How Investment Scams Work

You get a phone call from a Mr. Davis of Mutual Systems, Inc. Surely you've heard of Mutual Systems? Of course you have.

Mr. Davis is a nice man. He's concerned about your finances, and he asks if you've given any thought to your financial future. He would love to help you out, and he happens to have some hot, top-secret, inside information about a mobile device that Mutual Systems is releasing soon, a product that will change the way you see the world. He tells you the stock is cheap right now, and you have to act now or you'll miss out on making a lot of money -- money that will help secure your future.

"You can't lose," Mr. Davis says.

But you do.

You weren't the only person Mr. Davis called that day. Mr. Davis and his associates contacted hundreds of other people. And even though Mutual Systems is a legitimate company, its stock is not heavily traded. As it happens, the value of a so-called "thinly traded" stock is easy to boost with a burst of buyer action. And after the value does indeed skyrocket, the scammers quickly sell their shares. The value of the stock plummets, and there goes your money.

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]. Every citizen is a potential target.

So what schemes are lurking out there? Why do they succeed time and time again? How do you avoid them?

First, let's take a look at the top 10 investment scams.

Top 10 Investment Scams

Investment scams come in all shapes and sizes. Con artists often mix and match features of various scams to concoct a swindle that is hard to detect.

Below are descriptions of 10 common scams.

Affinity Scams

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.

Unlicensed Sales

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.

The Ponzi Scheme

The Ponzi money-shifting scheme consists of paying initial investors with the funds provided by later investors. 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

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.

Promissory Note Scams

A promissory note is a written agreement to pay back a loan with a certain amount of interest. Scammers offer an opportunity to invest in high-yield promissory notes, which work much like bonds. But the scammer never actually loans money to a third party. He simply takes the investor's money. Or he does make the loan, but he pays the investor less than promised.

Prime Bank Scams

The fraudster offers investment opportunities through "prime banks," overseas institutions normally accessible only to the upper crust of society. Unfortunately, these banks don't exist.

Unsuitable Investments

Fakers recommend investments that aren't suitable to the investor's financial situation. A common variation is the long-term investment pushed on someone for whom a short-term investment would be better.

Senior Scams

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.

Commodity Scams

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.

Investment Seminars

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.

Why do these schemes work? Unfortunately, our instincts sometimes work against us. Learn more on the next page.

Why Do Investment Scams Work?

Cons rely on basic principles of human behavior for their schemes to succeed.

Risk

Most people are afraid to take risks. How much are you willing to gamble on a high-stakes poker game? What are your chances versus your possible profit?

Con artists know you're afraid of risk. They'll tell you there is little or no risk in an opportunity that could yield untold riches. If there's no risk, why not jump on in?

Greed

Most people have a tendency to believe that the grass really is greener on the other side of the fence. "If only I knew how to get past the fence," you say, gazing longingly at that new sports car or the pile of gold coins. Con artists are greedy, for sure, but, more importantly, they know that you are greedy, too. They know they can mesmerize you with promises of great riches and future security.

Urgency and Scarcity

"Act now and you'll receive…"

"Memorial Day Weekend Sale."

"Clearance Sale -- Sunday Only!"

An important principle of sales is the limited-time, limited-supply offer: urgency and scarcity. Con artists use urgency and scarcity to lure their victims quickly, before the victims have a chance to do any research or background checks on the legitimacy of the investment opportunity.

"There's only room for a few more investors," Mr. Jones says. "If you don't give me a check today, I can't guarantee you any share of the profits."

You don't want to miss the train to the greener side. And the greener side is where the train is headed, right? Mr. Jones said so [source: National Futures Association].

Politeness

When a friend kindly offers to cook you dinner, and past experience has shown that he can't tell a skillet from a spatula, what do you say? You don't want to hurt your friend's feelings, after all.

Unfortunately, your fear of hurting someone's feelings works to a scammer's advantage. Yes, you're unsure about investing in this beachfront property in Montana, but Mr. Jones is such a nice young man. And he did drive all the way out to your house to talk to you, not to mention comp your ticket to the investment seminar.

Trust

When you go to a play, and one of the actresses doesn't know her lines, you lose confidence in the actress's character. You cease to believe.

The same principle applies to the confidence man. People tend to trust a person who seems to know what he's talking about and has full confidence in his plan. After all, not only are our emotions swayed by confidence and charisma, we are taught to trust experts. And if you tell a con artist, "No, I'm not investing," the con won't reply, "You're right. You got me." The con will say, "Well, I'll just take the opportunity to someone who is interested in making money." And you start to rethink your decision.

How can you spot a scheme? How do you know if you're already the victim of a scam? Send me your bank account number, and then go to the next page.

The Unconfident Man

A clever scammer can use an apparent lack of confidence to get your money. At first, Mr. Jones presents an opportunity to invest in a biopharmaceutical company that is developing a cancer treatment. "But cancer is such a clever disease," Mr. Jones says. "I just don't think we'll ever be able to beat it." He doesn't seem too confident in the investment opportunity. What you don't know is that Mr. Jones knows that one of your close relatives recently died of cancer. He is depending on your desire to invest in the cure to work in tandem with his apparent lack of confidence in the investment opportunity. "No, this is a great opportunity!" you say, playing right into his hands.

Avoiding Investment Scams

Here are some tips to help you steer clear of investment scams.

Don't judge a book by its cover. Salespeople are trained to be professional and charismatic. Con artists are salespeople, too; they just happen to also be criminals. They depend on you to be polite and to not interrupt them, hang up on them or delete their email.
Educate yourself. Scams succeed mostly with people who have little investment experience or knowledge. Consult a professional financial adviser. Consult your friends and family. While you're starry-eyed with the potential profit at your fingertips, others are more likely to have an objective viewpoint.
Trust only professional, licensed brokers and sales agents.
Don't trust "top-secret insider information" and "hot tips."
Don't rush to invest after receiving a single phone call, attending a single seminar, or meeting with the salesperson a single time. However exciting the prospect may be, do not "act now" or "act before it's too late."
Ask the salesperson for a prospectus, a breakdown of the investment's procedures, risks and potential.
Don't trust the "high returns, no risk" guarantee. An investment is a risk, just like playing roulette (but hopefully with better odds). No investment is a sure thing.
Don't trust a salesperson who tells you not to tell anyone about the investment. Always question "secret" investment opportunities.
Research every investment opportunity. Investigate the company, the product, the security, and/or the stock. Use resources available at the Financial Industry Regulatory Authority and the Securities and Exchange Commission to investigate the company and/or salesperson. If you are thinking of investing in a company not registered with the SEC, make sure you conduct a thorough background check on the company.
Take extra precautions when presented with an overseas investment opportunity.
Steer clear of opportunities that claim to be tax-free investments. Investment returns, like all legitimate ways to make money, are subject to taxes.
When you make an investment, make the check payable to a company, never an individual salesperson.
After making an investment, examine your investment reports and make sure no unauthorized transactions are being conducted.
Ask questions of your adviser/broker/sales agent. Get answers. If your financial adviser or broker is slow to respond, gives vague answers, or denies your requests to withdraw money from the investment when you have a right to do so, contact the authorities.
Don't sign anything you don't understand. Have a lawyer review any contracts you are asked to sign.
Be wary of very quick returns on an investment. Scammers often lure cautious investors by sending a few small payments early on to encourage them to invest more.

If you are the victim of a scam, the best thing you can do is report it. Scammers depend on your uncertainty and embarrassment at being swindled to keep the scam going. Don't be embarrassed -- even the best get taken. If there's a time not to sit around and feel ashamed, it's when you suspect you're getting robbed blind.

If you'd like to learn more about investment scams, you can follow the links on the next page.

What Was That Nigerian Scam You Mentioned?

A deeply troubled official of the Nigerian government e-mails you. He wants to transfer several million dollars into your bank account so that he can leave Nigeria with his fortune undetected. As a reward for your help, he'll give you a large portion of the money. All you have to do is give him your banking information, including your account number. And of course you have to send him a small fee to cover the costs of the transfer -- consider it an investment in both your futures.

Lots More Information

Sources:

Bell, Kay and Fleitas, Amy. "Top 10 investing scams." Bankrate.com. 2/5/2004. http://www.bankrate.com/brm/news/investing/20020829a.asp (Accessed 4/1/08)
Better Business Bureau. "Avoiding Investment Scams." 2006. http://www.bbbmoneynow.org/?lid=1&page=avoidingscams (Accessed 4/1/08)
Federal Bureau of Investigation. "Common Fraud Schemes." http://www.fbi.gov/majcases/fraud/fraudschemes.htm (Accessed 4/1/08)
Federal Citizen Information Center, written by National Futures Center. "Investment Swindles: How They Work and How to Avoid Them." 1987. http://www.pueblo.gsa.gov/cic_text/money/swindles/swindles.htm (Accessed 4/1/08)
Federal Trade Commission. "The 'Nigerian' Scam: Costly Compassion." July 2003. http://www.ftc.gov/bcp/conline/pubs/alerts/nigeralrt.shtm (Accessed 4/1/08)
National Consumers League's Internet Fraud Watch. "Investment Fraud." http://www.fraud.org/tips/internet/investment.htm (Accessed 4/1/08)
Nebraska Department of Banking & Finance. "2006 Top 10 Investment Threats." 2006. http://64.233.167.104/search?q=cache:tuuEUEre7BAJ:www.ndbf.org/press/scams%26schemes-brochure.pdf+top+10+investment+scams&hl=en&ct=clnk&cd=10&gl=us (Accessed 4/1/08)
North American Securities Administrators Association. "Ponzi Schemes." 2008. http://www.nasaa.org/Investor_Education/Investor_Alerts___Tips/8315.cfm (Accessed 4/1/08)
North American Securities Administrators Association. "Protecting Your Finances." 2008. http://www.nasaa.org/content/getsearchablefile.cfm?FamilyID=2895&filename=protect_your_finances.pdf (Accessed 4/1/08)
North American Securities Administrators Association. "State Securities Regulators Identify Top 10 Traps Facing Investors." 2007. http://www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/6669.cfm (Accessed 4/1/08)
Securities and Exchange Commission. "Internet Fraud: How to Avoid Internet Investment Scams." 8/6/2007. http://www.sec.gov/investor/pubs/cyberfraud.htm (Accessed 4/1/08)
Stinson, Jeffrey. "Monaco steers clear of once-shifty image." USA Today. 5/23/2006. http://www.usatoday.com/money/world/2006-05-22-monaco-usat_x.htm (Accessed 4/15/08)
Washington State Department of Financial Institutions. "2005 Top Ten Investment Scams." http://www.dfi.wa.gov/consumers/toptenscams.htm (Accessed 4/1/08)
Washington State Department of Financial Institutions. "How to Avoid Scams and Fraud." 5/9/2007. http://www.dfi.wa.gov/consumers/invest_scam_avoid.htm (Accessed 4/1/08)