Types of Investment Scams
Imagination is all that limits the scams that fraudsters conjure up to tempt the unsuspecting. Fraudsters can be incredibly flexible, turning on a dime when it comes to developing new pitches or come-ons. But while the wrapper or hook might change, the most common securities frauds tend to fall into four classic categories.
WATCH OUT FOR THE BIG 4
PYRAMID SCHEMES are scams where fraudsters claim they can turn a small investment into large profits within a short period of time. In reality, participants make money solely by recruiting new participants into the program. The scheme works in a manner that is similar to a chain letter, gathering momentum until it crashes. Fraudsters behind these schemes typically go to great lengths to make their programs appear to be legitimate multi-level marketing schemes, but the schemes eventually fall apart when it becomes impossible to recruit new participants, which can happen quickly.
In one example, the first level starts with each new participant enlisting eight more people. Each of those eight people then needs to recruit eight more, and so on. Participants only make money from new recruitment – there is no real investment. Once recruitment into the group stalls, the participants in the group cannot be paid. Game over. Everyone is a loser except those at the very early levels.
PONZI SCHEMES are scams where 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. 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 “profit.” Ponzi schemes tend to collapse when the fraudster 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 schemes are scams where 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 price. Believing they’re getting a good deal on a promising stock, investors buy 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 conducted out of boiler rooms using cold calls, faxes or online newsletters. Now, fraudsters are using modern technology such as emails, text messages, and even instant messaging apps.
ADVANCE FEE FRAUD, ALSO KNOWN AS THE NIGERIAN LETTER SCAM, are scams where an investor must send a fee in advance in order to receive a promised service or payoff. The “Nigerian Letter Scam” is a popular type of Advanced Fee Fraud. In this scam, fraudsters use letters or emails to target potential victims. Oftentimes, the fraudster claims to be either a high ranking public official with a fortune or an individual with an inheritance seeking a little financial assistance to retrieve a large amount of money. The fraudster promises a share of the money once it has been transferred in exchange for the assistance. After the fee has been paid, the investor never hears from the fraudster again.