One of the main building blocks of financial freedom is an investment. With the right kind of investments, one can secure their future, retire early, and live on passive income and ROIs. However, investments could be as dangerous as they are lucrative, especially if one puts money in the wrong one. There are many investment scams out there, and the real problem lies in distinguishing between real and fake. In this piece, we will shed more light on what investment scams are, and highlight a few famous ones to look for.
Investment fraud, also known as stock fraud and securities fraud is a deceptive practice in the stock or commodities markets that induces investors to make purchase or sale decisions based on false information, frequently resulting in losses and violation of securities laws. Investment fraud can also mean, among other things, outright theft from investors by stockbrokers. In simpler terms, investment fraud happens when investment fraudsters deceive potential investors into making purchases based on false information.
Legitimate companies may also lie to potential investors, saying they are making bigger profits than they actually are making to secure investment by falsifying audits and other company statements. Alternatively, fraudsters may set up fake companies or fake investment opportunities to scam victims into investing.
According to statistics in a 2019 report by the USSC (United States Sentencing Commission), securities and investment fraud has increased by 13.3% since the fiscal year 2015. UK Finance, a trade body, recently reported that investment scam reports surged by almost a third (32%) during 2020, with losses to these scams increasing 42% to £135.1m. Keep reading to learn about some of the most popular types of investment scams.
1. Pyramid scheme
This is one of the most common types of investment fraud. Likewise, it is one of the easiest to fall for. These schemes can be so enticing that victims hardly realise they’ve been taken in by a pyramid scheme. Individuals are usually first contacted by a family member, friend or acquaintance who wants to share more information about their new business opportunity. This often extends to an invitation to a recruiting event, coffee meeting or a proposition via social media, email, phone or even post.
At first, the rep will ask the individual to invest large upfront costs for a ‘starter’ pack or products. They’ll be promised a small commission for any products sold, and promised an even bigger return for recruiting others to join. This is because pyramid schemes rely on fees from new recruits and not from the sale of actual products. The pattern is however not sustainable and only benefits the people at the top of the pyramid.
This is because reps earn money from the recruits below them, but eventually, the member pool dries up. When that happens, top-level reps walk away with large ‘earnings’, and newer recruits with fewer recruits below them will leave empty-handed on top of losing their initial investments.
2. Affinity fraud
Affinity fraud is similar to Pyramid schemes in some ways. Perpetrators of this kind of fraud often target members of a group based on race, age, religion, etc. They use a pyramid scheme to lure members in and might even pretend to be a member of the targeted group to gain trust. An example of such pattern is a situation where affinity fraudsters con religious leaders into convincing their congregations to buy into a pyramid-like money making scheme.
3. Pump and dump fraud
In pump and dump, fraudsters build a portfolio of potential investors and pitch them a deal on low-priced stock. The fraudster owns a large amount of the stock they are selling, which doesn’t necessarily represent a legitimate business. As more investors buy shares in this stock, the value suddenly rises (i.e pumping the stocks). This is the point where the investment fraudster ‘dumps’, selling their own shares before the value of the stock crashes. The fraudster accumulates a large amount of money, and the investors are left with worthless stocks.
4. Offshore scam
In this category, the scammer promises amazing profits if investors send money offshore. The objective is to reduce or completely avoid taxes by sending money to a tax haven. This usually is an enticing idea for most people. The problem is, the company you believe you are sending your money to may be fake or set up to simply funnel investor funds to the fraudsters. The scammers may tell the investor that their money will be flowing in and out of their account, and sometimes, they provide proof to back this up. Whereas, there is likelihood that the money is actually going to a feeder account, which is clearing money out of the investors’ account.
A downside of offshore scams is that you may end up owing the government money in back taxes, interest or penalties for taking part in a tax avoidance scheme.
5. Boiler room scam
In Boiler room scam, a fake stockbroker contacts unsuspecting investors via telephone or online and share ‘insider knowledge’. They pressure you into buying shares which they ‘know’ are about to become very valuable. In reality, the shares are worthless, and the fraudster will sell them for a high price. As a result, the investor is left with a financial loss and worthless, unsellable stock.
6. Advance fee scam
This type of scam offers the promise of high returns in goods, services and/or financial gains, and all you need to do is pay an advance fee up front in order for the deal to go through. Usually, the scammer targets people who are vulnerable due to their age, youth, or disability.
Loan scams, rental fraud, clairvoyant or psychic scams, vehicle matching scams, career opportunity scams, dating scams, lottery or prize draw scams, and inheritance fraud are some of the popular advance fee scams.
7. Clone scam
This is one of the most difficult scams to spot. The Financial Conduct Authority (FCA) reported that 77% of investors admitted they were unsure what a clone investment firm was.
In clone investment scams, fraudsters set up fake firms that appear identical to a genuine firm, i.e. they ‘clone’ the genuine firm. They clone the name, address and even the Firm Reference Number (FRN) of genuine companies authorised by the FCA. They then contact potential investors with fake sales materials that are linked to the genuine firm. Sometimes, they go as far as encouraging potential investors to look up the firm’s FRN on the FCA Register to convince them that this a genuine opportunity.
The BBC reported that clone firm investment scams rose by 29% in April 2020, during the first national lockdown. This was because people were eager to find investment opportunities and therefore were easy prey.
Ten famous investment scams
Now that we have understood the concept of investment scams and seen the most common types of it, here are ten popular investment scams (culled from firmex.com) that shook the world, including the degree of losses in figures.
1. Charles Ponzi (Securities Exchange Company) – Loss estimated at $20 million
Category: Pyramid Scheme
The Charles Ponzi scheme promised clients a 50% profit within 45 days or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the US as a form of arbitrage. In reality, Ponzi was paying earlier investors using the investments of later investors. The scheme eventually failed in 1920 leaving 5 banks and all investors ruined. Charles Ponzi made $20 million through his pyramid scheme, equal to $250 million in 2020. He was charged with 86 counts of mail fraud and faced life imprisonment, however, he got a deal that made him serve only 5 years.
2. Bernard Ebbers (WorldCom) – Loss estimated at $100 billion
Category: Overstated cashflow
CEO Bernard Ebbers grew WorldCom to the 2nd largest telecommunications company in the US through acquisitions of smaller companies. While the acquisitions left the company in debt, Ebbers continued to exaggerate assets of the company by $11 billion dollars. Stocks eventually plunged from $64 per share to $1, with shareholders losing around $100 billion. In 2005, Ebbers was convicted of fraud and conspiracy for false accounting practices and got sentenced to 25 years in prison.
3. Jordan Belfort (Stratton Oakmont) – Loss: $200 million
Category: Pump and dump scam
Stratton Oakmont was a pump-and-dump firm in the 90s where brokers would drive up the price of stocks and then Belfort and his partners would cash out causing the stock to plummet in value. He hired hundreds of ambitious brokers to cold call unsuspecting people, selling worthless stocks. In 1998, Belfort was indicted for securities fraud and money laundering, and he served a 22 month jail term and paid a fine of $100 million.
4. James Paul Lewis Jr. (Financial Advisory Consultants) – Loss: $311 million
Category: Affinity scam
Lewis used a pyramid scheme to cheat investors over 20 years. He relied on referrals from his clients to gain new investors with the promise of high returns. On 22 December 2003, the SEC filed a complaint alleging that Lewis had committed securities fraud. Records showed that he used investor funds for trading in foreign currency, purchasing luxury automobiles, and expensive jewelry. In 2006, he was convicted of money laundering and mail fraud. He was sentenced to 30 years in prison and fined $156 million.
5. Michael de Guzman (Bre-X Minerals) – Loss estimated at $3 billion
Category: Falsified sample findings
Michael de Guzman, an employee of Bre-X Minerals, claimed he had found gold in the jungles of Borneo. From 1993 to 1996 he produced thousands of core samples containing gold. The companies stock, which was valued at a penny before the discovery, catapulted Brie-X Mineral’s value to $6 billion. Eventually the Indonesian government became suspicious. They revoked 45% of Bre-X’s control of the mine, leaving the rest to Freeport McMoran who, after much drilling, could not find a flake of gold, and as a result, Bre-X’s stock plunged to zero.
6. Sam Israel III (Bayou Hedge Fund Group) – Loss: $350 million
Category: Guaranteed unrealistic returns
Israel lied to his investors promising that their $300 million investment would turn into $7.1 billion in 10 years. In 1998, when the returns were lower than promised, Israel created fraudulent accounting reports to make it appear that the investments were growing. He escaped authorities and was only found after appearing on America’s Most Wanted. Israel was sentenced to 20 years and fined $200 million.
7. Joseph Nacchio (Qwest Communications International) – Loss: at $3 billion
Category: Inflated revenue and insider trading
Nacchio is the mastermind behind a $3 billion financial fraud scheme which allowed him to benefit from inflated stock prices and insider trading. He earned $52 million selling stocks he knew were going to plummet. After the SEC successfully sued Qwest Communications International in 2007, Nacchio was convicted on 19 counts of insider trading. He was also ordered to return the $52 million in illegal stock trading and pay $19 million in fines. He was sentenced to six years in prison.
8. Barry Minkow (ZZZZ Best Inc.) – Loss estimated at $100 million
Category: Pyramid scheme
In December 1986, at the age of 19, Minkow took his carpet cleaning business public, reaching a market capitalization of over $200 million. He created tens of thousands of fraudulent documents and sales receipts to make it appear like he was building a multi-million dollar corporation. Suspicious overages on client bills led to an investigation uncovering Minkow’s fraudulent revenue numbers. Minkow was convicted of 57 felonies, and was sentenced to 25 years and paid $26 million as restitution.
9. Kenneth Lay and Jeffrey Skilling (Enron) – Loss: $74 billion
Category: Falsfied financial reports
Enron’s founder, Kenneth Lay, lost $74 billion dollars from investors when he exaggerated the health of his company. Enron’s stock plummeted from $90 per share to less than $1 within 1 year. Once the 7th largest company in America, worth $68 billion, Enron ended in 2001 when the company filed for bankruptcy. Lay was indicted on 11 counts of security fraud and related charges but died on vacation while awaiting his court sentence. Kenneth was sentenced to 24 years in prison and was got a $45 million fine.
10. Bernie Madoff (Bernard L. Madoff Investments Securities LLC) – Loss estimated at $65 billion
Category: Pyramid scheme
Madoff sent fake balance statements to every investor and made it appear like their money was doing well and multiplying. As the markets crashed, investors began pulling out their investments and Madoff couldn’t provide. Investors were tricked out of $65 billion through Madoff’s Ponzi scheme. This is famously known as the biggest Ponzi scheme ever. Madoff got a 150 year jail sentence and was ordered to pay restitution of $170 billion.
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Without a doubt, you have learnt a thing or two about investment scams. It is best to apply caution and play by the rules when investing. Looking for shortcuts or trying to make quick and unjustified profit sets one up for easy scamming. In summary, if you must invest, do so wisely, and in the right way, lest you become yet another statistics in an investment scam report.