Detecting Investment Fraud
Forbes published an interview with Fred Joseph, Colorado’s securities commissioner and president of North American Securities Administrators Association yesterday on how to sniff out scams and fraudsters. On the same day, Shreveport Times published Diane DeCharles’ advice on doing due diligence to avoid investment fraud.
According to Mr. Joseph, 98% of the victims of investment frauds are senior citizens because they have accumulated sufficient wealth over a lifetime. And the problem is, as we begin to see during this recession, these Ponzi scam artists are legion.
Mr. Joseph thinks more Ponzi schemes and frauds are uncovered during tough times because more and more people are seeking guaranteed high returns. And that’s easy to sell despite the fact that “guaranteed high returns” is really an oxymoron.
But, let me offer another theory on why there’re more frauds reported during tough times. The reason is the fraud schemes are not sustainable. A Ponzi scheme that guarantees consistently high return is guaranteed to fail. In fact, the higher the return, the faster it falls. If you observe these fraud cases, they were started way before the recession. So people didn’t flee to the guaranteed high returns during recession. They were chasing guaranteed high returns when the economy was booming. In other words, we were greedy when we should have been afraid. The recession certainly helped make the fraud schemes fail faster.
Both articles chimed in on steps investors can take to protect themselves from fraud. The advice doled out echoes what I wrote in 5 Red Flags of Fraudulent Hedge Funds. Although, I don’t quite agree with DeCharles’ advice on diversifying. What if you are diversifying across all “guaranteed high return” funds? If you read 150 Stocks - The Secret to Proper Diversification?, you’d know why I agree with Warren Buffett when he said “Diversification is a protection against ignorance.”
