One of the main building blocks of financial freedom is an investment. With the right kind of investments, one can secure their future, retire early, and live on passive income and ROIs. However, investments could be as dangerous as they are lucrative, especially if one puts money in the wrong one. There are many investment scams out there, and the real problem lies in distinguishing between real and fake. In this piece, we will shed more light on what investment scams are, and highlight a few famous ones to look for.
Investment fraud, also known as stock fraud and securities fraud is a deceptive practice in the stock or commodities markets that induces investors to make purchase or sale decisions based on false information, frequently resulting in losses and violation of securities laws. Investment fraud can also mean, among other things, outright theft from investors by stockbrokers. In simpler terms, investment fraud happens when investment fraudsters deceive potential investors into making purchases based on false information.
Legitimate companies may also lie to potential investors, saying they are making bigger profits than they actually are making to secure investment by falsifying audits and other company statements. Alternatively, fraudsters may set up fake companies or fake investment opportunities to scam victims into investing.
According to statistics in a 2019 report by the USSC (United States Sentencing Commission), securities and investment fraud has increased by 13.3% since the fiscal year 2015. UK Finance, a trade body, recently reported that investment scam reports surged by almost a third (32%) during 2020, with losses to these scams increasing 42% to £135.1m. Keep reading to learn about some of the most popular types of investment scams.
1. Pyramid scheme
This is one of the most common types of investment fraud. Likewise, it is one of the easiest to fall for. These schemes can be so enticing that victims hardly realise they’ve been taken in by a pyramid scheme. Individuals are usually first contacted by a family member, friend or acquaintance who wants to share more information about their new business opportunity. This often extends to an invitation to a recruiting event, coffee meeting or a proposition via social media, email, phone or even post.
At first, the rep will ask the individual to invest large upfront costs for a ‘starter’ pack or products. They’ll be promised a small commission for any products sold, and promised an even bigger return for recruiting others to join. This is because pyramid schemes rely on fees from new recruits and not from the sale of actual products. The pattern is however not sustainable and only benefits the people at the top of the pyramid.
This is because reps earn money from the recruits below them, but eventually, the member pool dries up. When that happens, top-level reps walk away with large ‘earnings’, and newer recruits with fewer recruits below them will leave empty-handed on top of losing their initial investments.
2. Affinity fraud
Affinity fraud is similar to Pyramid schemes in some ways. Perpetrators of this kind of fraud often target members of a group based on race, age, religion, etc. They use a pyramid scheme to lure members in and might even pretend to be a member of the targeted group to gain trust. An example of such pattern is a situation where affinity fraudsters con religious leaders into convincing their congregations to buy into a pyramid-like money making scheme.
3. Pump and dump fraud
In pump and dump, fraudsters build a portfolio of potential investors and pitch them a deal on low-priced stock. The fraudster owns a large amount of the stock they are selling, which doesn’t necessarily represent a legitimate business. As more investors buy shares in this stock, the value suddenly rises (i.e pumping the stocks). This is the point where the investment fraudster ‘dumps’, selling their own shares before the value of the stock crashes. The fraudster accumulates a large amount of money, and the investors are left with worthless stocks.
Also read: 10 best smartphone apps to track your spending and save more
4. Offshore scam
In this category, the scammer promises amazing profits if investors send money offshore. The objective is to reduce or completely avoid taxes by sending money to a tax haven. This usually is an enticing idea for most people. The problem is, the company you believe you are sending your money to may be fake or set up to simply funnel investor funds to the fraudsters. The scammers may tell the investor that their money will be flowing in and out of their account, and sometimes, they provide proof to back this up. Whereas, there is likelihood that the money is actually going to a feeder account, which is clearing money out of the investors’ account.
A downside of offshore scams is that you may end up owing the government money in back taxes, interest or penalties for taking part in a tax avoidance scheme.
5. Boiler room scam
In Boiler room scam, a fake stockbroker contacts unsuspecting investors via telephone or online and share ‘insider knowledge’. They pressure you into buying shares which they ‘know’ are about to become very valuable. In reality, the shares are worthless, and the fraudster will sell them for a high price. As a result, the investor is left with a financial loss and worthless, unsellable stock.
6. Advance fee scam
This type of scam offers the promise of high returns in goods, services and/or financial gains, and all you need to do is pay an advance fee up front in order for the deal to go through. Usually, the scammer targets people who are vulnerable due to their age, youth, or disability.
Loan scams, rental fraud, clairvoyant or psychic scams, vehicle matching scams, career opportunity scams, dating scams, lottery or prize draw scams, and inheritance fraud are some of the popular advance fee scams.
7. Clone scam
This is one of the most difficult scams to spot. The Financial Conduct Authority (FCA) reported that 77% of investors admitted they were unsure what a clone investment firm was.
In clone investment scams, fraudsters set up fake firms that appear identical to a genuine firm, i.e. they ‘clone’ the genuine firm. They clone the name, address and even the Firm Reference Number (FRN) of genuine companies authorised by the FCA. They then contact potential investors with fake sales materials that are linked to the genuine firm. Sometimes, they go as far as encouraging potential investors to look up the firm’s FRN on the FCA Register to convince them that this a genuine opportunity.
The BBC reported that clone firm investment scams rose by 29% in April 2020, during the first national lockdown. This was because people were eager to find investment opportunities and therefore were easy prey.
Ten famous investment scams
Now that we have understood the concept of investment scams and seen the most common types of it, here are ten popular investment scams (culled from firmex.com) that shook the world, including the degree of losses in figures.
1. Charles Ponzi (Securities Exchange Company) – Loss estimated at $20 million
Category: Pyramid Scheme
The Charles Ponzi scheme promised clients a 50% profit within 45 days or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the US as a form of arbitrage. In reality, Ponzi was paying earlier investors using the investments of later investors. The scheme eventually failed in 1920 leaving 5 banks and all investors ruined. Charles Ponzi made $20 million through his pyramid scheme, equal to $250 million in 2020. He was charged with 86 counts of mail fraud and faced life imprisonment, however, he got a deal that made him serve only 5 years.
2. Bernard Ebbers (WorldCom) – Loss estimated at $100 billion
Category: Overstated cashflow
