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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 Schemes—where 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 Schemes—in 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 eman d 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.

'»•• ,<f.dvarice Fee F r a u d — w h i c h plays on an investor's hope t h a t he or she wi l l be able t o reverse a previous investment mistake involv ing t h e purchase o f a low-pr iced stock. The scam generally begins w i t h an offer t o pay you an ent ic ingly high price for wor th less stock in your port fo l io . To take t h e deal, you m u s t send a fee in advance to pay for t h e service. But if you do so, you never see t h a t m o n e y — o r any of t h e money f r o m t h e d e a l — a g a i n .

> Offshore S c a m s — w h i c h come f r o m another country and target U.S. investors. Offshore scams can take a variety of fo rms, inc luding those listed above. M any involve "Regulation S," a rule t h a t exempts U.S. companies f r o m register ing securities w i t h the Securities and Exchange Commiss ion (SEC) t h a t are sold exclusively outside t h e U.S. t o foreign or "o f fshore " investors. Fraudsters can man ipu la te these types of offer ings by resell ing Reg S stock t o U.S. investors in v io lat ion of the rule. Whatever f o r m an of fshore scam takes, it can be d i f f i cu l t for U.S. law enforcement agencies t o investigate f raud or rectify harm t o investors w h e n t h e f raudsters act f r o m outside t h e U.S.

2 Avoiding Investment Scams

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 church—and 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 es—rang 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 ing or f raud . Keep an eye on your account s ta tements to make sure account act iv ity is consistent w i t h your instruct ions, and be sure you know w h o holds your assets. For instance, is t h e investment adviser also t h e custodian o f your assets? Or is there an independent th i rd -pa r t y custodian? it can be easier for f raud t o occur if an adviser is also the custodian o f t h e assets and keeper of t h e accounts.

> A jsifshy salesperson: No reputable investment professional should push you t o make an i mme d i a te decision about an investment , or te l l you t h a t you've got to "act now." If someone pressures you t o decide on a stock sale or purchase, steer clear. Even if no f raud is t a k i n g place, th is type of pressuring is inappropr iate.

You can also use our Scam Meter to help spot red flags of inves tment f raud .

Who Gets Victimized? A lmost anyone w h o invests is a potent ia l f raud target , t h o u g h you can reduce your vulnerabi l i ty if you know w h a t to guard against. A 2007 survey by t h e FINRA Foundat ion examined how known investment f raud v ict ims di f fered f r o m non-v ic t ims. A m o n g its key f indings, t h e survey ident i f ied several investment f raud risk factors, inc lud ing :

@ O w n i n g high-r isk investments , inc luding penny stocks, promissory notes, fu tures , opt ions or private investments in fore ign currency;

@ Relying on fr iends, fami ly , co-workers for advice (for example, one - th i rd of the nat ional sample — b u t 70 percent o f v ic t ims — m a d e an inves tment based pr imar i ly on advice f r o m relative or f r iend) ;

^ Being open t o new investment i n f o r m a t i o n (for example, three t imes as many v ict ims w e n t t o a free investment s e m i n a r t h a n t h e nat ional sample) ;

^ Fail ing to check the background o f an investment or broker (for example, 1 in 8 v ic t ims fai led t o check w h e t h e r an investment professional had a cr iminal background, and 1 in 7 did not check the i r l icensing or registrat ion) ; and

0 Inabi l i ty t o spot persuasion tact ics used by fraudsters.

You can use our Risk Meter t o assess w h e t h e r y o u share any characteristics and behavior t ra i ts t h a t have been shown to make some investors vulnerable to investment f raud .

How Can I Protect Myself? In addi t ion to paying a t t e n t i o n to t h e red flags o f f raud and l e a r n i n g t o spot and avoid the persuasion tact ics f raudsters use, it is crit ical t h a t you ask quest ions about investments and t h e people w h o pitch t h e m — a n d t h e n verify t h e answers.

Here's how:

>• Check Out inves tment P r o f e s s i o n a l s - Always ask w h e t h e r t h e promoter of an inves tment oppor tun i t y is licensed t o sell you the investment — and conf i rm wh ic h regulator issued t h a t license, and if and w h e n the license has ever been revoked or suspended. A leg i t imate securities salesperson m u s t be properly l icensed, and his or her f i r m m u s t be registered w i t h FINRA, t h e SEC or a state securities r e g u l a t o r — depend ing on t h e type of business t h e f i r m conducts. An insurance agent must be licensed by the state insurance commiss ioner where h e o r s h e does business.

Be sure to independent ly verify t h e salesperson's or promoter 's answers as fo l l ows :

> For a broker or brokerage f i r m , use FINRA BrokerCheck at www.finra.org/brokercheck or call to l l - f ree : (800) 2 8 9 - 9 9 9 9 . BrokerCheck al lows you to conf i rm not only l icensing and registrat ion, but also w h e t h e r an indiv idual or f i r m has a history o f compla in ts or regulatory problems.

continued

4 Avoiding investment Scams

How Can I Protect Myself? (continued)

> For an investment adviser, use t h e SEC's Investment Adviser Public Disclosure websi te at www.adviserinfo.sec.gov or call to l l - f ree : (800)SEC-0330.

>• For an insurance agent, check w i t h your state insurance depar tment . You w i l l f i nd contact i n f o r m a t i o n t h r o u g h t h e Nat ional Association o f insurance Commissioners (NAIC) at www. naic.org or call to l l - f ree : (866) 470-NAIC.

>• For all sellers, be sure to call your state securities regulator. You can f ind t h a t number in t h e government section of your local phone book or by contact ing the Nor th Amer ican Securities Admin is t ra tors Association at www.nasaa.org or (202) 7 3 7 - 0 9 0 0 for t h e state's number .

Check Oy t Investments—.Ask whether t h e investment is registered and, if so, w i t h w h ich regulator. Most investors w i l l w a n t to buy securities products t h a t are registered w i t h t h e SEC or w i t h state regulators. W i t h very f e w exceptions, companies must register the i r securities before they can sell shares to t h e public.

You can f ind out w h e t h e r a product is registered w i t h t h e SEC by using t h e EDGAR database {www.sec.gov/edgar.shtmi). You can also use our Scam Meter t o help you de te rmine whether an inves tment you are t h i n k i n g about m i g h t be a scam.

sf a Problem Occurs If you believe you have been defrauded or t reated unfair ly by a securities professional or f i r m , please send us a w r i t t e n compla int . If you suspect t h a t someone you know has been taken in by a scam, be sure t o give us t h a t t i p . Here's how:

Onl ine:

File a Complaint [iox you) —www.finra.org/compiaint

Send a Tip (for others) —www.finra.org/fileatip

Mai i or Fax:

FINRA Complaints and Tips 9509 Key West Avenue Rockville, M D 20850 Fax: (866) 397 -3290

A Word About Registration:

Smart Thinking; Investors should always ask w h e t h e r a security is registered w i t h t h e SEC—and if not, w h y not. Not all

securities offer ings must be registered w i t h the SEC — s u c h as those issued by munic ipa l , state and federal governments .

The SEC also provides exempt ions for certain int rastate offer ings and smal l public and private offer ings under a rule know n as Regulation D. www.sec.gov/answers/regd.htm

Keep in m ind t h a t registrat ion w i t h the SEC does not guarantee t h a t an inves tment wi l l be a good one or i m m u n e to f r a u d . Likewise, lack of registrat ion does not mean t h e investment lacks legit imacy. The crit ical d i f ference is t h e ex t reme level of risk you assume w h e n you invest in a company about wh ich l i t t le or no i n f o r m a t i o n is publicly available. SEC registrat ion carries a number of advantages for investors, inc lud ing disclosure o f f inancia l and other i n fo rmat ion t h a t can help investors assess w h e t h e r t o invest in a company 's securities.

5 Avoiding investment Scams

Who We Are

FINRA

FINRA, t h e Financial Industry Regulatory Authority, is an independent regulatory organizat ion en-ipowered by the federal government to ensure t h a t America's 90 mi l l ion investors are protected. The mission of t h e FINRA Investor Education Foundation is t o provide underserved Americans w i t h t h e knowledge, skills and tools necessary for f inancia l success t h r o u g h o u t life. FINRA and the FINRA Investor Education Foundat ion do not sell inves tment products, p romote products or f i rms or offer specific investment advice. The FINRA Foundation's Investor Protection Campaign, SaveAndlnvest.org, is a targeted e f fo r t t o reduce t h e incidence o f investment f raud a m o n g investors by teach ing t h e tact ics most c o m m o n l y used by f raudsters and t h e s imple steps every investor can take t o reduce the i r risk. Become a Fraud F ighter—v is i t SaveAndlnvest.org.

Better Business Bureau

For 100 years. Better Business Bureau has been help ing consumers f i nd businesses, brands and charit ies they can t rust . In 2 0 1 1 , consumers t u r n e d t o BBB more t h a n 100 mi l l ion t i m e s for Business Reviews on more t h a n 4 mi l l ion companies and Charity Reports on 11,000 charit ies, all available for free at www.bbb.org The Council of Better Business Bureaus is t h e umbrel la organizat ion for 116 local, independent BBBs across the Uni ted States and Canada, as wel l as home to its nat ional programs on d ispute resolut ion and industry se l f - regulat ion.

Learn more about scams: www.bbb.org/smartinvesting

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Investor Resources

FINRA Investor Information — i n v e s t o r Alerts, tools and much more to help you invest smarter and safer.

• Investor Alerts • Smart Saving for College • Fund Analyzer

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Smart Bond Investing Smart 401(k) Investing Financial Calculators

FINRA Market Data Data on equit ies, opt ions, m u t u a l funds and a w ide range of bonds, inc luding real - t ime corporate bond prices and FINRA-Bloomberg Bond Indices.

Websi te : www.finra.org/marketdata

FINRA BrokerCheck —Check t h e background of a broker or brokerage f i r m .

Websi te : www.fnra.org/brokerclieck Tol l - free: (800) 2 8 9 - 9 9 9 9

FINRA Investor Complaint Cen te r— i f you feel you've been t reated unfair ly .

FINRA Investor Compla in t Center 9509 Key West Avenue Rockville, M D 2 0 8 5 0 - 3 3 2 9

Websi te : www.finra.org/complaint Fax: ( 8 6 6 ) 3 9 7 - 3 2 9 0

Additional Resources Risk Meter: www.finra.org/meters/risk

Scam Meter: www.finra.org/meters/scam

Avoid Identity Theft and Fraud: www.fnra.org/lnvestors/ ProtectYourself/AvoidlnvestmentFraud

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Avoiding Investment Scams