Finance “Fraud only happens to unsophisticated investors” Or, to say it more bluntly: only suckers get suckered, right?Wrong. In fact, research suggests that highly experienced, highly educated investors may in fact be more susceptible to investment fraud, in large part because of the overconfidence which they have in their abilities to outsmart any fraudster. Case in point: Bernie Madoff, the infamous investment manager who successfully bilked investors out of about $64.8 billion over the course of 20 years or so. Interestingly, Madoff had no time for the “average” investor − his so-called hedge fund (in actual fact, the largest Ponzi scheme in world history) was marketed exclusively to New York City’s financial elite, along with several prestigious colleges and charitable endowment funds. Why? Because of the “aura of exclusivity”; part of the attraction which the well-to-do enjoyed when they invested withMadoff was their pride in thinking that they were in on a good thing that nobody else knew about. Fact: protecting yourself from fraud has nothing to do with your net worth, your education, your experience in analyzing financial statements or anything like that. Rather, protecting yourself against fraud comes down to a mindset; a mental commitment to being vigilant about financial security, of thinking critically about investment opportunities, of asking tough questions, of having the discipline and the confidence to step away from investments which you don’t understand or opportunities that seem too good to be true. That mindset is available to any investor. “Fraud is obvious” In hindsight, sure. By the time a story about fraud hits the news, it’s pretty obvious that there was something fishy about the whole situation. But such stories don’t paint a clear picture of the psychological pressures, mental biases and the “salesmanship” that victims of fraud typically confront. When you’re faced with someone who seems highly professional, who’s highly skilled in the art of persuasion, who has reams of seemingly real data to back up his or her claims of a “sure thing” investment, suddenly fraud is a lot more difficult to spot. The fact is, we all have a propensity to take people and information at face value. For most people, it actually takes a lot of contrary evidence to shake them from this inherent belief that the information being presented to them is, in fact, true. Or, to put it another way, fraud usually has to be blindingly obvious before we recognize it for what it is. (If you’re interested in learning more about this psychological “default to truth,” check out MalcolmGladwell’s recent book, Talking to Strangers.) Always remember: the heart of any “con” is confidence. Fraudsters are highly skilled communicators who are very, very good at making you feel very, very excited about the “opportunity” on offer. They take great pains to hide obvious danger signs and distract you from data that just doesn’t line up. They prepare rebuttals and counter-arguments in order to convince skeptical investors. They deflect difficult questions. They rely on our natural propensity to assume that information is real, truthful and accurate. All of this effort makes fraud a lot more difficult to spot than you might assume. “My friends would never do that to me ...” Well, that’s probably true − at least, to their knowledge. But here’s the thing about fraud: most victims don’t recognize that they’re victims until it’s too late. And, by that time, they’ve usually unwittingly invited several of their friends, family members, colleagues or associates to join the exclusive investment club and “get in on the ground floor” of a sure-fire opportunity. There’s actually a name for this kind of situation: affinity fraud. It’s when a fraudster establishes trust with an influential member of a group − a religious group, an ethnic community, a bunch of workplace colleagues, members of an extended family, etc. − and uses the network of trust inherent in the group to ensnare other members of that group. It remains one of the easiest ways for a fraudster to rake in more money, because most of us are more inclined to believe people whomwe know and trust. So, you’re absolutely right: your friends would never knowingly involve you in an investment fraud. But it’s what they don’t know they’re involved in that might end up hurting you. “My bank/credit card company/ government/courts will protect me” Maybe. They’ll probably do everything they can − but you might be surprised at how difficult it is to prove and prosecute investment fraud. White collar crime is inevitably complex, typically involving assets stashed in different jurisdictions with vastly different laws, with fraudsters who often use bankruptcy laws to shield themselves against asset seizure. Even if you do find some help from the authorities, you’ll likely be facing a long, uphill battle to get your money back. And, even if you prevail legally, you almost assuredly will not get all of it back. Rates of recovery for investment fraud are notoriously low, avenues for redress are limited and potential for stress, conflict and frustration are sky-high. All of whichmakes prevention vitally important. Bottom line: the best way to protect yourself against fraud is to learn how to spot it before you get involved. Common (and dangerous) myths about investment fraud Unfortunately, there are a lot of misperceptions and misunderstandings about what fraud is, why it happens and who exactly falls for it. Ironically, that lack of understanding actually helps fraudsters, helping them conceal from their targets the way in which they operate. With that in mind, here are the four most-common myths about fraud, along with some thoughts as to why some people still believe them. CSANews | WINTER 2020 | 29
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