What Schemes and Scams Should Investors Look Out For?

Ponzi Schemes

This well-known fraud scheme was named after Charles Ponzi, who became famous for using the technique. In essence, investors earn returns based on the money from new investors. The earlier investors are getting regular returns and everything seems fine, except the scheme relies on a constant stream of new investors before it inevitably collapses.

The organizer relies on attracting new investors to make promised payments; but funds are usually used for personal gain instead of engaging in any investment opportunities.

Pyramid Schemes

Another well-known type of fraud is the pyramid scheme. It sounds very similar to a Ponzi scheme, as a Ponzi scheme can be a type of pyramid scheme. However, pyramid schemes are not always illegal, while Ponzi schemes are certainly always outside of the law.

A pyramid scheme works by convincing people to invest into a distributorship or franchise. The promoter may say the product is the next big thing and tells the prospective investor they are getting in on the ground floor of something amazing. In reality, the focus is less on the product the franchise sells and more on how to recruit other investors.

Ultimately, no product has been sold, no investment has been made, and no service has been provided. It becomes mathematically impossible for everyone buying in to ever see a profit.

Advance Fee Schemes

An advance fee scheme can be presented as various opportunities, all requesting an upfront fee. The victim pays money with the expectation of receiving something of greater value, but ends up with nothing or practically nothing in return.

There’s really no limit to how varied these scams can be; potential investments include: the sale of products or services, contracts, loans, or found money (gifts). The victim is asked to pay a contract fee, a finder’s fee, or provide money for some other reason in advance, sometimes also signing a contract stating they will pay the advanced fee in exchange for accepting the investment, loan, or other item of value. This contract may be legally binding unless the victim is able to prove the “finder” or “promoter” never intended to provide the item of value.

Affinity Fraud

Affinity fraud occurs when an individual exploits the connection and trust within a group to promote a fake investment opportunity. This type of scheme may involve elements of a pyramid or Ponzi scheme while specifically targeting members of an identifiable group. Religious groups, ethnic groups within a community, individuals connected through military or professional affiliations, and groups united by a specific cause or demographic are just a few examples of the types of groups these con artists will prey upon to commit this type of fraud. They may directly approach the group or focus on convincing the leader of the group to buy into the fake investment, taking advantage of that person’s respect and position to access the members. One of the biggest challenges this type of fraud brings, is the targeted group may prefer to ‘work out the matter on their own’ instead of reaching out to law enforcement or regulators for help.

The Securities and Exchange Commission (SEC) issued an Investor Alert and an Investor Bulletin on the dangers of affinity fraud.

Letter of Credit Fraud

A letter of credit is not something that can be purchased as an investment. The fraud perpetrators are taking something used to ensure there will be payment for goods shipped and trying to manipulate it for fraudulent purposes. Letters of credit are issued by banks and most commonly used for international trade. The letter of credit states the receiving entity has the funds to pay for the shipment and the shipping entity provides proof the goods are en route.

This becomes fraud when the entity shipping the goods provides documentation stating the goods have shipped in order to collect payment, but has no intention of sending items or sends items of far less quality.

Prime Bank Note Fraud

Like other shady investment schemes, fraud perpetrators offer a deal that promises remarkably high yields in a very short time frame. This scam uses “bank guarantees” to be purchased at a discount and guarantee a high return. They will state these guarantees are coming from “prime banks” of the world and that’s why the return is so high with almost no risk. In reality, the fraudster is trying to get the victim to send his or her money to a foreign bank where it will then be laundered or make its way to an account belonging to the con artist.

This type of fraud is also called a bank guarantee, which is a legitimate financial instrument for international trade, similar to a “letter of credit” used by U.S. banks.