What is fraud?

Fraud refers to any evasive action that is designed to provide one (usually the perpetrator) with illegal profit. Fraud can happen anywhere, from finance and real estate to investment and insurance. For this article, we will focus on fraudulent activities in investment.

Investment fraud can have many faces, all of which put investors, and sometimes creditors, at a significant disadvantage. It isn’t unusual to hear about a company that has been improperly recording its expenses, bloating their profits, and even covering up massive losses or cases of near-bankruptcy. These activities are usually done to make the company look good to investors who can provide much-needed cash to keep the business running and make up for the losses. But, more often than not, the outcomes of these cases are not concrete and ends in ruined businesses and lives. It’s also important to note that fraudulent activities can be carried out by an individual, a small group, or an entire company.

Examples of Fraud

In the 1920s, Charles Ponzi duped thousands of New England residents into investing in a postage stamp speculation scheme. He was notorious for promising his investors substantial returns of up to 50% in 45 days. Through the plan, these investors were paid using funds from new investors. Ponzi eventually failed, leaving at least five banks and all investors ruined in his wake. Investors were able to recover only 30 percent of their initial investment. This classic example of a pyramid scheme (rob one to pay another) still exists today.

Have you seen Leonardo DiCaprio in Martin Scorsese’s 2013 film The Wolf of Wall Street? In the 1990s, an infamous “pump-and-dump” firm called Stratton Oakmont made the headlines. During its prime, the company had its brokers drive stock prices up, after which Jordan Belfort, CEO of the doomed company, would cash out, causing the value of the stocks to plummet. Belfort’s brokers then proceeded to cold call unsuspecting people to sell the worthless shares to them. The corrupt activity was eventually stopped, with Belfort indicted for securities fraud and money laundering.

The old adage that “if something’s too good to be true, then it probably is” applies.

How do I avoid fraud?

Due diligence counts. Before investing in a company, make sure that they are not fudging their financial statements. An excellent accountant can help you with this.

Be cautious when someone contacts you about a stock that sounds too good to be true. You may want to read more about the grand Ponzi scheme Bernie Madoff pulled off in 2008. It’s a significant cautionary tale. (Spoiler Alert: It did not end well for all parties involved.)

Finally, always make sure that a respected third-party custodian is delivering the statements between you and the company. And don’t forget to review financial statements before investing. It’s always best to involve another party in the deal to ensure that all possible situations are taken into account. You never know when these precautions could save you from a financial crisis.

How does fraud affect investing?

Fraudulent activity can affect your investments in many ways. If you’re not careful, you could quickly lose your hard-earned money to an individual or to a company. Knowing the difference between an unlawful investment and a legitimate one means saving yourself from unnecessary trouble down the line. As long as money is involved, chances that someone somewhere is thinking of ways to get at it through secure, criminal means.



This material has been distributed for informational and educational purposes only, represents an assessment of the market environment as of the date of publication, is subject to change without notice, and is not intended as investment, legal, accounting, or tax advice or opinion. Stockpile assumes no obligation to provide notifications of changes in any factors that could affect the information provided. This information should not be relied upon by the reader as research or investment advice regarding any issuer or security in particular. The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell. There is no guarantee that any strategies discussed will be effective. Each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should not substitute these materials for professional services and should seek advice from an independent advisor before acting on any information presented.

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