Investment Fraud: What It Is and How It Works

Investment frauds in the USA are getting more common as its economy grows. Fake investors and fraudulent promoters compete to tempt their victims with false promises of sky-high returns. Thus, now more than ever, it is crucial to learn more about the many types of frauds out there and how to spot them.

What Is Investment Fraud?

The term refers to the illegal sale of financial instruments with the sole aim of enriching the seller at the expense of the buyer. While fraud comes in many guises, one telltale sign is the promise of low or zero-risk investments and guaranteed returns.

Types of Investment Fraud

Some of the most common types include:

Ponzi Schemes

Perhaps the most popular type, Ponzi schemes were named after Charles Ponzi, a 1920s swindler and con artist. He tricked thousands into investing in his venture by promising 50% returns in 45 days. Instead of carrying out a genuine economic activity, Ponzi paid his shareholders using funds he got from new investors. Finally, at one point, he simply ran out of investors. The scheme failed, ruining those who trusted him, as well as five banks.

Some of the biggest investment frauds and white collar crime cases involved Ponzi schemes. One notorious example is Bernie Madoff’s $64.8 billion scheme. To this day, it remains the largest financial fraud in U.S. history and the biggest Ponzi scheme in the world.

Pyramid Schemes

Much like Ponzi schemes, pyramid schemes need constant cash inflow to stay afloat. Fraudsters make money by promising high returns in exchange for a commission or membership fee.

The participants then make money by recruiting new members. Eventually, the pyramid grows too large to sustain itself solely through new membership fees, so it collapses.

Pump-and-Dump Schemes

Pump-and-dump schemers buy low-priced company shares. They then spread false information about the company to create demand and boost the stock price. At that point, the fraudsters cash out at a high price and vanish into thin air, leaving the other investors stuck with worthless shares.

One legendary 1990s pump-and-dump scheme, courtesy of Jordan Belfort, is so infamous that it was even depicted in the Hollywood movie The Wolf of Wall Street.

Advance Fee Fraud

This type of scheme tricks the investor into paying a service fee prior to buying a low-priced but promising stock. Once they pay the fee, however, they never hear from the seller again.

Watch Out for the Red Flags

To spot potential stockbroker frauds and malpractices in the securities market, look out for the following red flags.

Too Good to Be True

If an offer sounds too good to be true, then it probably is. There is no such thing as a free lunch in finance. You should be wary of anyone offering quick, risk-free, and high-return investments.

No Genuine Product or Service

If the proposed business venture does not seem to carry out a real and profitable economic activity, then it is probably a scam.

Undue Emphasis on New Recruits

If the company’s business model is based on recruiting new members or investors rather than selling genuine products or services, then it might be a pyramid or Ponzi scheme.

Schemes That Are Too Complex or Too Simple

Fraudsters often try to confuse potential investors with overly complicated schemes. Alternatively, they may try to win you over with a pitch that seems simple and self-evident.

If you have been a victim of an investment fraud it might be good to contact investment attorney and see if there is anything you can do to compensate for your losses.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes.