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Wall Street V. Main Street Podcast – Episode 9

Investment Fraud

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The following is a transcription of a recent episode of Wall Street vs. Main Street, a radio show hosted by the firm’s managing partner D. Daxton White.

In this episode, Mr. White discuss the most common types of investment fraud.

Producer: Welcome to Wall Street versus Main Street a different take on the investment show with our host Dax White.  Dax White is the managing partner of the White Law Group, a national securities fraud, securities arbitration and investor protection law firm with at offices in Chicago, Illinois and Vero Beach, Florida. The White Law Group has represented hundreds of investors in FINRA arbitration claims against their brokerage firms and throughout this show Mr. White will shine a light on some of the tricks of the brokerage industry while also providing valuable information for investors on how to successfully navigate the investor/ financial advisor relationship.

Dax: Welcome everyone you’re listening to Wall Street versus Main Street. I’m your host Dax White.  As we mentioned in the intro, this is a different take on the investment program. I’m not here to give investment advice “buy this, sell that.”  That’s not the purpose of the show and frankly I’m not a licensed investment professional to do that. Rather I’m a securities attorney who represents investors and claims against brokerage firms and through that work I’ve seen, over the course of my career, a lot of things the industry does to take the money out of your pocket and put in theirs. In the micro level that’s not what it is, it’s you with your financial advisor trying to make choices on how to invest your money.  But at the macro level and on Wall Street these big companies, it is about maximizing profits and making sure to make as much money as they possibly can off of their clients. There’s tricks that they use to maximize those commissions and there’s information that I think would be valuable to investors as they embark on that relationship to even the playing field a bit so that you ask the right questions and make sure that your financial advisor is looking out for your interests.  That’s what we’ll do week to week is tackle those topics.  This week I’m to go through the top 10 investment frauds that are out there, things to be on the lookout for, and tips on how you can better identify these types of investments so you can protect yourself and make sure that you’re, number one, working with the right person, and number two, investing in the right things. So that’s what we are going to do this week.

The number one investment fraud which is both the most difficult to identify and the most cataclysmic unfortunately for investors is the Ponzi scheme.  I think a lot of people through the news, and hopefully not through personal experience, are aware of what a Ponzi scheme is. But basically that’s any investment where the investment sponsor, the person who put it together, is paying you with new people’s money to give you the illusion that the investment is going great when in reality all he’s doing is taking new investors money and giving you a portion of their new investment to create this illusion for you. That is of course why it’s so difficult to identify because you’re getting your money.  You’re thinking everything is fine I invested $100,000 he told me I’d get 10% and each year he gets me $10,000 and I got a statement that says I got my $10,000. I actually got the money so why would there be any cause for alarm. Bernie Madoff is the most famous of the Ponzi schemes and the reality is that took advantage of very sophisticated people for a number of years.  Some of the biggest losers on that are the owners of the New York Mets. This is a family worth hundreds and hundreds of millions of dollars, so unfortunately that’s one that’s very difficult to identify. I think the easiest way that you can, at least to have some cause for concern, would be what they’re promising you.  In order to bring in and continue to bring in new money, because that’s how these things collapse, is that they stop being able to bring in new money and then you’re still expecting your payment but they don’t have any money to give you. And so the way to bring in new money is to make outlandish promises in terms of the return.  And so on that $100,000, in a typical Ponzi scheme it’s not going to be I’ll give you 4% return, it’s going to be something larger, it’s going to be like 15% or something that’s out of the norm. In any investment, investors have to understand there’s an absolute correlation between risk and return. So if you’re being told that there is this huge return of 15-20% per year and it’s guaranteed and there’s no risk. That’s a red flag.  That’s the easiest way to have some sense that maybe this is a Ponzi scheme because frankly that kind of return is very difficult.

My dad who fortunately it didn’t turn out to be a Ponzi scheme really, it hasn’t yet. But he called me not too long ago, he’s a lawyer so he should know better, he told me that he’d been pitched this investment that was paying 12% per month. I said Stop right there, that’s all I need to know. That’s a problem, it’s a red flag. No investment should be paying that much. The reality is if you’re putting an investment together why would you pay a return that high when the market is basically without risk right now, what are CDs paying .2%. You don’t have to pay an investor 12% per month to get somebody interested.  You can pay them 6% per year and you can have a line out your door. So if they’re offering you that much of return there’s probably a reason for it. Huge red flag.

The Ponzi schemes is the number one, not necessarily in terms of being the most common but certainly in terms of it being the most damaging.  Because of course what ends up happening, what’s the outcome. A bankruptcy receiver steps in, the money is gone, whoever put it together, almost every single time they’ve spent it on some sort of like outlandish lifestyles. So the money is gone, in the worst-case scenarios for that investor who put in $100,000 and was getting $10,000 return. Let’s say they been in it for five years, the bankruptcy receiver is going to come after that $50 grand.  Because that was someone else’s money and they are going to want it back. Maybe you spent it, or maybe you were living on it, whatever the case may be, that’s why it can be so cataclysmic is because it comes after the investor who was duped as well. The bankruptcy receiver, their job is to put everybody in the same position, and so these new investors who just basically gave their money to you, they’re going get some of that back and they are going to get it from you.  So that’s the one that’s the most damaging.


The second most common, or the second biggest investment fraud is promissory notes and I think this one has to do simply with regulation. These are not stocks, they are not mutual funds. This is literally someone writing a note saying you loan me hundred thousand and I will pay you a 6% return rate percent whatever the terms of the loan are with them, maturation of 2-3 years, whatever the terms are, but we see a lot of instances where these are abused.  And again I think it has to with regulation but unfortunately it’s oftentimes financial advisors who are putting them together and whether or not the regulated or not regulated, they are putting themselves out there as investment professionals and saying I got this great deal for you. It’s usually either they are in financial trouble and they’re basically borrowing money from you to keep things afloat, or they’re telling you I got this great business idea I’m starting this and were offering the terms as a promissory note, whatever the case may be.  Promissory notes are generally cause for concern. The problem is you know that they are only backed by whoever is offering you the note.  And if they can’t pay generally it’s because they don’t have any money so what’s your recourse. Limited, because you can’t get blood from a stone.  So that’s another one where if your financial advisor is offering you a note, particularly one that’s backed by him or her, that’s a red flag.  And certainly cause for concern and cause for some additional questions before you make that investment.

The next one in the top 10 which we deal with a ton in our particular practice has to do with private placements.  A private placement is a direct participation investment between an investment sponsor and the investor and it’s an exemption to SEC requirements on registration.  So as long as you offer it to an accredited investor and you offer it to a certain number and you don’t advertise at a certain way, you can offer this private placement without having to go through the rigors of an SEC registration like a public company would.  And so with that you have some potential hurdles because again it is not regulated in the same way that some investments are and the other problems that we see is that in order for, these are smaller companies who are trying to raise capital, and in order to do it they need somebody to sell it. Somebody who has clients that are willing to invest in it and generally speaking they offer a huge sales commission to do it because it’s a non-traditional investment.  Most people go to financial advisor saying I want stocks and mutual funds and bonds or what have you, so if they are being offered a private placement it is going to take sales pitch. It’s going to take a broker who is willing to make representations about how the investment will perform and what have you, and in order to incentivize a financial advisor to be willing to do that they pay huge commission on private placements. And so to me that’s really where the problem comes in on this one, is just the motivation of the broker and why they’re making the recommendation.  They might hope that it works out but you have to wonder if there is a significant conflict of interest in making that recommendation.  Is there something that maybe would be better suited for you but doesn’t pay the broker as much, and so that’s why they keep pushing this private placement. So if you’re been offered a private placement that doesn’t mean it’s a bad one, there’s tons of them out there is good ones and bad ones but it is at least pause for concern and reason to ask some additional questions, “Hey, how much are you being paid on this? Is it liquid? What is the track record of the company? Make sure they are asking more questions that’s where we see a lot of instances of fraud.

The next one is currency scams and frankly this one just has to do with the complexity and just risk in general with this particular type of trading.  Which is basically trading on where a particular currency will be relative to other currencies in the future.  And there’s an inherent amount of risk, look at what’s going on in the market today, the dollar has grown exponentially relative to other currencies over the last six months to a year.  If you were betting the other direction you would’ve gotten crushed and so it’s an enormous amount of risk and typically the scams have to do with guarantees of huge returns. These are often cold call situations where they call you on the phone, “Say do you invest in currencies? O you should here’s all the great returns that we been getting and here’s how we do it we got this algorithm and what whatever that whatever they’re doing, but the hook is usually a huge return.  This investment just in general should be cause for concern, if you’re not a sophisticated investor you probably shouldn’t be trading currencies and so somebody is telling you, oh, you can do, it no problem, that’s a red flag because it is a very complicated investment strategy and unless you are a sophisticated trader you should be steering clear of that.

The next one is similar in terms of its complexity and problems, but it’s investing in precious metals.  In my experience it’s the same sales pitch, it’s somebody, who knows where they get these lists, but they cold called you at home and said hey I’ve got the next great thing. Let’s buy silver. Let’s buy gold. Look at the returns over the last five years, look how much it’s gone up. That should be a cause for concern right there because it’s already gone up, where is it going to go next?  But they sort of pitch as a they’re going to have this infinite, here’s our arc, it’s going to keep going up forever . Usually they don’t start pushing it until it’s about to implode, and maybe they got their own reserves that they are trying to unload.  But we do see a lot of problems with this ultimately it does get back to them making representations about huge returns and it being a very, its not like buying a stock in a company that that has some product that it sells, it is you physically holding some precious metal and now you’re exposed to the whims of the market.  Again, precious metals over the last few years are have been very susceptible to stagnating growth.  They’ve been susceptible to changes in market.  If you own silver and suddenly they discover a silver mine someplace, that’s going to hurt the price because now, that’s a supply and demand scenario, and suddenly now there’s more supply.  Ultimately, if your getting cold called on investment, that should be the end of it. That should be the red flag. That should be the, why is this person calling me? Why are they offering me huge returns? Unfortunately most times, it’s to extract the money from you, and put it in their pocket.  And so just be very careful particularly if they’re offering precious metals or currency.

The next one in terms of commonality is an investment called life settlements and I find this one to be particularly morbid just because of what they are.  Essentially what you are doing is acquiring someone’s insurance death benefit. What the wholesalers of this investment will do is they will find people who have insurance and they need the money now as opposed to after they die and so they buy the insurance and acquire it and now they’re on the hook for making the premium payment but they get the death benefit so whenever that person passes away they get the check from the insurance company. And so essentially what they’re doing is betting on when you’re going die. If it’s $100,000 policy and you’re 85 years old with cancer and they think they only have to make eight payments before you’ll pass, they’ll though run a formula and come up with you how much they’re willing to pay.  Based on when they think you will pass away. So to me that’s just a morbid investment in general but they’re out there.  They’re called life settlements. You do see a quite a bit of fraud with them, and it’s not just, there are people out there who need this benefit. They’re people who have an insurance policy but they need the money now.  Maybe it’s for care or whatever it is and so there’s definitely a market of sellers, the problem is that the people the fraudsters, the ones who put a lot or some of these deals together anyway. They make misrepresentations about who the person is that sold it.  They will tell you we bought 10 policies and they all have AIDS, and they all are going to die within six months. And then you come to find out later that that was not remotely true. So you buy a life settlement thinking I’m going to get this great return because it’s going to start paying all these insurance policies, meanwhile you’re stuck with it eight years later making  premium payments because the people haven’t died. And so that’s where the fraud comes in, is the way they package the deals and the representations that they make.  Just be on the lookout for that investment in general.

The next one we see is on registered investments. This one would be a challenge for investors to identify because all these investments are sort of going to sound the same. But ask the broker the question, is this registered and with whom? Investments need to be registered typically with the SEC. Fortunately our world is shrinking in terms information that’s available. Get on Google, if you Google thing you can’t find it on the SEC website ask some questions. It should be there, and if it’s not that, that could be a red flag for you.

Another one that we see is prime bank scams. The hook on this one is convincing you that this investment is for the wealthy. This is what the uber wealthy do and don’t you want to be doing the same types of things that they do to acquire wealth. That’s usually the pitch that you see on that one but it’s is it is another sort of machination of the same type of fraud which is to make outlandish claims of return in exchange for them getting your money.  But if you’re being offered a prime bank investment, it’s cause for concern ask more questions.

Another one is investment seminars and this is not an investment particular but this is a type of investment fraud that we see a lot.  Seminars is a way that that either new financial advisors or financial advisors that don’t have a solid book of business often go about acquiring new clients.  But you have to understand when you go to these things you that the maybe they’re offering your free lunch but they’re doing it in the hopes of getting new clients. Unless it’s a new financial advisors, and why would you want a new one anyways. But if it’s an older financial advisor whose still doing seminars, you have to you have to ask why. Why doesn’t this person already have a pre-established book where they don’t have to be out there doing that.  So I think it’s cause for concern just because of who’s typically the ones doing them. I don’t think by its very nature that it’s necessarily bad that somebody would do investment seminar where they want to pass along some information. But usually it’s the financial advisors who don’t have an established book of business and don’t have enough clients. You have to ask why that is, why they need to pay for free lunch for me.  Just be on the lookout you go to those and understand, certainly, it’s a sales pitch to meet your there for a reason.  It’s not to eat their food.

So the last one that I’ll go into are annuities. This is one, is not is not the investment itself, annuities can certainly have a time and a place, it’s the insurance component.  If you’re looking for insurance for a particular need an annuity could certainly be appropriate.  But the reason that we see a lot of fraud involving annuities has to do with the commissions that it pays. It is one of the higher commission products that’s out there and so that just makes it more apt for abuse by the bad financial advisors. What you’ll see in terms of abuse is either recommending an over- concentrated portfolio in annuities.  Any time you put all your money in one basket it is going to be a bad idea but if they tell you all your money in annuities it’s probably to maximize commissions because it’s unlikely that you need such a substantial insurance component to your portfolio. If they’re selling it, and they’re all in the subaccounts and we’re still going to get mutual funds and all these things in the sub accounts, why wouldn’t you just but the mutual funds. Because that’s going to pay a substantially lower commission and usually result in a better rate of return for you.  So if they’re doing that, that’s a red flag. If they are switching you from annuities, saying I know you bought this three years ago, but this new product that they’ve got is substantially better.  That’s called annuity switching. Its basically a form of churning where there sort of flipping the annuities to keep getting the commission. So just be on the lookout for that cause that’s another instance where we see the product abused and  unfortunately annuities is one where you see a lot of fraud.

So those are the ten to be on the look out for. We are going to take a quick break and be back with some more info.

Welcome back you’re listening to Wall StreetVMainstreet. I’m your host Dax White, before the break we went through the top 10 most commonly seen investment frauds that are out there. For the next few minutes I’m going to talk about, those were sort of, we went through tips on how to avoid being involved in them. Now we’re going to talk about what happens if you already have been. What do you do? If you’ve been ripped off, what you do?  And it depends on what your motivation is. Let’s say that you’ve been defrauded but haven’t lost any money, but you know you been ripped off.  Maybe your motivation there is just to make sure it doesn’t happen to somebody else, at which point the best thing you can do is reach out to the regulators. That would be FINRA if it’s a financial advisor, they’re likely registered and in regulated by FINRA and you can find them at FINRA.org. Or there if they’re not by FINRA there probably then register by the SEC so visit SEC.gov and report them there.  They make it very easy on their website to find places for you to complain, and you can file a complaint and try to initiate an investigation by a regulator.  So that’s what you would do it if you just think the guys a bad guy but you haven’t necessary lost any money. If you lost money, if you been swindled and you’ve lost a substantial amount of money then while you still can file complaint, cause you still don’t want this to happen to somebody else, that’s not actually going to put any money back in your pocket. That’s not the function of regulators, the regulators are there to police the industry. What they would potentially do if they investigate your person is slap them on the wrist, fine them, suspend them, whatever. But it’s very rare that they actually go to the point where they issue a fine and have that fine paid to you. So if you lost money what you need to be doing is talking to a private attorney about initiating a claim. Either through FINRA, or it depend were the persons registered. It’s either going to be through FINRA, or it could be a different arbitration provision that calls for either AAA or JAMS.  But usually it’s FINRA. That’s all we do.  And so that’s where you would want to look if you’d lost money, and my suggestion in terms of private attorney, is there’s lots of lawyers who will take a case where you’ve lost hundreds thousands of dollars on a contingency fee,  and sort of go I’m going to try to figure this out. Talk to somebody that this is what they do. There’s very few lawyers out there, in the country, that exclusively do this kind of work. And FINRA is sort of its own animal and you want to have somebody that is experience with this type of work.  So try to find somebody who fits into that category.

And that’s it. Thank you for joining us. Next week we’re going to be talking about churning. I’m going to try to explain what it is and go into some detail about how to identify it. If you have questions for the show, visit us at WallStreetVMainStreet.com and I’ll try to answer those questions on a future episode.

Producer: You’ve been listening to Wall Street versus Main Street. The views expressed by the participants of this program are their own and do not represent the views of nor or they endorsed by The White Law Group, its officers, directors, employees, agents, representatives, shareholders, nor any of its subsidiaries, none of the content should not be considered legal advice.  As always consult a lawyer.

This transcription has been created by Dragon Software. There may be grammatical or translation errors. For clarification, listen to Episode 9 here.

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