General articles about stock scams

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Classic Cons: 10 Financial Scams Fair-Minded Investors Should Avoid

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Over the past 40 years, only one new entry has been added to the Federal Bureau of Investigation (FBI) roster of "Top 10" investment scams - the very broad category of "Internet fraud."

The other financial rip-offs listed are merely new versions of tried and true swindles that have been around for decades or more - from Ponzi schemes and pyramid systems to phony stock offerings and commodity cons.

The big difference is that the one new category - Internet fraud - has greatly increased the frequency, speed and effectiveness of the other types of financial fraud, as well as exponentially increasing the scammers' take.

In 2009, there were 6,062 robberies of physical bank offices and branches, netting the perpetrators a total of $45.9 million in loot, more than $8 million of which was recovered by law enforcement officials. By contrast, there were more than 14,000 reported (and countless unreported) online attacks on banks and bank customers, with the estimated loss exceeding $110 million, almost none of which was recovered.

In addition, where physical bank theft is local, online robbery is global. MSNBC recently reported that a ring of cyber thieves based in Eastern Europe had used a so-called Trojan horse computer program to steal more than $1 million from the accounts of more than 3,000 British bank customers in just four weeks - and, even though the banks had identified the problem, they weren't able to immediately stop the thefts.

That mirrored an even broader rip-off of banks and their customers.

According to the FBI, a highly sophisticated group of thieves using cloned or stolen debit cards, with PINs gained primarily via Internet phishing scams, hit more than 2,100 ATM machines in 290 cities across North America, Asia and Europe, walking off with more than $9 million in cash in under 12 hours. That figure would have been much larger had many of the ATMs not been drained of all their bills.

Banks aren't the only targets, either. Overall, the FBI counted 335,655 complaints of online thieves targeting U.S. consumers, financial institutions, brokerage firms, retailers and other companies that maintain customer accounts, up 22.3% from 275,285 the previous year. The total take in those incidents was estimated at $559.7 million, up from just $264.6 million the year before.

And those numbers will almost certainly increase dramatically in the decade ahead, thanks to the growing use of cellphones, laptops and home computers to access personal bank, brokerage and other types of online accounts.

The National White Collar Crime Center (NW3C) says direct online thievery is just a drop in the bucket compared to all white-collar crime, most of which involves some form of investment or financial skullduggery. Examples include bankruptcy fraud, bribery, credit card fraud, counterfeiting both of currency and securities, embezzlement, identity theft, insurance fraud, kickback schemes, money laundering, price fixing and others.

The total cost of worldwide white-collar crime rose from just $5 billion in 1970 to $20 billion in 1980, $100 billion in 1990 and $220 billion in 2000, according to NW3C surveys and research of global law enforcement and regulatory reports.

But while the technology may have changed, financial scammers continue to rely mostly on the old standards.

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Classic Cons

The Ponzi scheme, named for Charles Ponzi who first used it in the early 1900s to fleece investors out of $10 million, continues to head every list of top financial frauds, probably because of its simplicity. The perpetrator merely promises huge returns and then delivers them, using money from new investors to pay off older ones, who praise the investment and draw in more and more new investors - until the operator has built up a big enough cash pool to abscond with all the money. See Bernie Madoff.

The big difference now is that the Internet can bring in money to the Ponzi operator in days rather than the months it used to take. The same is true of pyramid scams, where early investors profit by bringing in new suckers and raking off a share of the new money - until the whole thing collapses.

The Internet is even better suited to more complicated frauds. Using e-mail and/or highly professional-looking Internet Web sites, white-collar thieves can send out hundreds of thousands of sophisticated marketing appeals or official-looking documents in a matter of hours, reaping hundreds or even thousands of responses.

Problem is, the charities are bogus, the investments are phony, and the operators are long gone.

Seniors are particularly susceptible to many of these scams, being sold false charitable gift annuities, viatical settlements, reverse mortgages, or having their pension funds drained.

In 2005, for example, Pennsylvania authorities shut down a well-promoted "IRS-approved, IRA-authorized" investor plan that pulled more than $2 million out of senior pension programs in the state.

Of course, anyone can fall victim to an investment scammer. Following are nine other types of frauds or dubious investment offers you might encounter:

1. Affinity fraud - These scams target groups with common interests, such as alumni associations or religious or ethnic clubs, letting the members sell one another on bad or fake investments.
2. Annuity misrepresentation - These aren't scams so much as failure to disclose hefty sales commissions, huge surrender fees and other things that eat up the buyer's money.
3. Promissory notes - These are short-term, supposedly high-return debt instruments issued by obscure or non-existent companies and sold by unlicensed individuals posing as brokers, insurance agents, etc.
4. "Prime-bank" schemes - These offer small investors high returns by giving them supposed access to the world's elite banks and entry into the exclusive world of the ultra-rich.
5. Brokerage scams - These can range from outright fraud, such as selling phony securities, to "pump-and-dump" promotions of penny stocks, unauthorized trading of customer accounts (known as "churning", excess or hidden fees and other irregularities.
6. Unlicensed agents - Nearly every financial endeavor is regulated and sales people are required to be licensed at either the state or federal level - but most scammers aren't. Even non-regulated operations usually have professional or business associations you should be able to check with if you have doubts.
7. Pressure tactics - Cold callers operating out of boiler rooms similar to those portrayed in the 1980s film "Wall Street" promote commodity futures, precious metals, penny stocks, coins, and travel and vacation properties. While some cold calling operations are legitimate, many aren't. The bad ones typically offer either "a special one-time deal" or an opportunity you have to "grab now or you'll miss out." Diamond investments are popular among pressure sales teams since they're one of the few commodities not traded on any organized exchange, meaning you have no real way to compare prices to actual market values.
8. False sales premises - These are often used in response to major shifts in public mood, such as the present distrust of Washington. A popular pitch currently being used promotes the purchase of antique gold coins because "the government has secret plans to confiscate all gold and prohibit individual ownership," as it did to a limited degree in 1933.
9. Fake real estate sales or leases - These scams reflect the recent mortgage crisis and collapse of the real estate market in many areas of the country.

Because of foreclosures, weak sales and abandonment, many homes sit empty in places like Phoenix, Las Vegas and California's Central Valley. Scammers fake ownership papers to the empty properties, advertise them for sale or lease at below-market prices and then walk away with the deposits or down payments when they hook bargain-hungry buyers or tenants.

A comprehensive list of potential financial and investment scams would have many more entries, but the ones above should suffice to raise your suspicions any time you encounter an offer that sounds "too good to be true." Don't put your money on the line for anything you don't completely understand - that goes for potential risks, as well as rewards. And always verify that the offering company actually exists and the person presenting the offer is properly licensed, not just a glib talker with a slick presentation.

Where to Turn for Help

If you have reservations about a potential investment opportunity, or if you've been victimized by a financial scam, you might turn to one or more of the following agencies.

Better Business Bureau - With offices nationally, in every state and most large and mid-sized cities, the BBB can alert you to problems with local businesses, work-at-home programs, distributorships, sales routes you can buy and other one-on-one type rip-offs. They usually have lists of current online offers that are suspect or drawing lots of complaints. You can access the national BBB Web site at http://www.bbb.org/us/ and navigate to your home state or city chapter from there.

U.S. Securities and Exchange Commission (SEC) - Information is available on all securities-related fraud issues and investment scams, and you can file your own personal complaints or suspicions online at http://www.sec.gov/complaint.shtml.

Your SEC complaint can be anonymous or you can provide only limited personal data. However, the more information you give them, the more likely they'll be able to help you. Either way, include specific details about how, why and when you were bilked with any contact info you have on the fraudulent person or company involved.

You can also verify financials and regulatory standing on all publicly traded U.S. companies by accessing the SEC's EDGAR Database at: http://www.sec.gov/edgar.shtml.

U.S. Commodity Futures Trading Commission (CFTC) - If the scam involves commodity futures or options rather than stocks or bonds, the CFTC can help at: http://www.cftc.gov/

Internal Revenue Service - Since most scammers don't pay taxes, the IRS tries to keep track of them as well - not only to put them out of business but to prevent having to let you deduct your fraud losses. Check out posted IRS fraud information at: http://www.irs.gov/privacy/ article/0,,id=179820,00.html?portlet=5

U.S. Federal Bureau of Investigation (FBI) - For any kind of Internet fraud, bank-related scams or other interstate criminal activity, check with the FBI or report complaints at: http:// www.fbi.gov/. (Just for fun, you can also review the "10 Most Wanted" list on the FBI home page to see if you recognize anyone.)

Financial Industry Regulatory Authority (FINRA) - A professional association of investment regulators and agencies, FINRA has a Web page where you can check out your broker's credentials and review past complaints: http://www.finra.org/Investors/ToolsCalc...okerCheck/.

If you've already been victimized, you might also get some combined help from all of these government agencies and others thanks to a new joint task force coming together right now and designed specifically to investigate and prosecute financial fraud cases.

Now take a look at our latest special report for intelligence on new ways to protect, and grow, your wealth. All the details are right here.

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The Shocking Truth About Wall Street Stock Recommendations

By John Reeves, and Ilan Moscovitz | More Articles | Save For Later
June 3, 2013 | Comments (17)

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It is difficult to get a man to understand something, when his salary depends on his not understanding it.
-- Upton Sinclair

When Apple announced its second-quarter earnings on April 23, a flurry of news reports cited Wall Street analyst forecasts to help explain the company's results. This is how the bottom lines of companies and stocks are ordinarily explained to the public.

An analyst from Goldman Sachs (NYSE: GS  ) noted that the March quarter was better than expected, but the June quarter guidance was "far worse than feared." He ultimately lowered his price target to $500 from $575, while maintaining a "buy" recommendation on the stock.

An analyst from JPMorgan (NYSE: JPM  ) also lowered his target price, in this case to $480 from $575, and advised he expected "AAPL to remain range-bound" until there was more visibility into new product launches. More bullishly, the analyst from Piper Jaffray felt Apple might trade higher in late 2013, and maintained his $688 price target and "overweight" rating.

Analyst opinions such as these routinely drive coverage of the stock market. But a new study, "Inside the 'Black Box' of Sell-Side Financial Analysts," by professors Lawrence Brown (Temple University), Andrew Call (Arizona State University), Michael Clement (University of Texas), and Nathan Sharp (Texas A&M), suggests that ordinary investors should look elsewhere for insights into their favorite companies.

Sharp and Call, who we interviewed about their findings, told us they wanted to understand what went on behind closed doors when analysts were putting together their research. The professors received completed surveys from 365 sell-side analysts, and later followed up with 18 of them to better understand their decision-making processes. "Sell-side" analysts produce research that's purchased by their firms' "buy-side" clients. They're the group that's often cited in stories about "Wall Street analysts."

Countless studies have shown that the forecasts and stock recommendations of sell-side analysts are of questionable value to investors. As it turns out, Wall Street sell-side analysts aren't primarily interested in making accurate stock picks and earnings forecasts. Despite the attention lavished on their forecasts and recommendations, predictive accuracy just isn't their main job.

Analysts are not that into you
Any time you want to really understand the financial industry, it's helpful to first look at what people are actually paid to do.

The survey found that "accurate earnings forecasts and profitable stock recommendations have relatively little direct impact on their compensation." Instead, industry knowledge and connections are what count.

The chart below ranks the main factors that play into analyst compensation:

Sharp and Call told us that ordinary investors, who may be relying on analysts' stock recommendations to make decisions, need to know that accuracy in these areas is "not a priority." One analyst told the researchers:

The part to me that's shocking about the industry is that I came into the industry thinking [success] would be based on how well my stock picks do. But a lot of it ends up being "What are your broker votes?"

A "broker vote" is an internal process whereby clients of the sell-side analysts' firms assess the value of their research and decide which firms' services they wish to buy. This process is crucial to analysts because good broker votes results in revenue for their firm. One analyst noted that broker votes "directly impact my compensation and directly impact the compensation of my firm."

So who are these clients that analysts are paid to cater to? Mainly hedge funds and mutual funds. Individual -- aka "retail" -- investors are the least important:

Congratulations on another great quarter, Mr. CEO
So if forecasts and stock picks aren't important, what exactly are these valuable institutional clients after?

Sharp and Call told us that institutional clients value analysts' access to the management of the companies they cover more than anything else. One analyst admitted that "one of the biggest things the buy-side compensates sell-side research firms for is corporate access: road shows, meetings, access to management teams." Another said:

As an analyst, if I call up a money manager, a hedge fund, whoever, and I've got a call to make on a stock, and I'm able to say, 'Hey, by the way, we were able to spend 20-30 minutes talking to senior management,' boom! Their ears are just straight up.

Overall, the study found that buy-side clients valued sell-side analysts' views more when analysts had direct contact with management. The study didn't go into detail about whether clients were primarily after hints of short-term market-moving information, or whether they were seeking more insight into company results. But Sharp told us he suspects analysts' institutional clients believe the most valuable insights are those that come directly from management.

Given the importance of providing their clients with access to corporate management, it only makes sense that sell-side analysts would want to maintain good relations with management. Sharp told us that "analysts are a lot more worried about maintaining their relationship with management than whether or not they're doing a good job, so-to-speak, for smaller investors." Maintaining strong relationships with management of the companies they follow is seen by analysts as central to their career success.

All of this appears to call into question the objectivity of the analysts. One analyst even mentioned that he saw himself as a "megaphone" for management. In our interview, Sharp raised the question, "are analysts really supposed to be merely broadcasting what management tells them?"

Because maintaining good relationships with management is so crucial, being cut off from management would be devastating. According to Sharp and Call, it would hurt their relationship with buy-side clients who expect them to provide access to management, and losing that access would also get them into trouble with the sales and marketing folks at their own firms. One analyst told them:

When a company cuts you off, not only do you lose the information value of that [access], but you actually lose revenue. The company won't come to your conference; therefore, your conference is going to be less important. Clients pay a boat load for that access.

Another analyst said that, "there are a lot of constituencies that analysts have to answer to, and none of them likes an underperform [rating on a stock]."

In addition to the pressure to remain in good graces with the management of the firms they cover, analysts often receive pressure to make positive recommendations from their own firms.

According to the study, 23.9% of the analysts surveyed specifically say they are pressured to "issue stock recommendations that are more favorable than their research would support." And Sharp told us that number is probably a floor, since analysts may have been reluctant to share such knowledge with outside parties. He added that it'd be a "fantasy" to believe that sell-side analysts are not influenced by the effect their recommendations might have on the profitability of their own firms.

In short, analysts provide management with a "megaphone" in exchange for access, which they are then able to sell to hedge funds, mutual funds, and other institutional investors.

The next pets.com
In the 1990s, gushing Wall Street "research" that awarded every half-baked business idea with a "strong buy" recommendation was a major cause of the $5 trillion dot-com bubble. Even stocks that analysts privately believed to be "dogs" and "pieces of [expletive]" received buy recommendations.

Eliot Spitzer, who prosecuted the investment banks, recalls that:

At that time, the investment banks' defenses were as astonishing as they were revealing. First, they claimed "everybody knew" that analysts' recommendations were worthless because of the enormous hidden conflicts -- admitting that no rational, knowing person would rely on the advice investment banks were sending to tens of millions of small investors.

As part of a $1.4 billion settlement for charges ranging from failing to disclose conflict of interest payments, to issuing unsound research reports, to "inappropriate spinning of 'hot' IPOs," to producing fraudulent reports, Credit Suisse, Merrill Lynch, Bear Stearns, Deutsche Bank (NYSE: DB  ) , Goldman Sachs, JPMorgan, Lehman Brothers, Solomon Smith Barney, Morgan Stanley (NYSE: MS  ) , and UBS (NYSE: UBS  ) agreed in 2003 to take a number of steps "to ensure that stock recommendations are not tainted by efforts to obtain investment banking fees."

One of the many troubling parts in the 2012 "JOBS Act" -- a law that weakens IPO standards in order to drive more IPOs -- was a provision (Sec. 105b) that makes it legal for analysts to accompany investment bankers who are trying to persuade companies to hire them to help them come public.

We think "Inside the Black Box" raises particularly troubling questions about the objectivity of analysts whose firms are underwriting IPOs. As Ilan mentioned last year in his Senate testimony on the IPO market, there's a strong likelihood that part of the reason investment banks would bring analysts to sales pitches is to indicate to management that the sell-side analysts will generate favorable "research" on their company.

The fact that 80% of analysts surveyed said their success at generating investment banking revenue was important to their own compensation, and 44% said it was "very important," appears to call into question whether Wall Street firms are abiding by the spirit of the settlement.

The JOBS Act also required the SEC to study the idea of having small-cap stocks trade in non-penny increments. Doing so may actually turn out to be a good idea if it results in a longer-term focus for investors and management and more capital for companies. But one of the other rationales -- raising transaction costs for everyone including ordinary investors in order to juice "trading commissions that formerly helped to fund research analyst coverage" -- seems dubious in light of what we now know about the black box of research analyst coverage.

The impossible dream
In "Moneyballing the Financial World," Motley Fool co-founder David Gardner wrote that he dreamed of a day when every financial source tracks itself publicly and transparently. For David, an analyst's track record matters a lot to an ordinary investor who might be considering that analyst's opinion before buying or selling a stock. It's only common sense to insist on a track record for an analyst's investing recommendations, once you stop and think about it.

Alas, common sense ain't all that common, especially on Wall Street. After examining this study, we've learned that sell-side analysts are not incentivized to care terribly much about their track records, and are far more focused on pleasing their clients by maintaining good relationships with the management of the companies they cover. That's fine, of course, but retail investors should keep this in mind the next time they hear a Wall Street analyst increase or decrease a price target on a particular stock.

In the end, we suspect that sell-side analysts won't be taking up David Gardner's challenge to track their forecasts and recommendations. Under the current circumstances, why would they bother? We greatly encourage all investors to read "Inside the Black Box." You'll never look at a Wall Street analyst quite the same way again.