The current financial crisis has not only battered the portfolios of many investors, it has also placed a spotlight on investment fraud. In turbulent economic times, ongoing schemes tend to unravel as wary investors begin demanding their cash. The opportunity for new fraud can rise, as fraudsters look for any hook to exploit those who hope to recover their losses.

Types of Investment Scams Investment scams can take many forms—and fraudsters can turn on a dime when it comes to developing new pitches or come-ons for the latest fraud. But while the wrapper or hook might change, the most common securities frauds tend to fall into the following general schemes:

• Pyramid Schemes—where fraudsters claim that they can turn a small investment into large profits within a short period of time—but in reality participants make money solely by recruiting new participants into the program. The fraudsters behind these schemes typically go to great lengths to make their programs appear to be legitimate multi-level marketing schemes. Pyramid schemes eventually fall apart when it becomes impossible to recruit new participants.

• Ponzi Schemes—in which a central fraudster or "hub" collects money from new investors and uses it to pay purported returns to earlier-stage investors—rather than investing or managing the money as promised. The scam is named after Charles Ponzi, a 1920s-era con criminal who persuaded thousands to invest in a complex price arbitrage scheme involving postage stamps. Like pyramid schemes, Ponzi schemes require a steady stream of incoming cash to stay afloat. But unlike pyramid schemes, investors in a Ponzi scheme typically do not have to recruit new investors to earn a share of "profits." Ponzi schemes tend to collapse when the fraudster at the hub can no longer attract new investors or when too many investors attempt to get their money out—for example, during turbulent economic times.

• Pump-and-Dump—in which a fraudster deliberately buys shares of a very low-priced stock of a small, thinly traded company and then spreads false information to drum up interest in the stock and increase its stock price. Believing they’re getting a good deal on a promising stock, investors create buying demand at increasingly higher prices. The fraudster then dumps his shares at the high price and vanishes, leaving many people caught with worthless shares of stock. Pump-and-dumps traditionally were carried out by cold callers operating out of boiler rooms, or through fax or online newsletters. Now, the most common vehicles are spam emails or text messages.

• Advance Fee Fraud—which plays on an investor’s hope that he or she will be able to reverse a previous investment mistake involving the purchase of a low-priced stock. The scam generally begins with an offer to pay you an enticingly high price for worthless stock in your portfolio. To take the deal, you must send a fee in advance to pay for the service. But if you do so, you never see that money—or any of the money from the deal—again.

• Offshore Scams—which come from another country and target U.S. investors. Offshore scams can take a variety of forms, including those listed above. Many involve “Regulation S,” a rule that exempts U.S. companies from registering securities with the Securities and Exchange Commission (SEC) that are sold exclusively outside the U.S. to foreign or "offshore" investors. Fraudsters can manipulate these types of offerings by reselling Reg S stock to U.S. investors in violation of the rule. Whatever form an offshore scam takes, it can be difficult for U.S. law enforcement agencies to investigate fraud or rectify harm to investors when the fraudsters act from outside the U.S.

Visit SaveAndInvest.org to watch a preview ofTricks of the Trade: Outsmarting Investment Fraud, a free 60-minute documentary on preventing investment fraud. The video uncovers the persuasion tactics con artists use to defraud their victims through compelling stories of victims and perpetrators. It also teaches the basic defenses investors can use to guard against fraud.  This video was developed by the FINRA Investor Education Foundation, in partnership with AARP.

Pre-order this free DVD via email (include your full name and street address in the body of the email), or by fax, phone or mail. 

The common thread that binds these different types of fraud is the psychology behind the pitch. We've all heard the timeless admonition "If it sounds too good to be true, it probably is"—which is great advice, but the trick is figuring out when "good" becomes "too good." There's no bright line. Investment fraudsters make their living by making sure the deals they tout appear both good and true. In a 2006 study funded by the FINRA Investor Education Foundation, the Consumer Fraud Research Group examined hundreds of undercover audiotapes of fraudsters pitching investments scam. The tapes revealed that fraudsters are masters of persuasion, tailoring their pitches to match the psychological profiles of their targets. They look for an Achilles heel by asking seemingly benign questions—about your health, family, political views, hobbies or prior employers. Once they know which buttons to push, they'll bombard you with a flurry of influence tactics, which can leave even the savviest person in a haze.

Some of the most common tactics include:

• The "Phantom Riches" Tactic—dangling the prospect of wealth, enticing you with something you want but can't have. "These gas wells are guaranteed to produce $6,800 a month in income."

• The "Source Credibility" Tactic—trying to build credibility by claiming to be with a reputable firm or to have a special credential or experience. "Believe me, as a senior vice president of XYZ Firm, I would never sell an investment that doesn't produce."

• The "Social Consensus" Tactic—leading you to believe that other savvy investors have already invested. "This is how ___ got his start. I know it's a lot of money, but I'm in—and so is my mom and half her church—and it's worth every dime."

• The "Reciprocity" Tactic—offering to do a small favor for you in return for a big favor. "I'll give you a break on my commission if you buy now—half off."

• The "Scarcity" Tactic—creating a false sense of urgency by claiming limited supply. "There are only two units left, so I'd sign today if I were you." If these tactics look familiar, it's because legitimate marketers use them, too. However, when we are not prepared to resist them, these tactics can work subliminally. Little wonder that victims often say to regulators after they have been scammed, “I don’t know what I was thinking” or “it really caught me off guard.” That’s why an important part of resisting these common persuasion tactics is to understand them before encountering them.

To stay on guard and avoid becoming drawn into a scam, look for the warning signs of investment fraud:
 
• Guarantees: Be suspect of anyone who guarantees that an investment will perform a certain way. All investments carry some degree of risk.

• Unregistered products: Many investment scams involve unlicensed individuals selling unregistered securities—ranging from stocks, bonds, notes, hedge funds, oil or gas deals, or fictitious instruments, such as prime bank investments.

• Overly consistent returns: Any investment that consistently goes up month after month—or that provides remarkably steady returns regardless of market conditions—should raise suspicions, especially during turbulent times. Even the most stable investments can experience hiccups once in a while.

• Complex strategies: Avoid anyone who credits a highly complex investing technique for unusual success. Legitimate professionals should be able to explain clearly what they are doing. It is critical that you fully understand any investment you’re seriously considering—including what it is, what the risks are and how the investment makes money.
 
• Missing documentation: If someone tries to sell you a security with no documentation—that is, no prospectus in the case of a stock or mutual fund, and no offering circular in the case of a bond—he or she may be selling unregistered securities. The same is true of stocks without stock symbols.

• Account discrepancies: Unauthorized trades, missing funds or other problems with your account statements could be the result of a genuine error—or they could indicate churning or fraud. Keep an eye on your account statements to make sure account activity is consistent with your instructions, and be sure you know who holds your assets. For instance, is the investment adviser also the custodian of your assets? Or is there an independent third-party custodian? It can be easier for fraud to occur if an adviser is also the custodian of the assets and keeper of the accounts.

• A pushy salesperson: No reputable investment professional should push you to make an immediate decision about an investment, or tell you that you’ve got to “act now.” If someone pressures you to decide on a stock sale or purchase, steer clear. Even if no fraud is taking place, this type of pressuring is inappropriate.

The Financial Industry Regulatory Authority (FINRA), is the largest non-governmental regulator for all securities firms doing business in the United States. This article is adapted from information found on the FINRA website. For more information, go to http://www.finra.org.