Another area in which financial advisors and financial planners can render a great service both to their own clients and to the general public is by assisting financial regulators in stopping investment scams.
Aided by the rise of the Internet, financial fraud, including investment scams targeting the elderly, is an increasing problem. Meanwhile, regulators find that financial advisors tend to be among their best sources of intelligence on new investment scams. There are two reasons for this. First, clients who have been approached by perpetrators of investment scams, or who are responding to ads for fraudulent deals, often will vet these with their financial advisors. Second, financial advisors themselves are frequently targeted (knowingly or unknowingly by investment scam operators.
Spotting Investment Scams: The North American Securities Administrators Association, as well as various regulators interviewed by The Wall Street Journal (“Advisers Help Spot Scams” in the Adviser Alert section of the September 19, 2011 issue), indicate that most investment scams today involve:
- Distressed real estate
- Precious metals
- Emerging technologies, industries or concepts
A financial advisor interviewed for the same article suggests that, before investing in a small, unknown company or investment product, one should conduct a thorough background check on all officers and principals. Additionally, the Public Company Accounting Oversight Board lists the auditing firms for all public companies. An immediate red flag for an investment scam is a supposedly public company that does not have an auditor, or whose auditor is a small firm with questionable credentials.
Investment Scams and Investor Psychology: Particularly useful in spotting and stopping investment scams is being familiar with the principles of financial psychology and behavioral finance. A March 2009 essay in Scientific American by professor of psychiatry Stephen Greenspan, author of The Annals of Gullibility, reveals that he lost over half his own retirement savings to ex-billionaire turned fraudster Bernard Madoff.
Greenspan observes that Ponzi schemes hinge on the tendency of people to follow the crowd, particularly concerning things that they don’t fully understand. Greenspan apparently followed friends and acquaintances who had invested with Madoff. He finds that our innate skills for detecting deception often fail in situations where, instead of direct personal interaction, we are in situations involving personal distance, anonymity and complex investment vehicles.
History of Investment Scams: Writing in American Heritage magazine in 2009, John Steele Gordon compiles a list of the perpetrators of the biggest Wall Street investment scams and schemes over the years that continue to recur in new guises.
Gordon’s top 10 scam artists include:
- William Duer created a 1792 speculative bubble in bank stocks prompted the first federal financial system bailout.
- Robert Schuyler (offspring of a prominent family whose uncle by marriage was Alexander Hamilton) made a fortune by selling forged stock certificates, then fled to Europe.
- Daniel Drew manipulated the price of railroad stocks (the hot new industry of the day), then cheated his partners in the scheme.
- Jay Gould ran a scheme for cornering the gold market that involved bribery of federal officials for inside information, and which sparked a general economic crisis.
- Ferdinand Ward recruited ex-President U.S. Grant as a partner to give his firm and its Ponzi scheme legitimacy; he went to prison, and the unsuspecting Grant was ruined financially.
- Richard Whitney, a president of the NYSE, was convicted on various counts, including stealing from a benefit fund for widows and orphans of exchange members.
- Anthony DeAngelis attempted to corner the market in vegetable oil, his victims including American Express and two big brokerage firms that went bankrupt as a result; the federal government pressured other Wall Street firms, including Merrill Lynch, to absorb the losses.
- Cortes Randall employed fraudulent accounting to create a hot conglomerate in the 1960s (when this was the hot investment fad) built on fictitious profits; see also the Ray Dirks case.
- Ivan Boesky used illegal inside information to reap huge trading profits.
- Bernard Madoff’s massive Ponzi scheme is the most recent of the group.
Gordon’s article is a valuable lesson in the usefulness of historical perspective in identifying investment scams and their perpetrators.