Ten Online Investment Scams You Should Aware Of

Every investor dreams of being an early stockowner in a Microsoft or Intel Corp. Dishonest brokers and stock promoters prey upon this greed and offer unsuspecting investors low-priced stocks in companies with new products or technologies (like the self-chilling soda can). Many fraudulent Internet messages are about general stock-picking advice or mention other investment possibilities. However, some messages tout specific stocks, moneymaking ventures, and service providers. Just remember one simple rule: Don’t believe anything you read until you’ve done some of your own research first.

The following are ten examples of online investment scams that you should be wary of.

1. Multilevel marketing plans and pyramid schemes

Pyramid schemes, sometimes called multilevel marketing plans, are sure ways to lose money. Individuals are often contacted via e-mail messages and encouraged to recruit six friends; those six people recruit six more friends — and so on, in a relentless search for new recruits. New recruits are expected to purchase a minimum amount of the pyramid’s products. If everyone cooperates, then by level 15, the scheme needs 7.6 billion participants — more than the Earth’s population.

Profits from these schemes don’t come from selling products or distributorships but from recruiting new participants. The endless recruiting of more participants eventually leads to an oversupply of sellers. Investors are left with garages full of products and the loss of their investment.

Three elements characterize pyramid schemes:

  • A reliance on funds from new investors (recruits) to pay returns, commissions, or bonuses to old investors.
  • The need for an inexhaustible supply of new recruits.
  • The promise of earning profits without providing goods or services.

A good example of a pyramid scheme is located in the United Kingdom and online. The enterprise is called a “gifting scheme” and was still available online as of February 2005. Unfortunately, because it doesn’t’ appear to breach any current U.K. legislation on pyramid schemes or multilevel marketing and doesn’t involve any trading of products for services, it has wriggled through a legal loophole and (at this time) can’t be shut down by U.K. authorities.

Here’s how the scam specifically works: If eight individuals invest £3,000 and then progress through the levels of the network, they can each expect to receive £24,000 when they reach the top level. However, to reach that top level, 64 people have to each invest £3,000. Each of those 64 investors also expects to collect her £24,000. However, that means that another 512 investors need to participate. The next level requires 4,096 participants, then 32,768 participants, and then 262,144 participants.

To sum it up, each investor needs eight investors in the scheme in order to get her money back and to make a return. In most cases, the supply of potential investors dries up, leaving the majority of investors with nothing to show for their investment.

2. Financial chain letters and Ponzi schemes

Financial chain letters can sneak around your spam-blocking software because they’re usually sent by people you know. Generally, the e-mail message states that you’re missing out on a big investment opportunity. If you forward the message to a dozen of your friends, you’ll be allowed to see the details of this once-in-a-lifetime investment opportunity and reap big returns.

Most financial chain letter promoters claim that if you participate, your name will eventually be at the top of millions of lists and you’ll receive millions of dollars. You may be asked to send ten dollars to each of the first ten people whose names are at the top of the list. Next you’re instructed to delete the name at the top of the list and add your name to the bottom of the list. Money is made solely by getting other new recruits to join the chain. Most people receive nothing for their “investment.” Anyone can break the chain and deprive you of your possible “gains.” Even if the financial chain isn’t broken, about 95 percent of financial chain letter participants don’t ever receive anything in return for their “investment.”

According to the U.S. Postal Service, financial chain letters are a form of Ponzi scheme and are illegal. Ponzi schemes are named after a 19th-century clerk, Charles Ponzi, who conned investors out of $10 million by promising returns as high as 40 percent. Ponzi schemes are a close cousin to pyramid schemes because they rely on new recruits. What makes the two approaches different is that with a Ponzi scheme, any profits go to one person. In contrast, in a pyramid scheme, any profits go to early investors that have reached a certain level.

If you’ve been targeted to receive a financial chain letter or if you believe you have been solicited for a Ponzi scheme, notify your Internet service provider or the Federal Trade Commission at spam@uce.gov.

3. Cons based on bogus research reports and newsletters

The Wall Street Journal (www.wsj.com) has a circulation of 1.8 million, and USA TODAY (www.usatoday.com) has a circulation of 1.6 million. In contrast, more than 70 million adults log on to the Internet each day. By using mass e-mailing programs, fraudsters can quickly and inexpensively reach more people than these publications can. In other words, with one keystroke, fraudsters can reach thousands, even millions, of potential online investors. This type of e-mailing strategy is called spam. Spam is junk e-mail, and creating it is easy. Often, you may receive unsolicited e-mail newsletters that tout stocks expected to double or triple in value over a very short time. If you look closely enough, you might find a disclaimer, usually included in the very small print at the bottom of the newsletter. The following are several examples of potential disclaimers:

  • The publisher of the report isn’t a registered investment advisor or broker dealer. The report isn’t an offer to buy or sell securities.
  • The owners of the report may already own shares of the stock described in the publication and may immediately sell all or a portion of these shares into the open market at or about the time that the report is published.
  • Investing in the profiled company is high-risk and use of the report is for reading purposes only. If the reader decides to act as an investor, it’s at that investor’s sole risk.
  • Statements in the report are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. These terms may include such words as expect, believe, may, will, intend, or similar terms.

Some so-called research reports are nothing more than paid advertisements for certain stocks. The authors of these supposedly legitimate newsletters don’t disclose conflicts of interest or biases in their reporting. For example, in December 2000, a stock guru misled prospective investors in companies highlighted on his Web site by failing to disclose that the companies had paid his firm a fee to publish favorable research analyses of their firms.

In October 1999, the SEC conducted their first nationwide sweep against these so-called research reports that touted stocks on the Internet but didn’t disclose that they were being paid to make the promotions. The SEC filed fraud charges against 44 people and firms, following up in February 2000 with charges against another nine people and four companies.

Spammers can purchase your e-mail address from a variety of sources. Sometimes, you may unwittingly provide the information yourself. For example, when you complete a free registration form at a Web site, you may overlook a little box that states Uncheck This Box if You DO NOT Want a Newsletter. Unwanted e-mail newsletters are often marked Urgent or Recommended Strong Buy. You should ignore e-mail messages like this and delete them immediately. Unsubscribe as soon as possible because this type of junk mail is a waste of your precious time. For more on how to protect yourself from unwanted e-mail of this nature, check out Fighting Spam For Dummies by John R. Levine, Margaret Levine Young, and Ray Everett-Church (Wiley).

4. Phishing for your personal information

Phishing (pronounced “fishing”) is a type of brand spoofing. That is, the Web page of a legitimate Web site — such as your bank, PayPal, Best Buy, and so on — is recreated by a fraudster. An e-mail message is sent to you in an attempt to fool you into revealing your personal financial information or password data. Sometimes, to gain your personal financial information, “Phishers” will use

  • Social engineering: Phishing sometimes uses social engineering to gain your confidence. Social engineering is when unscrupulous individuals exploit the weaknesses in people to gain confidential information, such as passwords that will compromise information system security. Social engineering is as a low-tech way that Internet users can have their identities stolen.
  • High-tech lures: The term phishing is used to describe how fraudsters use sophisticated lures to deceive everyday Internet users. Experts note that about 5 percent of all recipients respond to phishing exploits.

Industry experts state that about 95 percent of all phishing exploits originate from a spoofed (forged) Internet address. About five new phishing exploits are reported each month. This is how it works:

  • The bait: You receive an e-mail message from your bank stating that, due to a security break-in, they need to verify your password and ID number.
  • The hook: You follow the link to the phisher’s Web page. The spoofed Web page has a similar URL and looks just like the page you usually use.
  • Reeling you in: A pop-up appears, requesting that you sign on using your personal password and user ID.

The pop-up is often a dead giveaway that something is wrong. It’s important to report suspicious activity to the FTC. Another way to check whether something is wrong, in case a pop-up doesn’t appear, is to compare the current URL to the URL you usually use. If the URLs are different, you’re being scammed. If you get spam that is phishing for information and you want to help stop this type of activity, forward it to spam@uce.gov.

5. Nigerian e-mail letter investment scam

Over the last 18 months, I have received 147 variations (that’s almost three e-mail messages a month) of the Nigerian investment scam. I call these e-mail messages Nigerian, but recently many of these bogus business opportunities or advanced fee scams have originated from Iraq, Zimbabwe, London, Hong Kong, and South Africa. Often, these e-mail messages promise that I’ll receive millions in return for helping a VIP collect money trapped in a Central Bank. The plea for help assures me that the investment is 100-percent safe. Each version of the e-mail appeal is slightly different, but the scam remains the same: I’m guaranteed 20 percent of all recovered funds. In some instances, the fraudster will ask for enormous amounts of money for fees, taxes, traveling expenses, and so on. I’m then asked to provide the name, address, and account number of my bank. For those investors who fall for the scam, the con artist uses this information to rob the investors’ accounts. See the Federal Trade Commission’s Consumer Web site located at www.ftc.gov/bcp/conline/pubs/alerts/nigeralrt.htm, which offers a short history and details about this scam.

If you’re interested in more information about these scams, including copies of some of the initial letters and the extensive official documents that are sent to victims, download the Nigerian Advance Fee Fraud report from the U.S. State Department (www.state.gov/www/regions/africa/naffpub.pdf). You need to download Acrobat Reader from www.adobe.com to view the PDF file (if you haven’t already downloaded and installed the free program).

6. Investment hoaxes designed to get your cash

Many individuals have used the Internet as a medium for investment hoaxes. The following are two real-life examples of how a bogus press release allowed unscrupulous individuals to make thousands of dollars in illegal profits:

  • A bogus press release stated that Uniprime Capital claimed to have documentation from the government of Spain indicating that the Plasma Plus was a breakthrough treatment for the virus that causes AIDS. The stock was touted online in several investment chat rooms as undervalued. In a few days, more than 5 million shares were traded, and the stock skyrocketed by 800 percent. The investment hoax cost investors about $20 million.
  • In a similar story, an individual issued a negative press release about Emulex, a fiber-optic company. In the press release, the fraudster claimed that the CEO had quit and that the company was restating its quarterly earnings. In an effort to cover his tracks, the fraudster — who lived in El Segundo, California — went to a hotel room in Las Vegas to make his online stock trades on the day of the hoax. The stock dropped by 62 percent, and the con artist made $241,000 by short-selling the stock.

7. Bogus IRA-approved investment schemes

Many Americans are seeking ways to profitably invest their retirement nest eggs. Fraudsters are aware of this demand and have devised online schemes that may scramble the dreams of many investors with so-called IRAapproved or otherwise endorsed Internal Revenue Service (IRS) investments. Fraudsters frequently contact investors through bogus e-mail newsletters or Web sites to offer huge returns that will ensure investors an easy retirement.

Investments include high tech (including wireless cable television and specialized mobile radio) to exotic livestock (ostrich farming, anyone?) to real estate investment pools. Con artists use the “IRS approved” statement to evade the consumer protection requirements of state and federal securities laws by claiming the investments are unregulated general partnerships and limited liability companies. Keep in mind, there is no such thing as an “IRA-approved” or “IRA-sanctioned” investment. These investments are designed to fly below the regulatory agencies’ radars and are a guaranteed way to lose most or all of the money that you invest.

8. Guaranteed high returns frauds

Many fraudsters provide online ads that guarantee “the potential to make a six- or seven-figure annual income.” The Securities and Exchange Commission (www.sec.gov) has started a campaign to warn online investors about this type of stock market scam by creating a sting Web site — that is, a Web site that’s designed to shock online investors into being more cautious with their hardearned cash. In the first two days, the SEC’s sting Web site drew 125,000 hits by advertising fake offers, drawing interest in March 2002 with a press release that praises the biological defense firm McWhortle Enterprises (www.mcwhortle.com). The site features bogus testimonials and analysis reports regarding McWhortle. Clicking an Invest Now tab transports potential victims to a Web page, which states, “If you responded to an investment idea like this . . . You could get scammed!” The text goes on to explain how the Web site incorporates the telltale signs of online investment fraud, including information about how to tell that the corporation is a fake. Look for these signs:

  • Promises little or no risk with the reward of fast, high profits: Believing extravagant claims of quick wealth is a dangerous practice. Often, returns are based on pro formas (the hypothetical performance) of the company — not on actual returns.
  • Doesn’t offer any track record and has no legitimate products (being a fictitious company, it has neither): Before you consider spending any money, do some homework. For example, you can — and should — ensure that a company is a registered corporation and find its location and the names of its corporate officers.
  • Offers a lucky few investors an opportunity to get in on the ground floor of “pre-IPO investing”: Pre-IPO investing is the investment stage that carries the most risk for any venture. Consequently, this investment cannot be risk-free.
  • Requests that each investor supplies a credit-card number and a Social Security number online for identification purposes With these two numbers, the fraudsters can steal a potential investor’s identity and ruin his or her credit rating.

9. Get rich quick with investment seminars

One of the newer online scams is the fake investment seminar. Investors are encouraged via e-mail messages to enroll in expensive seminars to become day traders or to learn how to trade options, commodities, or futures. Often, unlicensed practitioners teach the seminars. These unlicensed practitioners are unlikely to disclose conflicts of interest. For example, attendees may be required to open a trading account at a specific brokerage (usually a firm that isn’t as inexpensive or reliable as a top-rated brokerage). Attendees must also pay hidden costs, such as buying a particular brand of software from the investment seminar company and using an expensive interface for real-time data. (Software for these courses can be in the thousands of dollars.) Unfortunately, naive investors often believe that if they follow the recommendations they learn in the course, they can earn 250 percent (or more) back on the money they spent for the course. Seminar leaders foster this belief by touting false testimonials about how past attendees are now using the fail-safe trading system and making hundreds of dollars per day.

10. Pump-and-dump schemes

Pump-and-dump schemes are swindles in which greedy people manipulate the stock prices so that they can make illegal gains. Frequently, pump-and-dump schemes target elderly investors. For example, fraudsters purchase shares in small companies with low stock prices and then use high-pressure telemarketers to hype the stock to unsuspecting would-be investors. The fraudsters pocket the money as the stock’s price rises, leaving investors with virtually worthless shares.

Fraudsters are using the Internet to perpetuate pump-and-dump schemes. Pairgain, a California company, was touted by scam artists on Internet message boards as being poised for a takeover by an Israeli company. The “takeover” announcement was hyperlinked to a bogus news release made to look like a legitimate financial reporting service had written it. This scenario is a classic pump-and-dump scam; fraudsters artificially drive up the stock price and unload it on unsuspecting investors who believe the stock is on the rise.

Cyber smears are also common. For example, a fraudster borrows 100 shares of a certain company’s stock from a broker and immediately sells them at $10 a share. Then the fraudster starts an illegal negative message board campaign with fabricated news stories. The stock price drops to $8 a share. The fraudster purchases 100 shares at $8 a share and returns them to the broker. He then pockets the $2 a share difference, less interest. The Investing Simulator Center, located at www.investingonline.org/isc/index.html, offers an interactive “Don’t Get Burned” simulator to assist you in test-driving what can happen when you take phony research reports seriously.

If you believe you’ve been scammed, file your complaint at www.ftc.gov and then visit the FTC’s Identity Theft Web site at www.consumer.gov/idtheft to learn how to minimize your risk of damage from ID theft. Visit www.ftc.gov/spam to learn other ways to avoid e-mail scams and deal with deceptive spam.
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