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What are the Types of Investment Fraud?

Fraudsters are endlessly creative in coming up with ways to try to part people with their money. Investment fraud methods which have been more common in recent years:

  • Ponzi Schemes. These are probably the most well known type of investment scheme. The defining characteristic of a Ponzi scheme is that the fraudster is using the investment money of new investors to provide the cash flow to make payments to previous investors. The older investors receive payments either in the form of income (dividends or interest) or redemptions of the investment (partial or whole) under the belief that the funds were being generated by some underlying investment. In reality, the thief is really just taking money from the new investors and using enough of it to keep the older investors in the dark. There is no real investment generating any returns (or in some cases there is an investment but generating far less returns than advertised to the investors). Inevitably, Ponzi schemes fail when the fraudster can no longer find the ever increasing amount of new investor money needed to cover the payments he or she needs to make to previous investors.

  • Promissory Notes. Some fraudsters get a hold of investor money by claiming to raise money for some enterprise through the sale of promissory notes. These notes often have very high interest rates, including many that purport to offer 12% annual interest. In many cases, these high interest rates are simply a lure to convince consumers to invest in a non-existent or substantially over-valued business. To be clear, not every promissory note is fraudulent; however, investors should always ask why the business is raising funds through promissory notes rather than through traditional financing. If no bank is willing to loan a company money at 12%, chances are individual investors shouldn’t either.

  • Pump and Dump. In a pump and dump scheme, individuals own a substantial amount of shares in a small, publicly traded company, typically low priced, penny stock level companies. The fraudsters then go out and heavily market the company, including promotions on online message forums, email and mail circulars, and sometimes even direct telephone marketing. The value and business prospects of the company are heavily overstated in an effort to convince the public investors that the stock should be, or soon will be, far more than it currently is. The more investors these people can convince to buy into this stock, the higher the stock price climbs. At some point, these individuals sell off the shares they (or some affiliate of theirs) owned for a substantial profit at artificially inflated share prices. Once they have sold out, they no longer have any reason to be pushing the stock, quickly resulting in the stock price crashing back down to its original levels or even lower, to the detriment of all of the investors who bought in at the urging of these fraudsters.

  • Binary Options Fraud. Binary Options are a new investment tool that has gained a lot of buzz on the internet. Conceptually, in a binary option an investor is entering an agreement with the firm selling the “option” that if some underlying investment in something like a stock, commodity, index, etc., goes up or down past a certain price within a defined period of time, then the investor wins and gets his or her money back plus a premium. If he or she guesses wrong, the entire investment is lost and goes to the company. In a binary option, the investor does not ever actually own the specified asset, or have any right to buy or sell it. All the investor has is a contractual right to payment from the company if the terms are met. There are a few companies in the U.S. that are properly registered to offer these investments. However, there are far more companies that market on the internet from overseas, even going so far as to claim they have U.S. based offices which do not exist to assuage investor concerns. However, once the investors put their money with the firm, it never comes back. They refuse to process redemption requests, even if the investor was successful with whatever trades were placed, often claiming that the contract opening the account included numerous requirements the investor has not met before they are allowed to withdraw the money. Moreover, as these companies are overseas, it is far more difficult, if not impossible, to recover the money through legal process.

For more information on common types of investment fraud, contact the team at SSEK Law Firm.

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