Types of Fraud

Advance fee frauds ask investors to pay a fee up front — in advance of receiving any proceeds, money, stock, or warrants — in order for the deal to go through. The advance payment may be described as a fee, tax, commission, or incidental expense that will be repaid later. Some advance fee schemes target investors who already purchased underperforming securities and offer to sell those securities if an “advance fee” is paid, or target investors who have already lost money in investment schemes.

Fraudsters often direct investors to wire advance fees to escrow agents or lawyers to give investors comfort and to lend an air of legitimacy to their schemes. They also may try to fool investors with official-sounding websites and e-mail addresses.

Advance fee frauds may involve the sale of products or services, the offering of investments, lottery winnings, found money, or many other so-called opportunities. Fraudsters carrying out advance fee schemes may:

• Offer common financial instruments such as bank guarantees, old government or corporate bonds, medium or long term notes, stand-by letters of credit, blocked funds programs, “fresh cut” or “seasoned” paper, and proofs of funds;
• Offer to find financing arrangements for clients who pay a “finder’s fee” in advance; or
• Pose as legitimate U.S. brokers or firms and offer to help investors recover their stock market losses by exchanging worthless stock, but require investors to pay an upfront “security deposit” or post an “insurance” or “performance bond.”

Much of the binary options market operates through Internet-based trading platforms that are not necessarily complying with applicable U.S. regulatory requirements and may be engaging in illegal activity. Investors should be aware of fraudulent promotion schemes involving binary options and binary options trading platforms.

What is a binary option?

A binary option is a type of options contract in which the payout depends entirely on the outcome of a yes/no proposition — typically whether the price of a particular asset will rise above or fall below a specified amount. Binary options exercise automatically, and unlike other options they do not give the holder the right to buy or sell the asset. When the option expires, the holder receives either a pre-determined amount of cash or nothing at all.

Complaints about fraudulent trading platforms

The SEC has received numerous complaints of fraud associated with websites that offer binary options trading. They fall into at least three categories:

1. Refusal to credit customer accounts or reimburse funds. Customers are encouraged by “brokers” over the phone to deposit more money. When they try to withdraw, the platform cancels the request, refuses to credit the account, or stops answering.
2. Identity theft. Some platforms collect copies of customers’ credit cards, passports and driver’s licences for unspecified uses. Do not provide personal data.
3. Manipulation of software to generate losing trades. Platforms allegedly distort prices and payouts — for example, extending the countdown on a “winning” trade until it becomes a loss.

Beware of overstated returns

Some platforms advertise an average return higher than a customer should expect given the payout structure. Suppose you pay $50 for a contract that promises a 50% return if XYZ trades above $5 at expiry. Even with a 50/50 chance of winning, the expected return is negative: an out-of-the-money expiry costs roughly 100%, while an in-the-money one pays only about 50%. On average, you lose money.

The Internet is awash in so-called “high-yield investment programs” or “HYIPs.” These are unregistered investments typically run by unlicensed individuals — and they are often frauds.

The hallmark of an HYIP scam is the promise of incredible returns at little or no risk to the investor. A HYIP website might promise annual (or even monthly, weekly, or daily!) returns of 30 or 40 percent — or more. Some of these scams use the term “prime bank” program.

Fraudsters often impersonate organizations or individuals to lure victims into scams. They may impersonate government agencies or employees, or legitimate investment professionals like brokers and investment advisers. Impersonators may be part of an advance fee scam, or may use personal information they obtain to steal an individual’s identity or misappropriate their financial assets.

Fraudsters may impersonate the SEC

Phone calls, voicemails, texts, social media messages, emails, letters and certificates may falsely appear to be from the SEC. Be skeptical if someone claiming to be from the SEC asks about your shareholdings, account numbers, PINs, passwords, digital wallet addresses or other information that could be used to access your accounts. Do not provide any personal information until you have verified that you are dealing with the SEC and not an impersonator.

If you receive a communication that falsely appears to be from the SEC, submit an Investor Complaint Form to the SEC. If you have lost money in a scheme involving SEC impersonation, contact the SEC’s Office of Inspector General at www.sec.gov/oig or (833) SEC-OIG1 (732-6441).

Fraudsters may impersonate registered brokers or advisers

Fraudsters may set up an account name, profile or handle designed to mimic a particular individual or firm. They may create a webpage that uses the real firm’s logo, links to the firm’s actual website, or references a real employee. They may also steer investors to an imposter website by posting comments on the social media accounts of brokers, advisers or other sources of market information.

Many investors use the Internet and social media to help with investment decisions. These same tools are attractive to criminals: a website, online message or social media post can reach large numbers of people with minimal effort, and it is easy to make a message look real. If an investment promotion grabs your interest, research the “opportunity” before you hand over even your phone number or email address — otherwise you may be setting yourself up to be targeted.

Social media

Social media lets fraudsters appear legitimate, hide behind anonymity and reach many people at low cost. Always be wary of unsolicited offers to invest. If you receive a message from someone you don’t know containing a “can’t miss” investment, your best move may be to pass — and report it to the SEC.

Online investment newsletters

Some companies pay newsletters to “tout” their stocks. That is legal only if the newsletter discloses who paid, how much and in what form. Fraudsters often lie about payments and track records, posing as independent while profiting from your trades. Being advertised on a reputable website does not make a newsletter legitimate.

Bulletin boards and chat rooms

Fraudsters use online discussions to pump up a company or pretend to reveal “inside” information. Because users can hide behind multiple aliases, one person can create the illusion of widespread interest in a thinly traded stock. People claiming to be unbiased observers may be insiders, large shareholders or paid promoters.

Spam

Junk email lets fraudsters send personalised messages to millions of people for almost nothing. Many scams — including advance fee frauds — use spam to reach victims. Most frauds on social media aren’t unique to the Internet: from pump-and-dumps to “guaranteed returns” to affinity fraud, the scheme is old even when the channel is new.

Some investment scams target members of identifiable groups, such as older investors or religious or military communities. The fraudsters often are — or pretend to be — members of the group, and may enlist respected leaders to spread the word. Many times those leaders become unwitting victims of the fraud they helped promote.

These scams exploit trust and friendship. Because groups are tight-knit, outsiders may not hear about the scheme, and victims may try to resolve things within the group rather than notify authorities. They often involve Ponzi or pyramid schemes, where new money pays earlier investors to make the investment look successful.

Tips to avoid fraud

• Research the person and the investment — no matter how much you trust whoever brought it to you. Check whether they are licensed and registered, and whether they have complaints or disciplinary history.
• Never invest based solely on the recommendation of a member of a group you belong to, especially if it comes through social media.
• Don’t fall for spectacular profits, “guaranteed” returns or “no risk” claims.
• Be wary if details are never put in writing, or if you are asked to keep the opportunity secret.
• Don’t be rushed. Someone else’s gains don’t mean you’ll make money — be especially skeptical of “once-in-a-lifetime” or “inside information” pitches.
• Watch for appeals to get in on the ground floor of the latest technology or growth industry.

If you receive an unsolicited stock promotion, be cautious. Whoever is promoting the stock may stand to profit at your expense by pumping up the price and then selling. Fraudsters often use emerging technologies or industries — including crypto assets — to entice investors, announcing developments designed to move the price or promoting companies tied to the latest news.

Why are microcap stocks easier to manipulate?

Public information about microcap stocks (low-priced stocks of the smallest companies), including penny stocks, is often scarce, which makes it easier to spread false information. They have historically been less liquid than larger companies’ stocks and often do not trade on a national exchange.

Warning signs

• Unsolicited recommendation or heavy promotion — especially if the stock is promoted more than the company’s products.
• No real business operations — aggressively promoted penny stocks may be dormant shell companies.
• Unexplained increase in price or trading volume.
• Frequent changes in company name or line of business.
• Quoted over-the-counter on alternative trading systems rather than a national exchange.

Even if the source looks legitimate

Fraudsters promote stocks through seemingly independent sources: social media, research sites, newsletters, online ads, email, chat rooms, direct mail, newspapers and radio. A promoter disclosing that they were paid doesn’t make the promotion legitimate — and the disclosure may hide that the money came from a company insider. Read the company’s SEC filings before investing.

A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Organizers promise high returns with little or no risk, but often don’t invest the money at all — they use it to pay earlier investors and keep some for themselves.

With little or no legitimate earnings, Ponzi schemes need a constant flow of new money. When recruiting slows, or many investors cash out at once, they collapse. The name comes from Charles Ponzi, who duped investors in the 1920s with a postage stamp speculation scheme.

Ponzi scheme red flags

• High returns with little or no risk. Be highly suspicious of any “guaranteed” opportunity.
• Overly consistent returns. Real investments go up and down; steady gains regardless of the market are a warning.
• Unregistered investments. Registration gives you information about management, products and finances.
• Unlicensed sellers. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
• Secretive, complex strategies. Avoid what you don’t understand or can’t get full information about.
• Issues with paperwork. Statement errors may mean funds aren’t invested as promised.
• Difficulty receiving payments. Promoters may offer even higher returns to stop you cashing out.

SEC staff continue to receive complaints — and bring enforcement actions — involving scams that claim to offer “pre-IPO” shares of companies. Pre-IPO investing means buying a stake before a company’s initial public offering. Promoters entice investors with the promise of getting in at the ground floor of a start-up.

Common red flags include unregistered investment professionals, aggressive sales practices, social media solicitations, and claims that the company is focused on emerging technologies. These scams may be promoted online, by phone, by email or in person.

Fraudsters may claim they have opened up opportunities usually reserved for the wealthy, or that they won’t make money until you do. They use impressive-looking websites and spam, make unfounded comparisons with established companies, and say the IPO is “imminent” or will happen “this year.” Claims that sound believable at first often turn out to be false.

In the classic pyramid scheme, participants try to make money solely by recruiting new participants, usually where the promoter promises high returns in a short time, no genuine product or service is sold, and the emphasis is on recruitment. All pyramid schemes eventually collapse, and most investors lose their money.

Promoters use social media, online ads, company websites, group presentations, conference calls and videos, and may dress the program up as a legitimate multi-level marketing (MLM) business. But money from new recruits pays earlier participants — until the promoter can’t raise enough to keep going.

Hallmarks of a pyramid scheme

• Emphasis on recruiting. Be skeptical if you earn more for recruiting than for product sales.
• No genuine product or service. Hard-to-value “products” — mass-licensed e-books, ads on little-used websites — are a common disguise.
• High returns in a short time. Fast cash may mean commissions are paid from new recruits’ money.
• Easy money or passive income for little work, such as making payments or recruiting others.
• No demonstrated revenue from retail sales to people outside the program. Ask for audited financial statements.
• Complex commission structure that you can’t explain.

The maths always wins

Imagine each participant must find six new recruits, who each must find six more. In only 11 levels you would need more participants than the entire population of the United States. That is why every pyramid scheme collapses.

If someone approaches you about investing in a so-called “Prime Bank” program, “Prime World Bank” financial instrument, or similar high-yield security, you should know that these investments do not exist. They are all scams.

Prime Bank programs often claim investors’ funds will be used to buy and trade “Prime Bank” instruments. Promoters make the schemes seem legitimate with complex, official-sounding terms: debentures, standby letters of credit, bank guarantees, an offshore trading program, a high-yield investment program, or some variation.

To reassure investors, promoters may claim the instrument is issued, traded or guaranteed by a well-known institution such as the World Bank, the International Monetary Fund or a central bank. They often say the program is secret and must be kept confidential, that only a select few may join, and that the returns are both enormous and risk-free.

A promissory note is a form of debt — a promise by the issuer to repay with interest. Companies sometimes sell notes to raise money, but legitimate promissory notes are generally marketed to sophisticated or corporate investors with the resources to assess the issuer, not to the general public.

Fraudulent notes are often sold to individual investors, sometimes by independent insurance agents or others who are not licensed to sell securities. They typically promise high, fixed returns with little or no risk, and may be described as “insured” or “guaranteed.”

Warning signs

• Returns well above market rates, presented as safe.
• Claims that the note is insured, bonded or guaranteed — check who actually stands behind it.
• Claims that notes with short maturities (for example, nine months or less) don’t need to be registered. Such exemptions are narrow and rarely apply to notes sold to the public.
• A seller who isn’t registered to sell securities.
• Notes used to fund an unclear business — or to pay earlier noteholders, which is the mark of a Ponzi scheme.

Before investing, look up the offering in the SEC’s EDGAR database and check the seller’s registration and record.

In a pump-and-dump, promoters try to boost a stock’s price with false or misleading statements — the “pump” — and then sell the shares they bought cheaply at the inflated price — the “dump.” Once they sell, the hype stops, the price typically falls, and remaining investors lose money.

These schemes most often involve microcap and penny stocks, where little public information is available and small amounts of buying can move the price. The same playbook is increasingly used with thinly traded crypto assets.

How the pump is spread

Promoters use social media posts, messaging-app groups, spam, online newsletters, chat rooms and paid ads. Messages often claim “inside” information, an imminent announcement, a breakthrough product or a link to a hot trend — and urge you to buy right now before the price “explodes.”

Protect yourself

• Be skeptical of unsolicited tips, especially ones that create urgency.
• Check the company’s SEC filings and whether it has real revenue and operations.
• Be wary of sudden spikes in price or volume that aren’t explained by company news.
• Remember that the people promoting a stock may be selling it to you.

In relationship investment scams — sometimes called “pig butchering” — fraudsters spend weeks or months building trust before ever mentioning money. Contact often starts on dating apps, social media, messaging apps or with a “wrong number” text that turns into a friendly conversation.

Once trust is established, the scammer introduces an investment opportunity, frequently in crypto assets or foreign exchange, and guides you to a trading website or app they control. Early “gains” look real and you may even be allowed a small withdrawal. Then you’re encouraged to invest more — until you try to cash out and are told you must first pay taxes, fees or penalties. The money is gone.

Protect yourself

• Be wary of anyone you have only met online who brings up investing, however long you have been talking.
• Never send money or crypto to someone you haven’t met in person.
• Don’t trust a platform because someone else recommends it — independently verify that it is registered.
• Treat requests to pay fees or taxes before you can withdraw as a sure sign of fraud.
• Be suspicious if they ask you to keep the investment secret or move the conversation to an encrypted app.
• If you suspect a scam, stop all contact, keep records of conversations and transactions, and report it.