Almost anyone can be a victim of financial fraud. But, not everyone knows how to recognize or prevent it, and even the term itself can be a source of confusion. Financial fraud encompasses a wide range of illegal activities. For anyone with a stake in the financial markets, a basic understanding of these frauds can prove invaluable.
Types of Financial Fraud
1. Securities Fraud
Otherwise known as stock fraud or investment fraud it generally involves the deception of investors or the manipulation of financial markets. Three common forms of securities fraud are insider trading, accounting fraud, and misrepresentations. Insider trading entails the illegal trading of securities by those who have learned valuable information not made available to the general public. Accounting fraud takes place when a company maintains inaccurate books or otherwise purposefully disseminates false information about the company’s financial status. Misrepresentations, on the other hand, consist of presenting misleading or untruthful information to an investor or to the public.
2. “Pump and Dump”
Also known as market manipulation schemes are yet another threat to investors. These types of financial frauds often occur with stocks that do not have a lot of trading volume. The aim of the fraudster is to artificially inflate or “pump up” the price of the stocks by aggressively recruiting investors using deceptive sales tactics or false information or rumors. Then, once share prices have reached a high enough level, the fraudsters sell (“dump”) their shares at a significant profit, causing the stock to tank. Such schemes are not only responsible for some billion in losses annually; they also have the ability to shake investor confidence.
3. Penny stocks or Low-Priced stocks
It has once been said that those “who look to get rich on penny stocks may find themselves penniless.” It been observed that penny stocks has a long history of fraud, yet it attracts new investors every day. The term "microcap" refers to companies with low or "micro" market capitalizations. These are companies typically ranging between $50 million - $300 million in market capitalization. Many microcap companies don't file reports, so it's tough for investors to get all the facts. Lack of reliable information makes it easy for investors to be seduced by scam artists. What makes micro-cap stocks very popular is the false feeling of big time investing that comes from buying more shares with less money. These companies are like shooting stars; they can fizzle out just as fast as they can light up the sky thus making them ripe for securities fraud.
4. Ponzi schemes
Pyramid schemes or ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns for early investors by acquiring new investors. This is similar to a pyramid scheme in that both are based on using new investors' funds to pay the earlier backers.
5. Affinity Frauds
Target members of large groups, such as the elderly, or religious or ethnic communities. The fraudsters involved in affinity scams often are – or pretend to be – members of the group. They may enlist respected leaders from the group to spread the word about the scheme, convincing them it is legitimate and worthwhile. Many times, those leaders become unwitting victims of the fraud by helping to promote fraud schemes. Investment fraudsters will exploit victim’s age, religious, ethnic, or professional identity to gain their confidence knowing that it’s human nature to trust people who are known and from same community. These scams exploit the trust and friendship that exists in groups of people. Because of the tight-knit structure of many groups, outsiders may not know about the affinity scam.
6. High - yield investment scheme
We often see internet advertisements that guarantee high-yield investment programs. These are unregistered investments typically run by unlicensed individuals – and they are often frauds. They promise of incredible returns at little or no risk to the investor. In reality, these high-yield investment programs are fraud schemes, and the organizers aim to steal the money invested.
7. Internet Fraud Scheme
In today's fast paced world internet is a useful way to reach a mass audience without spending a lot of time or money. Through creating a website, spreading online message or social media platform it has become easy to reach large numbers of investors with minimum effort. It's easy for fraudsters to make their messages look real and credible even many a time hard for investors to tell the difference between fact and fiction. If an investment promotion grabs your interest, get a thorough research of the opportunity even before providing your personal details. If not careful many a time it can lead you into an investment fraud.
Bottomline on Financial Fraud
Financial fraud comes in many different forms, and often creates a thin line between competitive and fraudulent practices. Don’t believe everything you are told when an investment scheme is proposed. Take time to do your own research on the investment’s potential. Check with a trusted financial advisor, your broker, or an attorney about any investments you are considering. Identify the warning signs if the offer sounds too good to be true. Regulation and enforcement bodies are most concerned with maintaining a disciplined trading practice that encourages people to invest in the markets without any fear of defrauded.Always follow a thorough due diligence process that uncovers and educates you to recognize fraud when you see it.