As evidenced by the many headline-grabbing financial frauds of recent years, such as the Ponzi scheme run by Bernie Madoff, regulators have their hands full. State and federal officials discover a new Ponzi scheme almost every week, and bring legal actions against about 100 questionable investment operations annually.
Ironically, some of today's most common scams are the unintended consequences of a recently passed federal bill designed to spur small-business growth. The 2012 Jumpstart Our Business Startups (JOBS) Act, which relaxed rules about who can raise investment funds and how, has apparently jumpstarted the careers of more scam artists. Indeed, three of the top "investor traps" identified by the North American Securities Administrators Association (NASAA) are linked to the JOBS Act. Below we present NASAA's latest "top ten" list with the hope that being aware of these traps may help you avoid becoming ensnared by one.
- Private Offerings
This pertains to raising capital by selling unregistered securities to a small number of "accredited" (wealthy) investors. While many legitimate companies raise money this way, private placements are high-risk, illiquid investments. Because the JOBS Act lifted an 80-year ban on advertising private offerings, NASAA says unqualified investors are being drawn in, and some businesses promoting them are not doing an adequate job screening investors — or are even scamming them. The Association expects problems with private offerings to grow because additional provisions of the Act, that are likely to be approved later this year, will make high-risk equity stakes available to less affluent "everyday" investors through web-promoted "crowdfunding" opportunities
- Real-estate Investment Schemes
According to NASAA, the most common problematic real-estate investments are offered by companies that (1) buy, renovate, and then flip distressed properties, (2) those that promise investor funds will be secured by interest in a property that's so leveraged it has no remaining equity, and (3) those offering non-traded real-estate investment trusts (REITS). In fact, the Wall Street Journal recently named non-traded REITs in a list of the five "most dangerous investments." These investments promise high yields but come with high fees, can be difficult to understand and value, and are usually difficult to resell.
- High-yield Investments and Ponzi Schemes
The telltale red flags here are promises of unusually high returns coupled with the promise of low risk, a plausible-sounding explanation of why the investment is so good, and a promoter who appears credible based on false claims of holding certain credentials and his or her own apparent prosperity.
- Affinity Fraud
This one isn't a particular type of fraud, but a method of perpetuating frauds, especially Ponzi schemes. Scam artists know that people tend to trust others with common interests, beliefs, and affiliations. The most commonly exploited are the elderly or retired, and members of religious or ethnic groups. Such people often find it hard to believe "one of their own" could be scamming them.
- Using Self-directed Iras To Mask Fraud
Here, fraudsters use the perceived protections of self-directed IRAs to dupe unsuspecting investors. The reality is that self-directed IRA custodians only hold assets; they generally do not evaluate the quality, value, or legitimacy of an investment. In some cases, scam artists convince investors to move assets from an existing IRA into a fake one owned by the scammer. Other forms of fraud related to self-directed IRAs center on their allowance to hold alternative investments such as real estate, precious metals, and private placement securities — investments where information necessary to make a prudent decision may not be readily available.
- Oil And Gas Drilling Programs
Some fraudulent promoters conceal the inherently high risk of investing in oil- and gas-drilling operations, using high-pressure sales tactics and deceptive marketing practices to peddle what turn out to be worthless investments. NASAA says there are active investigations into suspect oil- and gas-investment programs in more than 24 states and every region of Canada.
- Proxy Trading Accounts
In this type of fraud, individuals claiming to have trading expertise offer to set up or manage a trading account on an investor's behalf. NASAA points out that allowing someone without the legally required safeguards (proper registration and bonding) to control your account often leads to substantial trading losses as well as the loss of principal through outright theft.
- Digital Currency
Unlike traditional coinage, "virtual" money such as Bitcoin and others is not issued by a governmental authority and is subject to little or no regulation. Its value is highly volatile and the complicated algorithms that determine when new blocks of coins will be released is difficult to understand, even for financial experts. According to NASAA, "Investors should be aware that investments that incorporate abstract money systems present very real risks, including the possibility of leaving an investor virtually broke."
- Capital-raising Pitfalls
This one is similar to the warning about private offerings, but is targeted toward business owners who are trying to raise money. The warning here is to keep up with recent changes in securities law. New ways to raise money brought about by the JOBS Act, such as crowdfunding, carry risks for unwary entrepreneurs. Securities offerings must either be exempt from registration requirements (while remaining subject to federal or state anti-fraud provisions that require full and accurate disclosures) or be properly registered.
- Unregulated Third-party Service Providers
This warning, too, is aimed at business owners. The JOBS Act has created opportunities for companies to provide ancillary services, such as crowdfunding portals and accredited investor aggregators. NASAA points out that use of an unregulated third party to provide such services does not change a business owner's obligations under federal and state securities laws, so owners should do their due diligence.
What's an investor to do?
To protect yourself from such investor traps, ask lots of questions (NASAA points out that Bernie Madoff, the king of Ponzi schemes, once said he only turned people away when they asked too many questions), thoroughly check credentials, and above all, remember: If something sounds too good to be true, it probably is.