What you absolutely, positively, categorically must know about investment fraud

Myths, warning signs and strategies to protect yourself from fraud, cons and scams

OK, everyone: it’s time that we talked about something that nobody wants to talk about: fraud.

Yup, it’s a scary topic. Nobody likes to imagine their retirement nest egg wiped out because of a “can’t miss” opportunity that turned out to be a scam. But it happens. Nobody wants to hear that their inheritance has been stolen by a crook who pulled the wool over a parent’s eyes. But it happens. Nobody wants to hear that cases of investment fraud are on the rise. But it’s happening.

If you’ve been around for a few years (as most snowbirds have been!), chances are that you’ve already encountered some kind of attempted investment fraud: maybe e-mails from that Nigerian prince who keeps telling you about a hidden fortune which he needs help unlocking. Or phone calls from a salesperson telling you about an exciting “hot tip.” Or maybe you’ve been forced to sit through a high-pressure sales meeting for a “can’t miss” overseas condo investment.

How often do people fall for such frauds, scams and ripoffs? Nobody knows for sure − the lack of public information about fraud makes it impossible to get an accurate measure on either its prevalence or its impact. In fact, the RCMP suggests that, at most, only 5% of the $3 billion or so in investment fraud that happens in Canada each year is ever reported.

But here’s the good news: you can prevent fraud from happening to you. By learning the simple warning signs of fraud and taking tangible steps to effectively protect your portfolio − steps that are actually more common sense than anything else − you can largely inoculate yourself against shady deals, questionable investment “opportunities” and out-and-out cons, no matter what form they take.

With that in mind, here’s some information about investment fraud − common misconceptions, easy warning signs and effective strategies regarding how you can protect yourself. While this knowledge won’t eliminate the fraud risk altogether, it will help ensure that you don’t become an easy mark for fraudsters.

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.

“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 with Madoff 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 Malcolm Gladwell’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 whom we 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 which makes 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 warning signs of fraud

Investment fraud takes many forms, but most exhibit one or more of several common “warning signs” − features or identifiers that fraudsters use to make their scams more appealing to investors. If you can learn how to spot the following warning signs, you’ve gone a long way toward ensuring that you never become a victim.

1. “No risk”

One of the most certain warning signs of fraud is the elimination of financial risk. Many fraudsters will go out of their way to try to convince you that whatever idea they’re hocking is a “can’t lose” proposition, a “zero risk” investment or a “100% guaranteed” opportunity. Not only is this not true, it also defies one of the fundamental rules of investing: that there is no return without risk.

If you remember nothing else from this article, remember this: when it comes to investing, there is no such thing as “no risk.” Anyone who tries to tell you differently is either lying to you, or trying to scam you − or very possibly both.

2. Super-high returns

Often accompanying the promise of “no risk” is the promise of high returns − typically much higher than what you’d expect from publicly traded investments over a similar time frame.

Wise investors understand that promises of double-digit, triple-digit or even higher annualized returns are the bait that hooks fraud victims. Ask yourself: if the opportunity is so amazing, why doesn’t everyone else know about it? If the returns are so good, why aren’t professional managers pursuing them? If the performance is so great, why isn’t the financial press clamouring over it? The answer: because the “opportunity” is actually a fraud.

3. Get-rich-quick schemes

Closely related to points #1 and #2 above is the promise of speed; fraudsters will promise to double, triple or exponentially grow your money in weeks or months. Who doesn’t want that? Such promises are tempting, in part because we’ve all heard about billionaire investors and traders who are able to turn a small stake into a fortune overnight.

Here’s the thing: there is no simple, certain way to make money. Sure, sometimes traders, investors and high-tech entrepreneurs can make a lot of money quickly. But when it happens, there are typically years of financial education and investment experience behind the success, as well as several months of careful research and detailed analysis, along with a healthy dose of sheer dumb luck. Anyone who says that they’ve found a way to bypass this reality is taking you for a ride.

4. High pressure

Most fraudsters work on a “do it now” schedule. The reason: they don’t want you to take the time to think critically about the opportunity, ask tough questions, or listen to that “little voice” inside your head that’s telling you that something’s not quite right.

That’s why most investment fraud includes some form of “urgency message” within the sales pitch: it’s a “limited time opportunity”; you need to act now before others catch on; you need to invest before market conditions change; if you act early, you can take advantage of special terms for “early movers”; that kind of thing. All of which is intended to prey upon your fear of missing out − the idea that others are getting rich while you’re sitting around doing nothing − and encourage you to make a decision based on emotions, not analysis.

5. Complicated mechanics

It’s an old trick: industry jargon, complex data sets and slick PowerPoint presentations can go a long way to making you feel as if an opportunity is legitimate. Often times, these function as the smoke and mirrors which the fraudster uses to mask the con that’s going on behind the curtain.

All of this is intended to short-circuit your financial logic, and quiet that little voice inside your head telling you that something just doesn’t make sense. So remember: if you find yourself confronted with an opportunity that you can’t get your head around, or if you’re presented with information that seems to make things more complex, rather than more clear − it’s best to take a pass.

6. Proprietary trading strategies

A lot of frauds attempt to explain their “high return/no risk” promise by talking about secret trading strategies, special investment algorithms, or complicated “proprietary” stock market techniques that only the promoters have figured out. This was Madoff’s big lie − a trading strategy that only he knew about, but which he couldn’t explain to others because it was “proprietary.” The lie shielded him from closer scrutiny and led thousands of sophisticated investors to lose their shirts.

Bottom line: if you can’t understand how an opportunity actually makes money, or can’t verify the claims of “secret” trading strategies, take that as a huge red flag.

7. “Next big thing” ideas

Fraudsters love to talk up their scams as an opportunity to get in on the “ground floor” of new technologies, new patents or industry “revolutions.” Often, such scams are related to headlines and hot sectors that you may have heard about recently. Example: COVID-19-related frauds in the form of patented drugs, new detection technology, medical supply startups or miracle treatments.

Why do scammers do this? Because they know that so-called “average” investors have heard about people making a lot of money on these ideas, yet very few really understand how such technologies, patents or revolutions really work. A lot of greed and very little knowledge −you can see how that’s a pretty attractive combination to a fraudster.

8. Inside information

A fairly common angle for scammers to work involves some sort of “inside secret” that’s not normally accessible to the average investor. This kind of positioning is effective because many people assume that the key to investment success comes down to privileged information − information which you can act on before every other investor has it.

If you see some kind of marketing material or messaging which suggests that the opportunity will allow you to “profit like the pros,” “invest like an insider” or “take advantage of industry secrets,” it’s a sign that the opportunity may not live up to the hype.

9. Exclusivity

Many frauds have the aura of exclusivity − the idea that the opportunity is being presented only to a small group of “special” investors who are “in the know” or “in front of the curve.” Such positioning plays to the victims’ egos, making them feel smart, privileged, honoured or otherwise “better” than average investors.

Don’t fall for this puffery. If you come across an opportunity that screams “exclusive,” or flatters you for being part of a select group of “special” investors, make sure to do some digging before you jump in with both feet. This can be a big warning side of fraud.

10. Locked exits

It’s pretty simple: once a fraudster has your money, he doesn’t want to give it back. That’s why many fishy investments have clauses that make it darned-near impossible for you to extract your investment once you put your money down.

Don’t get us wrong here: not all “locked-in” investments are scams. Bank-offered GICs and similar certificates of deposit often have lockup periods during which you won’t be able to access your money. And many sophisticated hedge funds and private equity deals have lockups too. But, if you find yourself faced with an opportunity that requires you to “lock in” your investment for a significant period of time, it’s best to take a closer look. It could be legit − or it could be fraud.

Simple strategies to protect yourself from fraud

Here’s the bad news: there’s no shortage of dishonest people who are willing to do nefarious things to take money away from honest people. But here’s the good news: protecting yourself from them isn’t all that difficult. In fact, it often boils down to simple common sense. Here are seven common-sense tips that can help.

1. Take your time

Fraudsters don’t want you to think too much about the “opportunity” at hand. They don’t want you to dig too deeply into their investment data. And they certainly don’t want you to ask them difficult questions. So, they use high-pressure sales tactics, limited-time offers and other tactics to encourage you to commit your money quickly.

It comes down to this: if you need more time to thoroughly research an opportunity, take it. If you need time to think about how it fits into your overall financial plan, take it. If you need time to talk it over with your partner, your friend, your advisor, your accountant or, heck, even your dog − by all means, take it. And, if anyone tries to make you feel silly or stupid or amateurish about taking that time, tell the person to buzz off. Or better yet, tell the authorities.

2. Write cheques to licensed, registered investment dealers

One easy sign of fraud is when the fraudster asks you to write a cheque to him or her personally, rather than a licensed, registered investment firm. Oh, they’ll use a lot of creative excuses to explain why you need to do it this way: you’ll get into the opportunity faster; you’ll avoid taxes; you won’t have to pay extra fees; and so on. But the real reason is always the same: they want to make it almost impossible for you to get your money back.

Rule of thumb: always make deposits, contributions or investment payments payable to firms registered as licensed investment dealers, not individuals, not numbered corporations, not offshore bank accounts, not anything that seems fishy or out of the ordinary. Don’t know if someone’s registered? Check with your securities regulator (most have searchable databases of dealers licensed to operate in the jurisdiction) and make sure.

3. Can’t understand it? Then forget it.

This is an obvious, easy rule that could save a lot of people a lot of financial heartache. Remember what we said about jargon, data and charts: the more complex it is, the harder it is to understand, the less it seems to make sense, the greater the chance that someone is trying to hide something.

Never be intimidated by what you don’t know. Instead of being snowed under by fancy charts and PhD-level jargon, rely on your good old-fashioned common sense: if you can’t figure out how it works, either ask an independent professional to explain it to your satisfaction, or don’t invest.

4. Do your homework

Fraudsters will talk all day about the opportunity that they’re trying to sell you. And they’ll give you lots of data and info and analysis and charts to back it up. But all of this promoter-supplied material should never be a replacement for your own homework: you’ll need to analyze the data, gather different opinions and consider how the investment fits into your overall financial plans.

Here’s another rule for you: never take data, projections or promises from the promoter on face value. Trust only what you can independently verify. And if you can’t? Move on.

5. Does it depend on tax advantages? Get a second opinion.

A lot of frauds promise outstanding returns because of tax writeoffs, credits, rebates, refunds or some kind of special treatment that allows you to recapture previous years’ taxes. Are such strategies effective? Will they be accepted by the CRA or other tax authorities? There’s probably no way for you to know.

But there is someone who will know: a qualified accountant or tax lawyer. A 30-minute review of the opportunity is likely all that they need to tell you whether the tax advantages are legitimate, or whether they’re empty promises. Sure, you’ll probably have to pay a nominal fee for such advice. But it could be the cheapest protection you’ve ever purchased.

6. Treat testimonials with a grain of salt − even when they’re from your friends

Fraudsters typically put in a lot of time to create the aura of “social proof” around the opportunity that they’re selling − testimonials, recommendations, reviews and other declarations from “satisfied customers.” All of these are intended to allay your suspicions and anxiety about the investment − if others see the opportunity, you should too!

When it comes to investments, never rely solely on the positive reviews of other people. That includes those from friends and family members, who could be caught up in a fraud without knowing it. Instead, do the homework and find out for yourself whether an investment makes sense.

7. Above all else: trust your gut

If you’re like most people, you probably remember a few times over the years when a “little voice” tried to protect you from bad decisions (or at least encouraged you to think twice before you acted rashly). And, if you’re like most people, you probably remember at least a couple of times when you ignored that little voice − to your detriment.

Don’t let that happen when it comes to investing. Call it intuition, call it a sixth sense, call it a gut feeling, call it a little voice, call it whatever you want − if it’s reminding you that things which seem too good to be true usually are … well, it’s usually wise to listen.

The final word: if you spot (or suspect) a scam…

Come across an “opportunity” that doesn’t seem quite right? Friend or family member told you about an investment that sounds more than a little fishy? There’s really only one thing you need to do: report it to the regulatory authority in your jurisdiction. As in, right now.

Unfortunately, a lot of people don’t. Instead of talking about it, or calling the authorities, or challenging a suspected fraudster with tough questions, they keep their suspicions to themselves. If they find themselves caught up in a scheme, they don’t talk about it because they feel shame that they were “taken in.” If they find out that their family members were suckered, they keep quiet in order to protect the privacy of those involved.

Always remember: fraud thrives in secrecy. Like a cancer, it spreads because victims don’t know it’s there and, therefore, can’t take concrete steps to stop its spread and eradicate it. That’s why every investor out there − you, me, our friends and families − all have an obligation to speak out about fraud; to ask questions when we suspect it, to call it by name as soon as we see it, and to warn others about it if we come across it.

When it comes to investment fraud, we really are all in this together. When we talk to others about fraud, when we warn others about it, when we pass on what we’ve learned and teach others how to protect themselves − what we’re really doing is protecting ourselves. That’s the best way we can keep fraudsters out of our portfolios and put them where they belong: in jail.

by James Dolan