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Inside Five of the Most Pervasive Investment Scams

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

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To: smartinvestor@worldwideweb.com
Subject: Your lucky day is today!!!

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Maybe you're not sufficiently gullible to fall for an offer as transparent as the one above. But with the stock market taking as long as it has to gain back momentum, many investors have been looking for quick portfolio fixes in all the wrong places. Clinging to a promise of high returns or a chance to replenish a retirement account, the desperate (or shall we say, hopeful?) all too often end up grabbing opportunities that turn out to be straight-up frauds. And as we all should have learned from a crash course in Ponzinomics in 2008, the most cliché rule is still the most spot-on: If it sounds too good to be true, it probably is.

Here we detail five of the most prevalent investment scams being perpetrated today, and what you can do to avoid being a casualty of these assaults on your money.

Bernard Madoff
  • Bernie Madoff bilked investors out of $18 billion operating the largest Ponzi scheme in history.

1. Ponzi Schemes

Named after Charles Ponzi -- who didn't invent it, but made notorious use of it in the 1920s -- the Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Schemes like this demand a constant flow of money in order to keep going. If the fraudster can't recruit sufficient new investors, or if a large number of current investors want to cash out, the entire system collapses -- just as it did for Bernie Madoff on December 10, 2008 when his sons told authorities that their father had confessed that the asset-management arm of his firm was "one big lie." Total loss to investors: $18 billion.

The Hook:
Ponzi-scheme organizers ensnare new investors by promising to invest their funds in high-return, low-/no-risk opportunities. Unlike a pyramid scheme, investors don't have to help bring in new recruits to get paid. And when they make money, they naively assume it's from successful investments (since the source is never actually disclosed) when in reality, compensation comes from the newer recruits.

Red Flags: The US Securities and Exchange Commission (SEC) suggests looking out for other warning signs in addition to "high-return, no-risk opportunities" which include overly consistent returns, unregistered investments, unlicensed sellers, secretive and/or complex strategies, issues with paperwork (such as excuses as to why you can't see something in writing), and difficulty receiving payment.

In the Madoff case, however, many sophisticated investors were duped by the fraudster despite his complicated (in fact, fictional) strategies and secretive manner. Madoff's "play" was largely based on specific sorts of psychological manipulation, say some experts, which allowed him to gain investors' trust and thwart would-be efforts to verify his outrageous claims.

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).

4. Prime Bank
In this scam, fraudsters offer high yields in short time frames, saying they have access to "bank guarantees" that they can purchase at a discount and sell at a premium. Supposedly by reselling these "guarantees" a number of times, they can produce extraordinary returns on your investment. In reality, unsuspecting investors send money to a foreign bank where it's eventually transferred to an offshore account belonging to the con artist. An estimated $10 billion has been lost in this particular gambit.

In 2008, Jack A. Calvin was sentenced to 16 years in prison and ordered to pay restitution of $2,083,736.41 for operating a "prime bank" scheme that bilked approximately 115 investors out of more than $2.8 million. Calvin sold securities in a fictitious trading program called Growth Benefit Systems (GBS), soliciting investors by promising to pool funds to purchase "prime bank" instruments that would be traded by top banks and generate returns as high as 20% per month.

The Hook: Investors are not only lured by the promise of 20-200% monthly returns, but are credulous of the jargon that's used because it's derived from actual terms. "Bank guarantees," for example, are real instruments used by foreign banks, but they're never traded or sold on any kind of market. The term "prime banks" generally refers to the top 50 banks in the world; victims don't realize it's being used to describe a scammer's personal bank account.

Red Flags:
Be suspicious of fictitious financial instruments, variations on the terms above, "roll programs" (which is what the scams are often called), excessive guaranteed returns, extreme secrecy, "exclusive opportunities," and vague, complex claims. As the FBI's website points out, "Legal documents associated with such schemes often require the victim to enter into nondisclosure and noncircumvention agreements, offer returns on investment in 'a year and a day,' and claim to use forms required by the International Chamber of Commerce (ICC)."


Robert Allen Stanford
  • R. Allen Stanford was charged with perpetrating an $8 billion offshore-investment scam in 2009.

5. Offshore Investing

Conflicting time zones, the high cost of international calls, and varying currencies once made it challenging for international hoaxers to go after North American residents, but the Internet has paved a clear path for them along with the elimination of many restrictions on moving money around. Offshore scams can take different forms, including those already discussed, but a great deal of them involve "Regulation S." This is a rule that exempts US companies from registering securities with the SEC that are sold exclusively outside the US to foreign investors. Scammers manipulate this kind of offering by reselling Regulation S stock to US investors in violation of the rule.

In February 2009, Texas billionaire R. Allen Stanford was charged with perpetrating an $8 billion investment fraud. Mr. Stanford, as the Los Angeles Times reported "cast himself as offshore investment guru to the transatlantic jet set and benefactor to the Caribbean islands' poor through multimillion-dollar promotions of their beloved sport of cricket." He was arrested by the FBI four months later.

The Hook:
Impressive websites, lavish brochures, and "educational" seminars are some methods used to convince victims to put money in disreputable or non-existent organizations in foreign countries. The come-on is usually in the form of high, tax-free returns with no risk. Victims fail to consider that if they take a total loss of their investment, they do so without the protection of US law since law-enforcement agencies can't investigate easily outside America.

Red Flags: Sophisticated scams use complex terminology such as "bank debentures" or "standby letters of credit," complicated-sounding concepts like "offshore fund leasing," and mysterious instruments like "interbank trading" and "seasoned notes." Seminars are often held in exciting locations and cost thousands of dollars to attend; promoters tout "connections" and a guarantee of "no taxes" on your investment.


The SEC and the Financial Industry Regulatory Authority (FINRA) are the industry's watchdogs, but they're sometimes caught sleeping on the job. Visit their websites to get the details on these and other scams and the warning signs to watch for, but remember that your best defense is your own common sense.
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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