Of all the many tragic things that can befall us, few things come close to the heartbreak and desperation of losing all of one’s life savings in an investment scam. In spite of the volumes of news articles, investigative journalism, and financial documentaries warning us about the pitfalls of investment fraud, innocent and trusting people are still being conned out of their hard-earned funds by swindlers.
In recent financial news, yet another investment scam, this timeinvolving cryptocurrency Bitcoin, have come to light and investors have lost millions of dollars after the scheme have been found to be involved in fraudulent activities and operating illegally. The battle to recover investor funds is now being waged in courts, but not surprisingly, the kingpins are long gone, and investors will be lucky to recover any of their missing funds. Sad – but certainly not unique.
It is tempting to speculate that individuals who end up being conned out of their money should have known better or should have seen the warning signs, but the reality is, when returns are high and payouts continuous, caution is thrown to the wind, which is exactly why the irregularities at Enron and the Bernie Madoff Pyramid scheme went on undetected for so long.
But why are investment scams so prevalent in our society, and how do reasonable and intelligent people get caught up in them? Research offers two key explanations. Firstly, global markets have been performing poorly for a number of years and most people are eager to listen to promises of greater returns on their investments, even if those claims are sometimes ridiculous and beyond what the average investor can expect to earn.
Secondly, the investment world is shrouded in a plethora of investment jargon, concepts and principles, clever financial terms and unique product permutations which can quickly confuse and put to shame even the most proficient investor. Being human we don’t like to admit when we don’t understand something. A bruised ego doesn’t ask questions and we are ultimately ruled by our psychology. We would rather accept an illogical explanation instead of voicing our disagreement or asking for clarification; in short, we would rather keep quiet and trust the process than to opt out.
Before we discuss investment scam red flags, it is important that we familiarize ourselves with the types of investment scams that defrauders and conmen employ to lure unsuspecting investors.
Here are 6 of the more prevalent investments scams and how they work in principle:
1. Pyramid Schemes
A pyramid scheme starts off with an initial member (or group of members) who present themselves as investors. Other investors are then coaxed into investing, who in turn need to recruit more investors and placed in a hierarchical structure (hence the name pyramid) underneath the initial investor. Individuals joining later in the scheme, pay the person who recruited them to join in the first place. The pyramid keeps on growing, and investors joining lower down in the hierarchy, are less likely to receive the full benefit. By the time the scheme stops growing, the top tier “investors” have all made substantial amounts of money, and the investors who joined last, end up with empty pockets.
2. Ponzi Schemes
A Ponzi Scheme is a type of scam that creates credibility for a false (non-existing) trading enterprise. The credibility and hype is fostered and amplified by the quick and high returns to investors, but in actual fact early investors are paid “profits” from the money invested by later entering investors. All funds are usually paid over to an intermediary or so-called portfolio manager, who moves the money around and ensures that profit payments are paid out on time. The scheme collapses when no new investors are sourced and when existing investors can’t get their money out of the scheme anymore. Ponzi schemes go to great lengths enhance their credibility by referring to other known professionals and well-known enterprises in the investment world with a solid financial track record.
3. Pump and Dump Scheme
A pump-and-dump scheme is a type of fraud in which the offenders accumulate a specific commodity over a period of time. The price is then artificially inflated by means of misinformation (referred to as pumping) and then sold (referred to as dumping) at the higher premium to unsuspecting investors. Since the price was artificially inflated to begin with, it inevitably returns or drops below its original market price, leaving the investors at a loss. Pump-and-dump schemes are sometimes cleverly marketed under the disguise of fractional or syndicate investment schemes.
4. Boiler Room Schemes
A boiler room scheme refers to an operation using high pressure sales tactics to sell stocks to randomly called individuals. These names are either bought or simply taken from telephone directories. Boiler room operations are usually setup in low-cost office blocks where large numbers of telemarketers make the calls. The stocks on sale might be legit but the sales information, statistics and projected growth of these stocks are usually false and designed to mislead investors. The main objective is to close the sale and make a commission. These stocks are referred to as over-the-counter stock as they are not sold on the formal exchanges and not subjected to standard disclosure, regulations, or oversight.
5. Pay-to-Play Schemes
A pay-to-play scheme, as the name suggests, requires investors to make a substantial upfront deposit before joining the scheme, but only once they managed to spark the would-be investor’s interest with false marketing jargon. The financial investment is often referred to as the buy-in premium or payment. All investments requiring investors to pay upfront fees (pay-to-play) in order to participate in the scheme, should be viewed with caution. Besides being based on deception and lies, many of these so-called brokers are not qualified to work in the securities sector. Be wary of excessive and extravagant reference to wealth, possessions, importance, or a lavish lifestyle.
6. Cold Call Investment Schemes
Cold-call investment schemes starts with a phone call that offers investors a once in a lifetime opportunity to be part of a lucrative investment. Once a specific number of investors have been locked in, the company closes up shop, and re-emerges somewhere else under a new name, in search of new investors. Although similar to a boiler room scam, the key difference is that a cold-call investment scam, have no real investment opportunity to begin with, or little hope of the investment ever getting off the ground. In most cases all the investment capital is lost, and investors have no hope or means of recouping their losses.
The above schemes are just some of the most prominent scams doing the round to lure investors to the table. Sometimes investment scams can be a combination of different elements of each type of scheme to appear more credible. To pinpoint or expose an investment scheme as a scam operation requires investors to get into the detail, and to look for red flags or any irregularities that cause alarm bells to ring, and most important to report it to the authorities.
Below is a list of 5 of the most important telltale signs (red flags) that an investment scheme is likely to be a scam in action:
1. Attractive Investment Presentations
Who doesn’t want to make more than enough money to live a comfortable life or retire in style? One hallmark red flag on investment fraud is promises of above market returns, guaranteed profits, and investments with practically no risk and no efforts required. The presentation is aimed at weakening our senses by means of focusing on our desires, fears, and materialism to ensure we are primed to making a rushed decision.
2. Confusion and Jargon
Hiding the truth and obscuring the obvious by means of clever phrases, industry terms and made-up jargon are all tactics used to create a front of sophistication and complexity to ensure investors don’t ask questions and to intimidate all actions around the table. Investment articles, technical analysis, detailed commentaries, and clever graphs are all used to create the impression that the investment is backed by experts and people in the know. A detailed due diligence is your best bet to peek behind the proverbial curtain and to see if there are any real investment value or substance.
3. Unverifiable Claims
Boiler room scams, for example, often rely on making the ordinary sound out of this world. Claims such as pending patent rights, new technological breakthroughs, conspiratory claims, secret calculations, special formulas, and algorithms are all the stuff of smoke-and-mirrors and are difficult to verify. Check all claims by means of a third-party due diligence and keep all emotions out of the investment decision.
4. Controlling Sales Process
This red flag is far more than just dealing with a pushy salesman. Here we refer to tell-tale signs that something is amiss. In includes insufficient or unverifiable disclosures, unknown or unfamiliar payment or investment methods, non-traditional asset allocation or bundling together of funds, all presented on the basis of a trust relationship, hearsay or by simply applying sales muscle, or being intimidating to get you to decide on the spot.
Manipulative techniques or pushing a client for an on-the-spot decision is not in line with ethical practices and professional investment customs.
5. Unlimited Financial Control and Disclosure
Investment accounts, products, or funds should always be invested in your name with some oversight by a third party or a licensed entity. Transactions on your investment portfolio must be verifiable and clear to review daily or by means of an investment statement of account. Pooled funds with no record of transactions, or unlimited financial control by a fund or portfolio manager should be concerning. Make sure the account activity statements are reliable and issued independently from the investment entity.
CONCLUSION
In spite of all the useful articles, tips, and information to safeguard us against the unscrupulous attacks of thieves and scamsters, we are bound to be confronted with promises of never-ending wealth and unheard of returns, at some point in our lives. One of our best forms of defence is to educate ourselves on these foul tactics and to make sure we know how best to avoid them.
In similar vein, we also need to accept that, at times, the markets will be volatile and difficult to navigate, especially during uncertain times such as the current global pandemic. Consistently creating investor value is somewhat of an artform. We must also be reasonable in our expectations of what constitutes fair returns on our investments and make sure we live within in our financial means.
There is a famous Wallstreet saying that goes “This time it will be different”, but, as history proves time after time, it usually isn’t. We can all do our part by performing due diligences and consulting with unbiased third parties such as licensed financial advisors, Certified Financial Planners, or independent brokers, before investing our money. To report any illegal or suspected investment scams please contact the Finance Intelligence Centre (FIC) and follow the on-screen prompts.
Be vigilant, guard your funds and make use of reliable and established investment entities – but most of all, trust your instincts and learn the fine art of smelling a rat!
Oakfield Wealth Management is situated in Durbanville and a continuation of Thompson Financial Services.
With an active client base in the Western Cape and more than 20 years’ experience in the independent financial advisory and insurance industry, clients have access to wide range of services, expertise, and investment skills.
For more information call Gerald Thompson on +27 83 326 8276 or send an email to gerald@oakfieldwealth.co.za .