Ashley Percival, CFP®
If you have not yet watched the film The Wolf of Wall Street, do yourself a favour and watch it. The movie is based on a true story of former stock broker, Jordan Ross Belfort, who is brilliantly played by Leonardo DiCaprio. In 1999, Belfort pleaded guilty to fraud and related crimes in connection with stock-market manipulation and running a boiler room as part of a penny-stock scam. Belfort spent almost 2 years in prison as part of a plea agreement under which he gave testimony against numerous partners and subordinates in his fraud scheme. Belfort was also ordered by the court to pay $110.4 million to his victims.
Fraudulent schemes such as the one depicted in The Wolf of Wall Street come in many different forms and are more common than we realize. Determinations issued the Office of the Ombud for Financial Services Providers as well as reports of the Financial Services Board (‘FSB’) are indicative of the prevalence of fraudulent schemes. Typically, unsuspected members of the public are lured to invest in toxic schemes by the promise of extraordinary returns. The ‘financial advisers’ who peddle these schemes are nothing but conmen or if you prefer wolves in sheep’s clothing. They are charming, very slick, have the morels of an ally cat and scruples of a snake. They can literally sell ice to an Eskimo.
Sadly, most people falling victim to fraudulent financial schemes are those set to retire or retirees who can least afford to lose money as they simply do not have the luxury of time to make it back. They are targeted because they generally have large sums to invest. Retirees must be vigilant to ensure that they do not fall victim to investment scams peddled by wolves in sheep’s clothing.
Researchers have found that investment fraudsters hit their targets with an array of persuasion techniques that are tailored to the victim’s psychological profile.
Here are red flags to look for[i]:
1. Extraordinarily high ‘guaranteed’ returns
Fraudulent schemes usually offer abnormally high ‘guaranteed’ returns. The ‘guaranteed’ returns offered are often in excess of 20% per annum. Beware, there is no such thing as guaranteed returns in this world (even the money in your savings account can disappear if the bank goes bust). Clint Eastwood’s quip if you want a guarantee, buy a toaster comes to mind here.
Think about it: If a company is able to promise investors a return of 20% per annum, it simply means that they have to generate returns higher than 20% in order for them to turn a profit. If this company can generate annual returns above 20% consistently, the owner of the company should be one of the richest persons in the world.
2. Vague business model
Whenever you are offered an investment that guarantees high returns, you should ask the salesperson to explain how they are able to generate these high returns. With fraudulent schemes the investment process is usually confidential.
If the salesperson doesn’t understand how the company actually makes its money, why should you invest in such company? Even if they do explain how they make the money, the business model is usually overly complex and hard for a normal individual to understand. The point is: don’t invest in a company where you don’t understand how they are going to generate returns for you.
3. Investment products are generally located offshore or available to a limited number of investors
These schemes’ investment products are usually based in places far away from where they raise funds. Investors who invest in such schemes do not have the time or money to fly overseas to conduct their due diligence on the products these companies are selling. You have to ask yourself: If an offshore investment is really that good, shouldn’t it have been bought up by local investors before it even reaches your country? The main reason why many schemes raise funds in another country is usually because they are unable to sell successfully in their home country.
More often than not these schemes are said to be open to a limited number of investors. Monies also have to paid over in a short space of time. Conmen know that perceived scarcity will generate demand and persuade victims to part with their money. The reason monies have to be paid over promptly is to ensure that the potential investors cannot do their homework first.
4. Peddlers of the scheme are paid attractive commissions
Peddlers of fraudulent schemes are usually highly motivated to promote the scheme because their commissions are very lucrative. Commissions of 15% or higher is not out of the norm with these schemes. To put it into perspective, if you invested R1000 000 with a company, R150 000 is immediately paid as commission. That means that the company is left with only R850 000 to invest and generate 20% returns on the R1000 000 invested. The actual rate of return required to turn R850 000 into R1 200 000 (R1000 000 plus 20% return) is 41%. And that’s just for the investors – the company needs to generate more than that to also make a profit for themselves.
5. The investment is ‘risk-free’
All investments come with a degree of risk. Steer clear if someone touts a ‘risk-free’ investment. If the person selling the product cannot explain the risks inherent in the investment, it is a tell-tale sign that you should avoid the investment.
Be very sceptical of investments that seem to good to be true and always do your due diligence before making any investment. Make sure that the salesperson is licensed [ii] by the FSB to give advice on the product being sold. if you are not 100% convinced about the safety of an investment, ask guidance from a person you can trust like a knowledgeable friend, family member or seek independent financial advice. [iii]
If you have not made sufficient provision for retirement, try to supplement your income by other means. Do not gamble with your money by chasing unrealistic returns.
[i] http://www.businessinsider.co.id/5-red-flags-spot-ponzi-scheme/#BT8rDGGoslh86oPm.97 [ii] License search – https://www.fsb.co.za/Departments/fais/searches/Pages/providers.aspx [iii] See my blog DO I NEED I FINANCIAL ADVISER? https://glenfinadvice.co.za/2016/08/02/do-i-need-a-financial-advisor/