The media has illustrated the rise and fall of illegal activity in financial markets: the Enron scandal, the Bernie Madoff case, and most recently, Jordan Belfort’s securities fraud—a crime that inspired the Oscar-nominated film, “The Wolf of Wall Street.” While the heinous acts of these criminals are covered and sensationalized, we don’t hear many stories about the victims themselves. So, how should we avoid falling into the same sorts of traps? Read on to learn more about some common examples. A little knowledge will help you avoid disastrous mistakes.
When it comes to fraud, there are usually a few red flags in the initial sales stage, including:
- Small investments, large profits. “If you want to turn your small-time cash into big-time profits, this opportunity is for you!” An investment offering big payoffs is usually too good to be true, especially if your time is part of the deal. Also known as a pyramid scheme, this money-making model relies on “investors” to recruit new members to build their network and drive more business into the parent company. Participants are asked to pay an entry fee and promised a cut of the profits from the business they bring in. The problem? Rather than receiving the promised profits, investors are only given a fraction of the bottom line. Don’t get caught up in a dead-end deal. Value your time and avoid scaling the pyramid.
- Rapidly increasing returns. You may be wondering why consistent profits are a red flag. After all, isn’t that the point of investing? Although a steady stream of income can be a good thing, it can come crashing down without a solid foundation. Many scammers use social media and email strategies to increase the level of interest in specific (and cheap) stocks. After drumming up interest, the increased demand for shares will artificially drive up the price, leading new investors to believe that they have stumbled onto a gold mine. Unfortunately, the share price will eventually restabilize and result in a loss for investors. Of course, this is after the scammer has “pumped and dumped” his shares at the elevated price, allowing him to earn a hefty return at the expense of his unsuspecting victims. The moral: Don’t get caught up in the rumor mill or unstable marketing trends. Research your investments before taking the plunge.
- The “it’s very complicated” tactic. Investing can be a complicated business, but that doesn’t mean you should do it without understanding the deal. A broker who says, “It’s very complicated, but I promise…” is not interested in protecting your interests. Don’t get involved in murky deals with clear guarantees. They are sure to end in disaster.
These are only a few of the many ways investment fraud occurs every day. Protect yourself by taking the proper precautions from the beginning:
- Verify credentials. Visit http://www.finra.org/brokercheck to verify your broker or advisor’s credentials and licenses. This site will also list any applicable complaints or legal issues on the broker’s record.
- Research investments. The US Securities and Exchange Commission (SEC) houses a list of registered investments—a requirement companies are bound to follow. Search for your particular investment here. If the SEC has no active record, think twice before going forward.
- Consider your motives. Many investors have wandered into the market with the wrong motives. The wisest way to invest is to question your own motives before seeking opportunities. If you are experiencing money troubles or are panicked about another issue, you may think a get-rich-quick scheme is your only option. Don’t allow stress to cloud your judgment. There are plenty of ways to approach any problem—many of which provide safety measures to prevent further damage. Talk to a professional about your financial problems before taking additional risks. What you learn could change the path in front of you.