Investment fraud constitutes a major problem in the United States. In 2017, the Securities and Exchange Commission ordered more than $2.9 billion in disgorgement from ill-gotten gains and imposed $832 million in civil penalties against individuals and companies who violated securities laws and defrauded investors.
While several studies have investigated various aspects of fraud, we have far less information on victim characteristics of investment fraud. A new study conducted in part by researchers from The American College of Financial Services sheds new light on how fraudsters deceive their victims. Recently awarded the Northwestern Mutual Best Paper Award by the CFP Board, “Victim Characteristics of Investment Fraud” identifies five “fraud languages” and how they can be used to persuade clients out of conducting proper due diligence. Written by professor Benjamin F. Cummings and PhD candidate Steven Lee, both of The American College of Financial Services, and Jason Martin of Swarthmore College – the paper explores the characteristics shared by many of those people who become victims of financial fraud.
True, honest, and ethical financial services practitioners will do well to know how swindlers are operating so that they can spot the warning signs if ever presented by a client.
Below are five fraud languages to be wary of. Con artists will use these tactics to gain the trust – and the resources – of their victims.
1. Perceived success
The “confidence man” perpetuates an aura of perceived success on the part of their victims through false account statements, as well as a fabricated prospectus. These artificially inflated account statements are created to trick clients into believing that their investment is going as promised. Falsified account statements are also used to attract new prospects to the schemes.
Encouraging clients to be wary of pyramid schemes and overzealous investors is paramount for helping individuals steer clear of the “successful” confidence man.
2. Air of familiarity
One of the most powerful ways fraudsters bypass the need for due diligence is to project an air of familiarity in order to appear as a member of the prospect’s “in-group.” The familial scammer will already be a member of the group or pose as a fellow member. Members in a group feel more comfortable trusting someone that they know, causing people to neglect to conduct a background check on the individual clamoring for their money. This often occurs in religious communities; scammers will work at length to highlight the strength of trust and faith placed in fellow believers.
Clients need to be educated on affinity fraud to escape the familial fraudster. Affinity fraud is a form of investment fraud in which the fraudster preys upon members of identifiable groups, such as religious or ethnic communities, language minorities, the elderly, or professional groups.
3. Claim to authority
When their legitimacy is challenged, the imposter will appeal to authority, usually a government agency, that has supposedly already “cleared” or “checked out” the imposter or the investment scheme. Sometimes, this is done indirectly by associating the fraud with an already established entity like an investment advisory or stock brokerage firm. Imposters will often use other entities such as investment advisor firms, which are in turn regulated by authorities like FINRA, to bolster the legitimacy of their scams.
By assuring investors that their investments are backed by an authority, imposters are able to give clients a falsely developed peace of mind. Case in point, infamously known as the operator of the largest private Ponzi scheme in history, Bernard Madoff cited clearance from the SEC and was able to scam billions of dollars out of people because of that.
4. Noble pursuits
The swindler conveys a charitable goal to promote the interests and prosperity of a nonprofit or the group’s members.
For instance, many nonprofit organizations employ programs such as “Double Your Money” where invested funds are returned at greater amounts and the capital raised by the organization would ultimately help fund the church’s mission.
Though noble pursuits are admirable, they’re not always true. In 2013, an alleged Google exec, Kyle Sander, moved to Opelika, Alabama to open up a business incubator for its residents to help boost the town's economy. Sandler’s start up helper, The Round House, was pitched to residents as a business for leading entrepreneurs toward riches in a post recession town. Turns out, Sandler was a startup swindler and scarfed up over 1.9 million from over 50 investors.
To avoid being swindled into the ones that are in fact a scam, clients need to fact-check to make sure their money is going where it’s intended.
5. Framed authenticity
Framed authenticity is similar to the claim to authority. The fraudster claims alignment with apparently legitimate institutions that are often regulated by appropriate authorities. The difference here is framed authenticity emphasizes the legitimate business with which the investment program (and the fraudster) are aligned.
In 2013, the SEC filed a lawsuit against Steven B. Heinz for defrauding investors in a classic Ponzi scheme. Over a span of two years Heinz, absconded with about $4 million from 15 investors. Heinz “guaranteed” his investors a fixed rate of return by investing with his firm, but he used their funds to make payments of “profits” to older accounts and to fund personal expenses.
Always encourage clients to conduct a thorough background check on companies they wish to do business with – before any investments are made.
Trust and education
People are generally willing to trust others, but they are even more willing to trust those who are part of the in-group, meaning the same group as the person placing the trust.
Advisors should aim to increase their clients’ knowledge and autonomy, by providing clients with the best information in a manner that is designed to help clients correctly incorporate it into their decision-making process. When individuals are cognizant of the fraud languages and empowered to make sound decisions, they are less likely to fall victim to investment schemes.
Carry the shield
Throughout the decades, The American College of Financial Services has served as the premier educational institution dedicated to the development of financial services professionals. The College has worked tirelessly to educate our nation’s advisors, to help them raise the level of their service, and to ensure that society can rely on a profession built on trust. Graduates and designees of The American College of Financial Services have studied, passed rigorous exams, and have proven that they not only have the technical knowledge to serve their clients, but have sworn to practice ethically and in the best interest of the good people they serve.
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