It’s said that every fraud begins with a belief.
Perhaps this is why the types of financial fraud and scams are so wide-ranging and numerous.
Most scams start when an adviser or a broker claims that we stand to gain something financially and that our money–our nest egg–is safe with them.
It’s only human nature to want the best possible future, whether for our children, or for ourselves when our investments reward us down the road.
Fraudulent advisers prey on the willingness of clients to believe. They use multiple tactics that can erase a lifetime of their clients’ savings. Below are some common examples of financial fraud.
Churning involves the excessive buying or selling of stocks. Since financial advisers are often paid a commission per trade, by repeatedly buying and selling stocks or annuities they generate greater income for themselves.
Churning can be tricky to spot, especially because in some cases investors may not lose money in their accounts. However, the frequent buying and selling of stocks may reduce an account’s overall performance and investment return and may create unnecessary tax liabilities for the investor.
Pyramid Schemes and Ponzi Schemes
There is a tendency to use these terms interchangeably because they share similar characteristics, but these types of fraud are actually different.
According to Investopedia, both schemes offer consistent “profit” so long as new investors are recruited. In pyramid schemes, the initial schemer recruits individuals to invest money. Those recruits are in turn expected to recruit others to invest money. The pyramid grows with those at the top receiving the “profit” from new recruits. Once the pyramid stops growing, those at the bottom – the largest group of participants – fail to reap any reward.
Ponzi schemes may or may not rely on a pyramid type structure for investments. Typically, so-called portfolio managers promise high return on investment (ROIs), and rely on a constant flow of new investors. When current investors want their money back, they are repaid with the money from newer investors. Again, this scheme only works so long as new money is coming in. Scheme managers move money from account to account, foregoing real investment activity and spending the investors’ money for their own purposes.
To read more on Ponzi schemes, check out our earlier blog post here.
“Pump and Dump” and “Short and Distort”
Pump and dump occurs when a small group of investors is encouraged to buy a stock before it gets recommended to thousands of investors. The small group reaps exorbitantly large profits by selling their stocks after the recommendation, to the detriment of the many other investors who bought the stock at an overinflated price.
A variation of this scheme is the “short and distort,” which occurs when financial advisors create a smear campaign to drive down the price of a stock, so it can be purchased by a small group of investors at an undervalued price.
Still confused on “pump and dump” schemes? This short video from One Minute Economics does a pretty good job of explaining it.
In cases of affintity fraud, fraudsters prey on the trust people have for their friends and community leaders. Either as members or by posing as members of the community—such as a religious or ethnic group, or an elderly or professional association—the fraudster enlists community leaders to invest in a fraudulent stock or security and to recommend the investment to others.
These enlisted community leaders are often not aware that they are being duped and believe that in recommending the investment, they are helping their friends.
Be a skeptic
When you hear words and terms like; “low risk,” “risk free,” “high reward,” or “guaranteed return,” you need to raise your eyebrows and look a little deeper. While it is difficult to spot a fraud, approach each investment opportunity with skepticism. Take your time and make sure you’ve done your research before making a commitment.
If you are an investor and believe you may be the victim of fraud or negligence, you may be able to pursue a claim against your stockbroker. Contact Fishman Haygood to learn what actions you may be able to take.