5 Sure-Fire Signs of an Investment Scam

by Julie Rains on 9 July 2013 1 comment

There is a big difference between making a bad investment, which happens to nearly all investors, and investing in a fraudulent deal, which shouldn't happen to any investor. Just as you should learn to recognize a sound investment, you ought to become familiar with suspicious deals guaranteed to take your money but give disappointment in return. (See also: 6 Ways to Spot Work-at-Home Job Scams)

Though I've made investing mistakes, I haven't been defrauded, perhaps by simply avoiding the wrong people at the wrong time. Honestly, I would have trusted former NASDAQ executive Bernie Madoff with my money. In retrospect, though, there were some warning signs that his renowned investment firm was a sham.

Because even smart people may not be able to recognize a con immediately, it is helpful to learn from the mistakes of others. Scrutinizing swindles from the past gives you an idea of the elements of investment scams. Most have recurring themes and tell-tale signs, such as these.

1. Returns Are Reliably Steady

We hope (and frankly expect) our investments in stocks, ETFs, mutual funds, and real estate to grow over time. But this increase in value is never guaranteed and rarely steady, year after year. Inevitably, losses follow gains and gains follow losses.

Promoters of investment scams almost always guarantee returns that are typically much higher than market rates. A notable exception was the Madoff scandal, in which Bernie Madoff's investment firm delivered returns that were reasonable but strangely consistent year after year. This scenario became even more suspicious when the overall market declined but investor returns remained the same.

Note that SEC registered representatives should not promise certain investment returns or predict investment results. The potential for specific gain, above interest rates paid on FDIC-insured accounts, requires taking risk with the possibility of losing value.

2. The Opportunity Is an "Innovative Game-Changer"

Many reputable (although risky) investments have a high potential for growth and delivering above-average market returns. These may involve patented technologies, innovative distribution systems, and disruptive business models.

Such opportunities are rarely offered to a large collection of small individual investors, former hedge fund manager Todd Tresidder points out in his article on investment fraud. More likely, companies with such advantages seek funding through institutional investors.

For example, according to articles in Mother Earth Network and Denver-based magazine 5280, the Mantria Corporation sold shares to smaller investors for the purpose of building a supposed carbon-negative residential community constructed of sustainable materials and powered by alternative energy and producing "biochar," a charcoal substitute made of garbage that was purported as carbon-negative when used as fertilizer. The business plan sounded plausible and the green initiative was certainly desirable. However, actual product sales were less than $100 and the majority of its cash flow came from unsuspecting investors. The Securities and Exchange Commission (SEC) has ordered more than $135 million in relief from Mantria's owners and executives in what is being called the largest-ever green Ponzi scheme.

Investing in growth companies with a proprietary advantage is a key to achieving high returns. However, not all such opportunities are worthy of your investment dollars.

3. Victims Tend to Be in Affinity Groups

Investment scams are often promoted and perpetuated by those in your social circles. For example, a con artist may join a church and form relationships with its members before introducing the scam. Victims may be less likely to perform due diligence because they trust the person selling the product or promoting the opportunity.

We may think of those who are duped by friends, fellow churchgoers, etc. as being unsophisticated, particularly in terms of investing. But in the Madoff and Mantria schemes, the victims included well-educated, successful professionals with similar interests and connections.

4. Business Practices Are Sketchy

Sales representatives who promote investment scams and business owners who fraudulently seek investor dollars are likely to engage in sketchy practices and unusual operations. They may circumvent legal requirements or present misleading documents.

Such questionable activity may not directly impact the underlying investment opportunity. But the lack of concern for proprietary actions and straightforward communications indicate that money is a priority, not integrity.

For example, the SEC shut down ZeekRewards, a North Carolina-based company that offered profit sharing from its penny auction site in a business/investment opportunity presented as a multilevel marketing arrangement. The company structure and its claims that affiliates were not investing caused some confusion about what specific laws were being violated, if any. Still, the company's owner has agreed to pay a $4 million penalty and is cooperating with federal authorities to recover money for investors.

Notably, Montana refused to allow ZeekRewards to conduct business in its state because of a failure to register its multilevel marketing business, even after warnings. Unusual business practices, deception in advertisements, and even minor violations can indicate that something is wrong.

5. Prospects Who Don't Invest Are "Lazy" or "Stupid"

Sales pitches for investment scams often attempt to pressure prospective investors. Because returns are supposedly guaranteed and extraordinarily high, those failing to invest are made to feel stupid because they are not courageous, smart, or industrious enough to participate in the American dream of building wealth.

Special events, seminars, etc. are often used to promote the investment opportunity to unsuspecting information seekers. Resisting claims in such a setting can be more difficult than rejecting an offer in a more neutral environment, especially if you have not prepared yourself for an emotional reaction. Those who invest in scams may be skeptical yet hopeful, then shamed into a making a decision quickly.

True professionals don't label unwilling investors as cowardly or stupid. They are clear about the downsides to investment opportunities, which are never no-brainers in terms of guaranteed returns without loss of value. Any sales pressure or coercion is a signal that you should not do business with this person, investment firm, or company being represented.

How to Avoid Investment Scams

Focus on finding sound investments rather than letting opportunities find you via contacts from strangers or recommendations from social connections.

Further, to avoid scams, take these actions before making an investment:

  • Conduct due diligence by reading promotional materials, visiting the company's operations, etc. and verifying the accuracy of information provided to you.
     
  • Research the company and its filings by using the SEC - EDGAR database.
     
  • Use FINRA (Financial Industry Regulatory Authority) BrokerCheck to verify that your investment advisor has the credentials and identity she claims to possess.
     
  • Check out investor alerts and more warning signs from trusted sources such as FINRA, SEC, and ASIC (Australian Securities and Investment Commission).
     
  • Make sure that investments are held in a third-party custodian account unrelated to the company making the investment offering.
     
  • Don't rush or feel pressured to make an investment.

Getting started in investing is a major financial and emotional leap for many people. Protect yourself by knowing the signs of a scam and the indications of a legitimate investment.

Have you spotted an investment scam? What tipped you off that it was a scam and not an investment?

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No one wants to get caught up in an investment scam, but they are out there and you need to be cautious with who you trust with your money. Always work with certified professionals and be diligent, and don't be afraid to walk away if you don't feel comfortable of tell as though something is not right about the situation.