Types of Fraud
Used with permission from The United States Securities and Exchange Commission.
Frauds come in many types and varieties. Whether you are a first-time investor or have been investing for many years, here are some basic facts you should know about the different types of fraud.
Advance Fee Fraud
Advance fee frauds ask for payment up front before the deal can go through. The advance payment may be described as a fee, tax, commission, or incidental expense that will be repaid later.
One example is the so-called Nigerian advance fee fraud, where someone pretending to be a Nigerian official or businessperson promises high profits for help moving money out of Nigeria. This scam is so prevalent that the U.S. Secret Service has a task force devoted to it. For more information, read the alert on the Secret Service's website.
Other advance fee frauds try to fool investors with official-sounding websites and e-mail addresses. These addresses may contain ".gov" and end in “.us” or “.org.” U.S. government agency websites or e-mail addresses end in “.gov,” “.mil,” or “fed.us.” Be wary of a website or correspondence claiming to be from a U.S. government agency whose e-mail address does not end in “.gov”, “.mil”, or “fed.us”.
Affinity frauds target members of identifiable groups, such as the elderly, or religious or ethnic communities. The fraudsters involved in affinity scams often are – or pretend to be – members of the group. They may enlist respected leaders from the group to spread the word about the scheme, convincing them it is legitimate and worthwhile. Many times, those leaders become unwitting victims of the fraud they helped to promote.
These scams exploit the trust and friendship that exists in groups of people. Because of the tight-knit structure of many groups, outsiders may not know about the affinity scam. Victims may try to work things out within the group rather than notify authorities or pursue legal remedies.
Affinity scams often involve “Ponzi” or pyramid schemes where new investor money is used to pay earlier investors, making it appear as if the investment is successful and legitimate.
The Internet is a useful way to reach a mass audience without spending a lot of time or money. A website, online message, or “spam” e-mails can reach large numbers with minimum effort. It's easy for fraudsters to make their messages look real and credible and sometimes hard for investors to tell the difference between fact and fiction. That's why you should think twice before you invest your money in any opportunity you find online.
Here are some of the ways investors can be tricked online:
Online investment newsletters
While legitimate online newsletters contain valuable information, others are tools for fraud.
Some companies pay online newsletters to "tout" or recommend their stocks. Touting isn’t illegal as long as the newsletters disclose who paid them, how much they’re getting paid, and the form of the payment, usually cash or stock. But fraudsters often lie about the payments they receive and their track records.
Fraudulent promoters may claim to offer independent, unbiased recommendations in newsletters when they stand to profit from convincing others to buy or sell certain stocks. They may spread false information to promote worthless stocks. To learn more, read our tips for checking out newsletters.
Online bulletin boards
Online bulletin boards are a way for investors to share information. While some messages may be true, many turn out to be bogus – or even scams. Fraudsters may use online discussions to pump up a company or pretend to reveal "inside" information about upcoming announcements, new products, or lucrative contracts.
You never know for certain who you're dealing with, or whether they're credible, because many sites allow users to hide their identity behind multiple aliases. People claiming to be unbiased observers may actually be insiders, large shareholders, or paid promoters. One person can easily create the illusion of widespread interest in a small, thinly traded stock by posting numerous messages under various aliases.
“Spam" – junk e-mail – often is used to promote bogus investment schemes or to spread false information about a company. With a bulk e-mail program, spammers can send personalized messages to millions of people at once for much less than the cost of cold calling or traditional mail. Many scams, including advance fee frauds, use spam to reach potential victims.
A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise to invest your money and generate high returns with little or no risk. But in many Ponzi schemes, the fraudsters do not invest the money. Instead, they use it to pay those who invested earlier and may keep some for themselves.
With little or no legitimate earnings, Ponzi schemes require a constant flow of new money to survive. When it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse.
Ponzi schemes are named after Charles Ponzi, who duped investors in the 1920s with a postage stamp speculation scheme.
Nearly a century later, Ponzi schemes are still around. In FY 2010, the SEC brought 47 enforcement actions involving Ponzi schemes or Ponzi-like payments.
Ponzi scheme “red flags”
Many Ponzi schemes share common characteristics. Look for these warning signs:
- High returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
- Overly consistent returns. Investments tend to go up and down over time. Be skeptical about an investment that regularly generates positive returns regardless of overall market conditions.
- Unregistered investments. Ponzi schemes typically involve investments that are not registered with the SEC or with state regulators. Registration is important because it provides investors with access to information about the company’s management, products, services, and finances.
- Unlicensed sellers. Federal and state securities laws require investment professionals and firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
- Secretive, complex strategies. Avoid investments if you don’t understand them or can’t get complete information about them.
- Issues with paperwork. Account statement errors may be a sign that funds are not being invested as promised.
- Difficulty receiving payments. Be suspicious if you don’t receive a payment or have difficulty cashing out. Ponzi scheme promoters sometimes try to prevent participants from cashing out by offering even higher returns for staying put.