avoiding investment scams

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  • Brought to you by. BBB

    SaveAndlnvesti Finra Investor Education F O U N D A T I O N

    Avoiding Investment Scams Key Topics:

    Financial Scams

    > Investment Fraud

    > Fraud Tactics

    > Pyramid Schemes

    > Ponzi Schemes

    * P u m p - a n d - D u m p

    >- Advance Fee Fraud

    > Offshore Scams

    WHAT'S INSIDE

    Avoiding Investment Scams

    Types of Investment Scams

    Psychology of a Scam

    Red Flags of Fraud

    Who Gets Victimized?

    How Can I Protect Myself?

    The current f inancia l crisis has not only battered t h e port fo l ios o f many investors, it has also placed a spot l ight on inves tment f raud . In t u r b u l e n t economic t imes , ongo ing schemes tend to unravel as wary investors begin d e m a n d i n g the i r cash. And t h e oppor tun i t y for new f raud can rise, as f raudsters look for any hook to explo i t those w h o hope t o recover the i r losses.

    FINRA is issuing this Alert t o w a r n investors about classic types o f investment f raud and t o help investors spot and avoid the types of persuasion tactics fraudsters use. We also describe key red f lags and provide tools t o help you avoid f raud. Our Scam Meter (www.finra.org/meters/scam) can help you assess whether an oppor tun i t y is too good t o be t rue, and our Risk Meter (www.finra.org/meters/risk) reveals w h e t h e r you share characterist ics and behavior t ra i ts t h a t have been shown t o make some investors vulnerable t o inves tment f raud .

    Investment scams can take many fo rms a n d f raudsters can t u r n on a d ime w h e n it comes to developing new pitches or come-ons for t h e latest f raud . But wh i le t h e wrapper or hook m i g h t change, t h e most c o m m o n securities f rauds t e n d to fal l in to the f o l l o w i n g general schemes:

    > Pyramid Schemeswhere f raudsters c laim t h a t they can t u r n a small investment into large prof i ts w i t h i n a short period of t i m e b u t in reality, part ic ipants make money solely by recru i t ing new part ic ipants into t h e program. The fraudsters behind these schemes typical ly go t o great lengths t o make the i r programs appear t o be leg i t imate mul t i - leve l marke t ing schemes. Pyramid schemes eventual ly fal l apart w h e n it becomes impossible t o recruit new part ic ipants, wh ich can happen quickly.

    Stage Participants

    Level 1 Level 2 64 Level 3 512

    Level 4 4,096

    Level 5 32,768

    Level 6 262,144

    Level 7 2,097,152 Level 8 16,777,216 Level 9 134,217,728

    Level 10 1,073,741,824

    Level 1 1 8,589,934,592

    Notes

    Each part ic ipant recruits 8 new investors

    More t h a n t r ip le t h e U.S. populat ion

    More t h a n t h e wor ld 's populat ion

    1 Avoiding Investment Scams

  • > Ponzi Schemesin wh ic l i a central f raudster or " h u b " collects money f r o m new investors and uses it t o pay purpor ted r e t u r n s t o earl ier-stage investors r a t h e r t h a n invest ing or m a n a g i n g the money as promised. The scam is named after Charles Ponzi, a 1920s-era con cr iminal w h o persuaded thousands to invest in a complex price arbitrage scheme involv ing postage stamps. Like pyramid schemes, Ponzi schemes require a steady stream of incoming cash t o stay af loat. But unl ike pyramid schemes, investors in a Ponzi scheme typical ly do not have to recruit new investors t o earn a share of "prof i ts . " Ponzi schemes tend to collapse w h e n t h e f raudster at t h e hub can no longer at t ract new investors or w h e n too many investors a t t e m p t to get the i r money o u t f o r example, dur ing t u r b u l e n t economic t imes .

    NEW INVESTORS

    $$$[>$$$ 1 $[>$ POMZI HUB OPERATOR EARLIER INVESTORS

    The hub promises high f inancia l returns t o new investors t h a t aren' t available t h r o u g h t rad i t iona l investments .

    2. Then, t h e hub collects money f r o m addi t ional new investors.

    Instead of invest ing the money, t h e hub pays so-called " re tu rns " to earlier investors f r o m t h e new investors' money.

    The f raud perpetuates itself as long a s t h e hub f inds new investors.

    > P u m p - a n d - D u m p i n wh ich a f raudster del iberately buys shares of a very low-pr iced stock o f a smal l , th in l y t raded company and t h e n spreads false in fo rmat ion t o d r u m up interest in t h e stock and increase its stock price. Believing they ' re g e t t i n g a good deal on a promis ing stock, investors create buy ing d emand at increasingly higher prices. The f r a u d s t e r t h e n dumps his shares a t t h e high price and vanishes, leaving many people caught w i t h worth less shares o f stock. P u m p - a n d - d u m p s t rad i t iona l l y were carried out by cold callers operat ing out o f boiler rooms, or t h r o u g h fax or onl ine newsletters. Now, t h e most c o m m o n vehicles are spam emails or t e x t messages.

    ' ,

  • Psychology of a Scam The common thread that binds these d i f fe rent types o f f raud is t h e psychology behind the p i tch. We've all heard t h e t imeless a d m o n i t i o n " If it sounds too good to be t rue, it probably i s " w h i c h is great advice, but t h e tr ick is f i gu r ing out w h e n " g o o d " becomes " too good." There's no br ight line. Investment f raudsters make the i r l iv ing by m a k i n g sure the deals they t o u t appear both good and t rue .

    In a 2006 study funded by t h e FINRA Investor Education Foundat ion, t h e Consumer Fraud Research Group examined hundreds o f undercover audiotapes o f f raudsters p i tch ing investments scam. The tapes revealed t h a t f raudsters are masters of persuasion, ta i l o r ing the i r pitches t o match t h e psychological profiles o f the i r targets. They look for an Achil les' heel by asking seemingly benign quest ions a b o u t your heal th , fami ly , pol it ical views, hobbies or prior employers. Once they know w h i c h bu t tons t o push, they ' l l bombard you w i t h a flurry of influence tactics, which can leave even t h e savviest person in a haze. Some of t h e most c o m m o n tactics include:

    > The " P h a f i t o m Riches" T a c t i c - d a n g l i n g t h e prospect of w e a l t h , e n t i c i n g y o u w i t h s o m e t h i n g y o u w a n t but can't have. "These gas wel ls are guaranteed t o produce $6,800 a month in income."

    > ' The "Source Cred ib i l i t y " T a c t i c t r y i n g t o bui ld credibi l i ty by c l a im ing to be a reputable au thor i t y or expert. "Believe me, as a senior vice president o f XYZ Firm, I w o u l d never sell an investment t h a t doesn ' t produce."

    > The "Social Consensus" T a c t i c l e a d i n g y o u t o believe t h a t other savvy investors have already invested. "This is h o w got his start . I know it's a lot of money, bu t I'm i n a n d so is my m o m and hal f her churchand it's worth every dime."

    > The "Rec iproc i ty " T a c t i c - o f f e r i n g to do a smal l favor for you in return for a big favor. "I ' l l give you a break on my commiss ion if you buy n o w h a l f off ."

    > The " S c a n : - v " l : i : v - > c r e a t i n g a false sense of urgency by c la iming l im i ted supply. "There are only t w o units left, so I'd sign today if I were you . "

    If these tactics look fami l iar , it's because leg i t imate marketers use t h e m , too . However, w h e n w e are not prepared t o resist t h e m , these tactics can work subl iminal ly . Little wonder t h a t v ic t ims o f ten say t o regulators after they have been scammed, "I don ' t know w h a t I was t h i n k i n g , " or " i t really caught me o f f guard. " That's w h y an i m p o r t a n t part o f resist ing these c o m m o n persuasion tact ics is t o understand t h e m before encounter ing t h e m .

    Red Flags of Fraud To stay on guard and avoid becoming d r a w n into a scam, look for the w a r n i n g signs o f investment f r a u d :

    > Guarantees; Be suspect of anyone w h o guarantees t h a t an investment wi l l per form a certain way. All investments carry some degree of risk.

    >- Unregistered p r o d u a s : Many investment scams involve unl icensed indiv iduals sel l ing unregistered secur i t i esrang ing from stocks, bonds, notes, hedge funds , oil or gas deals, or f i c t i t ious ins t ruments , such as pr ime bank investments .

    > Overly consistent re turns : Any investment t h a t consistent ly goes up m o n t h after m o n t h o r t h a t provides remarkably steady returns regardless of market condi t ions s h o u l d raise suspicions, especially d u r i n g t u r b u l e n t t i m e s . Even t h e most stable investments can experience hiccups once in a wh i le .

    > Complex strategies-: Avoid anyone w h o credits a highly complex inves t ing techn ique for unusual success. Legit imate professionals should be able to explain clearly w h a t they are doing. It is crit ical t h a t you fu l l y understand any investment you're seriously c o n s i d e r i n g i n c l u d i n g w h a t it is, w h a t t h e risks are and how the inves tment makes money.

    > Missing documentation: If someone tries t o sell you a security w i t h no d o c u m e n t a t i o n t h a t is, no prospectus in the case o f a stock or m u t u a l f u n d , and no o f fe r ing circular in t h e case of a bond h e or she may be sel l ing unregistered securities. The same is t rue of stocks w i t h o u t stock symbols.

    3 Avoiding Investment Scams

  • > Account discrepancies: Unauthor ized trades, missing funds or other problems w i t h your account s ta tements could be the result of a genuine e r r o r o r they could indicate churn in

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