Investment Fraud
Hello Investigators!
Previously, we discussed the topic of Embezzlement. If you have yet to read that article, do check it out and share your thoughts with us via LinkedIn! This week, we will be exploring another type of fraud - Investment Fraud!
What is Investment Fraud?
Investment fraud generally refers to a wide range of deceptive practices that fraudsters use to entice investors to make investing decisions. These practices include untrue or misleading information, fictitious opportunities etc. Investment fraud can involve all forms of financial instruments, and usually takes on many different forms as the environment evolves (SaveAndInvest, n.d.). For instance, during the Covid-19 pandemic, fraudsters started to transit towards online activities, which caused investment scam reports to increase by almost a third (32%) during 2020, with losses to these scams increasing 42% to £135.1 million (Battersby, 2021) - wow!
Investment Fraud and its many forms
There are multiple forms of investment fraud till date. In this article, we will only be sharing some which are more common:
1. Pyramid Scheme
In a Pyramid Scheme, participants earn money by recruiting new participants. Money from these new participants are used to pay existing investors, and the cycle continues until it becomes impossible to recruit more ‘new members’ to continue the cycle and pay the existing participants. When this happens, such schemes will eventually fall apart, and most of the participants within the scheme will be negatively affected as they lose their money.
Some characteristics of the Pyramid Scheme include:
Emphasis on recruiting
High returns in a short period of time
No genuine product of services sold
2. Ponzi Scheme
In a Ponzi Scheme, the fraudster usually promises to “manage” the funds from the investors. A similar trait of Pyramid Schemes is present here, whereby the fraudster would promise existing investors “returns”, which come in the form of funds generated by new investors. However, unlike the Pyramid Scheme, less emphasis is being placed on the recruitment of new investors. Till date, the largest Ponzi Scheme was orchestrated by Bernie Madoff, which lasted over 10 years and cost investors over tens of billions in dollars.
Some characteristics of the Ponzi Scheme include:
High return with little to no risk
Consistent returns
Difficulties in receiving payments
3. Pump and Dump Scheme
In a Pump-and-Dump Scheme, the fraudster usually spreads false news (e.g., on the Internet) that a certain share of a company is about to increase to entice investors into buying that company’s shares (‘pump’). When the stock price increases, the fraudster will then start to ‘dump’ (or sell) all the shares that he holds, earning a huge profit margin. Consequently, other existing investors will lose a huge sum of money due to the fall in share price that comes with the sudden increase in number of shares.
How does the Fraud Triangle apply here?
Now that we have understood what investment fraud is about, let’s have a look at how it links to the fraud triangle!
Incentive → Fraudsters might have personal reasons to defraud investors through the various schemes. These sources of reasoning range from family, to satisfying their own desires.
Rationalisation → Fraudsters might intend to only commit the act once (but they never stop at just once). Another alternative would be promising to return the money once they are past their financial troubles (but they don’t meet that promise).
Opportunity → The opportunity arises when greed overcomes the investors, especially when promised lucrative investment returns. Fraudsters take advantage of these weaknesses in the victims.
Food for Thought
Robbing Peter to pay Paul is not helping Paul. Instead, it is using Paul to get the fraud ball rolling. Many times, Paul would also reinvest his gains, hoping to earn even more - greed. In the end, Paul loses both his capital and past gains. Everyone loses except the fraudster.
What other investment frauds have you come across?
References
Battersby, M. (2021, March 26). Investment fraud REPORTS 32% leap as criminals EXPLOIT COVID-19. InternationalInvestment. https://www.internationalinvestment.net/news/4029079/investment-fraud-reports-leap-criminals-exploit-covid-19.
Hayes, A. (2021, August 21). The Bernie Madoff Story. Investopedia. https://www.investopedia.com/terms/b/bernard-madoff.asp.
Save and Invest. (n.d.). Types of Investment Fraud. https://www.saveandinvest.org/protect-your-money-spot-and-avoid-fraud/types-investment-fraud.
U.S. Securities and Exchange Commission. (n.d.). Ponzi schemes. Investor.gov. https://www.investor.gov/protect-your-investments/fraud/types-fraud/ponzi-scheme
U.S. Securities and Exchange Commission. (n.d.). Pump and dump schemes. Investor.gov. https://www.investor.gov/protect-your-investments/fraud/types-fraud/pump-and-dump-schemes
U.S. Securities and Exchange Commission. (n.d.). Pyramid schemes. Investor.gov. https://www.investor.gov/protect-your-investments/fraud/types-fraud/pyramid-schemes.
