Late last year, the Securities and Exchange Commission (SEC) released the results of their enforcement actions for the fiscal year ended September 30, 2015.
In that 2015 fiscal year, the SEC filed a total of 807 enforcements actions and obtained judicial orders totaling approximately $4.7 billion in disgorgement (i.e., repayment of ill-gotten gains) and penalties. Of the 807, a record 507 enforcement actions related to independent federal securities laws violations. (That's up 22% from the 413 enforcement actions filed in 2014!) The other remaining enforcement actions related to security issuers who couldn't file their SEC filings on time and individuals the SEC thought shouldn't have a career in the securities industry at all.
What's unfortunate about these numbers is that they only consider the federal violations that were discovered and do not take into consideration individual state enforcement actions or the schemes currently in process.
How can you avoid becoming a statistic?
If you're not a vigilant and proactive investors, becoming a victim of investment fraud can happen very quickly and create irreversible damage on your savings. One way to avoid becoming a statistic is to stay alert for warnings signs of a possible investment scam. To give you a little ammo for your own research, here are the top 11 warning signs that an investment might be a scam:
1. Claims of high returns with little or no risk
When it comes to trying to lure investors into a scam, pitching high returns with minimal risk is Chapter 2 of the scammer's handbook ( with Chapter 1 being "How to be a Complete Scumbag"). As tempting as something like a 20% interest rate on a 1-year promissory note with minimal risk sounds, the chances are extremely high that that rate belongs to a scheme in the works.
In very basic terms, a 1- year treasury bill (T-Bill), which is deemed risk free under the idea the U.S. Treasury will always have money to pay its debt, has a rate of about 0.55% today. So if you have someone is claiming a 20% interest rate, approximately 19.45% of that interest rate is related to a risk premium, which is the minimum amount of money required to entice someone to purchase the investment because it is so risky. As an investor, you will always want more money for taking on more risk, so an investment with a high rate of return is naturally extremely risky investment.
What am I saying here? There are no investments with high returns and minimal to no risk. If someone says there is, either you will be the one getting ripped off or contributing to someone else being ripped off. So don't buy claims like this, but if you're tempted to check it out, proceed with caution. Securities with a high rate of return are notorious for being the foundation of Ponzi schemes, and you do not want to be part of those.
2. Aggressive sales tactics
Aggressive salesmen are exceptionally annoying and will be easy for you to spot and flag. They will most likely cold call and pressure you to make a decision to purchase on the spot. A true sign of aggressiveness is the use of manipulative phrases such as "once-in-a-lifetime" or "available for a limited time only."
When you're on the phone with one of these jerks, it is very easy to be manipulated into making a purchase through coercion, misrepresentation or false sense of limited availability. They might even try to trap you in a maze of flawed logic, technical finance jargon and other complete BS.
The easiest way to handle these people is to simply state you need to talk with your attorney or financial advisor first. Just keep repeating that you need to talk with those people. If that salesperson continues to pressure you after you make that statement, take that as a huge red flag for someone who is attempting to pull you into a scam and just politely tell them you are ending the call and hang up.
A true investment professional will respect your request and give you and your trusted advisors time to not only think about the opportunity but also research it until you feel comfortable.
3. Unregistered financial professionals
I think finding out if your financial professional is registered is one of the easiest red flags to uncover,
and failure to do so can cost you a lot of money. (See Mark Sanchez, Jake Peavey and Roy Oswalt's story here, where the investment adviser claimed to be a CPA was, in fact,not a CPA).
Both the SEC and the Financial Industry Regulatory Authority (FINRA) offer 2 great tools for checking backgrounds of financial professionals. The SEC offers the Investment Adviser Public Disclosure website, and FINRA provides BrokerCheck. Both are pretty self-explanatory. If you think you might need more information for your search, you can ask your financial provider for the right address, firm names and legal names to use for your search. Any reluctance to giving you that information should be considered a red flag.
There are other websites for certified financial planners (CFP), certified public accountants (CPA), attorneys and other professionals, and you can find out how to search those databases here.
If the financial professional is not registered, do not work with him, her or the company. You can always ask what the issue is, but to be conservative with your funds, you should stay away altogether because that financial professional should not be offering or advising at all if he/she isn't registered. By doing so anyway, you're being told how that person operates.
If, and when, you find registration information, spend a few minutes digging through any reports that are provided. Depending on the regulatory agency, e.g. SEC or FINRA, in which you’re doing your research, you may also find an extensive history of disciplinary actions, penalties and more against that person. This is great information that will give you a better idea of the financial professional asking for your trust.
4. Problems with sales documents
A sure sign of danger is a financial professional who refuses to give you information in writing, be it
an offering document, compensation arrangements or account statements. Since this post is talking about warning signs before investing, I want to focus on being cautious of securities with offering documents that look unprofessional or are simply unavailable.
The type of offering document you might receive will vary according to the type of security. Regardless of the document, what you want to look for are typographical errors, basic grammatical errors, incomplete sections, missing financial information or other items that just seem out of place.
To be straightforward about researching your offering documents, being able to scrub through these documents for issues is a skill that develops after reviewing these types of documents over and over. Additionally, disclosures required in these documents constantly change, so in some cases, additional research is required to find out if you are, in fact, receiving complete documents. While you could read and research on your own (which is doable and there are things online that could help), I highly recommend reaching out to a licensed professional, such as an attorney or CPA to look at your offering documents. Outsourcing the research will save you a lot of time and energy.
5. No net worth or income requirements
For securities privately offered to individuals, there are certain net worth or income requirements in order to participate in the offering and for the issuer to avoid securities violations. (You can learn about these requirements here.) One way professionals determine if someone meets these requirements is to provide a prospective investor with an investor questionnaire. This questionnaire is a checklist for determining if you meet accredited investor status. If you don't meet the criteria, you shouldn't be offered or sold the security.
If you are ever approached by someone who is offering you a private investment opportunity, and he/she doesn’t ask about your net worth or income requirements, be highly cautious about proceeding to invest in that opportunity. Even if they ask verbally, I would still recommend being cautious if they fail to provide you formal documentation, such as an investor questionnaire, to complete to verify your accredited investor status. Failure to do that is just amateur hour, and you don't want to be involved with that.
6. No one else seems involved
While not always 100% representative of a scam-free investment opportunity, a legit investment opportunity should have more than just the salesperson involved. Other parties involved might include investment banks, other investors, attorneys, accountants and brokerage firms. If it looks like, and it is, just you and the salesperson going in on the deal, be extremely careful. At the end of the day, he/she may not even be investing any money (despite claims), and if you don't have access to real bank statements, you may never find out if they are being truthful.
To find out if you are the only other party involved besides the salesperson, simply ask if you can speak with other investors. If the salesperson seems reluctant to providing you the names and contact information of other investors and goes as far as saying not to contact other people, consider finding another investment opportunity.
(As a side note, if you are given names. Google them. Check out social media presence. Do these things to make sure they don't have some tie to the salesperson other than being a third-party investor. The last thing you want is for the salesperson to give you name of someone else in on the scam.)
7. Sham or virtual offices
Some scams make use of virtual and/or temporary offices. Scammers do this to make it easy for them to quickly close shop or hide themselves soon after a fraud is executed. If you can’t find an address online, ask your contact for an address and cross check it with Google Maps and regulatory agencies (e.g., SEC or FINRA) that require registered financial professionals to provide their addresses. You'll want to do a cross check to make sure the information is consistent. If the address is located near you, you may even consider dropping by to check the office.
The idea behind investigating the office is to make sure it is being run as a legitimate operation and not out of a parent's basement or some boiler room (which is a makeshift brokerage firm that uses aggressive sales tactics and stock manipulation to make money). Today, it’s quite easy to purchase a mailing address in one location without having even stepped foot within the state. If you find that you are working with someone who is doing this, be cautious and follow up on the background behind the office location.
8. Legal entity is not in good standing
All corporations, limited partnerships (LP), limited liability partnerships (LLP) and limited liability companies (LLC) are required to be in good standing in the state in which it was formed and where it is operating.
For example, a corporation formed under Delaware law but operated out of Texas must have good standing in Delaware and the authority to transact business in Texas. The type of “active” or “good standing” status may vary from state to state, but the overall idea is to make sure the legal entity isn’t restricted in any way and that it exists. You'll want to do this information with the firm offering or selling you the security and any companies that might be receiving your investment funds.
To find this information out, you’ll need to visit the Secretary of State website of the state where the legal entity is formed and/or headquartered. (Google something along the lines of "Washington State Secretary of State Corporation Search" but for your respective state.) If you can’t find any information or the legal entity is “forfeited,” “inactive” or “not in good standing,” do not consider investing in or with that company until those items are cleared up.
9. Unsolicited investment offers
One thing fraudsters are good at doing is quickly gaining trust. They’ll research your background and find something near and dear to you, and use that to build a relationship built up a fake interest in causes, people and groups that really matter to you. Once they have this trust, they’ll hit you up with an unsolicited investment offer, that is, an investment opportunity that you never requested, and they'll leverage the trust to manipulate you into making the purchase. (I've seen this happen with investors who have a particular faith, and the fraudster will pretend to also be strong member of the same faith. Again, see the unfortunate tale with Sanchez, Peavy and Oswalt.)
Unsolicited investment offers can come from friends, teammates, family members, strangers on the phones and advisors. In each situation, be cautious and take time to determine why they are presenting this opportunity to you. What do they have to gain by your investing? What’s the motivation by asking you?
10. No website or other forms of Internet presence
With today’s technology, there really isn’t an excuse for a financial professional to not have a website that explains his or her business, objectives, background and other information you typically find on websites.
Even ultra-high net worth service providers have basic websites when only a handful of people serve as clients. So be careful if you can't find a website related to your financial professional.
When you’re researching an investment opportunity, not only should you look for websites for the financial professional, but you should also look for websites related to any companies in which you are planning to invest. Even early stage companies should have at least a launch page in place to start generating a buzz about its business.
In addition to personal and business websites, you’ll want to check if your financial professionals have any social media presence. Is he/she on LinkedIn? Is there a Facebook account? The idea here is to find as much information you can before you decide to hand over your investment funds. Zero Internet presence should be a red flag.
11. Suspicious or unverifiable biographies of managers or promoters
One way fraudsters lull unsuspecting investors into their traps is by claiming all sorts of professional credentials, prior employment history and professional awards. Fortunately, a lot of this information is easy to verify, so when you hear claims of achievement from prospective managers, promoters or others involved in the deal, search online for proof. For example, if your financial professional claims an award from a reputable organization, confirm that award with that organization. In addition to your own research online, you may even choose to ask for references (which is something I recommend when you plan to investment a significant amount of money.)
At the conclusion of your research, you may discover that there is truth to the claims being made, but despite this truth, competency may still need to be questioned. For example, if a prospective manager tells you he worked at Company ABC for 5 years (and he did), you may ask a few questions and find out he still doesn’t understand basics related to Company ABC’s industry. This would be a red flag.
How do you protect yourself?
The best way for you to protect yourself is to ask questions (lots of them), check out background of financial professionals involved, and keep these warning signs in your mind. All of these can be summed into simply do your due diligence (i.e., your own investigation).
If after you get into the weeds you still feel uncomfortable with the transaction or you think you would like more help with your research, you can contact me here, and we'll work together to help reduce the chances of becoming an investment fraud victim.
Homework: What other warning signs are on your checklist?
Please share below!
Chris McCauley, CPA, Esq. is the founder of McCauley Investment Risk & Legal Consulting PLLC, a Seattle-based law firm dedicated to helping professional athletes guard their earnings and investments. Chris is an attorney licensed to practice in Alabama and Washington and a CPA licensed to practice in Washington and North Carolina.