February 2, 2012 / 7:21 PM / 7 years ago

How to spot investment fraud

NEW YORK (Reuters) - For years, Shelby Dean Martin made grand promises to garner investor dollars: People could get in on the ground floor as he took companies public, they’d get a guaranteed handsome return and have their principal delivered back in a year. He lured in a constant stream of investors to build his Ponzi scheme.

And, for years, they kept coming.

In the end, nearly 200 people lost more than $18 million. And Martin, 73, is now a resident of Mountain View Correctional Institution in Spruce Pine, North Carolina, after pleading guilty to securities fraud.

While cautionary tales like Martin’s abound - not to mention the likes of Bernie Madoff and Allen Stanford - scammers still have no trouble finding willing dupes.

That’s especially true now that the tools of “affinity fraud” (when members of an identifiable group are lured) include Facebook, LinkedIn and online chat forums, reducing the need for top-tier, in-person networking, such as when Madoff trolled the Palm Beach Country Club for high net worth victims.

The Securities Investor Protection Corporation says investors lose between $10 billion and $40 billion a year, and the Securities and Exchange Commission has issued a special warning that social media is being used to promote scams (see this story - here).

John Breyault, who heads the National Consumers League’s Fraud Center, says social media is ideal for crooks.

“It’s a low-cost way to reach out to thousands of potential victims,” he says. “Fraud is based on trust. Social media ... is almost a perfect platform to commit affinity fraud.”

Investment scams, in general, are driven by victims’ belief that the opportunities presented are credible. That increasingly involves using false information disseminated online to inflate the worth of a potential investment to investors.

Randy Shain, founder of the investigative firm, The BackTrack Report, says it can be difficult sieving through investment opportunities - whether it involves a new venture or a great stock tip.

High net worth investors are prime targets if their money came from outside the world of finance. For athletes, actors or small business owners who strike it rich, Shain says the danger is that a shrewd fraudster will know how to play them.

“It’s a lot easier to fool someone who made their money doing something else; that’s why they are the targets,” he says. “It’s not random.”

Swindlers can be difficult to spot because they’re adept at disguising what they’re doing. And because they need your trust, Shain notes, it could well be someone in your social circle. If one victim is conned, he or she may vouch for the crook, unwittingly drawing in more victims. This is the nature of affinity fraud.

Whether it’s an athlete or actor who was taken in, vouching to other athletes or actors or members of a church group, the con artists count on someone else to give their (dubious) claims credibility.

In 2010, the SEC brought a case in which some 14,000 investors were defrauded of $7 million, on the promise of a daily return of more than 1 percent on their investments. Half the investors were deaf, allegedly duped by an investment adviser who was also hard of hearing.

Other common scams to watch out for include:

* Pump-and-dump stock schemes fueled by the sharing of false information intended to prop up the value of a small stock - allowing the scammers to cash out before it inevitably falls again.

* “Research opinions” and other promotions of a particular investment that neglect to mention the sender will profit by anyone following their guidance. These can quickly spread through social media.

* Online stock offerings which mislead investors, with such tactics as promising unachievable returns.

Shain suggests doing a background check on anyone to whom one plans to entrust money, even if it’s a rudimentary check. For someone planning to invest $5 million or more, it’s probably worth splurging on a professional investigation.

“A few thousand dollars is worth the investment to see if the person you’re dealing with is legitimate,” Shain says. “Most people are not equipped to both understand how to search the courts and to know where to search.”

There’s a fair amount that can be learned from what’s available online. The SEC and the Financial Industry Regulatory Authority (FINRA) have search tools that let you check if brokers are licensed or whether they’ve had disciplinary action taken against them. If you find something, it could be a red flag, though Shain cautions, “The corollary is not always true.”

Not finding any history of disciplinary actions is not necessarily a green light. “If Bernie Madoff didn’t teach us that, nothing will,” he says.

A slick-talking con will try to impress with his or her credentials and knowledge of the economy or some technical market information, says Shain. The key is to avoid being sucked in, which can be difficult, even for a savvy business person, and particularly for one with an entrepreneurial risk-taking spirit.

“Being boring in your investment life is OK,” Shain says. “You can be exciting in the rest of your life. When it comes to your money, being super-duper boring is probably good enough.”

Here are some tips from the SEC on how to avoid being a victim of investment fraud:

* Avoid unsolicited investment opportunities.

* Beware of promises of big or guaranteed returns or sure-fire stock picks that supposedly carry little risk.

* Avoid making a deal on the spot.

* Do a background check on the person dispensing the investment advice.

* Be leery of recommendations from online newsletters - not all are legitimate.

* Exercise skepticism when you hear the phrase “high-yield investment program,” which promise big returns but are typically scams.

* Use a fee-only adviser. This way you’re paying them for their time and expertise, not commissions that encourage potentially irresponsible buying and selling.

Editing by Bernadette Baum, Beth Pinkser Gladstone and Richard Chang

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