A bad return on your money

In April, Michael Kane, the former CEO of a New York-based financial technology company, Hydrogen Technology Corporation, found himself possibly facing decades in prison after federal prosecutors charged him and co-conspirators with falsely inflating the price of their virtual token to lure investors into a scheme that yielded $2 million in profits for the firm but left its victims out of pocket. [See “Five Individuals Charged in $2M Virtual Asset and Securities Manipulation Scheme,” U.S. Department of Justice (DOJ), April 24, 2023.]

According to the published charges, when the company created the Hydro token in 2018, it proceeded to give it away to investors with the condition that they promoted the virtual asset, which traded on the Ethereum blockchain. In October that same year, Hydrogen hired a South African firm called Moonwalkers Trading Limited, which allegedly used customized software, or bots, to create the appearance of robust trading volumes so that Hydrogen could then sell the token to unknowing investors for a tidy profit. Last year, the U.S. Securities and Exchange Commission (SEC) said that Hydro was an unregistered fundraising scheme. And in April, federal prosecutors charged Kane — along with Shane Hampton, Hydrogen’s chief of financial engineering, and George Wolvaardt, Moonwalker’s chief technology officer — with one count of conspiracy to commit securities price manipulation, one count of conspiracy to commit wire fraud and two counts of wire fraud. If they’re convicted, each will face a maximum of five years in prison for securities price manipulation and 20 years on each of the other counts, according to the DOJ. (See “SEC Charges The Hydrogen Technology Corp. and its Former CEO for Market Manipulation of Crypto Asset Securities,” SEC, Sept. 28, 2022; “U.S. Securities and Exchange Commission against The Hydrogen Technology Corporation, Michael Ross Kane, Tyler Ostern,” Southern District Court of New York, Case No. 22-cv-08284, Sept. 29, 2022; and “Crypto Executives Risk Decades in Prison for $2 Million Manipulation of Hydro,” by Rick Steves, Finance Feeds, April 25, 2023.)

In some ways, this scam echoes the bigger and better-known fraud scandal at crypto exchange FTX, where founder Sam Bankman-Fried — who now sits in a Brooklyn prison awaiting trail — is accused of using his firm’s FTT token in similar ways. Sadly, these are familiar stories for investors these days, not only in the crypto space but anywhere people are seeking to grow their money and keep it safe. (See “FTX made a cryptocurrency that brought in millions. Then it brought down the company,” by David Gura, NPR, Business, Nov. 15, 2022 and “SEC Charges Caroline Ellison and Gary Wang with Defrauding Investors in Crypto Asset Trading Platform FTX,” SEC, Press Release, Dec. 21, 2022.)

Inventor and statesman Benjamin Franklin had it right when he said, “An investment in knowledge always pays the best interest.” Educating yourself about the many ways you can lose money to swindlers is a good start, but more is needed to protect the value of your portfolio. As history shows, even self-described smart people fall prey to con artists who promise high returns and deliver nothing but heartache and empty wallets. Count yourself lucky if you’ve never received an email solicitation from a mysterious foreign prince or a telephone hustle to invest in a hot stock by the end of the call. For everyone else, be scared, be very scared. Investment fraud is huge, on the rise and ruinous if you put all your money eggs in a bad basket.

An investment in knowledge always pays the best interest.

Rise in investment fraud

According to the U.S. Federal Trade Commission (FTC), consumers lost more than $3.8 billion to investment scams in 2022. Not only was that double the amount seen in 2021, but it marked the highest loss among all the fraud categories followed by the FTC that year. The FBI tells a similar story. It notes that investment fraud complaints rose from $1.45 billion in 2021 to $3.31 billion in 2022. Of that $3.31 billion, $2.75 billion comprised crypto investments, a trend that has disproportionally impacted the elderly. According to the FBI, crypto-related losses reported by seniors increased by 350% from 2021 to 2022. (See “New FTC Data Show Consumers Reported Losing Nearly $8.8 Billion to Scams in 2022,” FTC, Feb. 23, 2023; “Internet Crime Report 2022,” FBI; and “Elder Fraud Report 2022,” FBI.)

Experts think those figures are probably the tip of a larger problem lurking beneath the surface. “Unfortunately, data from federal and state regulators excludes instances of people having lost money who were too embarrassed or ashamed to tell anyone they were conned,” says Chris Ekimoff, CFE, CPA/CFF, director of financial investigations & dispute services at consulting firm RSM US LLP.

While crypto cons have soared in recent years, traditional investment frauds, such as Ponzi schemes, pyramid scams and real estate fraud, continue to hurt Americans, according to a recent study by law firm Carlson Law. (See “First Annual Study: The 2023 State of Investment Fraud,” by Chase Carlson, Carlson Law, June 12, 2023.) Indeed, there are all sorts of investment frauds including affinity fraud, binary options fraud, pump-and-dump schemes, advance-fee fraud and prime bank investments frauds, just to name a few. (See image below.)

But the rise in investment fraud is hardly a U.S. phenomenon only. With the interconnectivity that technology brings, investment scams are now very much an international affair. In April, the BBC ran an expose on what they allege is a global network of fraudsters called the Milton Group that had used different investment brands to scam billions of dollars from investors across the planet. And earlier this year the Malaysia Anti-Corruption Commission (MACC) reportedly arrested over 70 people from various countries that had stolen more than $1 billion in Australian dollars ($670 million) from investors in fake market deals. Plus, in February, law enforcement agencies from Serbia, Bulgaria, Germany and Cyprus announced they’d stamped out a crime syndicate run by Israelis throughout Europe, targeting Australian investors who were lured by promises of easy money through social media ads. These are just a few of the concerning investment situations in different parts of the world, but they give a sense of their international reach and the scale of the problem. (See “More than 70 arrested over alleged global investment fraud,” by Robert Lawther, International Adviser, March 2, 2023; “Global investigation uncovers digital currency crime syndicate targeting Australians,” by Wahid Pessarlay, CoinGeek, Feb. 28, 2023; and “On the hunt for the businessmen behind a billion-dollar scam,” by Max Hudson, Simona Weinglass, Mark Turner and Joel Gunter, BBC, April 12, 2023.)

You no longer need to have a relationship with an individual who works in a brick-and-mortar office, someone you would meet every month or quarter to discuss trading strategies as part of a gradual and disciplined decision-making process, Ekimoff says. This twin phenomena of a rising demand for attractive returns and the heightened accessibility to transact in an instant creates a golden opportunity for folks to defraud.

An old scam on a bigger scale

Investment fraud has been around since ancient times. In 300 B.C. two Greek sea merchants attempted to defraud an insurance company by sinking their boat and then trying to collect the payout. Since then, investment fraud has only grown in scale and in the number of people it impacts. Bernie Madoff, arrested in December 2008, perpetrated a Ponzi scheme that adversely impacted hundreds of retail and institutional investors, costing them an estimated $65 billion. Executives at Enron fooled investors into thinking the energy company was a great success through complex accounting practices that hid hundreds of millions of dollars of debt. The discovery of the deceptive practices left Enron shareholders losing $74 billion. (See “The History and Evolution of Fraud,” fraud.com; “Bernie Madoff, mastermind of largest Ponzi scheme in history, dies at 82,” by Ethan Sacks, NBC News, April 14, 2021; and “Enron Scandal: The Fall of a Wall Street Darling,” by Troy Segal, Investopedia, Laws & Regulations, updated April 5, 2023.)

In the modern digital era, not only can investors buy a wide range of financial instruments and cryptocurrencies with just a few clicks on a smartphone or laptop, but they’re also within easy reach of anonymous fraudsters who are ready to lure them into scams with the promise of high returns and easy money.

Decision-making framework

We’re all potential targets for investment fraudsters unless we understand how to make good decisions and avoid bad ones. As psychology experts Daniel Simons and Christopher Chabris explain in their new book, “Nobody’s Fool: Why We Get Taken In and What We Can Do About It,” good information gathering is a core element of good decision-making. Often the ways we receive information can be especially appealing and act as “hooks” that fraudsters use to deceive us, according to the authors. For example, people tend to trust information and data that’s internally consistent, even though it may contradict external realities. This was the case with Madoff, whose returns from his fake hedge fund were excessively consistent given the normal gyrations of the financial markets. Whistleblower Harry Markopolos, CFE, proved this point with mathematical analysis showing that Madoff could never have consistently made such returns if he’d been investing in the U.S. stock market as he claimed. (See “Madoff’s legacy: What have we learned from the debacle?” by Dick Carozza, CFE, Fraud Magazine, July/August 2021 and “Nobody’s Fool: How to Avoid Getting Taken In,” interview with Ludmila Nunes, APS, July 13, 2023.)

“We don’t necessarily seek [hooks like consistency] out,” Simons, a professor at the University of Illinois, tells Fraud Magazine. “But when we happen to encounter them, we tend not to think critically enough about them, and that’s why people who want to deceive us make careful use of them.”

Simons claims we have a tendency to more readily accept information that comes from people we know, such as friends and relatives, or are familiar with, such as celebrities and leaders. What we should be doing is critically evaluating information before moving forward with a suspiciously too-good-to-be-true investment. Social media influencers sometimes use people’s distrust to promote things like cryptocurrency funds. If people have doubts about established institutions, they might be more likely to find a celebrity endorser’s crypto appeal compelling because it’s framed as anti-establishment in some way, creating a sense of shared beliefs. If we believe the status quo is bad, we’re receptive to alternatives.

“If someone’s investments aren’t doing well, or as well as they expected they would, it’s not at all surprising they might opt to invest in a nontraditional vehicle or take bad advice from someone they feel they know or can trust,” says Chabris, a professor at the Geisinger Research Institute.

Affinity fraud and familiarity

Fraudsters are skilled in exploiting the trust and friendships among certain groups of people, or what’s commonly called affinity fraud, to scam investors. This is often the case with Ponzi or pyramid schemes that rely on word-of-mouth about the success of the investment or business to sustain the fraud. Teresa Goody Guillén, a co-leader of the blockchain team at BakerHostetler, says affinity fraud is a consistent favorite among scammers. “I’m seeing an increase in cases that target a specific culture or age group.”

I’m seeing an increase in cases that target a specific culture or age group.

Indeed, the SEC brought a string of charges this year and last against alleged fraudsters using investment schemes that targeted members of numerous faith-based organizations, American military veterans and active-duty personnel, and various sociocultural communities. (See “2022-23 Affinity Fraud Cases,” SEC.) The North American Securities Administrators Association (NASAA) cautions investors not to get too cozy with people you think you know. Their advice is to ignore testimonials and do your own research; seek feedback from an independent third party such as an accountant, attorney, or financial planner; and secure a copy of the prospectus so you can critically assess projected risks and returns. (See “Affinity Fraud: Beware of Swindlers Who Claim Loyalty To Your Group,” NASAA.)

“Even people in the investment industry have been known to stop doing their homework,” says Ekimoff. “They heed the recommendation of a friend. They are embarrassed to ask questions, so they don’t. Later, they realize what they did was stupid, but it’s too late.”

The ticking clock

The fear of missing out, or FOMO, is another emotional gimmick that investment charlatans use. They urge investors to act now or risk losing out on the next Amazon or Apple. If you watched “The Wolf of Wall Street” film about real-life fraudster Jordan Belfort, you have a sense of the high-pressure sales tactics used by so-called boiler-room employees. These fast-talking salespersons want to force you to decide before their unsolicited phone calls end.

Alma Angotti, global legislative and regulatory risk leader at consulting firm Guidehouse, has seen a lot of get-rich-quick schemes in her two-decade career as a senior enforcement professional, turned compliance consultant. She served as the SEC consultant on the movie set of Belfort’s Hollywood depiction. “Fraud is universal,” says Angotti, “and it takes place everywhere in the investment world, from the boiler rooms where Belfort scammed victims with penny stocks to internet chat rooms.” Buyers must be wary of any salesperson who is only motivated by the bonus associated with a sale and ignores whether an investment product they sell is unsuitable for a particular investor.

The chance to be part of a special club of investors is another form of FOMO. Madoff used exclusivity as a tactic to attract wealthy investors, endowments and pension plans. More than a few famous people boasted about their special status as a Madoff investor.

Simons urges decision-makers to ignore sellers’ artificial ticking clocks and instead do their homework before committing their money. And Chabris recommends developing a habit of pausing to think about the gamut of possible choices.

“We are very good at focusing on the information that’s put in front of us and very bad at considering the option of investing with any of a thousand reputable sources or perhaps doing nothing for the moment,” says Chabris. “Our money is not going to disappear if we pass on what a high-pressure salesperson is pitching.”

Mitigating fraud risk

All investments have risk. Even putting your money under a mattress exposes you to potential loss should the mattress catch fire. Protecting against investment fraud is a crucial exercise in risk management. Here are some best practices:

• Check the background of the financial advisor. This applies to retail investors as well as the investment fiduciaries in charge of selecting and monitoring products for retirement plans, endowments, foundations and other kinds of regulated trusts.
• Vet the quality of returns data for a particular product or investment fund.
• Don’t invest based on cherry-picked data that excludes negative performance years. Nor should you focus on numbers that reflect hype about impossible-to-guarantee rewards.
• Be alert to red flags about a company’s deteriorating cash situation or the departure of key managers.
• Research whether a company has been the subject of enforcement or litigation or both. Push back against salespersons, including advisors and brokers, who try to pressure you into making hasty decisions about investments.
• Take advantage of educational resources, often available at no charge, about affinity fraud, broker fraud, digital currency fraud, elder fraud, insider trading, lending fraud, penny stock fraud, offshore scams, pump-and-dump schemes, pyramid cons, and the list goes on.

Fiduciary duties

For stewards tasked with managing billions of dollars in institutional funds, fraud prevention is a legal and regulatory imperative. Anyone designated as an investment fiduciary has a binding responsibility to prudently select and monitor investment managers and their products. Institutional fiduciaries typically have sufficient budgets, or the wherewithal to ask for money, to support their oversight duties. They can hire trained researchers and legal advisors to verify, at a minimum, must-know items, such as whether a fund manager: (a) uses a reputable auditing firm, (b) is SEC-registered (if appropriate), (c) has been the subject of past litigation and/or CFTC, FINRA, SEC enforcement (and/or charges levied by non-U.S. agencies), (d) employs a seasoned compliance team, (e) distributes sales materials that fully explain product structure, anticipated risks and fees, and (f) whether the key persons, including traders, have passed background checks.

Investment fiduciaries can also license or buy data collection and analysis technology tools. They can attend training courses to help them stay abreast of changes in the law and industry best practices. They can pay for forensic auditors to kick the tires on their due diligence process and front-to-back-office investment-related operations. They can engage consultants to help them review whether their stated investment objectives are being met in a risk-appropriate manner.

Goody Guillén emphasizes the importance of preemptive measures with her clients. “Expending resources to prevent a problem is less expensive than trying to fix a problem after it occurs. [But] it’s easier to convince those in charge after a major scandal occurs at another company,” she says.

The publicized fraud and money-laundering indictment of a now ex-trader at OpenSea, the non-fungible token (NFT) marketplace, led to more business for Goody Guillén. In this case, companies with digital assets got a wake-up call about the importance of strong protections against insider trading. (See “Ex-OpenSea manager convicted in NFT insider trading case,” by Luc Cohen, Reuters, May 3, 2023.)

Career risk and headline risk are weighty motivators for executives who remain unconvinced about opening their business wallets before trouble ensues. An investment fraud prevention program that merely checks off boxes is ill-advised. Angotti tells the corporate board members she trains, “Ethics is as important as fraud prevention.” She pushes her clients to act honorably, even when they know there are plenty of people who get away with their corruption or sub-par behavior.

Investment fraud prevention training

Investment fraud mitigation is an ongoing process. There’s no magic ending that equates to protecting yourself, your clients or your organization. Every day brings a swell of swindlers, each trying to dupe someone with a razzle-dazzle, and often complex, money scam. Training remains a vital part of any prevention program. It should start early, encompass a wide array of topics and take the form of continuing education.

Ronald Sages, portfolio manager and director of financial planning with Eagle Ridge Investment Management, LLC, amped up his efforts to train financial advisors about fraud after several of his clients lost money. “One of my clients, a very intelligent man and industrious worker, was bamboozled by Mouli Cohen [also known as Samuel Cohen],” Sages recalls. “Cohen forced several charities into bankruptcy because of his investment duplicity.”

Cohen was sentenced to 22 years in prison in 2012 for operating an investment scheme that defrauded more than 50 victims of around $31 million. Cohen conned investors affiliated with the nonprofit organization, Vanguard Public Foundation, and a few others, by encouraging them to buy shares in his company Ecast. He falsely claimed Microsoft was about to acquire Ecast. (See “Co-Founder and Former CEO of Technology Company Sentenced to 22 Years in Prison for $30 Million Fraud Scheme,” FBI, Press Release, April 30, 2012.)

Sages, also an adjunct professor of financial planning at the University of Georgia, asks students to analyze an episode of CNBC’s “American Greed” and then explain how the fraud could’ve been prevented. He asks budding advisors to think hard about how they’d modify compensation and bonus policies when they assume positions of authority.

“You can’t necessarily teach ethics, but you can heighten awareness,” says Sages. “You should periodically remind people there is a much higher standard they should be living up to, and working to, in their organizations. And of course, we review bedrock principles such as diversification, transparency, putting the client first and much more.”

Glass half full

Statistics about the continued growth in investment fraud suggest there’ll be more work for Certified Fraud Examiners and other professionals who specialize in compliance consulting and forensic analysis. For potential fraud victims, the outlook is gloomy, absent a conscientious effort to abstain from investments they don’t understand and steer clear of salespersons whose background or manner is suspect.

The world of investing is constantly changing. Questions about new or reinterpreted products and strategies keep investors, both retail and institutional, on their toes. Fraudsters clap their hands in delight. Ambiguity, trend-following and complexity are their friends.

“There will always be rotten apples in the industry, the people who are driven by greed,” says Sages. “That’s why it’s necessary to keep talking about how to prevent investment fraud and the lessons we can learn from fraud that already occurred.”

Author Mark Twain quipped, “There are two times in a man’s life when he should not speculate; when he can’t afford it and when he can.” All investors should heed Twain’s words and do their due diligence before committing their money or money they manage as a fiduciary or trusted advisor.

Susan Mangiero, Ph.D., CFE, CFA, is a writer, researcher and forensic economist with over 25 years of experience in covering and participating in the financial services industry. She’s testified as an investment fiduciary expert on multiple cases. Contact her at contact@ipaintwithwords.com.

[See sidebar: “Corporate accountability”.]

Corporate accountability

Investment fraud occurs in many forms and is perpetrated by a variety of bad actors, including persons employed by corporations. Securities fraud, one type of investment fraud, has resulted in numerous charges brought by prosecutors against a host of individuals working at well-known banks and companies from Enron to WorldCom to FTX. Cornell Law School defines securities fraud as “the misrepresentation or omission of information to induce investors into trading securities.” (See “Securities Fraud,” Cornell Law School and “What Is Securities Fraud? Definition, Main Elements and Examples,” by James Chen, Investopedia, Financial Crime & Fraud,  June 9, 2022.)

Even with the passage of laws such as the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, fraud that negatively impacts the values of stocks, bonds and non-security financial instruments is flourishing. A 2023 study estimates that on average 10% of large publicly traded firms commit securities fraud per annum. (See “How pervasive is corporate fraud?” by Alexander Dyck, Adair Morse and Luigi Zingales, Springer Link, Jan. 5, 2023.)

Alma Angotti, global legislative and regulatory risk leader at consulting firm Guidehouse, says accountability is one way to mitigate this type of fraud risk. Compensation is another. Angotti cites the recent case of NatWest Markets Plc, which in 2021 agreed to pay a $35 million fine after pleading guilty to one count of wire fraud and one count of securities fraud. The U.K. bank reportedly engaged in a practice called “spoofing” in the Treasury market where it created a false appearance of demand to its benefit. (See “NatWest pleads guilty to U.S. fraud charges, to pay $35 mln,” by Chris Prentice and Iain Withers, Reuters, Dec. 21, 2021.)

“One hopes this visible thrashing will discourage other financial institutions from violating the law,” she says. “More importantly, higher ups around the world should be taking a close look at how their traders are compensated. Cut the bonuses as soon as there is any hint of wrongdoing. Make clear, from the top down, that cheating, in whatever form, will have dire consequences, including job loss and no legal support if litigation results.”

The flip side, Angotti offers, is to reward ethical companies in the form of fewer regulatory fines. This concept of encouraging ethical behavior is analogous to a safe-driver discount.

Whistleblowers also play an important role in keeping companies and their employees from committing securities fraud and other types of wrongdoing. Ted Siedle, a former SEC attorney, has blown the lid off several investment scams. Most notably, Siedle won the largest-ever whistleblowing award from the SEC and the Commodities Futures Trading Commission when he exposed a conflict-of-interest case at J.P. Morgan. Siedle made regulators aware that the bank’s investment advisory business had been investing clients’ money in its own proprietary products without apprising their clients. J.P. Morgan said this lack of disclosure was unintentional. (See “Feds award JPMorgan Chase whistleblower a record $30M,” by Kevin Dugan, New York Post, July 12, 2018; “J.P. Morgan to Pay $267 Million for Disclosure Failures,” SEC, Press Release, Dec. 18, 2015; and “Whistleblower said to collect $30 million in JPMorgan case,” Bloomberg News, Investment News, Regulation, Feb. 16, 2018.)

Siedle, who along with Robert Kiyosaki co-authored “Who Stole My Pension: How You Can Stop the Looting,” also investigated how several state pension funds in the U.S. oversee assets and monitor conflicts of interest. (See “The High Cost of Secrecy,” STRS Ohio Watchdogs, Forensic Audit, June 7, 2021.)

“These cases keep coming to me,” says Siedle. “Overvalued assets, lack of transparency, complicated strategies, higher fees, higher risks, and political intervention are the tip of the iceberg. Active workers and retirees are worried for themselves and their families about the safety of their money.”

Whom to hold accountable when an individual at a company is caught committing securities or other types of investment fraud can be tricky and has resulted in a rigorous debate. “This debate has led to the question about whether to hold board members or line managers accountable,” says Teresa Goody Guillén, a co-leader of the blockchain team at BakerHostetler.

“A company may have adequate policies and procedures in place, but the corporate board may be deemed derelict in its fiduciary duties to properly oversee management’s adherence to those policies and procedures. When fraud is committed by a rogue employee, there is a stronger argument that the board of directors should not be held liable for the conduct of that individual,” Goody Guillén says.