How to Identify Financial Scams and Investment Schemes

An old proverb claims, “The art is not in making money, but in keeping it.” Unfortunately, con artists and swindlers are anxious to separate you from your money by means of deception and fraud.

In an interview with BBC Future, Dr. Eryn Newman of the University of Southern California said a positive story that “feels smooth and easy to process” is easy to accept as truth. Con artists are particularly talented in creating believable lies. Falling for their tricks costs U.S. citizens billions every year.

According to Anthony Pratkanis, “Every year, Americans lose over $40 billion in telemarketing, investment, and charity fraud.” However, this amount may be vastly understated because instances of fraud are likely under-reported. According to the Financial Fraud Research Center, up to 65% of victims fail to report their victimization. They typically do not tell the authorities because they lack confidence in the police and the likelihood of restitution. Many are embarrassed by their gullibility.

But in her interview, Dr. Newman claims that gullibility – the tendency to be duped or manipulated by one or more people – does not reflect intelligence. Anybody can fall prey to a financial scheme or scam. Therefore, your best line of defense is to have a thorough understanding of how con artists operate – and how to spot them before they take advantage of you.

The Players


Victims of scams – known as “marks” – are often fooled when they hope to get something for nothing or very little. Other victims – often the elderly – may be susceptible due to their good intentions and desire to help others.

While many believe that the typical victim of an investment scam is older and less educated than the general populace, the Financial Fraud Research Center reports that this stereotype is false. The average investment fraud victim is “more likely to be male, relatively wealthy, risk-taking, interested in persuasive statements, open to sales situations, and better educated than the general public.” Martha Deevy, director of the Stanford Center on Longevity’s Financial Security Division, stated in an interview with the American Psychological Association that the typical investment fraud victim is a middle-aged, married, educated, financially literate white male under some financial strain.

Dr. Stephen Greenspan has spent more than a decade studying the problem of gullibility. In the The Wall Street Journal, Dr. Greenspan names four distinct factors that make a person more susceptible to being duped:

  1. Situations. When pressured by others, people tend to make investment decisions that appear to be benign, but actually pose significant risks.
  2. Cognition. Gullibility affects people throughout the IQ range. Sometimes people are gullible because they fail to use their intelligence fully, relying upon intuition and impulsion. In other cases, they may simply lack the necessary knowledge and are unwilling to spend energy to correct the deficiency.
  3. Personality. Many victims are trusting people who feel the need to be a “nice guy.” The combination of these traits with tendencies toward risk-taking and impulsive decision-making create “easy marks.”
  4. Emotion. The excitement of increasing or protecting one’s wealth (some might call it greed) is a powerful stimulant to proceed with a risky investment, especially if the promoter is adept at assuaging the fear of loss.

Greenspan advises that rather than avoiding all potential investments with risks, ensure that a safety net is in place. In other words, don’t put all of your eggs in one basket.

Wall Street Journal

The Operators

Con men – known as “operators” – are not the shady, underworld characters portrayed in movies and television. The more successful grifters are actors, able to take on the persona necessary to manipulate other people’s hopes and fears. They are experts in making anything seem real. Whether dressed in a three-piece suit or in overalls, a con man gets a mark to drop his guard and ignore his skepticism by appearing trustworthy.

Operators also use accomplices. They are known in the trade as:

  • Ropers. Associates of the operator frequently pose as wealthy people to identify possible marks that are likely to fall for the trick.
  • Shills. Many con men work with fellow crooks who act like a strangers or independent experts to encourage the mark to go along with the scam. Professionals may unknowingly act as shills by confirming the apparent reputation of the operator. To their regret, some public accounting firms approved the audits of such companies as ZZZZ Best, Enron, and the multiple savings and loan businesses that failed in the late 1980s.

The Games – Types of Scams

Confidence games such as hoaxes, rip-offs, flimflams, shell games, and swindles are constantly changing, especially with new technologies and global communication. Nevertheless, their only purpose is to relieve a mark of his purse. In the past, most swindles were face-to-face, where victims dealt directly with the scammers. The expansion of the Internet, communication technology, and our tendency to believe what we read leads to such worldwide scams as the Nigerian prince and overseas sweepstakes.

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Games may be “short” or “long,” depending on their intricacy and duration. Many people have heard of the more common street cons portrayed in the movies. Fast-talking, snappy-dressed young men and women on the sidewalks of New York City are polished performers of three-card Monte or the pigeon drop. Another is the fake builder who collects fees upfront to perform a repair job, then disappears. These scams are short cons, typically involving small amounts of money (up to a few hundred dollars).

Long cons can be very elaborate, with fake offices, experts, and multiple shills. The 1973 Paul Newman/Robert Redford film “The Sting” was a great examples of this. The case of Bernie Madoff is a more modern-day example. Financial scams conjured in a Wall Street corner office can reap thousands, sometimes millions of dollars for their perpetrators. They touch every corner of the financial system, from volatile foreign currency markets to historically staid municipal bond markets.

Modern cons are often updated variations of old scams that have suckered people for centuries. The players and story lines change, but the results remain the same.

1. Ponzi Schemes

Charles Ponzi proposed to manage the arbitrage of international reply coupons and U.S. Postal stamps, guaranteeing his investors a profit of 50% in 45 days – a whopping 400% annually. However, Ponzi used the funds acquired from later investors to pay off his earlier investors (and to bankroll his luxurious lifestyle). This practice is the basis for the swindle. Ponzi collected $20 million before the fraud was discovered, and his name has been associated with the scheme since.

Billions of dollars have been stolen from unsuspecting investors by con men. Bernie Madoff, an investment advisor in New York City, defrauded $65 billion from friends and clients over a time-span of at least a decade. He is currently serving a 150-year sentence in Raleigh, North Carolina. Other famous Ponzi scheme perpetrators include Tom Petters ($3.65 billion defrauded) and Scott Rothstein ($1.4 billion).

The attractiveness of Ponzi schemes for con men continues. In the fall of 2016, the following stories appeared in various news sources:

  • The Pittsburgh Post-Gazette reported the arrest of Golan Barak, accused of swindling Israeli investors of $2 million in a scheme to buy and flip undervalued real estate.
  • reported on six people sentenced to prison for their parts in a $17 million scam based upon 60% returns on investment in the sale of fuel products.
  • KY3 news station in Springfield, Missouri reported the sentencing of an investment advisor for swindling three investors of $1.1 million in a collateralized mortgage obligation (CMO) Ponzi scheme.

2. Pyramid Schemes

While Ponzi and pyramid schemes are illegal and share some of the same characteristics, victims of the former believe they are earning a return on their investments, while participants of the latter know they have to recruit new members to make a return.

Many people are familiar with chain letters, a favorite method of grifters in the mid-1900s. Chicago Tribune reported the first money chain letter in the United States – the “Prosperity Club,” or “Send a Dime” letter – on April 21, 1935. The letter promised that those who participated would receive $1,562.50 for his investment of a dime and postage for five letters. The Send a Dime letter was immensely popular and clogged the Postal System in Denver at the time. As a consequence, Congress passed the Postal Lottery law (Title 18, U.S. Code Section 1302). The law declared chain letters requesting money or anything of significant value to be a form of gambling and illegal.

Multi-level marketing (MLM) companies rely upon a similar structure allowing investor/distributors to receive commissions for the sales of their downline – the levels of salespeople they have recruited to sell their products. Due to the possibility of abuse, the Federal Trade Commission regulates MLM companies to ensure they are legitimate. In 2015, the Federal Trade Commission fined Herbalife $200 million and required the company to restructure its business model, according to Fox Business. The difference between a legitimate MLM company and a pyramid scheme is that the former focuses on the sale of products rather than new recruits.

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Even though people recognize that a pyramid scheme must eventually burn out, the appeal of large returns for a small investment remains irresistible.

Pump Dump Scams

3. Pump and Dump Scams

The movie “The Wolf of Wall Street” exposed this old Wall Street scam that has been made easier with the improvement in technology. A pump and dump scheme begins with salesmen who promote thinly capitalized public companies by using fake news and questionable financial results to drive up the stock price (“pumping”), then sell their positions in the companies at high prices (“dumping”). Investor losses from pump and dump schemes are estimated in the millions of dollars annually.

In one such case involving Cynk Technology Corp, a software company located in Belize, the stock price surged from $0.06 to $21.95 in one month during 2014, as reported by Bloomberg. The stock price subsequently fell, and sells at $0.01 per share as of October 2016. The SEC has investigated and filed charges against several broker firms involved with the company.

Scam artists are adept at using social media websites (such as Facebook and Twitter) to promote the stock, and solicit thousands of potential investors by robotic phone calls and mass emailing. In many cases, they are located offshore beyond the reach of U.S. law enforcement. According to The Wall Street Journal, one group successfully hacked the customer files of JPMorgan Chase to steal data from its clients used later in a pump and dump scheme.

4. Pre-IPO Investment Frauds

Many investors dream of buying stock in a successful company before its initial public offering (IPO). Stories of buying stocks in private corporations such as Microsoft, Apple, and Facebook before they become publicly traded are the myths of Wall Street with just enough detail to make them seem credible. Con men are adept at offering investors looking to cash in on the next great company, especially when stocks of a particular industry become hot. According to MarketWatch, pre-IPO scams rely heavily on spam emails, impressive websites, and glitzy offering documents, as well as recommendations from shady stockbrokers.

It is not illegal to sell securities to the public through a private offering, but the offering must be registered under Regulation D of the Securities Act of 1933 or meet one of the few regulatory exemptions to be legal. Furthermore, those who can be legally solicited must meet strict financial standards. Scammers typically manipulate the loopholes or ignore the law completely.

Promoters solicit most potential investors through a private placement memorandum (PPM) purported to be the equivalent of a prospectus issued by companies with their IPO. However, the SEC specifically warns that PPMs are not required, nor reviewed, by any regulator. Memorandums typically contain highly optimistic projections of revenues and profits, and downplay significant risks. Financial records may not be audited, and the experience and credentials of management are often exaggerated or entirely false.

Investing in pre-IPO offerings is rarely successful – the Financial Regulatory Authority (FINRA) claims they range from “risky deals to outright frauds.” They advise that potential investors should always ask the question, “Why me?” In other words, why would a total stranger tell you about a great investment opportunity? Odds are there is no such opportunity.

5. Tax Shelter Cons

Few people enjoy paying income taxes. In fact, citizens have the right to “arrange their affairs as to keep taxes as low as possible,” according to a U.S. Court of Appeals decision rendered by Judge Learned Hand in 1935 (Helvering v. Gregory) and subsequently upheld by the Supreme Court. As a consequence, a significant portion of accountants and lawyers specialize in helping citizens reduce their annual tax burden.

Congress, recognizing the desire to lower taxes, has intentionally manipulated the tax code to encourage investments in socially-desirable actions:

  • The Revenue Act of 1913 initially allowed oil companies to treat oil reserves in the ground as capital equipment and write off a percentage of each barrel produced. Subsequent legislation allowed oil drillers to deduct their intangible drilling costs from income in the year they occur (rather than capitalize them over the life of the well), and replaced cost depletion with percentage depletion.
  • The American Jobs Creation Act of 2004 allowed domestic manufacturers and others tax breaks of 9% of income from domestic production, totaling $77 billion.
  • The Energy Policy Act of 2005 introduced a 30% investment tax credit for the costs of an installation of residential and commercial solar systems. The credit has been extended several times and is available for systems placed in service before December 31, 2016.
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While the intent of tax benefits may be laudable, con men have been quick to capitalize on fraudulent investments that promised generous tax deductions and credits to individual investors. By promoting the idea that the dollars invested would otherwise be lost in taxes, scammers can divert attention from the poor economics of their schemes.

As a consequence, the Internal Revenue Service actively pursues promoters and investors in “abusive tax shelters,” those deemed to have a sole purpose to generate losses, deductions, and credits more than the investment amount. Abusive shelters typically use unrealistic allocations, inflated appraisals, losses in connection with non-recourse loans, and mismatching of income and deductions to generate false financial results.

6. Fake Charities

According to the 2016 World Giving Index, America is one of the most generous nations of the world. The Giving Institute, a nonprofit organization that has tracked philanthropy in the United States, reported that Americans donated $373 billion in 2015 alone. As a consequence, there are more than 1 million public charities tracked by the National Center for Charitable Statistics. Whether to find a cure for a deadly disease or recover from a natural disaster, Americans are quick to open their pocketbooks for worthy causes.

Unfortunately, such generosity is irresistible to con men and scam artists looking for a quick score. Social media and mass emails expand the number of potential victims who can be solicited at low cost. Using similar-sounding names of well-known organizations to confuse donors while siphoning the bulk of donations to insiders and affiliated organizations, many so-called charities escape detection for years.

Several examples include:

  • Cancer Fund of America Inc., Cancer Support Services Inc., Children’s Cancer Fund of America Inc., and The Breast Cancer Society Inc. were charged with charity fraud in 2015 after collecting $187 million between 2008 and 2012, according to ABC 7.
  • Adam Shryock was fined $5.89 million in 2015 for his role in setting up Boobies Rock!, a fake breast cancer charity. Westwood reported that Shryock has also been charged with another scam involving the Ecumenical Refugee and Immigrations Services Inc. of Denver.
  • The U.S. Navy Veterans Association, a bogus charity in Tampa, Florida, raised almost $100 million from donors. Reuters reported that John Donald Cody, a Harvard-trained lawyer and veteran of a U.S. Army intelligence unit, had previously been involved in embezzlement and was suspected of espionage before disappearing with a new name.

Ken Stern, the author of “With Charity for All” and a former CEO of National Public Radio, claims that charitable exemptions are easy to obtain and there is no system in place to ensure they meet their charitable purposes. Recognizing the high probability of scams, the IRS issued a bulletin in early 2016 to warn citizens of fake charities with three specific recommendations:

  • Be wary of charities with names that are similar to nationally known organizations.
  • Don’t give out personal financial information to anyone who solicits a contribution.
  • Don’t give or send cash – instead, use a check or credit card to document the transaction.

Potential donors should also be aware that the percentage of their donation distributed to those in need is likely to be significantly less than their donated amount, according to CharityWatch. For example, for every $1 donated to the Red Cross, $0.30 goes to fundraising and $0.10 to administration. By contrast, the Michael J. Fox Foundation for Parkinson’s Research spends $0.08 for fundraising and $0.11 for administration, delivering $0.81 of each $1 to final beneficiaries.

There are several public charity watchdogs, including CharityWatch, the BBB Wise Giving Alliance, and Charity Navigator.

Fraud Fake Charities

Final Word

Unfortunately, gullibility is not the only human trait that leads to being scammed. Economist and Nobel Prize recipient Robert J. Shiller asserts we are often victims of “drinking our own bathwater.” In his book “Irrational Exuberance,” Shiller explains that overconfidence and excessive optimism is the consequence of a psychological feedback loop or cycle of reinforcement. As more people participate in a scam, other people lose their objectivity and fear of loss. When they buy in, the cycle continues.

No one is immune from becoming a victim. Laura Carstensen, a Stanford University psychologist who participated in the aforementioned American Psychological Association interview, notes that “we’re all victims in waiting. We will all very likely be victims at some point [of a con game], and we’ll probably never know that we’re victims.”

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