Every investor’s worst nightmare doesn’t have to be yours
By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) — James Elton Warr didn’t attract investors by promising astronomical returns; he got them by comparing his results — which he promised would continue — against the stock market.
But the Warr Investment Group of Austin, Texas, was showing its purported 8% annual gains against a particularly poor time frame for the stock market in order to look good. And Warr wasn’t even running his investment business during the time frame he was showing, much less delivering those returns.
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Alas, investors who might have been able to figure out Warr’s Ponzi scheme with a few simple steps never did. According to the Texas State Securities Board — which forced Warr Investment Group into receivership earlier this year — Warr raised about $1.1 million from investors; he used a significant portion of the funds to pay commissions to unregistered sales agents, to cover his travel and dining expenses, and to buy an E350 Mercedes Benz.
Instead of the promised 8% annual returns from Warr’s real estate program — which he promoted as both safe and lucrative in Internet advertising and YouTube videos — investors were lucky to get about one-third of their money back. That’s because Texas securities regulators got there before all of the money disappeared.
Don’t trust — and verify
It is every investor’s worst nightmare — being a sucker for a scheme or fraud, a fish for the stock tout whose only motives are their own profits, but whose sales pitch suggests something completely different.
Regulators acknowledge that they typically don’t do enough to protect investors, that they only arrive well after the crime has started and that their recovery rates are small.
With that in mind, they say that investors can protect themselves, and note that simple checks and balances will typically be enough to avoid most scams.
“It’s not hard to protect yourself,” said attorney Michael Unger of Rubin & Rudman in Boston, a former director of the Massachusetts Securities Division. “If it sounds too good to be true — even just a little too good — well, you can fill in the blank on how to end that sentence.”
While regulators would have a long list of safeguards and checks, here are five things that experts suggest would help investors avoid the vast majority of investment scams and rip-offs.
1) Check the registration of the adviser and the securities.
While big swindlers like Bernie Madoff make headlines, little frauds are far more common. These are most easily stopped by simple background checks, making sure that the person selling the securities is registered, has a clean background, and is selling a legitimate product.
One call to the state securities administrator in your area should be sufficient to find out if the basics are in place and okay.
Consider the case of John F. Langford, sentenced in September to up to 15 years in prison for stealing almost $7 million from dozens of investors in Texas. Langford, a former insurance salesman from Amarillo, told investors they were buying “private annuities” — by itself a red flag because regulators don’t believe the term is a description of a legitimate investment — that effectively were fraudulent promissory notes.
Langford wasn’t registered to sell securities, and the illegal investments he pitched to investors also weren’t registered. One check with the Texas State Securities Board would have shown that to prospective investors.
“People can call to find out if the guy they are working with is registered, and if the securities they are buying — especially when we are not talking about big stocks or mutual funds but something like a ‘private annuity’ — are registered,” said Robert Elder of the Texas State Securities Board. “If you don’t invest with someone who is not registered — and you shouldn’t — making that one call would save you a lot of trouble.”
The cost of not making the call? Of the $7.55 million investors put into the fraud, $212,126 was left for restitution; victims are getting back 2.8 cents for every dollar they gave Langford.
2) Dig into illustrations and comparisons for inconsistencies and nonsense.
The same way that legitimate investment firms don’t advertise the returns of their worst funds, promoters of investment frauds and scams fail to disclose key facts. They also make statements and comparisons that fall apart under scrutiny.
That’s how the Warr case played out. An investor who noticed the time frames — how it was a terrible time for the market, or a time when Warr’s company wasn’t even operating — would have been worried enough to ask more questions or simply run away.
Goofy comparisons don’t just involve the details behind an investment’s performance. Often, it is the tout lumping themselves in with famous investors.
In April 2011, for example, the “Elite Stock Report” issued a “special report” touting Tuffnell Ltd. TUFF 0.00% , a micro-cap gold stock. The promotional piece compared Colin McCabe, the unknown editor of the newsletter, with billionaire money managers George Soros, John Paulson and Eike Batista. See analysis of the Elite Stock Report promotion of Tuffnell.
While the billionaires had been reported as buying gold at the time, they weren’t doing it through penny stocks. Within weeks, Tuffnell stock had cratered; today it trades for fractions of a penny per share.
3) Be careful about who gets the check.
Writing the check to a big brand-name firm that is protected by the Securities Investor Protection Corp. is good, writing it out to some small adviser or the adviser’s firm is a huge red flag.
In 2004, when a 15-year Ponzi scheme run by Boston financial planner Brad Bleidt hit the news, it included one curious fact. Unlike many scammers who are simply ripping customers off or selling fake investments, Bleidt had many customers in real investments getting genuine returns from his financial maneuvers.
The deciding factor in who got real advice and who got ripped off came down to who the checks were payable to. Money written to the clearing firm that Bleidt used as a custodian for assets were managed properly because he couldn’t touch them; checks made out to his firm, Allocation Plus Asset Management, wound up in Bleidt’s personal account.
“Knowing who is getting the check — and that it’s a legitimate place that will safeguard your money — is important,” said Unger, the former Massachusetts regulator. “If you put the money right in the hands of an adviser — even one who has been legitimate right up until now — you are giving them the opportunity to take it.”
4) Make sure the returns are reasonable for the type of investment.
With Treasury yields at record lows, and banks and money-market funds paying interest in pennies or fractions of pennies, anything promising ultra-safe returns that are five-, 10- or 20 times those levels should be greeted with a healthy dose of skepticism.
Generating above-average returns requires taking larger-than-normal risks. Generating consistent returns regardless of market conditions — the big selling point in Bernie Madoff’s fraud — is next to impossible.
If the returns are outside of normal range for any reason, demand some answers before writing a check.
“If someone says they can deliver a big return or a safe return, you have to ask how they do it,” said Elder, the Texas regulator. “You have to make sure the explanation makes sense. If it doesn’t — if any little thing sounds wrong — there’s probably a problem there.”
5) Talk to your family or someone you trust before investing.
Your family may not know better about money than you do — and you may worry that their recommendations are based on their desire to someday have your money themselves — but they nonetheless provide a great sounding board in case you haven’t recognized the sound of “too good to be true.”
“One hopes that family always has your back and is going to at least give you a sounding board for your decision to invest in uniforms for the Japanese army — that’s an actual case — or whatever you are being sold,” said Bryan Lantagne, director of the Massachusetts Securities Division.
Family is also important, he added, because “seniors have the money and are, more often than not, the target of these folks. We have, over the years received many a call from family members saying that their folks had talked to them about a call they received that just didn’t seem right.”
In fact, Massachusetts had a case several years ago in which the firm it sued had internal training materials instructing agents to tell seniors not to discuss the investment deal with their children, Lantagne said.
Telling the story of a potential new investment to a loved one forces you to make sure you understand the product. If you can’t explain it, you probably don’t know enough to buy it, regulators say.
Elder noted a recent Texas case where investors were buying “interests in harvesting the Amazon rain forests.”
“I don’t know what goes into people’s minds that makes them say ‘Wow, this is the right thing for me to do right now,’” Elder said, “but you wouldn’t have to describe what you were doing to too many people before someone said, ‘Oh come on, that can’t be for real”