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Inside Five of the Most Pervasive Investment Scams


How these frauds work, the bait that's used, and the red flags to watch for.

2. The Pump and Dump
This highly illegal practice involves artificially inflating the price of an owned stock through deceptive and misleading positive statements so that the stock can be sold at a higher price. A small collective of informed people purchase a stock before they recommend it to thousands of investors. The stock price rapidly spikes, but equally as quickly, it falls. The original group sells off when the price peaks, banking a huge profit. There's a variation on this scam called the "short and distort," where, instead of spreading positive news, perpetrators use a smear campaign to drive down the price of the stock and then profit by short-selling.

An unprecedented example of the pump-and-dump occurred in 2000 when Jonathan Lebed -- then 15 years old and living an otherwise normal teen life in New Jersey -- bought penny stocks and promoted them on message boards online. When other investors bought the stocks, he sold his for a profit, leaving investors in the lurch. The SEC filed a civil suit against him, and though he never admitted guilt, he ended up paying $285,000 -- a pittance, considering he made in the neighborhood of $800,000.

The Hook:
Fraudsters claim to have inside information about a stock, which they use to lure people into buying it. The desire to make money fast is tempting to many investors, who fall for the email-spamming techniques swindlers' use, which include beguiling phrases like "Don't you dare take your eyes off this one!" or "Catch the new leader in stocks!"

In recent months, this scam has become prevalent in the green-technology sector, wherein promoters endorse "compelling macrothemes: the rise of solar, wind, and other alternative or renewable energy sources. The promoter convinces you that some tiny stock has a game-changing technology, a huge untapped market, or a big government contract about to fall in its lap," explains Toby Shute of The Motley Fool.

Red Flags: Many scammers will recommend small companies since they tend to be more unstable; it's easier to manipulate a stock when there's little or no information about a company. Other cautionary signs include emails with unrecognizable "from" fields, audacious promises (how would a stock gain 35% in one day?), no contact information for the email sender, excessive use of exclamation points, forecasts of fast, exponential growth, and no actual product but a promise that "the prototype is just about ready!"

Marc S. Dreier
  • Mark Dreier sold $700 million in counterfeit promissory notes and was sentenced to 20 years in prison.

3. Promissory Notes

These notes are short-term debt instruments frequently sold by independent insurance agents and issued by little-known or nonexistent companies. Fraudsters (who may or may not be part of a bogus company) convince insurance agents or brokers to persuade clients to make large investments that promise lucrative commissions. The catch? The insurance companies are generally located outside of the US, aren't licensed to do business in the US, and lack the resources to deliver on promises. Affluent seniors are the primary targets of these scams, but no one is immune.

Case in point: In May 2009, Marc S. Dreier, a prominent New York lawyer, pleaded guilty to a complex scheme in which hedge funds and other investors, as well as his clients, lost at least $400 million. Mr. Dreier sold $700 million worth of counterfeit promissory notes to investors and was sentenced to 20 years in prison.

The Hook: Investors are tempted by the promise of a high, fixed-rate return -- sometimes upward of 15%-30% monthly -- with very little or no risk. The notes are highly attractive because the seller will falsely claim that they're "guaranteed" or "insured." Furthermore, many fall prey to this scam because the seller is frequently an agent the investor has done business with in the past and so is trusted implicitly.

Red Flags: Watch out for claims that your promissory-note investment will be "risk-free," promises of fast, guaranteed double-digit returns (and/or the guarantee of an above-market rate), labels of "prime quality" on a start-up company's notes, notes for a nine-month period or less, unlicensed sellers, and notes offered to the general public (most are not sold this way).
No positions in stocks mentioned.

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