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CP Investment Help Center

A Guide to Common Frauds
By Ali Jaffery

Back to Investment Help Center Back to FAQs

One of the biggest risks you face is that of fraud, usually through some investment scheme. But you can also be defrauded by seemingly legitimate planning, which turns out to lack substance.
Though scams are funny once you know the inside scoop, the sad fact is that many persons -- including smart businessmen -- and corporations get taken by these scams amazingly often.
Wealth can be lost through the fraud and embezzlement of bad employees, bad faith of insurance companies, or investment fraud by  financial advisors.
Wealth can also be lost because of bad decisions in trusting others. It is imperative that we learn to identify these risks and adopt procedures and practices to avoid them .
Investment con artists are clever and creative. They base their scams on the latest political and scientific developments in the news. For example, a popular investment scam sells stock in a company that is just about to announce a cure for AIDS. Some swindlers focus on specific groups, church groups, blacks, Hispanics, doctors, the elderly, and offer pitches tailor-made to the needs and concerns of these audiences. Still other scams take advantage of economic downturns and employment uncertainty with glowing reports on the earnings of those who buy a franchise or business opportunity.
Among the types of investment scams consumers are likely to encounter are:

  • pyramid schemes
  • Ponzi schemes
  • precious metals frauds
  • stock swindles
  • international investing
  • affinity fraud
  • franchise and business opportunities

It's a Super RabbitHop on the Deal
Con artists come up with hare-brained schemes to rip off consumers. Take the case of Rex Rabbit, in which investors were promised tax benefits and income for betting their savings on a new breed of super bunnies. First, investors were to get tax breaks for investing in the research to develop the new breed of rabbits. Second, the pelts of the new rabbits were said to be more luxurious than mink and would be sold for top dollar at New York City department stores. Third, the meat of Rex Rabbit was to be an exotic gourmet delicacy. It was rumored that the super rabbit meat would sell for more than $14 an ounce to South Korean mercenaries guarding Saudi Arabian oil fields. This scam took in over $1 million from investors in the Phoenix area, including a group of airline pilots who convinced each other to hop on the deal.

Pyramid Schemes
Pyramid schemes operate on the principle that each member of a group will receive a profit or a cut for recruiting others to join the scheme. One popular pyramid scheme is the "airplane game" in which new recruits buy in as passengers for $100 and are then told that if they bring in new investors they will be able to move up to flight crew, co-pilot and finally pilot. At that point they will receive $1,000 or more. In another variation on the pyramid scheme, investors buy one gold coin for $50 and are told that, when they reach the top of the pyramid, they will get five gold coins valued at $250.

Pyramid investment scams should not be confused with legitimate sales organizations that recruit to expand their sales staff. A characteristic of legitimate sales services is that the emphasis is on the sales of tangible, usable products rather than simply on recruiting new salespeople. The hallmark of illegal pyramids schemes is that participants receive payment for recruiting new members of the sales force rather than for selling products.

The problem with pyramid sales schemes is mathematical. There simply are not enough potential participants in the whole world to keep pyramids growing steadily for even a few months. Danger signs of pyramid scams include:

  • promise of sky-high profits for a small amount of effort
  • payment of a membership fee to participate in the scheme
  • products have a high price compared to similar products
  • unrealistic claims about product quality or performance
  • sellers and buyers are expected to recruit new sellers and buyers to keep the pyramid growing

Welcome to "Crud Farms"
It may not sound like much of a greeting, but 10,000 investors in Texas and the Midwest were swindled by it. These consumers lost tens of millions of dollars to promoters who charged $40 for packages of milk culture under name of Culture Farms. The promoters said they planned to produce Cleopatra's Secret, a major new perfume that used the milk product as an ingredient. Investors were told to grow the milk culture in kitchen refrigerators and then present the containers for repurchase by Culture Farms at a guaranteed price. The perfume never materialized and before investors figured out that something smelled wrong more than $100 million in hard-earned savings were gone.


Ponzi Schemes
Ponzi schemes are a type of pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme. Ponzi determined that it was possible to take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons.

Ponzi told investors that he could provide a 40 percent return in just 90 days compared to a measly five percent for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during a single three-hour period. Though a few early investors were paid off in order to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.

Ponzi worked in the 1920's, but to this day, the Ponzi scheme continues to work on the rob-Peter-to-pay-Paul principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses. In one case, a con artist now serving 12 years in prison told investors that he could buy Mexican pesos for a fraction of their face value and then convert them at full value back into U.S. dollars. Victims in this scheme included members of Kansas churches and Texas motorcycle gang members. The swindler behind the pesos scam took in $27 million, promising investors phenomenal returns of 12 percent weekly 600 percent a year!

Ponzi schemes often have the following characteristics:

  • The promoter promises very large returns on an investment, such as "double your money in 60-90 days."
  • A "can't lose" scheme for making money that others have overlooked.
  • Payments are made to a few early investors to prove that the investment isn't crooked. These fortunate few are known as songbirds, since they sing the praises of the scam to others, bringing in new victims eager to make the same kind of generous returns.
  • The Ponzi scheme collapses when the number of previous investors seeking a return exceeds the number of new investors bringing in additional money.

The Ponzi of Rock and Roll
Charles Ponzi's investment scam may seem like ancient history, but it is kept fresh by new generations of swindlers, including the Ponzi of the rock and roll generation.

One Ohio teenager realized that he could use other people's money to buy rock concert tickets and then turn around and "scalp" them for a 40-50 percent profit or even more. So, the Ohio youngster rounded up his friends to stand in line and buy rock tickets and then scalp them. At first, he ran his business out of the back of a van, but as the word spread, the Ohio youth soon raked in millions of dollars!

When the bubble of this modern-day Ponzi scam burst, the youth would have had to buy every rock concert ticket in Ohio and all surrounding states in order to keep paying out the promised returns to investors. This guy's friends, and their friends, lost money on this scheme.

Precious Metals Frauds
Precious metals always have attracted investors. Such tangibles as gold and silver seem particularly appealing to investors during uncertain times. Con artists urge jittery investors to put their savings into something they can hold on to, as opposed to paper investments such as stocks and bonds.

Examples of precious metals schemes include:

Coin swindles. Swindlers may sell consumers coins that are said to be graded at a higher quality level than is actually the case. Often, these coins are delivered in poor condition or are never sent at all.

Gold mining schemes. How does gold, silver or platinum at dirt-cheap prices sound? That is the promise of swindlers who claim to be able to sell precious metals directly from mines. Claims are made that a new technology will be used to recover microscopic gold that other firms have not been able to retrieve. Regulators sometimes refer to these schemes as "dirt pile" swindles involving promises of "no-see-um" gold, since investors never see the promised precious metals. All they get for their money is dirt.

Bullion deals. How can swindlers avoid delivering when they promise gold bars? One popular stalling tactic: con artists will offer bullion storage services, where a consumer supposedly buys precious metals in bullion form, and then has them stored in a vault. This is an open invitation to fraud. In one major scam, con artists simply pocketed millions of dollars of investor funds and never bothered to buy the gold.

Another popular bullion scheme is bank-financed precious metals or leveraged precious metals. A consumer pays 20 percent of the total cost of gold and then finances the rest, including a heavy dose of interest, storage fees and loan brokering charges. Con artists lie about having connections with major, reputable banks for loan and storage purposes. They simply pocket the money of investors and never buy or store the gold, silver or platinum.


All That Glitters
The two brothers had a fancy office building and offered a seemingly sound and straightforward way for investors to make money: "Instead of buying gold outright and holding it for appreciation, investors could make a small investment that the firm would use to secure financing for much larger quantities of gold, which would be bought and held in the investor's account. That way, when the price of gold rose as was "sure to happen" investors would realize highly leveraged profits.

The company provided storage vaults where investors could view the wall-to-wall stacks of glittering bullion. By the time authorities caught up with the brothers, the only gold was the color of paint on the cardboard used to construct look-alike bars of bullion.

The vault filled with phony gold proved easier to find than the millions of dollars of investors' money. Most of that is still missing.

Stock Swindles
Stock swindles pose a major threat to consumers. In the late 1980s small investors lost $2 billion in scams involving penny stock, so-named because the shares sell for less than $3. A stock swindler may claim that a company has developed a cure for AIDS or is about to announce a huge business deal that will cause its stock to double or triple in value.

A penny stock example: con artists convinced investors to put millions of dollars into a company that claimed to have developed a breakthrough technology a self-chilling beverage can that would eliminate the need to store soda and other liquids in a refrigerator. When this deal failed, small investors saw their money go down the drain!


Insiders Only
Beware of a broker who tells you that he or she has a secret to share that will make it impossible for you to lose money. If this is such a hot tip why would a complete stranger call you?
Trading on the basis of inside information is against the law. From an ethical standpoint, insider trading jeopardizes the free market where prices move up and down based on information available to all parties.

Con artists know that everyone is concerned about losing their money to a swindler. How do they address this issue? One way is to impress a potential victim with their connections and access to special information that makes success inevitable. One such scheme told investors they were chosen from a select group of active investors and financial experts to be a part of the world's most exclusive investment organization. Investors were lured with promises of a constant flow of secret financial information that would create wealth and financial security.

Sound good? Even if it was true, it would be illegal, since trading on the basis of such inside information violates federal law.


International Investing
International investing is a fast growing area of interest for U.S. investors and con artists are not far behind. With the rapid pace of political and economic changes overseas and the strong performance of many foreign stock markets, many American consumers are investing some of their funds abroad. Con artists have responded by offering scams with an international flair. In one recent case, a Washington state con artist fleeced 400 investors out of $7 million by promising 30-40 percent returns on certificates of deposit and other investments through a bank in the Marshall Islands. After the swindler fled the United States, investigators found that the bank existed only on paper and that its sole officer was a Marshall Islands gasoline station attendant who was instructed to go to the post office, pick up investors' checks and then re-mail them to the con artist back in Washington state.

Even when U.S. investors deal with legitimate investment opportunities overseas, they remain vulnerable to such factors as loose or nonexistent investor protection regulation, currency fluctuations, limited opportunities to pursue grievances and political instability in some nations. Savvy investors will exercise extreme caution before putting money into any foreign investment situation.

Affinity Fraud
Affinity fraud is the term used to describe investment schemes that prey upon members of identifiable groups, including religious communities, the elderly, blacks, Hispanics and professionals, such as lawyers, doctors and even teachers. (Affinity is a word used to describe things that are attracted to one another, are similar to one another, or belong together.) Con artists promote affinity scams that exploit the sense of truth and friendship that exists in groups of people who have something in common. For example, 1,000 immigrants from El Salvador recently saw $6 million of their savings wiped out in a phony investment bank that promoted itself exclusively to Hispanics in the Washington, D.C. area.

Con artists recognize that the tight-knit structure of many groups makes it less likely that a scam will be detected by regulators and law enforcement officials, and that victims will be more likely to forgive one of their own. Affinity fraud also poses a danger since it undercuts the usual warnings about investment schemes promoted by strangers. In these cases, the fraud may come to a consumer's attention as the result of a contact from a friend, colleague or someone who inspires a bond of trust.

A warning: Swindlers who promote affinity fraud schemes will enlist respected leaders within a community or group to spread the word about an investment deal. So, the key to avoid being a victim in an affinity scheme is to check out everything—no matter how trustworthy the person is who brings the investment opportunity to your attention.

Franchise and Business Opportunities
Franchises and business opportunities address the dream of many Americans to be their own boss. In fact, legitimate franchise operations may soon account for a majority of all retail sales made in the U.S. Unfortunately, con artists realize that the desire of many Americans to own their own business may make these investors less cautious when it comes to evaluating franchises and business opportunity deals. Such investments may be promoted on the basis of the fear of losing a job or general uneasiness about the economic situation.

Ads for fraudulent business opportunity schemes may appear in otherwise reputable television programs, newspapers and magazines. Investors incorrectly assume that since the media outlet is reputable, the advertisers are as well, not realizing that the media may not screen its advertisers. Ads for frauds often offer high income to the person who will invest enough to cover individual start-up costs, ranging from $50 to several thousands of dollars. The only people who make money are the swindlers who receive the start-up investment money.

Fraudulent business opportunity ads frequently appeal to people who have few job skills and are desperate for money. Examples include work-at-home and animal-raising schemes.
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