Top Investment Scams

July 22, 2014
Laura Joszt

While anyone can become a victim of investment fraud, they tend to be more financially literate, have a college education, and earn a high income.

While anyone can become a victim of investment fraud, they tend to be more financially literate, have a college education, and earn a high income, according to the Securities and Exchange Commission (SEC).

So, if investment fraud victims are supposed to be smart and financially savvy, how do they keep getting fooled, sometimes to the tune of millions of dollars? Mostly greed. According to the SEC, victims are also high risk takers.

The very nature of most investment scams is to prey on our greed. They offer high returns in a short amount of time or tout exclusive investment opportunities for a finite number of lucky investors. However, it’s not just the financially literate who are taken for a ride. Other scams appeal to our sense of trust in small-knit communities to get people who might not normally invest to hand their money over.

Although there are watchdogs out there to help keep investors safe, they are not all-seeing and some scammers are increasingly difficult to catch and bring to justice.

Here are 10 popular, and devastating, investment scams:

10. Ponzi schemes

Recently, made famous by Bernie Madoff, the Ponzi scheme is a well-known investment scam, although knowing the name doesn’t necessarily mean investors are able to avoid becoming victims.

The Ponzi scheme uses money from new investors to provide returns to previous investors. These schemes always collapse eventually, though, as it will reach a point when the money owed to previous investors is greater than what can be raised from new ones.

The promoter will generally interact directly with the participants, encouraging them to roll over their investments for greater returns rather than cashing out. This strategy also makes it take longer for the scheme to collapse, according to the SEC.

The scammer will promise high investment returns in a short period of time with little or no risk. The scheme typically uses investments that are not registered with the SEC or with state regulators. While both of those are red flags, another is when the investor receives overly consistent returns, which is unrealistic given values tend to go up and down over time.

9. Risky oil and gas drilling programs

Right now, scams in oil and gas drilling can hit investors who are looking for alternatives to traditional securities. High oil prices have also created more interest in energy-related business ventures.

While most oil and gas investments are legitimate, though they can be risky, con artists can still take advantage of investors. Scams are usually structured with the limited partnership in one state and the operation in a second state. Then, the offerings made to prospective investors are in states other than the first 2 since there is less of a chance that the investor will stop by, according to the North American Securities Administrators Association (NASAA).

Some of the scams simply conceal the risks involved with oil and gas drilling and use high-pressure sales tactics and deceptive marketing practices to sell worthless investments.

The scam is pitched via the internet and email, using claims that risks are minimal, that the promoter has hit on every well drilled, that a geologist has given a tip, or that the deal is private and only open to a few chosen investors.

8. Digital currency

Though it may be confusing to most people, Bitcoin and others like PP coin are very real, very legitimate digital currencies. However, these alternatives are not backed by tangible assets, are not issues by a government authority, and are subject to little or no regulation.

The value of these currencies is volatile and the concept is confusing because of the complicated mathematical algorithms that determine when more coins will be released. As such, digital currency is prime real estate right now for scam artists to capitalize on the increasing popularity of digital currency and the lack of understanding surrounding it.

Investments in digital currencies include real risks, including the possibility of leaving an investor virtually broke. Platforms used to buy and sell digital currencies can be hacked, transactions can be subject to fraud and theft, and they offer anonymity that allows it to be used in illegal activities.

However, it’s not just cams that investors should watch out for. FINRA has warned about the risks of Bitcoin as well since payments are irreversible, it is a speculative investment, and it is not legal tender. Plus, abuses of digital currencies can lead to law enforcement agencies shutting down or restricting use of platforms and exchanges, which affects consumers and investors who are using the digital currency legally.

7. Real estate investment schemes

Real estate is currently a very popular alternative investment. As the market recovers and housing prices climb, investors should be wary of fraudulent schemes involving new real estate development projects, or buying, renovating, flipping, or pooling distressed properties.

Scams were common during the housing bubble, though these scams subsided as the housing market recovered and technology evolved. According to the NASAA:

“In particular, state regulators have seen problems with non-traded real estate investment trusts (REITS), properties that are bank-owned, pending short-sale, or in foreclosure, and flimsy promises of investment funds being secured by an interest in real property when the property in question is already highly leveraged and has no remaining equity.”

Real estate investments were the second-most common product leading to fraud investigations, according to NASAA. An investment property scam is usually spread by word of mouth and requires individuals to invest large sums of money in properties. The scheme promises either a large increase in the property’s value or higher-than-market interest on contributed capital.

6. Private offerings

The most common product or scheme takes advantage of laws that allow private placements to be sold without registration. These investments are highly illiquid, lack transparency, and have limited oversight, which makes them perfect for scammers.

It’s also expected that advertisements for private placement offerings will increase since the passage of the JOBS Act relaxes restrictions on how they can be marketed to the general public.

Even legitimate private placements are risky since the investments can happen without watchdogs looking out for investors’ best interests. Scams are billed as an exclusive opportunity available only to a small set of lucky investors.

Although the investment does not have to be registered, the salesperson must be properly licensed and his or her firm must be registered with FINRA, the SEC, and a state securities regulator.

5. Pyramid schemes

By claiming the can turn a small investment into large profits in a short period of time—always a warning sign for investments—fraudsters recruit participants to recruit more participants. The only way people can make money off this scheme is by bringing more people into it.

While the pyramid scheme often looks like a legitimate multi-level marketing scheme, a closer look reveals that the scheme quickly falls apart. Take a look at the following chart from FINRA:

The pyramid scheme is very similar to a Ponzi scheme in that the money from the new investors is used to pay off the previous ones. As such, there can only be “profits” so long as the number of investors increases. However, in the pyramid scheme, the investors are doing the recruiting.

Even though the investors are recruiting new, unsuspecting individuals, the only guilty party in a pyramid scheme is the originator of the practice, not the unsuspecting participants.

4. Off-shore investing

American and Canadian investors are frequently the targets of this scheme, which makes use of conflicting time zones, differing currencies, and the high cost of international telephone calls in order to prey on North American residents.

Many off-shore scams involve “Regulation S,” a rule that exempts US companies from registering securities with the Sec that are sold exclusively outside the US to foreign investors. Scammers will offer to resell this stock to US investors. Off-shore scammers offer high, tax-free returns with no risk as long as you send your money to another country.

Although the internet has eroded most of the above barriers, investors should still be cautious when looking to invest in an opportunity from another country as it can be difficult for local law enforcement to investigate and prosecute.

3. Affinity fraud

This scam preys upon members of identifiable groups, such as religious or ethnic communities, the elderly, or professional groups. The scammers either are or pretend to be members of the group in question. They will convince respected leaders from within the group that the investment is legitimate and use the leaders to spread the word.

Affinity fraud exploits trust and friendship among tight-knit groups. According to the SEC, these scams can be difficult to detect for regulators because victims often try to work things out within the group.

Often the fraudster will promote a Ponzi scheme or a pyramid scheme. And since the community only has a finite number of members, the money runs out and the victims find most or all of their money is now gone.

Even when information is coming from someone you trust, always do the appropriate research and obtain written information of the investment and how to get your money out—something fraudsters do not provide.

2. Advance fee fraud

A common scam, the advance fee fraud, also known as a 419 scam, involves promising the victim a large sum of money but only with a small up-front payment. Once the payment is made, the scammer either takes the money and runs, or he or she invents a series of additional fees in the hopes of getting more money out of the victim.

In the investment world, the investor is asked to pay a fee upfront before receiving any proceeds, money, stock, or warrants in order for a deal to go through. According to the SEC, the fee “may be in the form of a commission, regulatory fee or tax, or some other incidental expense.”

These scams target people who have already purchased underperforming securities and are hoping to reverse the previous investment mistake.

Often, the schemers will use websites and email addresses that end in “.us” or “.org” and contain “.gov” as part of the domain address. However, a true US government agency would have a website or email address that ends in “.gov,” “.mil,” or “fed.us,” according to the SEC.

1. Pump and dump

The pump and dump scheme is a frequently used scam. In the past, these scams were perpetrated through cold calls over the phone. Now, investors get spam emails or text messages touting low-priced stock of a small company.

In the pump-and-dump scam, the fraudsters buy shares of a low-priced stock of a thinly traded company. Then, they drum up interest by promoting the stock as “the next big thing.” As they gather interest, investors create a buying demand and pump up the price of the stock. Because the company is thinly traded, the price increases quickly and the scammers dump their shares, take the gains, and leave the rest of the investors holding worthless shares.

These thinly traded companies are known as penny stocks, and fraudsters usually find it easier to manipulate these stocks because there is little or no independent information available.

Unlike other scams, this one does not require the spammer to contact the victims to collect their money or transfer it. They simply push the victims to make a poor investment decision and then reap the rewards by cashing out.