Four Ways to Protect Yourself From Investment Scams
Just this week the news broke about investment powerhouse JP Morgan falling prey to a scam as it invested millions of dollars in a scam business called Frank, a college financial planning platform.
It seems appropriate that we are looking at ways that you can protect yourself from investment scams. We will look at Ponzi schemes including the Madoff Plan (did you know actor Kevin Bacon got caught in that one?) as well as several lesser-known Canadian schemes and share some practical and tactical tips on staying aware and protecting your finances.
(BTW - it's the 20th anniversary of Internet Security Day today - a good day to be thinking about ways to stay safe online)
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Rather Read All About It?4 Ways to Protect Yourself From Investment Scams
Most of us who are investors invest our money, accomplish our goals and move on with our lives. But there are investment scams out there.
One of the classic investment scams is called the Ponzi Scheme. This fraudulent scheme is created by paying existing investors with money brought in by new investors. The existing and new investors usually have no idea that that is how they’re being paid. You can picture the flow of money as a pyramid, with one new investor paying money at the top that then flows down to all the other investors at the bottom.
The house of cards falls when no new investors pay in, which causes the investment returns to dry up. By the time investors discover what happened, the fraudsters have moved on.
The most famous of these schemes was conducted by Bernie Madoff in the US. Let’s look at some real life Canadian examples.
Brian and Shannon Kitts defrauded $5 million out of 38 people over two years before they were caught. They issued promissory notes to these investors, promising a 20 percent monthly rate of return.
Then there was the Manna Trading Corp Scheme. This was run by a person who went by several different names, was not registered as an investment advisor in any province and defrauded $16 million out of 800 people, mostly elderly individuals. He vanished after being found guilty, but was found several years later.
Like the Kitts’ scheme, the Manna Trading Corp Scheme was a Ponzi scheme. Investors were promised double digit monthly returns through foreign exchange currency trading. Investors were unaware that their returns were being funded by new investors coming on board.
Finally, there’s Rashida Samji. Samji ran a $110 million dollar Ponzi scheme for almost 10 years. Investors were promised steady returns of up to 12 percent. They believed they were investing in the expansion of a BC winery into South Africa and South America. Samji managed to keep the scheme hidden for 10 years before it began to fall apart.
Now these stories can sound scary and make us feel vulnerable. As with most media stories, these headlines point out the rare, worst case scenarios. But there ARE real scams you need to be aware of. How can you tell the difference between legitimate opportunities and scams?
Today, I’m going to cover four ways to protect yourself from investment scams.
Be suspicious of investments that guarantee a high return.
Generally, as the potential rate of return on your money goes up, so does your risk of losing money. Let’s look at some low risk investments.
First, there’s cash. Cash is a very safe investment, but it earns you nothing. Cash under the mattress can give us a feeling of security, but in exchange for that, we will earn no return for it.
As of today, Bank High Interest savings accounts are paying about 3%. There’s very little risk when you open a bank savings account. A lot of that is because your savings accounts are protected by Deposit Insurance, like the CDIC, Canada Deposit Insurance Corporation. If the bank you’re keeping your money at goes bankrupt, this insurance will kick in and return most of your money back.
GICs, Guaranteed Investment Certificates, are another example of a lower risk investment. Right now, they can be bought at a bank paying 4.5%. This is still a low rate of return because it’s still protected by deposit insurance but it’s a little riskier because the bank requires you to keep your money with them longer and in return they’ll pay you 4.5% instead of the 3% that savings accounts are paying you. More risk, higher return.
Bank savings accounts and GICs are about as close to risk free as you can get, so you can expect a lower rate of return.
Let’s say that you are told about an investment where you’re guaranteed a rate of return of 10%. We’ve said savings accounts are at 3% and GICs are at 4%. This new investment says it is guaranteed, that means low risk. But it’s paying 10%. Your first question should be “What’s the catch?” How can you be earning such a high rate of return when other low risk investments are paying 3% and 4.5%?
This idea of trying to get a high return with low risk is behind every classic Ponzi Scheme.
You get a hot tip or insider information.
Bottom line, If the tip is false, you could lose money.
If you’re offered a ‘hot tip,’ think about the person offering it. What do they have to gain by telling you about this tip? Will they get a sales commission? Will they get a referral fee?
If the investment was suggested by a friend or family member, that doesn’t mean it’s the right investment for you. Research the opportunity for yourself. Understand the investment and its risks to determine whether it’s legitimate and right for you.
What if someone tells you they have a hot tip that no one else in the public knows about? That could be what’s called Insider Trading. It might be illegal to act on that tip under insider trading laws. That’s what happened to Martha Stewart 20 years ago.
In 2001, pharmaceutical company ImClone had conducted clinical trials on a cancer fighting drug and were seeking licensing of the drug from the FDA. The FDA found that the clinical trials were so deficient that they refused to issue the license and refused to even review it further. This caused ImClone’s stock to plummet.
So what does this have to do with Martha Stewart and insider trading? Stewart was a friend of Sam Waksal, the CEO of ImClone. When word got back to Waksal that the FDA was going to turn down ImClone’s request to license their new drug, he sold thousands of shares in the company and suggested that Martha’s stock broker do the same. Martha’s stock broker sold her 4,000 shares. The next day, the FDA news came out to the public and the share price plummeted. Both Stewart and Waksal were accused of Insider Trading. They were selling their stock based on information that was not public yet. That gave them an unfair advantage in the market. They both went to prison for that crime.
You feel pressured to invest quickly.
Scammers frequently use high-pressure sales tactics to get your money and then move on to other victims. If you’re asked to make a decision right away or are given a limited time offer, it’s likely not in your best interests.
You should be allowed adequate time to research any investment you’re considering before making a decision.
One of the biggest potential scams around these days involves crypto currency scams. North American regulators believe more than a billion dollars has been scammed this way just in the past two years.
Often what will happen is the victim receives a text or email encouraging them to open a cryptocurrency account. After depositing money in the account, the investor is sent fake statements showing their money is growing. When victims attempt to withdraw money, the scammers demand high additional fees and then stop responding altogether, taking the investors money with them. Just this month, 20 Nova Scotians reported losing $750,000 to a scam like this.
The person offering the investment is not registered to sell that type of investment.
Many investment scams in Canada are the result of people investing with unregistered individuals. Anyone selling securities or offering investment advice must be registered with their provincial securities regulator, unless they have an exemption.
Always check individual and firm registration before you invest. If an advisor is registered, ask them for the spelling of their full legal name as it is registered so you can conduct a search on the Canadian Securities Administrators’ National Registration Database to verify they are properly registered in Canada. I’ll leave a link to the registration database in the show notes.
If you’re considering an investment and you’re not sure it’s a scam, check out the Ontario Securities Commission Scam Spotter Tool. If there’s been an investment scam discovered in Canada, the commission will know about it. This tool helps you understand what to look for when researching an investment so you don’t get scammed.
If you still aren’t sure or you suspect it is a scam, talk to your provincial securities commission or the Ontario Securities Commission for help.
That’s all for today, if this podcast helped you, please subscribe and tell others about it so we can help them too.
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