that fraud tactics listed on the Financial Industry Regulatory Authority (FINRA) match those discussed on numerous marketing websites. Both legitimate sales and fraud rely on psychology to overcome a consumer’s natural skepticism. The best way to inoculate one’s self and remain objective is to be on the lookout for these commonly used psychological tricks.

Greed
Most of us have at least a small streak of greed in us. You might have $100,000 in investments, but what if I found an investment that could turn it into $1 million? Scammers play on the part of us that desires what we don’t, or can’t, have.

Credibility
By using something called the “halo effect” a scammer can easily establish trust. Fraudsters understand that trust is the foundation of all human interaction. They understand that a target’s worst fears can override even their loftiest goals. Successful scammers overcome these fears by immediately winning trust by establishing themselves as credible. Would you accept investment advice from someone who doesn’t have any credentials or a Registered Investment Advisor? It doesn’t really matter because both are equally capable scamming you, the Registered Investment Advisor will just have more success because they come across as more trustworthy.

Social Consensus
We tend to think of it as a teenage problem, but we’re subjected to peer pressure on a regular basis. The desire to fit in with a group is normal and peer-pressure goes a long way to accelerating an individual’s acceptance of social norms. Fraudsters will subtly use peer pressure against you by dropping the names of your coworkers or neighbors who have already invested. They’ll mention how Warren Buffet used the same investment way back in his earliest days. They’ll even tell you about how they signed their pastor up.

Reciprocity
Better known as “you scratch my back and I’ll scratch yours," this tactic makes it appear that a consumer is getting something up front in return for signing up right now. Meant to distract from the enormity of the initial investment, this tactic is a highly effective closing technique that appears to sweeten the deal. This tactic usually takes the form of a discounted commission or waiver of fees or even a tangible good if you sign-up right away. Suppose I offered you an iPad for that $100,000 investment I’m going to turn into $1 million? Sure I’m out the price of the iPad, but I just nabbed a hundred grand from you. Congatulations, you’re now the owner of the world’s most expensive iPad.

Urgency
“Act now! Supplies are limited!” Sound familiar? Fostering a sense of urgency is another tactic used to cloud consumer judgement and prevent further investigation into the investment. A fraudster might tell you that there are only two slots left for this investment and that they have three appointments after yours. Oh, and guess what? All three are hot to get into this exclusive investment opportunity.          

Look for these red flags to know if someone is trying to scam you

Unsolicited contact 
Believe it or not a scammer will call you out of the blue. If you didn’t seek out the contact or aren’t looking for a new investment option, it’s time to go on red alert. It’s wise to ignore the contact completely before the scammer can use their tricks against you.

Guarantees 
Even the safest legitimate investments come with some degree of risk. Be wary of anyone who promises a specific return.

Overly consistent returns
There are money managers and investments that get consistently positive returns but even the best will see fluctuations in those returns. If the investment consistently outperforms similar investments there’s a decent chance that someone is being dishonest in their reporting.

Unregistered products or individuals 
If you can’t find the product or individual listed on a reputable source like the SEC, FINRA, or a trading exchange, beware! Take a look for a similar investment on a well known exchange, investment company or reporting agency.

No prospectus, or offering circular
Not only should this raise your suspicions about whether the investment is legitimate, it is also an indicator that the investment is unregistered. Be cautious of individuals who have documentation but can’t give it to you, “because it’s my last copy”. Of course these days anyone with a computer and printer can make professional looking documents so don’t use the plan documentation as the only indicator.

Transactions and balances do not match 
Whether it is a bank, credit card, wages or security the issuing agency should provide regular statements and transaction records. If you find something amiss on a statement once it might be a mistake. If statements and transactions are wrong consistently there’s a problem beyond a simple mistake.

The investment strategy is confusing
If an investment professional can’t explain an investment in clear terms they may not have any idea themselves how the investment works. They may also be attempting to disguise a sham. If you don’t understand the investment or it seems too complex, step back and take a breath. Complexity is a big warning sign.

Aggressive sales people
Aggressive sales tactics are a no-no even when the investment is not fraudulent. Anyone who won’t give you time to consider your decision is probably not someone you want to work with anyway, or they may be worried about what you might find out when they aren’t around. Be cautious when someone starts putting a pen in your hand, berates you for not making a quick decision, or repeatedly calls after you have declined the offer.

What to do it if you think you’re getting scammed

Slow down
No matter what you think about the legitimacy of the investment careful consideration is always important. Take a moment to catch your breath and remove yourself from the torrent of a sales pitch. This means changing your environment completely, not just the sales representative giving you fifteen minutes alone in their office. Go home, go for a walk, or get a cup of coffee and think things through without distraction.

Do your homework
Known as doing due diligence, look into the person or firm offering the investment. If the individual holds a license or certification, contact the issuing agency to determine if licenses and certifications are current and or under suspension for disciplinary reasons. Verify that the investment is registered with the appropriate regulatory agencies such as the SEC or state securities commission. Compare the investment to similar investment classes to determine if the returns and potential are in line.

Say no
If you are declining the offer use the word “no” often. Be clear and firm in your declaration. If a scammer sees a glimmer of doubt they won’t quit until they’ve reeled you in.

Report
Financial regulators are over worked but it is important to report suspicious investments and individuals to the appropriate regulatory and certifying agencies. Regulators are there to protect consumers but they need your help to sniff scammers out. Most regulating and certifying agencies have websites where consumers can lodge complaints easily. If not, they all have phone numbers.

Conclusion

The world of investing is difficult enough to navigate as it is without the addition of dishonest people. While we want to trust others and their good intentions, it is important to give careful thought to any investment, including the validity of the opportunity.  Educate yourself, keep your eyes and ears open for warning signs, and do your homework.                  

This post was written by Shane Linart, a field education representative from Colorado PERA. Would you like to write a guest post for The Dime? Email us at dimecontact@copera.og.