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Investment Scams Can Cost You and Your Business

Filed under Detecting & Deterring Fraud. Fact checked on May 24, 2012.

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Ponzi schemes, pyramids, and pump and dump frauds are but a few of the colorful names given to the multitude of ways to separate people from their money through investment scams. A sophisticated investment scam, but a scam nonetheless, involves securities fraud. While some of these schemes have involved billions of dollars, be wary of scams involving much smaller dollar amounts.

There are many investment frauds are in use today and the following are just a few of them.

Ponzi Schemes Are Still Going Strong

Named for Charles Ponzi, a Ponzi scheme is simply a system of robbing Peter to pay Paul. It's a pyramid of investors, the earlier (top) ones being paid off from the investments of the later (bottom) ones. Although these kinds of schemes were conducted long before the illustrious Ponzi was born, and they continue to proliferate today, he raised it to an art form and richly deserved to have this technique bear his name into perpetuity.

The Fraud: Ponzi died broke in 1949 in Brazil, but his legacy lives on. Every new day dawns on some innovative scam based on Ponzi's pyramid scheme model, as the Madoff scandal amply demonstrates. 

The peak of the pyramid thrives as long as the "downline" foundations don't crumble. But pull out just a few of those bottom rows of stones and fail to replace them--and see how quickly the mighty structure crumbles to dust. The modern day example of a spectacular Ponzi scheme is the Bernard Madoff scam uncovered in late 2008 where enormously wealthy people were conned into this multi billion dollar fraud "by invitation only!"

Many Multi Level Marketing (MLM) operations are pyramid schemes at heart. The difference is that while Ponzi dealt in cash or cash substitutes, MLMs allegedly deal in products. There is a fine line between legitimate MLMs and MLM scams. The courts have held that if a majority of profit comes from product sales to end-users, rather than inventory purchases by new recruits, the MLM is legit.

The Flaw: Gullibility and greed.

The Fix: As always, if it seems too good to be true, run for the exit!

Pump and Dump Is a Form of Security Fraud

Pump and dump is a catchy handle for artificially pumping up the price of a security and then dumping your own low-cost shares at a huge profit.

The Fraud: A fast-talking fraudster promotes a loser stock in online message boards, social networking sites, via telemarketing, and lots of spam. The relentless hype causes uninformed people to impulsively buy into the stock tip, driving the price way up. The fraudster then bails out of his holdings at the pumped up high, having dumped all his worthless shares on the unsuspecting hot tip believers.

The Flaw: The rapid dispersal of information and emphasis on urgency to act causes ignorant buyers to become unwittingly complicit in the scheme. (It sounds like such a good tip!)

The Fix: As always . . . if it's just too good to be true, run, run away!

Securities Fraud Never Gets Old

Stock market manipulation through deceptive practices has been rampant of in recent history.

The Fraud: Securities fraud brings to mind images of Ivan Boesky or Michael Milken--and more recently the merry band of Enron entrepreneurs and Bernie Madoff. Inflating earnings, accelerating income, hiding liabilities off-balance-sheet, insider trading and a host of other devices have been inflicted on the public.

The Flaw: A blatant lack of regulation. What regulatory power existed with the SEC and CFTC had been watered down over the years in the name of "free market" economic theory.

For example, the Glass-Steagall Act of 1933 protected bank depositors from the additional risks associated with security transactions .... until it was dismantled in 1999.

The Fix: Since the securities industry failed to regulate itself, regulatory changes have been made to attempt to re-establish and maintain stability and investor confidence.

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