Red Alert for Financial Frauds

The financial crisis means it is time to be on high alert for financial frauds. Scamsters know this is the best environment to find vulnerable targets.

I dug through my files recently for a 2004 Wall Street Journal interview with imprisoned scamster Eric Stein. He laid out how frauds operate and why now is a time for us to be on high alert.

Stein said scamsters do extremely well when regular people are looking for alternatives to traditional investments. When people lose confidence in stocks, bonds, and real estate, frauds step forward. They did well after the bursting of the technology stock bubble burst and the corporate scandals early in the decade. Their pitches sound like political speeches, telling people that markets are manipulated and that corporations and governments cannot be trusted. To protect their capital and earn high returns, investors need to seek alternatives.

Most financial frauds do not use regulated securities or markets. Instead, targets usually are offered opportunities to invest in partnerships or make deposits into “accounts” that will pay high returns.

Here are some other characteristics of classic financial frauds, according to Stein.

The “financial opportunity” is something people can understand without a lot of explanation. It usually is something related to products people use every day or see regularly on television.

The promised return on investment is very high, often 20% or more per calendar quarter. These are returns that cannot be earned in any conventional investment except in rare, short periods, yet the frauds promise those returns indefinitely.
Targets usually are in their 50s or older and are in or near retirement. They are good targets, especially when the markets are down, because they are uncertain about how their portfolios will fare in retirement and are looking for higher returns to replace the working income they recently gave up or soon will give up. They figure they cannot go back to work, so they have to look to investments to boost their income.

Targets usually have a fair amount of money, because successful people tend to be the targets. Early in the sales process the con will determine how much the target has in liquid assets that can be invested. Questions that try to discover cash or near-cash positions can be a tip off to a scam. Beware of inquiries such as, “Would you be able to put $10,000 to work in the next week?”

The best targets are risk takers. People who have built businesses are sought by fraud artists. Doctors and dentists also are enticing to scamsters because they have money and want to earn higher returns.

Certain personality types also are of interest to the crooks. A person who likes to do everything in a big way and wants to tell his friends and associates about the deals he is in tends to be easiest to talk into a deal. Also, this personality type might bring in friends and associates.

Crooks have innocent ways of finding targets. The goal is to get people to give away their contact information. A common strategy is to stand in a shopping mall and tell people that as a marketing test they can have an opportunity to win a car by completing a form or survey. People give away their contact information (and sometimes other details) for a chance to win a nice car.

This method has shifted to the internet. On web sites the scamsters tell people they can win free goods and services by providing personal information. Sometimes the web sites list products that will be won, including the names and logos of well-known companies. That gives the impression those companies are participating in the activity.

A significant fraud usually has several levels of sales people. The first contact is a junior person whose job is to determine if the target has enough liquid assets and is interested in the investment. This person might not even know the deal is crooked. After a target is qualified, a senior person calls with the detailed sales pitch. A third person might appear to close the deal after some glossy information is mailed to the target.

Here are some ways to protect yourself from the avalanche of financial frauds that is sure to come.

• Do not provide personal information to firms you don’t know and when you did not initiate contact.

• Do not discuss financial information (both your information and proposals from others) unless you initiated contact or know the person. Do not respond to “financial opportunity” offers unless you know the person or firm.

• Be aware that anyone may use terms such as “financial consultant,” “financial advisor,” and “business consultant.” Learn about the firm a person claims to be associated with.

• Avoid unregistered securities and private place-ments. These are investments that do not trade on a major stock exchange and are not registered with the Securities and Exchange Commission or its state counterparts. Such investments can be profitable, but they also are widely used by crooks. You need to undertake a very thorough investigation of the investment and the firm promoting it before investing. If you do not have the background and resources to do such an investigation, leave the investment to others.

• Be wary of affinity investors. These are church members, business colleagues, golf club members, and the like who tell you about the great investments they are in and that you could also profit from. The affinity investor might not be in on the scam; he might be a victim. But many frauds rely on such early investors to establish credibility and bring in more investors. A key exchange in such situations is that the affinity person initially says the investment is closed to new investors. But some time after you express interest he tells you it now is open for a short time.

• Don’t trust investments labeled as high return and low risk or simply safe. If an investment offers a return greater than a savings account at an FDIC-insured bank, there is risk involved. The higher the potential return, the greater the risk of loss is. If a high return is described as guaranteed or secure, the odds are it is a fraud.

• Scams usually come with a slew of testimonials and references. In a fraud, these tend to be from people who are paid to provide them or early participants in the scam who do not realize their returns are coming from the investments of new investors. Be skeptical about such support for the investment.

These days are prime time for con artists. Be on guard and do not let your need to recover investment losses lead you into even more treacherous financial territory.