white collar crime

Every now and then, reports circulate through the financial press in regard to a group of unsuspecting investors who have become victims of investment fraud. Making a bad investment is one thing, but ‘investing’ in a fraudulent transaction is quite another. The fallout from being the victim of a fraud is devastating given its impact on your finances, your psychological well-being and your lifestyle. The good news is each of the investment scams during the last 20 years have shown an eerily similar pattern. Whether it be Enron, Bernie Madoff, Allen Stanford or Tom Petters, there were a number of tell-tale signs that these potential investments were just too good to be true.

What does a Fraudulent Investment look like?

Fraudsters prey on our emotions of greed, fear and arrogance by promising an easy return for the participation in a scheme that you probably don't fully understand. This can be done using a variation on one of the following basic premises:

Bernie Madoff
  • Getting you to purchase a non-public investment which promises unreal returns - also called the Ponzi scheme. Named after Charles Ponzi, this technique is a gathering of funds from early investors then paying back those funds using proceeds from future investors. This scheme has resulted in billions of dollars in losses over the past decade. Experienced fraudsters target people of influence as their ‘early investors’ in order to turn these individuals into supporters as the scam builds momentum. As this scheme grows and gains momentum, more victims are drawn in and existing victims start relocating a greater portion of their investment funds into this fictitious scheme. This is little more than a financial form of ‘musical chairs’ - those left with money into the scam when the music stops suffer all the losses. At some point, it is inevitable that the Ponzi scheme will ultimately topple in on itself, and when it does, the community is usually shocked to learn that the perpetrator has lost their funds on living a luxurious lifestyle and/or funding an addiction.
  • Paying a percentage to manage their money - aka the Nigerian Prince scam. At some point over the past ten years, you've probably received an unsolicited email from a member of the recently exiled Nigerian Royal Family promising a healthy return for you in return for your helping to transfer a small fortune into your country. The premise here is that a stranger provides you with a big check in return for your giving them an advance to “start the process”. As soon as you send them this start-up money, they might give you an enormous (bogus) check in exchange for your sending them back a check for the amount of their check minus your commission. Inevitably, their check will bounce (and also the money withdrawn from the bank account where you deposited their check) and the fraudster is long gone. Depending on where their bank is, I have seen it take up to two months for a Non-Sufficient Funds Check to find its way back to your account. This technique has been modified (blank) on Craigslist and typically involves somebody purchasing something from you for more than you asked, then asking that you (blank) refund them the difference. Overall, the Nigerian Prince scam is usually a one-time scenario with a mild loss to the victim.

The 5 Signs of a Fraudulent Investment or Investment Advisor

1. Promised “low-risk” returns that exceed today's 5 year mortgage rate + 8% - a good general rule is to compare the return that you are being offered against the prevailing 5-year residential mortgage rate. If the expected ‘low-risk’ return is 8% above that rate, be suspicious. As of the time of this writing, the average annual return on the Dow Jones has been 5.3% over the last decade while the ‘hurdle’ rate (5-yr residential mortgage rate plus 8%) is 11%. It is possible to get quick growth in a stock from time to time, but getting an exceptional return without risk over a 3 to 5 year investment horizon is unheard of.

2. The Investment Advisor exhibits one or more of the following traits:

  • Narcissistic - a healthy level of ego is not necessarily a bad thing, however someone capable of perpetuating investment fraud tends to present an extremely elevated sense of self-worth (to the point of extreme arrogance). This allows them to continue perpetuating the fraud with little regard for the damage they're causing to others.
  • Megalomaniac (or ‘god complex’) - this is a psycho-pathological condition where the individual is obsessed with growing their power base and believes themselves to be omniscient (all knowing). These are dismissive of the opinion of others and believe that they always know what is in everybody’s best interest because of their superior intelligence.
  • Incredibly Charismatic - the most effective scammers are usually highly networked people with fantastic charm. They have a tendency to make friends with influential businesspeople, civil servants or even politicians as a way to gain legitimacy. Quite often they'll fabricate connections with non-local champions of industry (e.g. claiming a personal relationship with the likes of Donald Trump or Warren Buffet).
  • Flashy demonstrations of wealth - this follows along the idea that wealth attracts wealth. If a person asking for your investment lives a luxurious life-style with the trappings of modern society (e.g. seaside mansion, personal jet, luxury yacht or weekend golf trips to Vegas), do a very thorough background check. There also tends to be a pattern of supporting high-profile local charitable organizations in an effort to foster goodwill and give an altruistic appearance.

3. Use of buzzwords to give the appearance of legitimacy - being told that an investment is being held “In Trust” suggests absolutely nothing. The job of your Investment Advisor is to make a complicated situation something you can easily understand. In the event you don’t fully understand an investment or can’t see how it serves an actual commercial objective, it is really not for you. The general rule here is that you need to be able to explain the investment to your friend and have them understand why it's a good idea. I had a friend who wanted to pay a ‘bond trading insider’ a 2% ‘commission’ to access a $25 million Bank Guarantee that was to have been pledged as collateral for an investment in a 90-day ‘risk free’ bond trading platform. This scheme was to have created $5 million in profit after 3 months. ”After all,” he told me, “this is how the global big banks make their money”. Against my strict warning, he proceeded with the investment and 90 days later was shocked to learn that he lost his 2% as the supposed trades did not generate a profit. Undeterred, his ‘insider’ told him that he could recoup his losses by investing in a “high velocity trading robot” that was located near the NYSE on Wall Street. All over again, in spite of my continued protestation, he doubled down. Again there was an excuse (snags in the computer programming, but the kinks are worked out now, so why not top up your account and try it again…).

4. Sketchy documentation - all would-be investments should have a prospectus or offering memorandum where the business model is well articulated, historical financial results are summarized and financial projections are presented. Without this essential information, you don’t have sufficient information to run the fundamental analysis needed to make an investment decision. I have prevented clients from getting involved in a bad situation by running a quick GoogleMaps check to see where the investment originated. I also tend to not trust any Financial Services professional who uses an @gmail.com email address for business purposes.

5. The Investment Representative wants you to make your check payable to them personally- I have seen this first hand and it made me cringe. Possibly they tell you that they have access to a special program and therefore need to invest in their name on your behalf, or that your investment is being sent alongside the Advisors. This is always bogus. If the amount of the investment is material, you should be using a third party brokerage or seeking other professional advice (lawyer, accountant) to ensure that the funds are disbursed for their intended purpose.

The consequences of losing a large sum can be devastating - don’t let your eagerness for a fast and easy return derail your entire financial future.