How To Spot A Financial Scam

I was watching “American Greed” on CNBC and was surprised by the number of people that were duped by con artists. Con artists trick millionaires, celebrities, and average investors out of their hard-earned dollars with the promise of quick profits. These crooks use ponzi schemes, pyramid schemes, and offshore investment scams to enrich themselves and defraud investors.

Ponzi Schemes

These “high yield investments” promise exorbitant returns with little to no risk. Remember the old adage that if something seems too good to be true, then it probably is. People that promise instant riches are often scammers just looking to make a quick buck. Sam Israel, Bernie Madoff, and Martin Frankel ran some of the largest Ponzi schemes in the history of the United States. These financial criminals often claimed that they could generate extraordinary returns because of a secret trading model or access to financial instruments not available to the general public. A Ponzi scheme is a shell game where the money from new investors is used to pay old investors. Ultimately, the scammer runs out of new investors and is unable to pay old investors and the scheme collapses. So, how can you spot a Ponzi scheme?

Signs of a Ponzi scheme are:

  • The investment returns are abnormally high or unusually consistent. Markets fluctuate and so should the value of your investments.
  • The company makes impossible claims and guarantees like “double your money back” in 6 months.
  • The company makes it difficult to withdraw your money, claiming that funds are frozen.

Pyramid Schemes

A pyramid scheme is an “investment opportunity” that promises members money based on their ability to recruit new members. Pyramid schemes often sell products which have little to no value and the only way that you make money is by recruiting new members to join the business. All of the money is made by the members that got in early while the other members are often left with nothing. Pyramid schemes involve complex matrix models and payout formulas to determine how much money you are going to make. The allure of pyramid schemes is that early investors are able to make large sums of money for a little while. Pyramid schemes often use buzzwords like upline and downline. It is increasingly difficult today to tell the difference between pyramid schemes and multi-level marketing.

Signs of a potential pyramid scheme are:

  • The emphasis is on recruiting new distributors, not the products.
  • The business has very high start-up costs.
  • The company will not buy back unsold inventory.

High-Yield Offshore Investments

Con artists will often tout offshore investments as high-yield and tax-free. Wealthy people made offshore investing famous by using it to reduce their tax burden. Offshore investing involves holding money in a country outside of your legal residence. This normally takes place in less regulated countries. While offshore investing is perfectly legal, it can be a very risky proposition. Less regulated countries do very little to police their financial institutions. Once your money is out of the country, it is almost impossible to get back. Offshore investment scams can be hard to detect. Allen Stanford used offshore banks to defraud investors of $8 billion dollars.

Signs of a fraudulent offshore investment:

  • The institution promises high interest rates on financial products such as CDs and bank accounts that pay 30% interest.
  • The financial institution claims that the investment is free from taxes in all countries. U.S. citizens have to pay taxes on income earned in any country.
  • The investment is risk-free.

Has anyone ever tried to get you to invest in a financial scam?  If so, when did you realize you got sucked into a scam?  Let’s share our experiences to help other people not make the same mistakes.

(photo credit: Don Hankins)

  • megscole64

    So my question is … how do you convince someone that they are part of a Ponzi scheme when they swear otherwise. It’s a family member and a very tough situation. :(

    • Mark Riddix

      It can be difficult to prove to someone that they are involved in a Ponzi scheme. If you suspect that it is a Ponzi scheme than the best thing to do is contact the authorities. The SEC can investigate if it is an investment firm.

      • megscole64

        Thanks…it’s called “Fortune High Tech Marketing” and it’s just breaking my heart. :( They use lines like “Get paid to pay your bills” and “If you were told you could own and opperate a legal business for less that $500.00 would you take to opportunity?” *sigh*

        I’ve done a bit of research and there isn’t a ton of information out there. It just really seems like a Pyramid scheme to me.

  • Karmella

    I feel really fortunate not to have been caught up in something like this – but I can absolutely see how one of these could sound like a really great idea, if presented properly.

  • Winston C

    My dad often receives calls from people asking him to participate in mutual funds, claiming the usuals: risk free, big payoff, small entrance fee,etc. Obviously, he knows that these are scams, but he never hangs up on them. He likes to talk to them to see what kinds of gimmicks they use. Then later, he would tell relatives and friends to be aware of those shenanigans.

  • Mac

    I think that any company that doesn’t tell you the specifics on how you are going to make money is probably a scam. Even many of those MLM (multi-level marketing) companies are essentially pyramid schemes as well. I got sucked into the Quixtar (now Amway) scam for a very short time a while back. They make most of their money off seminars & cd’s that new members buy. The actual products sold are junk, or identical to much cheaper alternatives at retail.

    If someone asks you about your dreams before telling you how to sell, run away!

  • David/Yourfinances101

    Its simple, if it sounds too good to be true, it usually is.

    • Chris

      Seconded… there is no “free lunch”, as they say. If its too good to be true, it usually is.

  • gina

    I used to work for an organization that unfortunately fell prey to Madoff’s scam. It is really sad that so many people were affected. I agree, if it sounds to good to be true, than it is! We work too hard for our money to let it all go…