*U.S. News & World Report* has placed an article on its web site: "The
Psychology of Investing Scams: 5 techniques fraudsters use to draw
investors into Ponzis, pyramid schemes, and other scams" by Katy Marquardt.
Here are some excerpts:
The tally of money managers recently accused of bilking investors out of
billions of dollars is growing: Bernard Madoff and his alleged Ponzi
scheme; R. Allen Stanford, accused of swindling investors with high-
yielding certificates of deposit; and a handful of others arrested in
fraud probes. Investing con artists certainly aren't new on the scene,
but many have been flying under the radar for years, says Jeff Layman,
chief investment officer of BKD Wealth Advisors, based in Springfield, Mo.
So what makes investors fall for scams in the first place?
Psychological persuasion techniques are the key, says John Gannon,
senior vice president for investor education at the Financial Industry
Using actual transcripts of fraudsters in action, FINRA put together a
list of five common scam tactics:
1) The "Phantom Riches" Tactic. This is the classic too-good-to-be-true
pitch. Think lofty interest rates on traditionally conservative CDs--as
in the Standford case--or guaranteed double-digit returns a la Madoff.
The bottom line: If someone promises an investment return that is
unnaturally high or steady, the warning alarm should start sounding.
2) The "Source Credibility" Tactic: A scary truth is that anyone can
call himself or herself a financial planner or adviser, so it pays to
check with national organizations that issue credentials (they include
the National Association of Personal Financial Advisers, the Financial
Planning Association, and the Certified Financial Board of Standards.)
After you make sure that the person you're dealing with is accredited,
you should also make sure product he or she is selling is registered
with the SEC. Hedge funds are an example of an investment that's not
registered, Gannon says: "In the Madoff situation, people truly had no
idea what he was doing with their money--there was the fuzzy idea that he
had an algorithm to make profits, but no one had a good understanding
how he was going about making money."
If you don't understand how the investment generates returns, think twice.
3) The "Social Consensus" Tactic: Scam artists may employ a sort of peer
pressure by claiming that other investors have already invested, such as
those in your social circle or perhaps your church. "Madoff had people
in country clubs in Florida investing," says Gannon. Dean Barber,
president of Barber Financial Group in Lenexa, Kan., says fraudsters
sometimes use the allure of exclusivity: In the Madoff case, people
believed because this guy had been around a long time and had some big
clients." When investment frauds occur, it's often when a client signs
on with a manager (financial adviser) who's also the the custodian of
the account. A custodian, which would include the Fidelitys and Charles
Schwabs of the world, is in possession of your investment account and
issues periodic statements of transactions. The manager of assets
executes those transactions.
It's a good idea to keep managers and custodians separate, which ensures
that all power won't fall into one person's hands.
4) The "Reciprocity" Tactic: In this situation, a fraudster will offer
to do a small favor in exchange for a big one.
For example, a free lunch at an investment seminar may make you feel
obligated to invest. Or you might be offered a break on commissions if
you buy now.
According to a recent study by the North American Securities
Administrators Association, nearly half of all investor complaints
submitted to state securities agencies came from the senior set.
5) The "Scarcity" Tactic: This high-pressure technique creates a false
sense of urgency by claiming a limited supply.
At the very least, ask for a written explanation of the investment, and
say that you'd like to pass the proposal along to a third party, such as
an attorney or accountant. That's a classic turn-off for a swindler.
Another from Ken Pope.