Do You Know How to Avoid an Investment Scam?

In December of 2008, Bernard L. Madoff was arrested for defrauding investors of $20 billion over a span of decades. Despite the notoriety of the Madoff scam over the years, American investors still collectively lose $50 billion per year to fraud. Conservative estimates are that one in 10 investors will eventually fall victim to this problem.

Fraudsters are innovative professionals, constantly reinventing their scams. When fraud happens, victims are left not only with financial loss, but compromised identities and emotional distress as well.

Still, there are ways to protect yourself. We’ll look at common scams, why they are successful, typical signals that an investment scam may be afoot, and what to do if it happens to you.

Common Investment Scams

Ponzi Schemes

Named for Charles Ponzi who originated this scam before he was arrested in 1920, a Ponzi scheme—also known as a pyramid scheme—uses money from recent investors to return “profits” to early investors. Ponzi schemes can run for years, until the promoter runs out of new investors, disappears, or investors try to withdraw their money.3

Note: Bernie Madoff ran a Ponzi scheme, using market profits and money from new investors to pay original investors. If the market hadn’t collapsed in 2008, he might have been able to continue for years.

John Powers is a Certified Fraud Examiner (CFE) and president of Hudson Intelligence, a private investigation agency that specializes in investment fraud cases and financial crimes. He provided another illustration of a common investment scam.

Advance Fee Schemes

In this scam, Powers told The Balance by email that victims invest a relatively small amount upfront, after being promised a huge payout in the future. The scammers then continually increase their demands for more money.

Fraudsters claim the additional payments are necessary to pay taxes, bonds, security deposits, insurance, or other transactional fees required to complete the deal. Eventually, the investors walk away, realizing they have been duped, Powers said. In one case prosecuted and won in 2015 by the Securities and Exchange Commission (SEC), investors were bilked out of millions of dollars by fictitious brokerage firms promising to bring non-existent Brazilian bonds to market.

Market Manipulation

Also known as “Pump and Dump,” in this scheme, promoters first “pump” the price of a stock they hold using misleading or false information, and then sell, or “dump,” it quickly. Scammers use the internet, email, and fake newsletters to promote the target stock. A variation on this scheme involves identity theft. Hackers gain access to online brokerage accounts and use them to buy up a particular stock, driving up the price. The fraudsters then sell their holdings at the inflated price and leave other shareholders in the lurch.

Initial Coin Offerings

These are a way to raise capital for new technology platforms using cryptocurrency. Not all initial coin offerings (ICOs) are regulated by the SEC. They can be easily promoted using social media, creating an ideal environment for con artists. In Oct. 2020, the SEC charged technology entrepreneur John McAfee with fraudulently promoting an ICO and then selling his holdings in a pump and dump scheme.4 The North American Securities Administrators Association (NASAA) has designated cryptocurrency and such ICOs as an emerging threat to investors.5


Why Investment Scams Succeed

Investment scams are successful because they often are believable. Scammers are skilled at using current news and events to make their cons sound legitimate.

Powers explained one of the latest approaches to scamming investors that’s emerged in 2020.

“Fraudsters try to make their offers sound like legitimate investments that have been covered in the news, so their victims will believe they are getting involved in something innovative and exciting,” Powers told The Balance.

Fraudsters are also adept at creating credibility by exploiting personal connections. Scammers introduce a scheme to a few members and then use them to recruit other victims among friends and neighbors.

Fake accounts on Facebook and other social media can also be used by fraudsters to create a false sense of affinity, allowing them to pose as members of a group they are trying to infiltrate, Powers said. Bernie Madoff was highly successful at using these “affinity link” tactics among target victims.

Important: A cardinal rule for avoiding fraud: “If it sounds too good to be true, it probably is.”


Typical Signs of an Investment Scam

Look for these warning signs supplied by the SEC’s investor education website if you suspect potential fraud:

A Promise of Phantom Riches
Statements like “guaranteed profits,” or “No one has made less than 50%.”

Scarcity and Exclusivity Pitches
“You need to act now because the offer is closing to investors,” or “Only a few investors get this exclusive opportunity.”

Vague and Inflated Credentials
Fraudsters will often fabricate credentials, industry awards, professional experience, and associates. They also may appear on television or radio shows as guest commentators.

Social Proof
A statement like “This investment has made hundreds of people wealthy” should set off an alarm for targeted investors.

Unusual Wire Instructions
Any request to wire funds overseas or to an account that is not managed by a registered brokerage firm, bank, or other financial institution is a huge red flag.


How to Avoid Investment Fraud

Fraudsters are always on the lookout for your personal information, both offline and online. Protecting your identity can help minimize these types of attacks.

Tip: If you are asked to share personal information, ask why it is needed and how it will be safeguarded.

The Financial Industry Regulatory Agency’s (FINRA) is the first site you should visit to verify the identity and credentials of someone asking you to invest. BrokerCheck is a free service that tells you whether a person or firm is registered, what they are licensed to sell, and whether they can offer investment advice. The site will also list complaints violations and regulatory actions. If the person or firm is not found on BrokerCheck, it is a huge red flag.

Investments that are not registered with the SEC, such as investments in a privately held business, ICOs, crowdsourced offerings, and other non-traditional opportunities, may have huge upside potential, but they are also big opportunities for fraudsters.

In addition, be wary of any free newsletters and unsolicited stock tips. A legitimate newsletter will have very specific disclosures about writers’ stockholdings and how they are compensated. Unsolicited tips about “penny stocks” of micro-cap companies trading at low prices and often through over-the-counter transactions are one red flag for a pump-and-dump scam.

Precious metals, foreign currency exchange (also known as forex), penny stocks, and cryptocurrencies sometimes can be very rewarding. They’re also complicated, and not always transparent, which creates more ways for fraudsters to operate undetected, according to Powers, the fraud examiner. Do your research, and look for the warning signs if you’re considering any of these investments.


What to Do If You Suspect Fraud

First, don’t let embarrassment or shame prevent you from getting help. Investment fraudsters are skilled professional criminals. They often employ teams of people to emotionally manipulate victims.

Notify Your Bank Immediately
If you wired or transferred money electronically, the transaction can be reversed within a narrow window of time.

Contact Local Law Enforcement
They may be able to refer you to state or federal authorities

Contact Regulators
The SEC, your state securities administrator, your state consumer protection agency, FINRA

If there is a substantial amount of money involved, you may want to consider contacting an attorney or a private investigator who specializes in investment fraud. Be aware though, that there can be significant contingency fees and out-of-pocket expenses.


Key Takeaways

If an investment doesn’t make sense, or sound right, take a step back. Do your research. Just because an opportunity comes to you from a trusted source doesn’t mean it’s legitimate.

Be on the lookout for red flags, especially high-pressure sales tactics.

Never wire money to an account that is not a legitimate financial institution, like a bank or brokerage house.


ARTICLE BY Jeffrey M Green
REVIEWED BY Gordon Scott
The Madoff Recovery Initiative. “A Message From SIPA Trustee Irving H. Picard.” Accessed Feb. 24, 2021.
Pension Research Council. “Understanding and Combating Investment Fraud,” Pages 274-276. Accessed Feb. 24, 2021.
U.S. Securities and Exchange Commission. “Ponzi Scheme.” Accessed Feb. 24, 2021.
U.S. Securities and Exchange Commission. “SEC Charges John McAfee With Fraudulently Touting ICOs.” Accessed Feb. 24, 2021.
North American Securities Administrators Association. “Be Cautious of the Crypto Investment Craze.” Accessed Feb. 24, 2021.