Finance
Verify and Diversify: Protecting Yourself Against Financial Fraud
CBN.com – In June, financier Bernard Madoff was sentenced to 150 years in prison for running a $50 billion investment con that fooled bankers, economists, insurance executives, pension-fund managers, and thousands of individual clients — including film mogul Jeffrey Katzenberg, actors Kevin Bacon and John Malkovich, and baseball great Sandy Koufax.
The fact that Mr. Madoff's operation had once seemed to be a reputable business run by an experienced investor with a solid reputation had many investors rightly wondering, "Can I really trust the people handling my money?"
Trust is a necessary ingredient in the investment arena, as well as in life generally. But a wise investor should adopt the standard President Ronald Reagan used in dealing with the Soviet Union: "Trust, but verify." Before entrusting money to a company or an adviser, an investor has the right to ask questions and examine evidence related to what will be done with the money.
In the Madoff case, a key warning sign that something was amiss was that Mr. Madoff offered returns that were unrealistically steady. In both good times and bad, his "investments" chugged along with virtually no volatility, offering returns of about 1 percent a month. If only Wall Street investments actually performed that way! They don't. (According to investigators, Mr. Madoff was able to produce steady returns not by actually investing in the market but by simply funneling money from client-to-client in a giant "Ponzi scheme.")
In addition to asking hard questions before investing—especially when warning signs are present—investors can further protect themselves by "not putting all their eggs in one basket," to use a well-worn phrase. Sadly, many Madoff victims entrusted the financier with virtually their entire holdings and now face losses of millions (in some cases, even hundreds of millions) of dollars.
Common types of fraud
While the Madoff case grabbed the headlines (due to the size of the fraud and the prominence of the accused), authorities are constantly investigating hundreds of lower-profile investment-fraud cases.
The North American Securities Administrators Association (NASAA), pulling together information from state regulators across the country, has issued a list of the 10 most pervasive "investor traps"—common schemes all aimed at separating unsuspecting investors from their money.
1. Insufficient disclosure about complicated investments. A major area of fraud under this heading is the sale of "auction-rate securities," which often are misrepresented to investors as being similar to very safe cash deposits or money market accounts. NASAA warns that "investors should remain cautious when pitched complex investments accompanied by deficient disclosures."
2. Online affinity fraud. "Communication tools provided by some social networking websites make it easy to advertise and promote investment scams to a wide audience for free," notes NASAA's Karen Tyler. To gain trust, scammers often identify with their victims' religious views or ethnic background (trusting someone similar to you is human nature).
3. Prime bank fraud. In this scheme, fraudsters purport to be working with "a big player behind the scenes" who has access to a "secret trading program" sanctioned by the Federal Reserve, the World Bank, or the International Monetary Fund.
4. Private securities offerings. NASAA urges caution if you are encouraged to invest in a "general partnership" or "limited liability company." Although sometimes legitimate, such offerings "are often associated with fraud."
5. Promissory notes. Legitimate promissory notes are almost always marketed to "sophisticated or corporate investors," notes NASAA. The non-legit ones are sold to inexperienced average investors, accompanied by false promise of "insured" or "guaranteed" above-market returns.
6. Pump-and-dump schemes. Sometimes called "micro-cap fraud," these schemes involve the e-mailing of phony press releases that suggest the price of a certain stock is about to skyrocket. Shares are then sold at an inflated prices not supported by actual value. The crash comes soon thereafter.
7. Real-estate investment schemes. "As the housing market continues to reel from the subprime lending crisis, schemes promising large returns from various types of real-estate-related investments also are increasing," NASAA warns. Many schemes involve promoters trying to dump worthless real estate investments onto "unsuspecting retail investors."
8. Sale and leaseback contracts. These schemes involve "investments in equipment or animals." Unfounded promises are made about high returns and "guaranteed" future repurchase.
9. Unsuitable sales. This is a catch-all category of investments that simply are not suitable for certain types of people—such as complex variable and equity-indexed annuities being sold to senior citizens who know little about investing.
10. Energy scams. This type of fraud isn't quite as widespread as when oil prices were hitting record highs last year, but it hasn't gone away completely. Energy scams often involve a promise of high returns from new technologies that will "ultimately replace oil and gas."
The common denominator in every scam is a promise (stated or implied) of better returns than you can find elsewhere—often accompanied by claims of little risk and/or "guaranteed" results. The reality is that risk and return are inextricably related. An investment described as "low-risk/high-return" should put you on your guard immediately. Also remember that in investing there are no guarantees, only probabilities.
Given the incidence of financial fraud, it is appropriate to be wary when investing. But don't become cynical. There are many reputable organizations run by people who take seriously their stewardship role in handling your investments. Such folks will gladly respond to your concerns.
After all, they understand that you're trying to be a good steward, too.
Sound Mind Investing exists to help individuals understand and apply biblically-based principles for making spending and investing decisions in order that their future financial security would be strengthened, and their giving to worldwide missionary efforts for the cause of Christ would accelerate. In other words, we want to help you have more so that you can give more.
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