How to Avoid Investment Scams

You read about investment scams, and their catastrophic impact, but you may not believe they will ever impact you.

You may be right, but a lot of stories have documented how sophisticated investors have been damaged by slick financial scams. And, it stands to reason scams will be slicker in the future because new scams will continue to learn from their predecessors’ mistakes.

Don’t assume the regulators (SEC, FINRA, state securities commissioners) will protect you from scams. You may have noticed by the time they get involved the money is usually gone and investors are lucky if they recover 10 cents on the dollar.

Your best defense is avoiding scams. Since someone has to sell you the scam this Guide focuses on advisors, sales pitches, and the characteristics of legal and illegal scams. 

Too Good to be True

When an investment sounds too good to be true it is not true. Scams usually include pitches that tell you what you want to hear. For example, the sales person for the scam tells you they have unique processes that developed a risk-free promissory note that yields 18% or a risk-free, offshore CD that yields 12%.

High Return, Low Risk

Every investor would like to believe there are investments that produce high returns for low risks. For example, many scams promise 40% rates of return for little or no risk. Even sophisticated investors have fallen for this sales pitch.

High returns require high exposure to risk. Low risk produces low returns. There is no investment that produces high returns for low risk.

Black Box Investments

Several high profile scams have been based on trading currencies using a proprietary computer program (the black box). Due to its magical algorithms you are not supposed to understand how the program works. The representative's pitch is designed to convince you the black box has discovered a rare investment opportunity that is capable of producing extraordinary returns for small amounts of risk.

If you can’t understand it, don’t invest in it.

Referrals

Numerous scams are based on referrals from one investor to another. For example, the scam operators produce false reports that show high returns for one investor then they ask that investor to refer the scam’s sales representative to friends and family. These crooks work churches, country clubs, retirement communities, and other groups that have common interests.

A referral from someone you like or trust does not relieve you of the burden of conducting your own research on the advisor.

False Promises

Some advisors will promise specific rates of return to gain control of your assets. These promises are illegal because advisors cannot predict the future performance of the securities markets. Get the advisor to put the promised return in writing and send it to FINRA, the SEC, and your state’s securities commissioner.

Seniors

Seniors are particularly vulnerable to investment scams because the operators of the scams know exactly what they want to hear, for example high interest income and low risk. It is easy for them to develop fake products that have the characteristics that appeal to seniors who are trying to maintain their current standards of living.

Physical Possession of Your Assets

Bad guys cannot steal your assets unless they gain physical possession of your assets. Part of their scam is convincing you to write a check, in the amount of your investable assets, to them or a company they control.

Never write a check to an advisor or a company controlled by the advisor (except brand name firms). Always require a brand-name custodian like Schwab, Fidelity, Pershing, or TD Ameritrade to hold your assets. In fact, the advisor should never come in direct with your check or assets. You should interact direct with the custodian.

Advisor and Product Licensing

If the advisor is selling an illegal scam, there is no reason for the advisor to be registered with the regulatory agencies. The same applies for illegal products. Licensing brings increased scrutiny that could expose the scam. Ask the advisor for his CRD number and verify his licensing by going to FINRA.org/Brokercheck

Legal Scams

Not all scams are based on illegal products such as Ponzi schemes. Some scams are based on legal products that have excessive expenses, high risk, and bad performance. Advisors sell these products because they pay higher commissions than products with reasonable expenses and competitive returns.

There are 50 legal scams for every illegal scam. As they say, “there is no law that says advisors have to provide competent advice”. It is up to investors to protect their assets from predatory sales practices. 

Summary: Protection for Your Assets

Follow a few simple rules and you can greatly reduce your exposure to investment scams, bad advice, and bad products.

• Make sure the product is registered for sale in your state by contacting your state’s Securities and Insurance Commissioners

• Ask to see the advisor’s current licensing and registrations. Use the CRD number to check the advisor’s compliance history at FINRA.org/BrokerCheck

• Always write your check to a third party custodian that is not owned or controlled by the advisor or the advisor’s firm

• Be extra cautious if the advisor is recommending offshore investments in tax havens. Most of the havens have minimal regulations that govern investments, licensing, and disclosure. Many of the countries are also corrupt and susceptible to bribes from scam operators

• If you are going to invest substantial assets it is a good idea to have background checks conducted for the advisor, the firm, the product company if it is a third party, and the custodian