10 Types of Investment Fraud (With Examples of These Scams)
It’s normal to stumble around this world knowing that there are bad apples but thinking you’re never going to bite into one. People have a normalcy bias — a bias that causes many to miss or underestimate the threat of something abnormal happening to them.
Unfortunately, in the investing world, this normalcy bias can cost you dearly.
Fraud is nothing new in the market. Many credit a fraudulent investment scheme with triggering the Great Depression. Investment opportunities aren’t always what they seem and it’s important you’re aware of common frauds and scams to protect yourself as you build wealth and plan for your future.
Types of Investment Fraud (With Examples of These Scams)
It’s easy to assume regulatory agencies like the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and Financial Industry Regulatory Authority (FINRA) protect you from any wrongdoing in the market. Sadly, these agencies can’t catch wrongdoing until investors have already been victimized.
But you don’t have to be a victim as long as you’re aware threats exist.
There are 10 common types of investment scams to watch out for. You can spot, avoid, and report them all when you look for the signs below.
1. Ponzi Schemes
The Ponzi scheme got its name from the criminal who developed the scam, Charles Ponzi. Scammers deploy the scheme by telling potential investors about an investment opportunity that’s too good to be true.
As investors buy into the scam, earlier investors are paid their promised returns with money from new investors. When new investors dry up, the scheme implodes and early investors are usually the only ones who make a profit. Unfortunately, all the later investors lose their entire investments and those in between often lose large portions of their initial principal investment.
Example of a Ponzi Scheme
In the early 1900s, Charles Ponzi told investors he could create 50% returns in a few months by investing in international mail coupons. He knew such high returns were impossible and devised a plan to pay early investors with money he raised from new investors.
As long as he could talk new investors into getting involved, he could pay everyone and take millions of dollars off the top for himself.
Unfortunately, the early investors were the only people who got paid. Eventually Ponzi was unable to attract enough interest to keep everyone in the pool happy, and with no real underlying investment, the cash completely dried up.
In the end, investors lost $7 million. Accounting for inflation, that’s equal to more than $100 million today. Ponzi served 14 years in prison and died penniless, yet con artists still use his tricks today.
2. Pyramid Schemes
The pyramid scheme evolved from the Ponzi scheme. Scammers quickly realized that once the pool of investors gets large enough, it’s impossible for a single person to attract enough new investors to keep the con going.
Pyramid schemes use early investors to recruit others.
The scam usually starts as a business proposition. The scammer’s goal is to get you to purchase inventory of a product and join a club. Once you’re in, you have the same goal, and as you recruit others who recruit others, the new members’ fees to buy inventory is split by those higher up the pyramid.
The problem with pyramid schemes is the business proposition isn’t real and the product isn’t meant to be profitable. Instead, the scheme is built to collect as many investment fees as possible, keeping the scammers at the top of the pyramid flush with cash.
Example of a Pyramid Scheme
In 2014, the SEC filed an investment fraud suit against eAdGear. The company claimed to be a successful marketing agency that could help you build a business that produced more than $3 million per year. All you needed to do was sell the company’s branded products and earn commissions.
Of course, one of those branded products was a membership to the club.
The SEC found that the actual marketing agency earned little money from its services. Instead, the company was generating hundreds of millions of dollars in revenue through investor contributions. The SEC deemed that the company couldn’t pay its investors back without new investor contributions. In the end, the SEC fined eAdGear owners Charles Wang and Francis Yuen more than $26 million; they were also sentenced to 46 months in prison after pleading guilty to felony fraud charges.
3. Pump-and-Dump Schemes
Pump-and-dumps are perhaps the most common investment scheme on the market. They’re also the scams depicted in movies like “Boiler Room” and “The Wolf of Wall Street.”
The scheme usually starts with a fraudster who owns a large number of shares in a lesser-known publicly traded company, cryptocurrency, or some other risky financial asset. The owner of the asset uses chat rooms, social media, financial media promoters, and email and telemarketing campaigns to spread false information suggesting the value of the asset will climb soon.
The assets involved usually have limited supplies, so when the phony information leads to strong demand, the price of the asset skyrockets. When the con artist behind the scam believes the price has gone as high as it can, they sell their positions, dumping a significant supply of the asset into the market and driving the price down.
In the end, investors who purchased the asset while it was being pumped up are left accepting significant losses.
Example of a Pump-and-Dump Scheme
The Enron scandal was the biggest pump-and-dump scheme in history. Members of the company’s management team falsified documents, issued misleading press releases, and misstated revenue and earnings for years.
According to everything the company was telling investors, it was one of the strongest in the world.
In 2001, Enron was unable to keep up the charade. As the scam drew to a close, several members of the company’s management team sold their shares in the company. By the time the public knew a scandal was happening, the company was headed for bankruptcy and the management team had completely divested, costing investors billions of dollars.
Multiple members of the Enron management team were convicted of conspiracy, securities fraud, wire fraud, and making false statements. They spent years in prison and had to pay millions of dollars in fines for their part in the Enron collapse.
4. Promissory Note Fraud
A promissory note is a complex investment product that’s typically only available to sophisticated investors. These notes are promises from the companies that issue them to pay the principal plus interest over a period of time in exchange for a loan.
Promissory notes are typically sold by a third party who doesn’t even know the scam is happening, making it harder to spot.
The con artist creates a fictitious company and uses a salesperson to market the promissory notes. Instead of marketing the notes to sophisticated investors, the con artist usually targets the elderly or new investors, promising to pay higher-than-average market returns.
Investors buy in under the false impression that they’re purchasing a secure investment with a solid return. Once the victims invest their money, the con artist pays the salesperson and disappears. The investors who purchased the notes never see an interest payment and their principal investment is never returned.
Example of Promissory Note Fraud
In April 2022, the Missouri Secretary of State’s Securities Division announced that it’s seeking a final order from the Commissioner for a $200,000 civil penalty and other remedies against Tomorrow Drivetrains, LLC, and Dennis R. Di Ricco for promissory note fraud.
According to the Securities Division, the two worked with Retire Happy, LLC, an unregistered third-party agent, to raise about $5.4 million through the sale of unsecured promissory notes. The notes were sold to 88 investors in 35 states including an elderly resident of Missouri.
Upon selling the notes, Di Ricco and his team used investor funds to manipulate the price of a publicly traded stock in a pump-and-dump scheme, and investors in the promissory note fraud were left high and dry.
To date, no other states have stepped in, but the case is still young. The $200,000 civil penalty in Missouri is likely the least of Di Ricco’s long-term worries, as the SEC and other agencies often take years to build their cases.
5. Internet/Social Media Investment Fraud
Internet and social media investment fraud is when a con artist uses message boards and other web-based tools to disseminate information to make their schemes possible.
These can be pump-and-dump schemes, pyramid schemes, or any other type of investment fraud on this list.
The key to avoiding social media investment scams is to never trust anyone on a message board. It’s perfectly fine to get investment ideas from your favorite chat rooms and social media outlets, but it’s up to you to do your research and ensure the ideas you invest in are legitimate.
Example of Internet/Social Media Investment Fraud
Starting in 2008, Sandy Winick gained control of 11 worthless publicly traded companies. The companies had little to no assets and had ceased operations.
For the next five years, Winick used social media and disseminated false information in online press releases to pump the market values of these companies up. In the end, investors in 35 countries lost more than $120 million. Winick was sentenced to six years and six months in prison, ordered to pay $2.43 million in restitution, and ordered to forfeit an additional $5 million.
6. Affinity Fraud
Affinity fraud is a type of investment fraud that targets members of a specific group. It could be any kind of group: a race, a religion, or even a country club. The fraudster is or pretends to be a member of the group and uses their status as a member to peddle investment fraud.
In most cases, the investment frauds perpetrated by affinity con artists are pyramid and Ponzi schemes. However, any type of investment fraud that targets a specific group of victims is affinity fraud.
Example of Affinity Fraud
In 2012, the SEC shut down a Ponzi scheme led by Shervin Neman. Neman claimed to be an investment professional and created a bogus hedge fund called Neman Financial LP. He used his Persian-Jewish heritage to target others in the Persian-Jewish community, telling them he could generate significant returns by buying and flipping foreclosed homes and investing in popular IPOs like Facebook.
Unfortunately, he did nothing of the sort. Instead, he used new investor money to pay early investors in a classic example of an affinity-centric Ponzi scheme.
Investors lost a total of $7.5 million to the con artist, who was sentenced to 135 months in prison and ordered to pay $3.25 million in restitution.
7. Coin & Precious Metals Fraud
Coin and precious metals scams generally target the elderly. Fraudsters use a mix of fast-paced sales tactics and fear to get retirees to “protect” their financial security by purchasing coins and precious metals. Then the fraudsters sell their victims coins and precious metals at multiple times the going market rate.
For example, a con artist may use high-pressure sales tactics to sell silver bullion for $100 per ounce, knowing it’s only worth about $25 per ounce.
Some victims cash out tens of thousands of dollars in other investments to overpay for precious metals, thinking they’re making a sound financial decision to protect themselves in retirement.
Example of Coin & Precious Metals Fraud
The biggest example of coin and precious metals fraud came to a head in 2021. The federal government and 30 states filed a suit against Metals.com for defrauding at least 1,600 customers out of $185 million.
According to the allegations, the company’s salespeople called elderly consumers and told them the market was headed for a major crash. The salespeople also said that in the event of an economic collapse, the government could seize their traditional assets, using fear to push the sale of overpriced physical precious metals.
The company has been ordered to pay millions of dollars in some state cases, but the federal case is still ongoing. Metals.com’s assets remain under the control of a federal court-appointed attorney until all claims have been resolved.
8. Prime Bank Investment Fraud
Prime bank investment fraud is a scam that was developed to target beginner investors and retirees. The fraud starts with a phone call or an online message or advertisement urging you to call a phone number to talk about a unique investment opportunity.
The salesperson on the other end of the line tells you about what they call “prime bank securities,” which sounds fancy but is a type of security that doesn’t actually exist. The highly-educated con artists use complex language to convince you they know what they’re talking about as they promise unrealistically high yields.
Once the victim transfers money to the fraudster, it’s gone for good because the investments they peddle are fictitious.
Example of Prime Bank Investment Fraud
In 2005, the SEC announced Alyn Richard Waage and three of his associates were sentenced to a combined 24½ years in prison for their roles in a prime bank scheme.
The four members of the con worked together to defraud investors out of more than $60 million selling prime bank investments that didn’t exist. The team used investor funds to buy expensive houses, 10 antique cars, a yacht, a helicopter, and several luxury cars, some of which were seized once the fraud came to light.
Unfortunately, by the time Waage was caught, many of his assets were held overseas, although the SEC and other government agencies were successful in repatriating millions in assets for seizure.
9. Real Estate Investment Fraud
Real estate investment frauds typically have little to do with actually investing in real estate. Instead, fraudsters create bogus programs they say can teach you how to change your life by investing in real estate, typically through hard-money investing or house flipping.
The fraudsters use bold claims and charge bold prices for training packets, memberships, and access to workshops and seminars. However, after spending thousands of dollars, consumers are left right where they started, gaining little-to-no value from the supposed training materials and coaching they paid for.
Example of Real Estate Investment Fraud
In 2019, the Federal Trade Commission (FTC) filed a complaint against a real estate investment training company called Nudge. According to the complaint, Nudge used infomercials to make false promises that insinuated they could turn anyone into a real estate millionaire.
When consumers called to learn how, salespeople sold seats to seminars that came with a $1,000 price tag or higher.
As eager potential real estate investors made their way to the seminar, they were presented little more than additional sales pitches for advanced training courses costing tens of thousands of dollars.
In the end, the FTC found that only about 5% of people who went to the seminars earned enough profit in subsequent real property transactions to cover the cost of their training.
10. Cryptocurrency & NFT Investment Fraud
There are several flavors of cryptocurrency investment fraud. Some fraudsters hack wallets and steal all the crypto they can find while others build pump-and-dump, pyramid, and Ponzi schemes around crypto assets.
Cryptocurrencies aren’t the only crypto assets at the center of scams. Non-fungible tokens (NFTs) are also common subjects of fraud. NFTs have their own cons known as rug pull events, where a con artist creates a collection of NFTs and promises future utility.
Once the NFT drops and investors purchase the collection, the con artist disappears and investors are left with nothing. In some cases, the NFTs never even existed.
Example of Cryptocurrency Investment Fraud
A recent rug pull scam took place in early 2022. Con artists marketed a new collection called the “Big Daddy Ape Club.” Investors paid a total of 9,136 Solana (SOL) — worth about $1.3 million at the time — to mint pieces of the collection. Unfortunately, investors soon found the NFTs didn’t exist.
Another unfortunate part of cryptocurrency and NFT scams is that the blockchain helps con artists hide behind pseudonyms. The fraudsters behind the Big Daddy Ape Club scam haven’t been caught.
Warning Signs of an Investment Scam
The best way to avoid being the next victim of an investment scam is to know about and look for the warning signs. The good news is they’re not hard to spot if you know about them.
Promises of High Returns
One of the biggest red flags that you’re dealing with in an investment scam is the promise of exorbitantly high rates of return. The average rate of return in the stock market is about 10% per year. Legitimate investments typically can’t promise a rate of return much higher than this — if they could, everybody would invest in that instead.
Scam artists often promise 50%, 100%, or more in a matter of months. If someone makes you such a promise, it’s time to turn and run.
High-Pressure Sales Tactics
Con artists can’t afford to let you do your research. After all, if you research what they’re selling, you’d never buy it. So they use high-pressure sales tactics with language that invokes fear to get you to sign up right away.
If a salesperson ever makes you feel like you’re going to miss a once-in-a-lifetime opportunity or lose everything if you don’t buy what they’re selling right now, you have a compelling reason to stay away.
Paid Promotion Disclosures
Pump-and-dump scammers often use paid stock promoters to pump the price of a stock up. These promoters charge tens or even hundreds of thousands of dollars for their services. Although there are some legitimate informational service providers who are paid to write about stocks, they tend to charge less for their services.
If you see a disclosure at the bottom of an article saying the author was paid $10,000 or more to publish the content you’re reading, there’s a strong chance you’re reading about a fraudulent investment.
Cold calls, emails, mailers, and social media messages are among the most popular tools con artists use to bring their investment scams to the masses. If you receive an unsolicited phone call, email, message, or mailer about an investment opportunity, you should ignore it.
What to Do if You’re a Victim of Investment Fraud
The best thing you can do if you’re the victim of investment fraud is to report it. Start by reporting it to your state’s attorney general. Simply type “[Your State] attorney general contact,” into your favorite search engine and make a phone call.
Once you’ve reported the scam to your attorney general, report it to federal regulators. If the fraud has to do with a securities or crypto investment, report it to the SEC. If it has to do with commodities or futures, report it to the CFTC. If you’re the victim of real estate investing seminar fraud, report it to the FTC.
Although you may never get your money back, your report can be the one that saves countless other people from finding themselves in your shoes. Moreover, you may receive reward money if your report leads to a conviction and fine.
The vast majority of investment opportunities are legitimate; there’s not always a fraudster lurking around every corner of financial markets. However, investment scams have become more prevalent since the internet became a widely accepted tool.
Today, more than ever, it’s important to stay informed of the latest investment scams and to actively look for red flags to make sure you’re not the next victim.
You should never take anyone’s word for it when it comes to investing, no matter how solid the opportunity seems. Always do your research to develop a thorough understanding of where your money’s going when you make an investment.