10 Rules for Avoiding Investment Scams

Fraudulent investment schemes run rampant, often with enticing guaranteed high rates of return. The more alluring an investment sounds, however, the higher the probability that you are dealing with a fraudster. The best way to prevent losing money to a con artist is to never entrust it to one in the first place. Here are ten rules for avoiding them:

1. Trust Your Instincts.

We often downplay our intuition, particularly when dealing with investment vehicles that may appear too esoteric for a lay person to understand. But go with your gut. You don’t have to be able to articulate every reason why an investment seems fraudulent. Perhaps the high pressure sales tactics of the salesperson are unsettling. Perhaps it just seems too good to be true. Or maybe the promoter just seems a little too eager to get your cash. If it doesn’t feel right, simply pass. A common theme among fraud victims is that they knew something was wrong but made the investment anyway.

2. Do Your Research.

Never make an investment without being provided with a written prospectus or offering memorandum. Never ask your salesperson for references from other investors, as it is very common for fraudsters to pay early investors high rates of return to give their sham investment the appearance of legitimacy. Instead, verify the investment with regulatory authorities like the Securities and Exchange Commission (SEC), National Association of Securities Dealers (NASD), and state securities regulators, and verify that your salesperson is registered and licensed to sell securities. Also, make sure you request historical data verifying the rates of return. These are common due diligence practices. If your requests irritate the sales person, do not invest.

3. Avoid Affinity Funds.

It is human nature to trust people with whom you share a commonality. Unfortunately, con artists prey upon this susceptibility by marketing fraudulent investment schemes to closed and identifiable communities, particularly religious and ethnic groups. Just because an investment is marketed by a member of your community does not make it more trustworthy. In fact, it often makes it less so. Remember to do your research, and to make sure the salesperson is registered and licensed.

4. You are Not Special.

One way to increase demand is to limit supply. Con artists use this knowledge to defraud the public by creating “exclusive” funds and inviting unwitting victims to participate in a “once in a lifetime opportunity.” This devise is often, although not always, utilized with modest investors who have less than $100,000 to invest. Be very wary of these tactics. If the investment vehicle was as good as the marketer claims it to be, they would have no problem raising funds from more savvy institutional investors.

5. There is Always Risk.

Simply put, there is always a risk when investing. If a promoter tells you otherwise, he is lying. And if the historical data provided to you appears to show a guaranteed rate of return or overly consistent returns, it is probably falsified.

6. There is Never a Secret.

The markets exist because good investing is not a secret. Granted, some investment managers are far better market players than others, but the information they act upon is publically available.  So if your salesperson tells you that they have secret or inside knowledge available only to them, walk away.  On the off chance he or she actually does have access to inside information, investing based on inside information is illegal.

7. Avoid Pyramid Schemes.

Multi-level marketing of products has become relatively commonplace, but it is illegal to market and sell securities and investment vehicles through multi-level marketing. If you are offered a portion of the return to “down-line” investors that you can bring into a program, it is a fraud.

8. Look for Badges of Fraud.

Typically, con artists are charming and gregarious, but they are also intensely narcissistic. If you spot any of the following red flags, you may want to consider investing your money elsewhere:

  • grandiose demonstrations of wealth or importance;
  • an investment fund named after the promoter;
  • a one-man show without employees;
  • refusal to use independent third-party custodians;
  • high pressure sales techniques;
  • easily offended by reasonable requests for information; and
  • claims “special” contacts or knowledge.

9. Stay Onshore.

If you are a modest investor with less than $100,000 to invest, it is wise to keep your money here in the United States. While offshore investments can be lucrative and perfectly reasonable for sophisticated investors, keeping your money onshore means that you avoid cumbersome federal tax requirements while maintaining the protection of the SEC, the NASD, and various state securities regulators.

10. Attorney Review.

When in doubt, have an attorney review the prospectus or offering memorandum. Involving a knowledgeable professional often mitigates high pressure sales tactics, and brings an outside perspective to the transaction.

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