Avoiding Investment Fraud

There is, sadly, no fool-proof way to avoid investment fraud.

Ellen Roseman, the Toronto Star’s (print) investment columnist, suggested being wary of non-publicly traded investments:

Typical victims of investment fraud are male, university-educated, older than the general public and with a higher income, according to AARP, which represents people over 50 in the United States.

Stocks, bonds and mutual funds may not be a quick road to wealth. But they are safer than securities that don’t trade on public markets and don’t provide regulated disclosure to investors.

A recommended source of information is The BC Securities Commission’s website, BeFraudAware.ca, which alerts investors to the warning signs of fraud.

If you decide to go the private investment route, FAIR Canada, a non-profit organization that seeks to advance the interests of investors in Canada, suggests five steps to avoid fraud:

RULE 1 – ONLY DEAL WITH REGISTERED ADVISORS

Only deal with registered advisors and firms. Check the registration of both the advisor and the firm before you invest. (Note: Securities commissions license (otherwise known as “register”) advisors to sell investments.) You should also check the financial advisor’s disciplinary history before investing.

Registration – You can check registration at AreTheyRegistered.ca. For further information about conducting background checks.
Discipline – You can review disciplinary history records on the Disciplined Persons List. If the advisor has a history of disciplinary action, this is a red flag. You should make sure you fully understand any proceedings brought against them before investing, or find a provider who does not have a disciplinary history.
We recommend that investors deal with advisors who work for a firm that is a member of a self-regulatory organization (referred to as an “SRO”) – either the Investment Industry Regulatory Organization of Canada (IIROC) or the Mutual Fund Dealers Association of Canada (MFDA). Such firms are subject to a closer level of regulation and supervision. They also offer greater financial stability and are required to participate in compensation funds which may provide compensation to investors in the event of firm insolvency.

RULE 2 – BE AWARE OF FRAUD ‘WARNING SIGNS’

Unrealistic Returns – Unrealistic rates of return are a big red flag. Investments that offer a higher-than-market rate of return and little to no risk are almost always fraudulent. The CSA’s 2012 Investor Index found that many Canadians have unrealistic expectations of market returns. When asked what they think the annual rate of return on the average investment portfolio is today, only 12% of Canadians gave a realistic estimate. A reasonable return in today’s market is a maximum of 5 or 6 percent annually, and such returns would be associated with some risk.

Guaranteed High Returns – With most investments, there are no guarantees. Guaranteed high returns are a red flag that the investment is likely a scam.

Pressure to Borrow – Pressure to borrow money to invest is an investment fraud warning sign. Fraudsters often recommend that you borrow to invest. FAIR Canada believes it is highly inappropriate (and overly risky) for most individuals to borrow to invest (otherwise known as ‘leverage’), particularly where it involves borrowing against your home. If you lose your investment, borrowed money still needs to be repaid. If your house was used as collateral, it could be sold to cover your investment losses. Even in legitimate investments, leverage can lead to financial ruin for consumers.

High-Pressure Sales – Recognize high-pressure sales tactics (“limited time, act now” or “don’t miss this opportunity”). Such tactics are investment fraud flags. Legitimate investment opportunities should provide you with adequate time to review any information and make an informed decision. Do not make spur-of-the-moment decisions with your life savings. Take your time and if unsure, don’t invest. Visit BeFraudAware.ca for more persuasion techniques you should be aware of.

“Inside Information” – Another flag involves exclusivity (particularly where the information is “confidential” or “inside information”). Registered investments (see Rule 4 below) are required to file public information, so there would be no reason to require investors to keep any details about such investments secret.

Ponzi Schemes – The Ponzi scheme is one of the most common forms of investment fraud. A Ponzi scheme lures investors in with the promise of high returns. The fraudster pays early investors “returns” from funds contributed by new investors, and steals the rest. The schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out. If you have been dealing with someone who is not registered and have received “interest” payments or account statements this is no guarantee that the investment is legitimate. Learn more about other common scams.

RULE 3 – CHEQUES PAYABLE TO REGISTERED FIRMS, NOT INDIVIDUALS OR OTHER COMPANIES

Only hand over money in the name of registered firms (see Rule 1). Never issue a cheque made out to an advisor personally (i.e. in the individual’s name rather than the firm’s). If you are asked to make funds payable to the individual or some other entity, this should be a red flag that something isn’t right.

RULE 4 – STICK TO REGISTERED INVESTMENTS

Consumers should only invest in products that are properly registered with a securities commission. Usually this means a document has been filed about the investment called a prospectus along with other disclosure documents. Investments in unregulated private real estate offerings and “bulletin board listed” (over-the-counter) companies have often turned out to be scams. To find out whether a particular investment is properly registered, call your provincial securities regulator.

Only those who are sophisticated investors, with the necessary knowledge and experience to conduct sufficient due diligence about a prospectus exempt investment should invest in one.

RULE 5 – ASK QUESTIONS, VERIFY, AND ‘JUST SAY NO’

If you do not understand a form of investment after discussing it with your advisor, do not buy it. Never sign a blank document or one that you do not understand. Scam artists and unethical advisors will often ask investors to lie about their personal financial situation: do not lie about your income or other information.

Provincial regulators have contact centers to answer inquiries. If you have any questions, don’t hesitate to call your regulator and ask. If you think that an investment opportunity is a scam or is not suitable for you, don’t be afraid or embarrassed to just say no.

Keep in mind, ultimately, that education is key to avoiding fraud.