Fools and Their Money

Feb 1, 2010

Think you know how to spot an investment scam? So do all the other Albertans enticed, year after year, by sweet-talking frauds

by Scott Messenger

To prevent you and your money being soon parted, keep in mind the world of investing is governed by a simple, direct relationship: The greater the projected return, the greater the risk. But with the best mutual funds returning a meagre 4% or so to your retirement portfolio last year and the worst of them losing much of their value, double-digit promises from that real estate investment firm might seem too good to pass up. “If people have had some losses in the last year… maybe they’re feeling they would like to diversify or supplement those returns,” surmises Lorinda Brinton, senior adviser for investor education at the Alberta Securities Commission (ASC). “So what they may do is jump on something a little more quickly than they normally would.” Instead of rushing in and becoming the victim of investment fraud, the investor’s best approach to any new opportunity is to be skeptical, patient and, above all, smart.

Common Scams

Ponzi or pyramid schemes, which the exposure of Bernie Madoff has yet to ruin for other fraudsters, con funds out of new investors only to pay “dividends” to earlier ones.

Promissory notes aren’t always fake, but the fixed-rate, high returns these short-term debt instruments promise make them worthy of investigation.

Pump and dump scenarios tend to revolve around penny stocks. Following large-scale purchases, unscrupulous buyers pump up prices by convincing others to invest, after which they dump it for a profit.

Private placement offerings, like promissory notes, are generally legitimate, but they occur outside the regulated securities market to small groups of investors. Know who you’re dealing with.

Prime bank scams rely on financial jargon and amazing – and entirely fictional – double- and triple-digit returns from “exclusive” portfolios out of the world’s top banks.

Offshore investments, whatever their form, aren’t tax-free, regardless of any convolutions of loopholes. “You can defer paying taxes,” says Brinton, “but you can’t avoid paying them.”

Making Contact

Emails and boiler-room cold calls aside, the most concerning source of fraudulent investment advice and offers remains friends and family, says Brinton. At the office, the golf club, the backyard barbecue, the church social, people swayed by the charismatic salesman at that recent investment seminar serve as the unwitting agents of the financial undoing of investors of all ages, ethnicities and financial experience. It’s known as affinity fraud, and it relies entirely on personal connections and social networks. “That’s what concerns us: the element of trust,” says Brinton.

Warning Signs

Fake investments can be extremely difficult to spot, and not just because they might be buried in the jargon of unnecessarily complicated financial instruments. “The people offering these fraudulent opportunities are very slick. They present themselves in a very professional and charismatic way,” says Brinton. “We often say they’re not selling you an investment; they’re selling you a dream. They know exactly the buttons to push to appeal to that emotional component.” But do they really have your best interests at heart? Besides that, consider the answers to these questions before signing your savings away:

What’s the history of this company?
Can it really “guarantee” these high returns?
Where are the audited financial statements or prospectus?
Why are the promoters so eager for you to invest immediately?
Can you really afford to lose money on this?

Staying Safe

People will spend more time researching the purchase of a big-screen TV, says Brinton, only half-joking, than, say, a purportedly lucrative land-hold deal on a spit of sand in Mexico. Why? It takes time. Here’s how to best spend that:

The ASC investigates every complaint it receives, so report anything suspicious. If it has taken regulatory action against a broker or has tips from other Canadian securities commissions, it posts that information on its website.

The Better Business Bureau also keeps record of complaints lodged against companies. Unlike the securities commission, however, it cannot remove a broker from the securities market.

A basic Internet search can turn up valuable information the regulators and watchdogs have yet to receive. Check online investor forums for gossip. Be prepared to treat it as such.

Preferred Habitat

Among publicly traded stocks, be especially wary of those trading only on essentially unregulated markets such as the OTC (Over the Counter) Bulletin Board or the Pink Sheets. The TSX Venture Exchange, successor to the troubled Alberta and Vancouver stock exchanges, has cleaned up its act and requires both prospectuses and regular audited financial statements of all listed companies.

Do the Due

Overall, the best way to protect yourself is due diligence. Once your money is spent, you’re operating on trust, hope, luck and, ultimately, little else. Regulators like the ASC have a mandate to protect the market and the investor, but they can’t rescue your funds from an investment revealed to be bogus. That’s a matter for the courts, which will require its own significant input of time and money, and, like any bona fide investment, can make no promise of a positive outcome and no guarantees of a return.