How to Spot Financial Scams—Transatlantic Edition

If “it’s different this time” are the four most dangerous words in investing, “it can’t happen to me” might be the five most dangerous words about investing scams. Many hear stories of retirees losing their life savings at the hands of some smooth-talking huckster, but it is easy to presume you won’t be a target—or if you were, spotting the ruse would be a breeze. Perhaps! But even self-described savvy sorts routinely succumb to crafty scammers’ bag of tricks—and as a result, they are all too common. But they can be easy to spot if you know what to look for. We think two recently busted financial scams in the US and UK hold important lessons on how to do so.

A Classic Ponzi Scheme

Ponzi practitioners attract investors with promises of unrealistically high returns—then use newer investors’ funds to deliver those returns, at least for a while. A recent SEC complaint describes one such scheme run by five rogue advisers who filched $102 million from 637 investors. They did so by purchasing retiring investment advisers’ businesses, then persuading the clients to transfer their money from staid, traditional investments into debt securities issued by three companies the scalawags controlled.^[i] They ultimately pocketed $20 million between them, distributed $38.5m to early investors (in conventional Ponzi fashion) and misappropriated much of the remainder. The SEC complaint alleges the five used the stolen money to fund luxurious lifestyles^[ii]—while sending clients fabricated account statements showing outsized profits. Now the cat is out of the bag—and victims may not be able to recoup even a portion of their losses.

We sympathize with these folks’ plight. But their experience highlights several red flags for investors everywhere. First, beware promises of guaranteed payouts and risk-free double-digit returns. This is a free lunch—and as any economist could tell you, there ain’t no such thing. All legitimate investments have up and down periods. Paper statements suggesting otherwise are no comfort—any manager seemingly delivering on unrealistic promises deserves equal suspicion.

The second no-no: Taking ownership of your assets. This means handing a financial manager your life savings to do with what they will—while you have no way to know where your money is.^[iii] Conversely, third-party custody by a well-known financial institution ensures your money is in an account with your name on it and therefore still your property. It also adds transparency, generally removing the possibility of fake account statements. Third, resist pressure to put all your money in a couple obscure, unknown firms. Those featured in this hustle had snazzy-looking websites and brochures, but even so—there is virtually never a good reason to for investors to concentrate like this. Especially if said firms have inexplicable names like First Nationle.

Abundant jargon and vague buzzwords are the fourth red flag. One business’s brochure described it as a holding company for “several sales affiliates that represent a group of companies who offer a rich portfolio of premier Insurance and Impaired Risk products.” Huh? We count three corporate layers in there and are still unsure what it (theoretically) does—even with the knowledge that impaired risk products are a special type of life insurance or annuity Evel Knievel would qualify for. How exactly would any of this realistically achieve the advertised returns? Another’s website claimed it “is a singular-disciplined company that specializes in providing Physician's financing, supporting the initial development phases of Physician owned clinical laboratories.” Ok, sounds medicine-ish. But “singular-disciplined company” is just technical-sounding gibberish. A Google search for the phrase turns up zero results.

This could happen to anyone, even the smartest of investors—but learning to spot fraud tactics helps. Here are some ways to protect yourself:

• Eschew pie-in-the-sky promises of big returns with low risk.
• Demand your assets be held at a reputable brokerage firm, in an account with your name, where you can access your account online to see current holdings.
• Identify known miscreants via Brokercheck—a free tool for researching brokers’ and advisers’ professional background, including any complaints or judgments against them. The SEC’s Investor.gov website is another good resource. None of these shysters were actively registered with FINRA, which had sanctioned four of them for previous misconduct.
• Ask to see advisers’ ADV II forms. These summarize the services they provide, fees, plus any conflicts of interest and past disciplinary actions—all “in plain English.”

The Cold Call

We head across the pond for the second bout of financial chicanery, where thanks to some April 2015 reforms, UK pensioners have more control over savings sitting in tax-advantaged retirement accounts. Savers can now access 25% of their “personal pensions” tax-free starting at age 55 (rather than waiting until retirement). The rest is subject to standard income taxes when withdrawn. More flexibility and control is neat! But shady characters have been exploiting confusion about the change.

The common caper—euphemistically known as “pension liberation”^[iv]—goes like this. You get a call (or email, or text) from someone ostensibly at a government agency saying it is now legal to withdraw your pension pot before you turn 55—which it isn’t, except in rare cases. The caller tantalizes with promises of attractive returns and exclusive opportunities—then (if you bite) pours the money into high-risk, illiquid investments or takes it outright. Victims also typically owe large punitive taxes and fines for withdrawing from their pension funds too early.

Those over 55 may receive unsolicited offers for a “free pension review” from someone claiming to be from the Financial Conduct Authority (FCA, a UK regulator). This might sound legit, as anyone who wants it can indeed receive free and impartial pension advice from a dedicated government agency—a key plank in the recent reforms. But the agency tasked with helping pensioners navigate the new system is called Pension Wise—and (like the FCA) they don’t cold-call, especially not bearing offers to invest in something lucrative and exciting.^[v]

Falling for this variation doesn’t result in taxes or fines, but it still risks theft or huge losses. In one recent example, a shady pension fund trustee persuaded almost 300 people to turn over £13.4 million in pension savings in exchange for shares in a fund invested in companies he owned. (Sound familiar?) According to a Telegraph report, “The scheme invested the remaining funds into high-risk investments, including an olive oil processing plant and a gem mine. [The perpetrator] paid himself nearly half a million pounds from scheme funds in just 12 months.” There is a push to ban the practice, but proponents admit this is mainly to raise awareness, as enforcement would be near-impossible. Thus, proactively informing and protecting yourself is essential. Here’s how:

• If you get a call from someone you don’t recognize offering clever tips on how to exploit pension law loopholes—or the chance to make a quick buck (or pound) by giving them the keys to your retirement savings—hang up straightaway.
• Research pension rules yourself—or get second (or third) opinions from sources who aren’t trying to sell you something.
• Check the Financial Services Register to see if the person or organization is legit—or visit the Financial Conduct Authority’s “ScamSmart” website to learn about this and other schemes.

Most importantly, for both this and Ponzi swindles: If it seems too good to be true, it probably is. Scams like these could happen to you, but remembering this adage—and the preceding tips—should make it a lot less likely.

[i] While purportedly involved in diverse ventures ranging from financial and medical services to insurance to real estate, these companies were effectively fronts with no business activities whatsoever.

[ii] For one, name of Perry Santillo, this (per the SEC’s complaint) included “paying for housing in multiple states, car leases, expenditures at a country club and a Las Vegas resort and casino, credit card payments and other personal expenses. … [He] threw himself a party at a nightclub in Las Vegas for which he commissioned a song about himself to be played. The lyrics to that song refer to (Perry) Santillo as ‘King Perry’ and describe his typical attire: ‘ten-thousand-dollar suit everywhere he rides.’ The song also depicts his lifestyle as follows: ‘pop the champagne in L.A., New York to Florida; buy another bottle just to spray it all over ya.’” No word on whether the song’s composer has been charged with crimes against music.

[iii] To be crystal clear, we aren’t lumping in brokers or dual-registered broker/advisers who work for the major brokerage houses here. They will still put your funds in an account with your name on it, making them your property. Rather, we are talking about practitioners who want you to transfer your money to them personally or to a company they own/run.

[iv] We mean, no one calls car theft “vehicle liberation.”

[v] You can learn more about Pension Wise at their website, including more information and tips about avoiding pension scams.