How the financial advice industry takes advantage of unsuspecting investors – part 4

The financial advice industry does not have a monopoly on fraudulent practices. Wherever there are large sums of money moving around, there will always be people who resort to dishonest means for financial gains.

Most investment scams use the same basic principles: promises of great profit, assurances of no risk and assertions of urgency and secrecy. The con artist is likable, friendly and professional.

A lot of people think they can spot a scam from a mile away. But most scams aren’t as obvious as the pushy salesman calling out of the blue or the notorious Nigerian bank account scheme. Every year, Americans lose billions of dollars to scams of every size and shape [source: National Futures Association].

We know there is always risk when it comes to investing, but educating yourself is one of the best ways to manage those risks.

When it comes to fraud, bad things can and do happen to even the most careful and diligent person. However, seeking out education on the most common schemes and scams is a great step towards protecting your investments and your financial future.

What should you look out for? First, let’s take a look at the most prevalent investment scams.

A well-known type of fraud is the pyramid scheme. It sounds very similar to a Ponzi scheme, as a Ponzi scheme can be a type of pyramid scheme. However, pyramid schemes are not always illegal, while Ponzi schemes are.

A pyramid scheme works by convincing people to invest in a distributorship or franchise. The promoter may say the product is the next big thing and tells the prospective investor they are getting in on the ground floor of something amazing. In reality, the focus is less on the product the franchise sells and more on how to recruit other investors.

Ultimately, no product has been sold, no investment has been made, and no service has been provided. It becomes mathematically impossible for everyone buying in to ever see a profit.

Our next scam scheme is called a pump-and-dump. It’s so named because the burst of buyers “pumps” up the value of the stock. When the stock value peaks, the scammers “dump” their stocks, which often causes the value to drop sharply [source: U.S. Securities and Exchange Commission]. Readers may be familiar with some high-profile cases of pump-and-dump, such as the one featured in the movie “The Wolf of Wall Street.”

For better or worse, humans have a tendency to listen to people with whom they have something in common. Scammers depend on this trait. They join hobbyist groups and religious groups, or trade on ethnic similarities. Affinity fraud occurs when an individual exploits the connection and trust within a group to promote a fake investment opportunity. This type of scheme may involve elements of a pyramid or Ponzi scheme while specifically targeting members of an identifiable group.

Religious groups, ethnic groups within a community, individuals connected through military or professional affiliations, and groups united by a specific cause or demographic are just a few examples of the types of groups these con artists will prey upon to commit this type of fraud. They may directly approach the group or focus on convincing the leader of the group to buy into the fake investment, taking advantage of that person’s respect and position to access the members. One of the biggest challenges this type of fraud brings, is the targeted group may prefer to ‘work out the matter on their own’ instead of reaching out to law enforcement or regulators for help.

The Securities and Exchange Commission (SEC) issued an Investor Alert and an Investor Bulletin on the dangers of affinity fraud.

Unlicensed brokers or sales agents approach you with financial advice or an investment opportunity. An unlicensed insurance agent might sell fake insurance policies. Or, worse, you could seek advice from an unlicensed broker at a disreputable firm.

Mention this phrase in a discussion about investing, and Bernie Madoff’s name will immediately pop up. This well-known type of fraud was named after Charles Ponzi, who became famous for using the technique. In essence, investors earn returns based on the money coming in from new investors. The earlier investors are getting regular returns and everything seems fine, except the scheme relies on a constant stream of new investors before it inevitably collapses. The organizer relies on attracting new investors to make promised payments; but funds are usually used for personal gain instead of engaging in any investment opportunities.

As in affinity scams, Ponzi scammers often target groups of people. Since these schemes rely on trust and word of mouth, initiating the scam in a group allows the con artist to spread it quickly.

Internet scams include e-mail offers and spurious Web sites promoting investment opportunities in nonexistent companies or products. Chat rooms, newsgroups and bulletin boards are also common playgrounds for con artists. Schemers use multiple user names to endorse the company with false testimonials, creating the illusion of legitimacy.

Seniors often live alone, depend on others for care and worry about how their retirement savings will support them. Many seniors are eager to believe the confident man who can dispel these fears with his sound advice and exciting opportunities. These scams include life insurance fraud and unsuitable investments.

These schemes include investments in gold, silver, rare coins and gems. Con artists have recently capitalized on the political circumstances that have driven up the cost of oil and natural gas. The same circumstances make investments in alternative energy quite attractive. Just because it sounds good for the environment doesn’t mean it can’t be a scam.

The scammer invites a hundred people to a seminar, where she presents an unbeatable investment opportunity. You must sign up right then and there. You can’t sign up later because she is leaving town in two hours. So is your money.