Recognizing Investment Scams

By Herrick K. Lidstone, Jr. and Colleen R. Belak

As an investor, how do you distinguish a great investment opportunity from a scam? Are those claims of fantastic returns for real? What if it is a scam?

Most investment scams are a variation of the Ponzi pyramid scheme or the pump-and-dump scheme.

The Ponzi scheme is a pyramid scheme in which sellers attempt to make money solely by recruiting new investors into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than making the investment. The promoters generally use the money coming in from new investors to pay early stage investors, or they will simply pocket the money for their own use. Eventually the scheme collapses because there are insufficient funds to pay investors their promised returns.

A pump-and-dump scheme occurs when a person publishes overly optimistic information regarding a particular company, product or segment of industry, the market reacts to such information by driving up the price of the stock and then the persons publishing the information sell their shares at a large profit. Remaining investors, especially those who purchased stock during the hype, take a loss in market value when the hype dies down and the stock price falls back to more normal levels, frequently zero.

These scams pull in experienced and inexperienced investors alike. Each of the following vignettes is based on a real-world experience. Judge them for yourself. Would you fall for these come-ons? Many people have, and unfortunately more will.

Scam Number 1: Secret Securities and Affinity Fraud

The promoter has an investment program that trades in European intra-bank markets in accordance with Christian and humanitarian investment principles. You are promised very high returns within a couple of months of making the investment. The principal amount of the investment is guaranteed because the promoter invests in instruments representing obligations of major world banks. These investments are extremely lucrative. The market is so secret that those with access to the market might deny its existence and the investor’s own well-experienced brokers or bankers likely have not heard of it. In fact, the promoter’s response to the question of how the promoter found out about or got involved in the investment program is itself a secret.

Religion is an important part of the promoter’s program. The promoter claims to be devout and humanitarian and is offering this exclusive business opportunity only to like-minded investors. The meetings at which the opportunity is presented are motivational and inspirational events, often including prayer and hymn singing.

The investment will be used to advance charitable causes. Former clients of the promoter include nationally well known, prominent families. To show his integrity and good faith, the promoter will personally guarantee your investment with his own personal assets, which are substantial (but unsubstantiated).)

Scam Number 2: The Government Is Involved

You have the opportunity to invest funds in an overseas trading program. The program will earn a 10% return per week (which is more than 1,400% per year after compounding) on a risk free-basis. The program is run by an administrator from the Federal Reserve and the investments are held by this administrator.

Scam Number 3: The Wrong Number

“Hi Jennifer, this is Peggy. Remember Mark, that guy I was dating last year? Well, he was a stock broker and we are still friends. He called me up a couple of months ago and gave me a tip to buy ABC security and I did. Wow, a 75% increase in the stock price in three weeks when I sold. Well, he called me again and suggested XYZ. If you want to invest, give me a call and I will give you his number.”

Of course, you are not Jennifer. And perhaps the solicitation comes by fax or e-mail. Clearly you need to invest immediately before others catch on to what a good deal the stock is and the price goes up.

Scam Number 4: Bird Flu

The 2006 threat of bird flu fueled stock scams touting large gains from companies that claim to be poised to capitalize on helping the world avoid a global pandemic. You receive a fax claiming the company “has the solution for tracking and containing the Bird Flu virus in turn preventing it from spreading.” Citing the enormous cost of fighting avian flu, the fax stated the stock was “positioned to gain 250% or more.” The fax urges you not to miss out on a stock that was “clearly missed by Wall Street” but has the support of the National Institute of Health, the Centers for Disease Control, or even the United Nations. The communication also points to other companies in the industry segment that have seen exponential growth and notes there are very few companies positioned to provide the products or services that are needed.

Conclusion

Each of the foregoing vignettes is a scam that has been perpetrated on people who should have known better. There are common themes through most of these scams.

• The investor must invest quickly or the opportunity will disappear;
• They offer high returns at low or no risk; and
• There is no opportunity to perform due diligence.

It is also fairly common for scam artists to represent that the investments they are hawking are somehow sanctioned by the federal government. However, the Federal Reserve System and other U.S. government agencies never get involved in the operation of any private investment opportunity.

It seems the more farfetched the promises, the more investors fall for the scam. The old adage remains sage advice today: “If it sounds too good to be true, it probably is too good to be true.”

Herrick K. Lidstone, Jr.
For more information, please contact Herrick K. Lidstone, Jr. at (303)796-2626 or e-mail . Mr. Lidstone is a senior member of the firm. Mr. Lidstone practices in the areas of business transactions, including corporate law, federal and state securities compliance, mergers and acquisitions, contract law, tax law, real estate and zoning law, and natural resources law.

Colleen R. Belak
For more information, please contact Colleen R. Belak at (303)796-2626 or e-mail . Ms. Belak has a substantial amount of experience in business transactions, corporate law, intellectual property and commercial litigation. Ms. Belak represents clients in many aspects of their businesses, including assisting clients in forming their businesses; the purchase or sale of a business and negotiating and drafting contracts of all types.