August 8, 2022

Avoiding Investment Fraud

By Joseph DeCusati, CPA, ABV, ASA, CFE, Partner, Advisory Services & Jesse Keen, Advisory Services

Avoiding Investment Fraud Investigations, Forensic Accounting & Integrity Services

We are currently experiencing difficult financial times: Inflation and interest rates are high, stock markets have dropped dramatically, and the supply chain is seemingly broken. Even the most respected businessperson can struggle financially when luck turns against them. In that case, they might look to make an investment that will turn their luck around. Aren’t we all?

By nature, investors are willing to take some risk — or they would not be investing. When making an investment, however, you should take the necessary steps to ensure the person handling your funds is making a legitimate investment on your behalf.

History is littered with investment scams. Many make the news, but many others do not. Understanding past investment frauds can help current investors avoid them in the future. Some of these cases are truly amazing, such as those of Ponzi schemers like Bernard Madoff1 and pump-and-dump stock fraudsters like Jordan Belfort2. Early in the pandemic, some fraudsters even exploited the need for PPE (personal protective equipment) and bilked individuals, hospital systems, and even governments.3

Many frauds are successful for a common reason: the investor did not ask enough questions or request sufficient documentation prior to making their investment.

Keep in mind the three elements of well-known criminologist Donald Cressey’s fraud triangle: pressure, opportunity, and rationalization. For a fraudster, bad economic times provide the pressure, and the need to make money provides the rationalization. Your investment provides fraudsters with the potential opportunity.

So what can be done to protect you, the potential investor, before you make an investment?

1. Don’t invest more than you can afford to lose.

A comprehensive financial plan for your investment portfolio should begin with risk-averse securities. Private equities or other risky investments are not right for an investor who is just starting out.

2. Take your time.

Many frauds depend on a sense of urgency. If you receive an unsolicited call or email and you’re pushed to commit before you have time to make a reasoned decision, that’s a red flag.

3. Ask for information.

Before you invest, take a hard look at the investor or entrepreneur’s CV, an investment prospectus, and financial records if available. Do they have a strong accounting team in place? (If the accounting team is an afterthought, that’s a red flag!) Do they understand manufacturing and the channels of distribution? Do they have the equipment to succeed? If this is a new area of investment, who is helping provide expertise? What other investors are already on board?

4. Think critically about the business model.

Does it make sense? If they’re claiming a hot new product or an emerging market, what hard evidence is there for its success? Don’t get bamboozled by fancy-looking websites or technobabble — a nice website is easy to make and is not evidence of a rock-solid business.

5. Use your resources.

Check your state’s secretary of state website and look up the business. How long has it been operational?

Remember the golden rule of investing: If it sounds too good to be true, it probably is. There is no such thing as a guaranteed return. Researching an investment opportunity is very important and it’s better to be safe than sorry.

Additional Resources