Elliott Greenblot | AARP Fraud Watch: The inside scoop on pyramid, Ponzi schemes

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So, how is your long-term savings and retirement fund faring these days? Not so good, huh? Well I have the ideal opportunity for a person like you and it guarantees a 10 percent a year net growth. THAT'S RIGHT! A GUARANTEED 10 PERCENT A YEAR! Your money will almost double in about seven years.

Sounds good? You bet! And it is just one pitch used by con artists pushing investment schemes. Most people have heard the terms Ponzi or pyramid when describing an investment scheme but few really understand the meaning of the terms.

These are some of the more common investment scam vehicles we are seeing today. Pyramid schemes claim that you will be able to turn your investment into a huge pile of money in a short period of time.

The process goes like this: You are approached and asked to invest an amount of money with an administrator. You recoup your expense by "recruiting" only eight others to participate. These eight "recruits" pay you for the opportunity to participate and you get to keep their investment after forwarding a portion to your administrator. They, in turn, recruit eight participants, keep the amount these people pay and forward a sum to you from which you draw income and pass payment to your administrator.

Simple! As long as new investors are recruited, you will continue to make money. But here is the problem. It only works for you if you and those you recruit successfully lure others into the scam. If you are an early investor, you may make your money back but the reality is that only the very few people at the beginning of the process actually make money.

In fact, if there are four levels of investors ahead of you, the scheme or pyramid would require more than 260,000 investors to pay off your level of entry. That's a number equal to the population of all of Western Massachusetts not counting greater Springfield.

The Ponzi scheme

Ponzi schemes have some similarity to the pyramid. The operator attracts investors with the promise of high returns or yields. While he claims to invest the money given to him, he initially uses some of it to pay investors and demonstrate that the promise actually pays off. They and the operator in turn attract new investors using the "proven" success of the scheme as bait.

The operator pockets most of the new money and uses some to pay the "returns" to the earlier investors. As new individuals are drawn into the scheme, the operator becomes wealthier from the fraudulent investments. This is precisely what broker/adviser Bernard Madoff was convicted of doing.

The victims

For now, it is important to know what type of person most likely ends up being victimized and how they become victims. There are five primary victim types identified by FINRA, the Financial Industry Regulatory Authority.

Many victims already own high-risk investments. In other words, they are already gambling with their investment money by purchasing penny stocks, futures, or currency exchange rates.

Secondly, many victims make investment decisions based on advice from friends or relatives, not licensed advisers. Often those who became victims were open to new investments based on "free lunch" investment seminars and did not check the background or credentials of those making the sales pitch.

Finally, most victims were unable to recognize the persuasion tactics used by the criminals.

There are many other scams used by con artists including pump-and-dump, advance fee fraud, offshore scams, and "free lunch" seminars. I'll review these in the next column in two weeks as well as review the psychology of the scam, red flag warnings, and steps for self-protection.

Elliott Greenblott is a coordinator for the AARP Fraud Watch Network and writes this biweekly column. If you suspect that you may be a victim of a computer-based scam, call the AARP Fraud Watch Network hotline at 877-908-3360 or the Massachusetts Attorney General's Consumer Protection Division at (617) 727-8400.


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