Unlike risks in life and financial activities, frauds are activities by some people to purposely steal from other people through intentional acts of deception. The frauds can be financial fraud such as investment fraud and Ponzi schemes, identity theft, medical fraud, tax fraud, etc.
Investment fraud often purposely exaggerates or simply makes up a great return on one investment. One famous example is the Mississippi scheme. In 1719, Louisiana was still a mysterious faraway land to the most Europeans. John Law from Scotland started a company to develop the land. Although he knew that the land was mostly wild swamp, he drew a beautiful picture for investors and implied a great (but fraudulent) return. He even won the backing from the French government to support his company. However, when people found what Louisiana really was, the share price of his company plummeted and he was almost lynched.
Today, there are many emails, newsletters, phone calls, or personal sales of fraudulent investments.
The term Ponzi scheme is named after Charles Ponzi. A Ponzi scheme is a fraudulent investing scam that always promises a very high rate of return with almost no risk. It is often disguised with a seemingly legitimate operation. For example, when Ponzi started his scam, he purchased postal coupons in bulk, which entitled him to a 5% discount. Then he shipped the coupons abroad and sold them for full price. Everything looked legal and not much different from the activities of similar businesses. However, Ponzi exaggerated the profit as 50% instead of 5%, and he promised the return in 90 days. In order to increase his income, he used the proceeds from the new investors to pay for the “profit” of the earlier investors. The so called “pyramid” scheme eventually blew up when there were not enough new investors to throw new money into it.
In the late 1900s and early years of this century, Bernie Madoff did the same thing to thousands of investors by promising a consistent return on investment. The total money involved was a whopping $65 billion. After decades, this scheme eventually busted with the 2008 financial crisis. Madoff was sentenced to 150 years in prison.
The scam typically involves promising the victim a significant share of a large sum of money in return for a small up-front payment, which the fraudster supposedly requires in order to obtain the large sum. If a victim makes the payment, the fraudster either invents a reason for additional fees for the victim, or simply disappears. There are many variations on this type of scam, including the 419 scam, the Spanish Prisoner scam, the black money scam and the Detroit-Buffalo scam. The scam has been used with fax and traditional mail, and it is now prevalent in online communications like emails.
Many people do almost all transactions online and are more susceptible to online identity theft. Identity thieves look for any information they can find to get access to financial accounts or other personal assets. How can you protect against online identify theft?
Guarding personal information while online is critical for your personal life. Your passwords, online-banking transactions, online purchases, and other transactions should be private and protected. There are some simple and effective ways to do this.
First, you need to understand where you can be tricked and how your information can be stolen:
- Social engineering: You are staunch visitors to social media and avid online social-community contributors. Criminals may pose as members of an online community and try to win your trust.
- Spam and phishing: You sometimes can’t recognize phishing e-mails and may open them.
- Risky ads, pop-ups, and downloads: You are quick to open up pop-ups without thinking.
- Fake websites: These websites are designed to trick people and are very difficult to identify.
- Free software and file sharing: If the software is free, stop downloading, and do the research first. File sharing is very common practice among teens but may inadvertently spread viruses.
Financial fraud is a type of crime. People generally fall victim because of unrealistic expectations of high return and low risk, innocent belief in other people’s false authority, lack of financial intelligence or financial knowledge, or other preventable or unpreventable activities.
The best way to protect yourself against financial fraud is to be more knowledgeable about financial intelligence, so you will know what can be expected and what will be unrealistic, what are safe activities and what are not. Then you will be able to recognize various types of scams and schemes.
There are many signs of fraud if investors know what to look for.
- A high return in a short period of time is promised. We had a client who was promised double the money in three years with a $10,000 investment in the venture. Three years later, the client couldn’t even find the information on the original investment, not to mention the promised return.
- A no-risk guarantee without the security of government insurance is provided. Remember, every investment has risk, as we discussed earlier. Otherwise, it’s not an investment.
- There is investment comingling. Your investment should be under your name officially and have a third-party custodian. The party handling your assets should be different from the party that is making the investment decision for you. Don’t have your funds combined into a pool.
- An immediate investment decision is demanded. Timing is important. Good investments should be able to allow for the time needed for careful consideration.
- Hard-to-understand jargon and investment terms are used. Don’t ever invest in anything you don’t understand. Don’t invest in anything you can’t verify. Most legitimate investment opportunities can be verified through the SEC, state regulators, or Financial Industry Regulatory Authority (FINRA) website.
There are many resources provided by federal and state governments to protect you against financial fraud. For example, stopfraud.gov is a great website where you can find the past cases of financial fraud and where you can report a case if you unfortunately fall a victim. Since we have explained these in the investment chapter, we will not repeat them here.