How to Spot an Investment Scam

 

Investment scams have been in the news far too often in recent years. Bernie Madoff is arguably the biggest fraudster of all time, funneling billions out of investors’ pockets.

But many money scams are born from misplaced trust and greed — and it’s important you take the necessary precautions to safeguard your investment funds. Here are common examples of investment scams to watch out for.

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A Background Check Reveals a Sketchy Past

Kirk Chisholm, wealth manager at Innovative Advisory Group, said, “Many times fraudsters will relocate from time to time when they have outstayed their welcome in other areas. In this age of information, it is much easier to research people and their background. Sometimes taking five to 10 minutes to check references or prior work associates can uncover more than you expected.”

BrokerCheck, BrightScope’s Advisor Pages and the CFP Board site are among the ways you can do a background check on a perspective financial advisor.

how to spot an investment scam
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The Organization Isn’t Registered

Another warning sign you’re about to fall into an investment scam: The entity isn’t registered.

“Check whether this investment is actually an entity,” said Chisholm. “We have uncovered a few ‘scams’ in the past by simply just doing a quick check to see if the entity is registered in the manner that the manager states it is. For example, if the entity is stated as being an LLC, check with the state it is registered in. Every LLC should be registered with the state they reside in. You should also check with the SEC.”

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Overly-Consistent Returns

Elizabeth Avery, a Washington, D.C., securities attorney and founder of Kalorama Capital, said Ponzi schemes are a common type of fraud, where investor funds are used to attract new investors and make payments.

Avery warns that overly-consistent returns are a warning sign of a scam. “This was a tip-off in the Madoff case but one that was largely unrecognized for many years,” she said. “The reason this is a warning sign is because even expert investors will experience market vacillations impacting performance.”

Related: 13 Investing Tips for Beginners

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Difficulty Getting Payments

Investment advisors registered with the SEC must abide by the custody rule, which helps safeguard investors’ funds against theft and misuse. The protections offered by the custody rule mean advisors should be able to provide you information about where your investments are being held, and you should be seeing regular account statements.

 

If you’re having trouble getting payments, Avery said, “This is a tip-off [of a scam] because a legitimate investment firm that has custody of investors’ cash or securities must meet certain custodial requirements.”

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You’re Pressured to Buy in Now

Don’t ever invest your money because someone is pressuring you to do so. If someone claims you need to buy in quickly because you’ll miss the proverbial boat — you might want to stay ashore.

“As an investor, you need to make decisions with a long-term perspective,” said Deb Shaw, chief operating officer of ForeignExchange.com. “Don’t fall victim to any deal that is offered in the ‘next hour’ or ‘only available today.’ It’s your money, and you worked hard to earn it. Don’t feel pressure to make a decision.”

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They Have ‘Insider’ Information

Another common investment scam is called a pump and dump. In this type of scam, someone who owns a stock will get others to buy in, usually on the promise of insider information. “Once the stock has been artificially ‘pumped,’ he or she will sell their stock,” said Avery. Chances are, after the scammer sells out, the stock will see a sharp decline.

“Warning signs start with intense pressure for investors to buy stock quickly,” she said. “A second alert is a claim of ‘inside’ information that make this a valuable opportunity not open to everyone.”

Steven Weisman, an attorney who blogs at Scamicide.com, said, “Investing based on ‘inside information’ obtained through an unsolicited email, fax or other communication is an indication that it is a ‘pump and dump’ scam. Insider trading is illegal, and no one is giving inside information to random people.”

Learn: Should a Mutual Fund Be Your First Investment?

where your investments go
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They Won’t Disclose How Your Money Is Invested

An investment firm should be clear on how your money is being invested. Some scammers will refuse outright to explain where your money is going. “That is, they will typically say it is a ‘black box.’ In other words, they can’t or just refuse to explain their investment strategy,” said Paul Ruedi, CEO of Ruedi Wealth Management.

Ruedi indicated this was Madoff’s methodology as he understood it. Madoff claimed to have the “secret sauce.” But in reality, he just made up the numbers.

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The Investment Advisor Is the Custodian of the Investment

“Investments where the investment advisor is also the custodian of the investment is a bad indication [of a scam],” said Weisman. “This format has been used by scammers such as Bernie Madoff many times. The person making the investment for you should not be the entity holding the investment because you don’t have any checks and balances for protecting your investment.”

If any investment advisor ever suggests your investments don’t need to be held by a reputable third-party custodian like Fidelity or Schwab, run — don’t walk — away from this person — and certainly don’t entrust them with your money.

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In Short: Never Invest in Anything You Don’t Understand

“Warren Buffet stayed clear of tech stocks for a long time because he didn’t understand them,” said Weisman. Scammers hope to nab investors who are willing to invest in things they don’t understand. In fact, “Bernie Madoff even went as far as to blame his victims for their losses, saying that if they investigated what he said he was doing, they would have realized it was impossible,” Weisman added.

If you’re working with a financial advisor or firm, and something doesn’t make sense, don’t be afraid to get a second opinion — or at least ask questions. Be diligent and aware of potential scams. This is basic, but vital, advice for all investors.