8 Ways to Avoid Investment Fraud

By QuickBooks Canada Team

3 min read

Investment fraud, also known as securities fraud, is a practice involving financial securities that is intentionally deceptive and meant to lead investors to make buying or selling decisions based on false information, resulting in financial losses. These practices are in clear violation of the laws of every developed nation. In honor of Financial Literacy Month in Canada, learn ways investors can reduce their odds of becoming a victim to investment fraud.

1. Understand the Strategy

Understand the investment strategy clearly. It is extremely important to fully comprehend the purpose of the investment strategy, what financial securities are being invested in, how the investment generates returns, and how losses occur. Unfamiliar language should be immediately questioned. Sometimes, investment fraud is hidden beneath layers of jargon.

2. Confirm Returns Are Reasonable for the Asset Class

Investment returns should be in-line with similar types of investments. If an investment manager promises returns that are far above what a comparable benchmark returns, this should be a red flag. Bernie Madoff did exactly this over the course of his scam.

3. Confirm the Auditors, Custodian, and Regulators

Find out who the auditor and custodians are, and confirm they are reputable. Investment managers should use outside firms for custody, and financial audits should be from well-known, respected firms.

The more regulatory agencies looking over a specific type of investment, the lower the possibility for investment fraud, all else remaining equal. Mutual funds are more highly regulated than hedge funds. Thus, it follows that mutual funds should have less instances of investment fraud than hedge funds, and this is true. If an investment manager is reluctant to provide this regulatory information, avoid him or her.

4. Always Remember That Guaranteed Returns Aren’t Usually Possible

With the exception of a few, very low-paying securities, guaranteed returns simply don’t exist. Be alarmed by anyone guaranteeing a certain level of return, especially if it is high. The old adage, “if it seems too good to be true, it probably is” is especially true in the world of finance.

5. Don’t Send Money Fast or Over Email

Be wary of pressure to send money immediately. Scam artists will push you to send money right now since this once-in-a-lifetime offer will be gone tomorrow. There are no investments that are once-in-a-lifetime. If the investment opportunity is legal and reputable, it will allow you to take your time to make a decision. The good investment managers never pressure you.

Also, don’t invest in any opportunities sent via email. Too many scams exist and are perpetuated through email. Professional investment managers simply won’t solicit you over email.

6. Research the Investment Manager

Perform a background check on the investment manager. Through some simple searching, it is easy to confirm whether the investment manager offering you the opportunity is legit, has any lawsuits or investigations pending or past, and is certified with the designations he or she claims. In Canada, the Investment Industry Regulatory Organization of Canada (IIROC) can provide such information.

7. Confirm the Personnel Are Qualified

Verify the people making investment decisions on your money’s behalf are qualified, trained, and certified in finance and investments. If the firm is filled with people without investment training, this is also a red flag.

8. Limit the Amount You Invest

Though following the suggestions listed above will prevent you from becoming a victim of investment fraud the vast majority of the time, even if all safeguards are met, there is always a minute chance of investment fraud. With that in mind, it is worth limiting the amount you invest in any one opportunity. Diversification is a great defense against the losses incurred from investment fraud.

Types of Investment Fraud

There are dozens, if not hundreds, of investment fraud schemes, so investors must remain very diligent. One of the more popular investment fraud schemes is known as affinity fraud. The scammers prey upon members of a certain group or demographic. Religious groups, ethnic groups, and even the elderly are targeted by people who are or pretend to be members of the same group.

Another popular version of investment fraud is the Ponzi scheme. This scheme, similar to a pyramid scheme, is where money from one investor is used to pay off another investor. This pattern continues as long as the person running the scheme can keep generating new prospects and get their money. During the whole process, the investor pockets a large portion of the funds. Since it is extremely rare for all the investors in a fund to want to cash out at once, these schemes can run for years or decades.

Other types of investment fraud include advance fee fraud, high-yield programs, internet and social media fraud, micro-cap fraud, pre-IPO schemes, pyramid schemes, and pump-and-dump schemes. Read more about investment fraud on the Investment Industry Regulatory Organization of Canada website.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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