The allegation further claims that the adviser raided client accounts to spend on luxury cars, hotel stays and sporting events.
And it’s not just small-time investors who still find themselves defrauded. Last year, AIJ Investment Advisors in Japan was exposed for misreporting balances to several pension funds. Similarly, an Iowa-based futures broker, primarily working with farmers looking to hedge production and sales, was exposed for siphoning millions from client accounts. The US legal system and SEC is more forthcoming with fraud details than other countries, like Australia and Canada, generally are.
Yes, financial fraud is still alive and well. No organization appears to track or even estimate global financial fraud perpetrated by financial advisers, but a lot of it looks, well, the same as it always has.
“Investment fraud perpetrated against individuals is decidedly low-tech and often has very little to do with the regulations in place,” said Daniel Karson, Chairman, Kroll, a global investigations firm. “Their tactics: charm and a convincing argument.”
While the biggest scams often hit high-net-worth individuals — that’s where the money is — the records show that fraudster target all races, nationalities, education levels and affinity groups. Save for somber documentaries and rare personal accounts, these other narratives — the true lessons in financial fraud — hardly bubble to the surface.
“In the majority of cases, a level of trust in the person who is selling or managing the investments has already been established, usually through a personal referral or a series of meetings,” said Jack Duval, chief executive officer of Accelerant, a securities litigation consulting firm, which has provided expert testimony in many cases alleging financial fraud. “Another common pattern is when the victims are those who only recently came into money through an inheritance, insurance proceeds, or settlement.”
Duval warns that pitches based on “exclusive opportunities” and “guaranteed returns” should be immediate warning signs. Other recent schemes have involved promissory notes — basically IOUs held in place of assets — and offshore investments, often held or managed outside of the client’s jurisdiction for tax purposes.
Of course, not every financial fraud is a Ponzi scheme — the tactic whereby a pitchman uses money from the next investor to pay off the previous investors. Frauds can also be based on errors of omission or significant misrepresentations of risk. These often arise in the purchase of derivative securities (futures, options, swaps and the like), non-listed real estate opportunities, oil and gas partnerships, even the receivables owed to medical offices and other businesses.
But an adviser or broker with discretion over trading in your investment account could also surprise you with over-active trading or using debt to buy on margin or borrowing stock to sell short to goose returns.
Buying on margin, for example, involves putting up cash and some amount of non-cash collateral (say, listed stocks or high-quality bonds) in order to buy more shares than you might otherwise afford. It’s not uncommon among professional securities traders, but it’s hardly appropriate for a conservative long-term investor.
“Most investors don’t understand a margin call until they are hit with one,” said Karson. In this scenario other securities are sold in order to post more collateral against a margined stock that has fallen in value. While the activity itself is not fraudulent, brokers and advisers have been hit with fraud cases (or arbitration) for representing to clients that their strategies were far less risky than they actually were.
In some cases of investors buying unlisted or private securities, obtuse legalese explaining worst-case scenarios and loss of principle is buried deep in the offering documents. An adviser who sells these securities to you without fully explaining the risks or his take in the offering could have different motivations than yours.
“Be sure to verify the manner in which your adviser is compensated: fees or commissions?” said Duval. “And ask, is he operating under a fiduciary standard, which binds him professionally to act in your best interest?"
Of course, even those who invest your assets with the best of intentions can make mistakes. Therefore, it is wise to be smart when you hire an adviser.
“If you are going to invest, do so with a branded or large firm,” said Karson. “You have a greater chance of being made whole in the case of a rogue trader or an unsuitable investment. If you opt to invest with an individual or small firm, the need for verification is much higher.”
Karson also said investors should always independently verify the account, the custodian, the valuation firm, the lawyer and anyone else providing services related to their investments.
Most of all: always be skeptical.
“If it sounds too good to be true, it probably is,” Karson said.
Investment fraud... is decidedly low-tech and often has very little to do with the regulations in place.