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The Securities and Exchange Commission (“SEC”) has recently initiated a program to educate both first-time investors and seasoned professionals on the identification of various red flags of investment fraud to conduct a “do-it-yourself” due diligence investigation. While the SEC outlines several important ways to avoid falling victim to an investment advisor fraud, (e.g. “pump and dump,” pyramid, ponzi scheme or affinity scheme), an experienced due investigator specializing in due diligence investigations is trained to tap into numerous resources to obtain critical facts which often help investors make more “informed” decisions and help you avoid an investment fraud.

In addition to conducting quantitative due diligence on a potential investment advisor/broker/hedge fund manager (i.e. reviewing financial statements, understanding the investment scheme, etc.), here are some additional tips on how to avoid falling victim to an investment-related fraud from a due diligence investigation perspective:

“Googling” is not due diligence

Did you know that by recent estimates, the surface web (a typical “Google” or search engine) accounts for less than 1% of what is actually on the Internet? Consider that the next time you spend an hour “Googling” a particular person or company and come up empty. It is also important to understand that the more successful and more complicated the particular scheme has become, the more likely the fraudster will “bury” any derogatory or damaging information about themselves into the Internet. (See related post, What You Find on the Internet May Not Be True?)

Value your references, but check it out anyway!

Someone who has been referred to you by a respected member of your community should be treated with the same skepticism as anyone else. There has been an explosion of affinity frauds (investment frauds that prey on an identifiable group) over the last few years, including the now infamous Madoff scandal. Former investors, employees and business associates can provide critical details that you may not be able to find anywhere else.

Verify Credentials

It is common for fraudsters to claim numerous memberships to exclusive organizations or relationships with wealthy families. In addition to finding information to support such claims, attempts should also be made to confirm that the broker or advisor really did receive that “ivy league education” or that they are licensed with appropriate regulatory agencies (e.g. FINRA).

Review Litigation

Historical civil complaints filed by current or former investors are oftentimes the first warning sign that trouble has been brewing. Federal and state litigation searches can also identify potential red flags such as divorce petitions, which often provide evidence of stress/tension or information concerning conflicts with former employees, employers, suppliers or business partners.

“Conspicuous Consumption”

A major warning flag for investors is a “showcase” of wealth. Investment fraudsters driven by greed and power, often camouflage the legitimacy of their investments by purchasing luxury homes, automobiles, yachts and one-of-a-kind items (e.g. artwork). In addition, certain fraudsters will make significant contributions to exclusive charities or organizations, often with a big splash or press release attached.

Review Criminal/DMV Records

Would it surprise you that several high profile fraudsters have had criminal records or a history of alcohol abuse, which could have been easily identified during a routine background check? For example, Sam Israel (Bayou Hedge Fund Group), who defrauded over $400 million from loyal investors, had a history of alcohol abuse. While Nicholas Cosmo (Agape World, Inc.), who is awaiting trial on a separate $400 million Ponzi scheme, previously served more than a year in federal prison for stealing client funds.

Confirm Service Providers

Outside accounting firms and fund administrators, who are “independent” third-party providers, provide an important buffer between the investment managers and their victims. But what if these “independent” providers were not so independent after all and were actually aiding in the scheme? Bernie Madoff used a unusually small two-person accounting firm to manage his billion dollar hedge fund while Sam Israel used an accounting firm run by his CFO. Are these arms-length relationships worth knowing bout beforehand?

Conclusion

As the daily headlines reveal more and more fraudulent investment schemes, individuals and businesses should use all of the investigative due diligence resources available today to avoid becoming another statistic tomorrow.

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1 reply
  1. Tina Myers
    Tina Myers says:

    It’s great to be educated on this topic. I’ve recently been researching investment fraud because a close friend of mine was in an unwanted situation a few months ago, but he hired a securities fraud attorney to help properly advise him. Thanks for the sharing, this was very informative.

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