Types of Investment Fraud
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Investment fraud generally refers to a wide range of deceptive practices that scammers use to induce investors to make investing decisions. These practices can include untrue or misleading information or fictitious opportunities. Investment fraud may involve stocks, bonds, notes, commodities, currency or even real estate. The 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 hook might change, the most common frauds tend to fall into the following general schemes:
- Pyramid Schemes: A pyramid scheme is when fraudsters claim that they can turn a small investment into large profits within a short period of time. But in reality, participants make money by getting 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, which can happen quickly.
- Ponzi Schemes: This is when a 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 scheme is named after Charles Ponzi, a 1920s-era con criminal who persuaded thousands to invest in a complex 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: A scheme 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: This type of fraud 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. 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: These 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 to rectify harm to investors when the fraudsters act from outside the U.S.