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With the Federal Reserve’s decision this week to leave interest rates unchanged, everything remains in place for stocks to continue the strong advance that began in late summer. Overall market conditions remain essentially the same as they have for many weeks. So rather than give a repetitive market analysis, I’m devoting today’s report to something of potentially greater value.

As you are probably aware, I work full-time as marketing director for Strategis Financial Group, an SEC registered investment management firm headquartered in Utah. Because of our long-term success, we are regularly solicited by people who would like us to sell their investment strategy to our clients. We were recently approached by someone offering us the opportunity to sell a fraudulent strategy–something that is not uncommon. 

I thought by describing how this strategy is designed it might help some of you recognize and avoid similar fraudulent attempts to steal your hard earned investment dollars.

This scheme was promoted to us as a currency trading strategy that produces a guaranteed return of 24% a year. Income would be paid monthly at 2%. Already that is enough information that it should send alarms clanging in your head. No legitimate investment strategy or firm can guarantee returns that high. Current guaranteed return rates are about 6% maximum and are only available on products like certificates of deposit (CDs), some fixed income products (bonds) and variable annuity riders. Anyone who could produce currency returns of even 12% a year would have Wall Street’s biggest firms offering him a multi-million dollar salary.

Another warning sign was the fact that neither the person offering the product nor the one doing the trading were licensed in securities.

Now let me explain how someone can set up such a fraudulent investment to make it seem legitimate. How can someone produce guaranteed returns of 24% a year? First, the return really isn’t guaranteed. Second, the investors are paid with their own money.

Imagine that I convince you to invest $100,000 in this type of currency trading scheme. I am going to put the money in my account, and then set up a separate account for you. Each month I am going to deposit $2,000 into your account. This money comes from your original $100,000 investment. If you happen to be someone living on a fixed income who was previously invested in the stock market, this is going to seem wonderful to you. You are getting a regular monthly payment that is much higher than you could get anywhere else and you are not seeing monthly fluctuations in your account value like you did when you were invested in the stock market.

After six months or a year, you are going to start referring your friends to me because you are so pleased with the steady monthly return you receive. Many of them will sign up based on your recommendation. Some may express initial skepticism, but you will assure them that while you also had concerns, you have gotten your $2,000 a month every time as promised. You might even show them your account statement to convince them.

As your family, friends and neighbors sign up, I follow the same pattern for each of them. As my initial investor, I can continue to pay you your $2,000 a month for four years until your initial investment of $100,000 is used up. At that point, I have to make a decision. I can continue to pay you $2,000 a month from money I’ve collected from others, or I can simply shut everything down and disappear. Realistically that decision will come after about three years, because I will have taken a good chunk of your original investment for myself–after all, I need to get paid, too.

Let’s imagine that over the course of three years, with strong testimonials from you and others, I am able to convince 100 people to invest $100,000 each. That is a total of $10 million. My plan is to take 15% or $1.5 million for myself. All the rest I am going to pay back to the investors in monthly increments. 

As the end of three years approaches, I’m going to start expressing some concerns about the currency markets. But you probably won’t pay much attention, because you are still getting your monthly payments. Besides, by now you trust me completely and we are good friends. 

Eventually I am going to call with really bad news. One of the currency trades went bad and all the money is gone. I’m going to sound very upset and explain that I’ve lost all my personal money as well. Perhaps I’ll even put my fancy home up for sale.

Naturally you are going to be unhappy. But as you start to evaluate the situation, you realize that you really only lost $15,000. All the rest was paid back to you at $2,000 a month. Heck, you’ve probably taken much bigger losses in the stock market through the years. It doesn’t take long for you to accept your losses and move on. You might even feel sorry for me as you drive by my home and see the for sale sign. You might hear through the grapevine that I had to sell my Lexus and start driving a used Buick.

In the end, we might remain friends and a couple of years down the road I might approach you about a new investment opportunity. 

I assure you that this type of scenario takes place constantly. It might be described as an international bond strategy or as “kind of like a hedge fund.” If the payouts are kept more reasonable–say 15% a year–the person operating the scheme can keep it going for five or six years.

If the swindler chooses his victims carefully, chances are there won’t even be an investigation in the end. Everyone will accept their losses and move on. Besides, the victims don’t want to report on a friend who seemed to be just as taken in as everyone else. Even if some disgruntled investor goes to the authorities it is unlikely anyone will take much interest. After all, out of 100 investors there are only a few complaints and no one lost very much money. Chances are the paper trail would be very complicated and difficult to explain to a jury. Besides, many of the investors would be willing to testify that I’m a great guy who just ran into some hard luck. They don’t really hold me accountable.

If you want to avoid becoming a victim of such a scam, there are a few steps you can follow to protect yourself.

• Invest only with licensed securities firms. Licensing is no guarantee of honesty, but licensed firms are held to much higher levels of scrutiny.
• Don’t be unrealistically greedy. It is possible to make 50% in one year in an investment. But if someone is claiming outrageous returns year after year, don’t believe it.
• Choose firms that have been around awhile. Any type of investing has both up and down markets. Choose a firm that has survived both. If someone says he has been in business a long time and never had a loss, he is lying.
• If it sounds too good to be true–you know the rest. Be wary even if the person is a friend or family member.
• Don’t chase speculative investments with money you can’t afford to lose. Understand that risk and reward are inseparably connected. The higher the potential return, the higher the risk. 

F.S.

If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group.  This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call Mark Sumsion or Scott Garbutt at 800-279-3377.

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