How to spot an investment scam

[Excerpted from the State of Maine - 8/17/00]

Indicators that the Caller could be a crook:

• Promises of spectacular profits. Any offer that sounds too good to be true probably is too good to be true.
• High pressure sales tactics.
• A "guaranteed" investment or an investment without risk.
• Insistence on an immediate decision. The caller may even have a courier driving in your area ready to stop by your home and pick up your check within minutes of the call!
• Recommendations based on rumors, tips, inside information, or an unannounced breakthrough in the industry.
• Recommendations based on the caller's ability to predict future events.
• A request for your credit card number for any purpose other than to make a purchase. Such requests are typically made for "identification" or "verification" purposes, or merely as an "expression of good faith."
• Unwillingness to provide written information, state securities registration information, or verifiable references.
• A suggestion that you invest mostly on the basis of trust.
• Investment opportunities in another country or that are dependent on the participation of an offshore bank.
• Unwillingness to let you discuss the investment with a third person.
• Claims that the investment is not a "security" and therefore not covered by the securities laws. Be very suspicious of such statements, and be sure to check further on the specifics.

The Most Common Investment Scams

Cold Calls

Many securities firms telephone investors they do not know to sell stocks and other investments. Known as "cold calling," these calls can serve as a legitimate way of reaching new customers, but they can also lead to trouble. Dishonest brokers may pressure you to buy a bad investment or a scam. Whether the calls are annoying, abusive, or downright crooked, you can stop cold callers. The law protects you by requiring cold callers to follow several rules:

• Call Only Between 8:00 a.m. and 9:00 p.m. These time restrictions do not apply if you are already a customer of the firm or you've given them permission to call you at other times. Cold callers may call you at work at any time.

• Say Who's Calling and Why. Cold callers must promptly tell you their name, their firm's name, address, and telephone number, and that the purpose of the call is to sell you an investment.

• Put You on Their "Do Not Call" List, If You Ask. Every securities firm must keep a "do not call" list. If you want to stop sales calls from that firm, tell the caller to put your name and telephone number on the firm's "do not call" list. If anyone from that firm calls you again, get the caller's name and telephone number, note the date and time of the call, and complain to the firm's compliance officer, the SEC, and your state's securities regulator.

• Get Your Written Approval Before Taking Money Directly From Your Bank Accounts. Before investing, you should always get answers to the questions below and written information about the investment. If you do decide to buy from a cold caller, do not give your checking or savings account numbers to the broker over the phone. Brokers must get your written permission - such as your signature on a check or an authorization form - before they can take money from your checking or savings account.

• Tell You the Truth. People selling securities must tell you the truth. Brokers who lie to you about any important aspect of an investment opportunity violate federal and state securities laws.

Boiler Rooms

A boiler room is often just a short-term rented apartment or office with multiple phone lines and an impressive-sounding address. Boiler rooms earn their name from the "heat" and high pressure generated by the callers as they try to convince investors to part with their money.

In many cases, either the company or the product does not really exist, or it doesn't operate as represented. Telephone pitches are read from prepared scripts, with quick answers to the most common objections. Your phone number may have been obtained from phone directories, purchased lists, or newspaper articles. Boiler-room operators have even been known to call recent widows and widowers or people who have lost large sums of money, offering to "help" recover the losses quickly and effortlessly.

Pyramid Promotions

Pyramid promotions focus on the quick profits to be earned from recruiting other investors, who then will recruit others, and so on. Little mention or emphasis is placed on the product or service to be sold. The fraud derives from the ever-decreasing number of potential investors in a given area. The common elements of a pyramid scheme involve the following:

• An invitation from a friend, neighbor, or coworker to attend an "opportunity meeting" to learn how to earn lots of money;
• At the meeting, a well-rehearsed presentation that downplays the traditional methods of acquiring money and will offer instead an exciting shortcut to wealth and adventure;
• Payment of large fees for products, courses, etc., and/or the right to recruit others and profit from their participation.

The emphasis is to get others to invest. True pyramid schemes are illegal in Maine, but are difficult to prosecute. Victims' money is often filtered up through the pyramid and lost. Sooner or later, all pyramid schemes collapse of their own weight (taking many investors down with them, of course).

Advance-Fee Loans

These loans are usually offered to desperate borrowers who have exhausted all of the traditional approaches to financing. Loans are arranged and promised only upon payment of an "up-front" or "advance fee." It is common for the promoter to represent the source of funds as foreign investors or an offshore bank. Loan amounts are typically very large ($5 to $100 million), and offer long repayment terms at below-market rates of interest. Minimal qualifications, other than the advance fee payment, are required. The promoter takes the advance fee and never delivers the loan.

Online Newsletters

Hundreds of online investment newsletters have appeared on the Internet in recent years. Many offer investors free of charge seemingly unbiased information about featured companies or recommend "stock picks of the month." While legitimate online newsletters can help investors gather valuable information, some online newsletters are tools for fraud.  

Some companies pay the people who write online newsletters cash or securities to "tout" or recommend their stocks. While this isn't illegal, the federal securities laws require the newsletters to disclose who paid them, the amount, and the type of payment. But many fraudsters fail to do so. Instead, they'll lie about the payments they received, their independence, their so-called research, and their track records. Their newsletters masquerade as sources of unbiased information, when in fact they stand to profit handsomely if they convince investors to buy or sell particular stocks.  

Some online newsletters falsely claim to independently research the stocks they profile. Others spread false information or promote worthless stocks. The most notorious sometimes "scalp" the stocks they hype, driving up the price of the stock with their baseless recommendations and then selling their own holdings at high prices and high profits.

Ponzi Schemes

Promoters offer high rates of return on the various impressive-sounding investments. However, instead of using the money as promised, new investors' money is used to pay the monthly "interest" or "return" to earlier investors. These "satisfied investors" then report the high returns to their friends, who in turn invest in hopes of achieving the same above-average returns.

In a Ponzi scheme, investors are not in fact investing in an underlying business, even though they believe they are. Early investors are simply being paid with the funds received from later investors. The scheme only continues as long as new investors provide additional funds. When the scheme collapses (as it always does), current investors lose their money and the promoters walk away rich.

Loan Roll Programs/Prime Bank Notes

These investments are similar in many respects to the advance-fee loan schemes described above. Promoters offer the "little guy" a chance to pool money with other investors to buy bank notes internationally, often touting a large offshore bank as instrumental in the deal.

Investments range from a few thousand dollars to a hundred thousand dollars or more. Returns of fantastic wealth are promised, sometimes even in the $100 million range. Details about how the program works are either unavailable or, when examined closely, nonsensical. Investors' money is rarely recovered.

Gold and Silver Mines

These speculative investments typically offer new or secret methods for reclaiming mineral reserves from untested or abandoned mines, or even the recovery of microscopic traces of valuable minerals from soil in your geographic area "where no one else would think to look!" These are classic frauds. Often, the promoter will base a mining forecast on an unknown expert's geological report or prediction, or will offer part of a valid report out of context. Promoters exaggerate the quality and quantity of the minerals to be extracted, while downplaying the expense or actual likelihood of recovering them.

Oil Wells

By acquiring interests in a "proven" oil field or in the immediate vicinity of other proven oil fields, investors are promised "can't-miss opportunities" for great wealth. These investments are frequently sold to people who live far from the oil company's headquarters, which may be nothing more than a rented trailer.

As with gold and silver mines, promoters frequently offer new and secret methods for reclaiming missed oil reserves on previously drilled oil fields.

Coins and Precious Metal Schemes

Promoters offer "investment-grade" gold and silver coins, claiming their present value can be independently verified, and promising tremendous future profits, usually based on some current or political event.

For the cost of your investment and a nominal storage fee, the promoter will purchase the coins and bullion for you and have them delivered to and stored in a large, well-known bank, nearly always outside of your geographical area. Often these promoters promise the opportunity to "leverage" your purchase. Leveraging, in theory, is like buying on margin, in that you only make a down payment toward the total cost of the metal you wish to buy. The rest of the money is advanced or loaned to you, with the precious metal serving as collateral. For instance, for $10,000, you might purchase 22 ounces of gold at $450 and ounce. By leveraging your purchase at 20 percent down, you could purchase five times as many ounces, or 110 ounces.

The problem with a leveraged purchase occurs when the value of this precious metal decreases. As the buyer, you are responsible to cover the downturn in value by putting in more money. If you fail to cover the downturn, your precious metal is sold (often at a discount), and you are liable for the difference. Leveraging is extremely risky, and not recommended for the casual investor.

Some schemes charge extremely high commissions, so that there must be a great increase in the value of coins or metals before you see a profit. Other schemes don't even bother to purchase the coins or metals. The promoters just take your money and move on to the next town. If you want to purchase precious metals, talk with the local merchants who will deliver the goods to you and who have local reputations to protect.

Remember:

To protect yourself from becoming a victim of these or other investment scams, educate yourself before making any investment