Most Common Investment Frauds

Fraud

I discussed in a previous post that there are mechanisms in place to protect investors however, we should never under estimate the determination of a scammer. Their most recent successes show that they are innovating just as quickly as the laws are evolving to stay ahead of the regulators. One of the ways that you can protect yourself is by learning to recognize the features of a fraud  before it happens. Here I will discuss some of the most recent and successful schemes that have robbed Americans of billions.

PONZI SCHEME: The fraud is set up in a way that the existing investors’ “returns” are actually payments from the funds collected from new investors. The issue with a Ponzi scheme is that the investment managers do not actually invest the money so there is no return. The dividends being paid out rely on a continuous flow of new investors and eventually, they will run out of new investors, at which point the oldest investors will see their returns decline and the newer ones will never have a chance at getting their money back as the scam collapses.

Some red flags include guaranteed returns (there is no such thing), unlicensed investment managers (no regulatory oversight), inaccurate or inconsistent records (if it’s true the information should be correct and consistent every time).

PYRAMID SCHEMES: We’ve all seen the social media posts of Shakeology/Beach Body, Herbal Life, #shoppingannuity, etc. Before social media, those of us who were kids in the 90s remember our parents discussing Amway. They are old and the concept has not changed. The only thing that changed is the service or product they’re selling. Essentially, the participant offers a service or product, but the key to actually making money heavily relies on recruiting new members. Participation often requires steep membership fees or even low but regular dues that quickly add up in addition to being required to buy the product being offered. The primary emphasis is usually on recruiting as the products being sold tend to be available elsewhere for a more reasonable price, making it difficult to build a consistent client base with it. All pyramid schemes will collapse eventually and most investors except for those at the very top of the pyramid will lose their money.

Pyramid scheme red flags are aggressive recruiting efforts that border desperation (that’s where the real money is), confusing commission structure (why does everyone above you get a cut of what you earn?), no real revenue from product (as stated above).

PUMP AND DUMP SCHEMES: This one is near and dear to my heart. When I first started investing in the stock market at 22, I lost $5,000 in a pump and dump scheme after following the advice of someone I thought was a knowledgeable after he made some good profit on Citi stock. Usually the scammers will tell you they have info (pumping) on this hot new stock, often penny stocks (which is why some brokerage firms won’t let you invest in penny stocks if you don’t mean a minimum account balance). You and hundreds if not thousands of other people invest and the activity drives up the price of the stock. The fraudsters then decide when they get tired of the game or when they have run out of people to contact, they sell their share of the stock (dumping) making big profits right before the price collapses and everyone else who didn’t know better loses big time.

Some red flags you should watch for are stocks that no one else has heard of, stocks that you’ve only ever seen on social media or unsolicited email chains, stocks for companies where little to no financial information is available.

Remember that no one is immune fraud no matter how seasoned or inexperienced the investor is. The key is to stay vigilant and scrutinize every proposal.

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