How To Avoid Being A Victim Of Financial Fraud…And One Victim’s Gut-Wrenching Story

“When the tide goes out, you get to see who’s been swimming naked.” –Warren Buffett

In the Great Recession of 2008-09, the financial tide went out in a big way. And true to Buffett’s words, we got to see who was swimming naked. And with a big tide, there were plenty of naked swimmers:

Bernie Madoff. The largest of all Ponzi schemes, in December 2008 Madoff revealed that the asset management arm of his firm, Bernard L. Madoff Investment Securities, was “just one big lie”. It’s estimated that he took his investors for $65 billion over the course of nearly two decades. And he didn’t just con billionaires and celebrities (such as Zsa Zsa Gabor, Kevin Bacon and Steven Spielberg); individual investors, banks and even charities lost money in the scheme. The scam wasn’t revealed until Madoff himself confessed to his crimes. In March 2009, Madoff pled guilty to the charges against him, and he was sentenced to 150 years in prison the following June.

Allen Stanford. Texas billionaire Allen Stanford spent more than 20 years charming investors, who handed him billions of dollars they had spent their lives accumulating through hard work and saving. Stanford promised them safe investments that would help fulfill their dreams of being able to retire comfortably or pay their children’s college tuition. All the while, he was pulling their money out of his Caribbean bank to pay for a string of failed businesses and a jet-setting lifestyle. Stanford was convicted in 2012 on charges he bilked investors out of more than $7 billion.

Marcus Schrenker. Schrenker seemed to have it all. A 10,000-square-foot home in an upscale suburban Indianapolis community, a beautiful wife, three children and a thriving investment company. In 2010, Schrenker plead quilty to securities fraud charges and was sentenced to 10 years in prison, after a brazen get-away attempt that included him jumping out of an airplane in mid-flight. They say Schrenker bilked nine clients, including a friend of 10 years and even his own aunt, out of a total of about $1.5 million they thought they were investing in a foreign currency fund that didn’t exist.

Back to the future

In the years preceding the recession, and during what seemed to be a plethora of financial frauds being unveiled, the stock market was making all-time highs. In August of 2002, the Dow was at 7,591. Just five years later in September of 2007, the Dow had almost doubled to reach 13,930. I don’t think this is a random coincidence. And with the market now making historical highs, I thought now would be a good time to pen an article about financial fraud.

Now, I’m not saying that financial fraud and the market reaching new highs are directly correlated. I’m saying that they seem to act in tandem some times. And that’s because bull markets generally bring with them a common malady for investors – blind optimism.

BlogQuoteWhen everything seems “too easy” is also when over-confidence sets in. This can lead to one of my favorite Wall Street expressions: ”Don’t confuse brains with a bull market.” It’s times like these that can lead a person to start thinking that they have the Midas touch. Not satisfied with decent returns, some investors want indecent returns and start to look for investments that they think can produce them. This can lead to “unicorn chasing” and blindness to obvious signs that an investment opportunity may be too good to be true.

As financial scams evolve to keep pace with the changing American economy, it is important that consumers educate themselves about common scams, which you can do here. Additionally, here are four signs that an investment opportunity may be a fraud:

1. Scarcity. This is perhaps one of the most frequently used financial fraud tactics. The con man creates a false sense of urgency by telling the investor that he has to move fast because there are only a few opportunities left or that the opportunity will go away on Monday. This creates a fear of “losing-out” that drives many into scams. Look, there are literally thousands of investment opportunities each day. Never rush into anything. If you’re not allowed time to do proper due diligence and feel completely comfortable, give it a pass. One key attribute successful investors have is being calm when others are screaming at them to do something. You don’t need to swing at every pitch. Almost all of the time the best thing to do is nothing. Sleeping well at night is worth more than any potential return on an investment.
2. Outstanding returns, in the short-term. The market is littered with prospectuses trumpeting the high returns of various investments in a given year. A fund that generated a whopping 50% return one year will be all over the financial press and its manager hailed a financial wizard. But remember, even a broken clock gets it right twice a day. Many of today’s rocket rides to the moon, will be tomorrow’s dud crashing back to the earth in a cloud of smoke and ashes. A good investment is one that demonstrates reasonable returns with a track record over many, many years. Be wary of an investment opportunity that only has 2-3 years’ worth of performance. Although not a fraud, the case of Long-Term Capital Management comes to mind here. Members of LTCM’s board of directors included Myron S. Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences. Initially successful with an annualized return of over 21% (after fees) in its first year, 43% in the second year and 41% in the third year, in 1998 it lost $4.6 billion in less than four months following the 1997 Asian financial crisis and 1998 Russian financial crisis requiring financial intervention by the Federal Reserve, with the fund liquidating and dissolving in early 2000.
3. Straight-up or remarkably consistent returns. It’s been said that Stanford’s purported annual returns where like a straight horizontal line across the graph, extremely consistent. Too consistent. Friends, there is absolutely nothing in the financial world that behaves that way. One of the most stable, largest companies in the investment universe, Berkshire Hathaway (run by Warren Buffett), has had up years and down years. And this is as it should be. After all, the economy doesn’t move in one consistent line for decades. Neither will investments. The same goes true for returns showing a near straight-up trajectory. If someone were to show me a graph plotting an investment’s return and it was a perfect 45 degree line upwards, I would not walk from that opportunity, I would run. If it’s too good to be true, it probably is!
4. Too complicated. Just because an investment is difficult to understand, doesn’t automatically make it a fraud. However, some people get lured into frauds by nothing more than an investment’s complexity. Complexity can be seen as sexy, and sexy sells. This is because it generally takes smart people to figure-out complex investments. Some investors conflate smart people with smart investing, thinking that if the smart guys are investing in it, it must be good. Back to the Long-Term Capital Management example: LTCM had two Nobel laureates (very smart people) working for them and they lost it all. Every penny. Here’s my advice: When you don’t know what you are doing, don’t do anything related to that lack of knowledge.  Remember, Buffett has a “too hard” pile where he files away opportunities that are just too complex for even him to understand and feel comfortable. Everyone should have a “too hard” pile. As Einstein said, “If you can’t explain it in simple terms, you don’t understand it.”

Before I summarize this article with some steps to take if you believe you’ve been a victim of financial fraud, I want to go back to the notion of over confidence. If you had a room full of 100 people and asked them by show of hands, how many considered themselves good drivers almost everyone would raise their hands. Of course, we know that this can’t be the case.

Similarly, if you ask most people if they would ever fall victim to a financial fraud, most would say they wouldn’t. Most investment frauds seem so obvious and it’s easy for reasonably smart people to believe that they could see the signs of fraud and avoid it.

But that’s exactly what can lead someone to becoming a victim. Even someone like Steve Sampler, a licensed stockbroker with years of investing experience. He knew how markets worked and how to analyze companies. But a promising opportunity to invest in an oil well deal turned out to be a scam, and the $40,000 he invested vanished.

If it can happen to someone like Steve, it can happen to anyone. Don’t kid yourself. I encourage active skepticism when it comes to investing your hard-earned dollars. Don’t worry about hurting someone’s feelings. Do your homework and ask hard questions. Remember, there’s only one problem with investments that have all the answers. They don’t allow questions. As Thomas Huxley said, “Skepticism is the highest duty and blind faith the one unpardonable sin.” The safest assumption is that everyone is susceptible to fraud.

What to do if you believe you are a victim of financial fraud:

1. Collect everything. Create a fraud file and collect all of the documentation you have about the fraud in one file. At a minimum, this should include: the alleged perpetrator’s name, contact information and any regulatory registration numbers, a timeline of events, and any evidence of the fraud or deception, such as brokerage statements, email correspondence or logs of phone conversations.
2. Know that you have rights. You have victim rights under federal law and, in some cases, state law. Federal victim rights include being “treated with fairness and respect for your dignity and privacy,” and to be “reasonably protected from the accused offender.” You can find the full list of federal victim rights, as well as other laws that affect your rights, on the U.S. Department of Justice’s website.
3. Report it. Reporting the fraud to the national, federal and state regulatory organizations that oversee investment products and professionals may help you and could help others avoid a similar fraud. You can turn to agencies like the Federal Trade Commission or the U.S Securities and Exchange Commission. If you aren’t quite sure you’ve got the right one, don’t worry, they regularly route tips and cases of suspected fraud to the right group.
4. Contact local law enforcement. You shouldn’t just report the crime to regulators. You’ll also want to reach out to law enforcement to help ensure that the responsible parties are investigated. You can contact any local law enforcement office to file a police report. You can also contact your local district attorney’s office and your state attorney general’s consumer protection unit or prosecution unit to report the fraud.

In summary, financial fraud is a major problem. An estimated $40-$50 billion of measurable direct costs are lost to fraud annually. You work too hard for your money to give it away to a scam. Remember, if it’s too good to be true it probably is.

Be free. Nothing else is worth it.

Financial Freedom Monty Campbell

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