Smelling a Rat: Tell-Tale Signs of Fradulent Schemes

A recent story in The Star highlighting 'the future richest man in the world' setting up shop in Malaysia is just the latest example of people getting excited by schemes promising easy money without risks. These schemes keep cropping up even though investors keep getting burned.

Maybe the people and investors involved are different but the same type of schemes never fail to attract participants, not only in Malaysia. It just shows that many people still think that there is a way to get rich without hard work or being extremely lucky.

People generally want  high returns without any risk. That is why Bernard Madoff was so successful in the US until his scheme unravelled. He offered fixed returns to his investors. Apart from that, investors also tend to gravitate towards investments that are currently hot.

Realising this human weakness, fraudulent schemers will always tailor their offerings according to what people want. For example when gold was riding high, there was a number of gold based schemes, which have collapsed spectacularly. 

A few years ago in Malaysia, there was an IPO based scheme that managed to lure many prominent people. It ended with the operator absconding with the money and still not caught till now. Then,  palm oil based schemes cropped up and recently property based investments.

While gold, stocks, palm oil and property are legitimate investments, they are subject to volatility and nobody can guarantee that you can make money all the time from these investments. These get rich quick schemes offer good returns without volatility.

The MLM business is also a legitimate business, but in a normal MLM business, you really need to work hard and promote and deliver products to customers to make money. Just like any other business.

The first thing that we need to realise is that there is no such thing as a free money. In order to make higher returns, you will have to take some risks and accept volatility over a period of time.

In the wake of the Bernard Madoff and Allen Stanford cases in the US, Ken Fisher, a famed investment manager and writer, wrote a book called How to Smell A Rat.  He basically underlined five signs of financial fraud.

It contains valuable information. Unfortunately, this is the type of book which is read by people who are already careful with their money, but those who actually need it the most will not.

It's not that difficult to spot a get rich quick scheme (apart from a huge self promotional billboards).  Here are the five signs given by Fisher and a few others I gathered from other sources.

1.  Your advisor/scheme has custody over your assets.
If you provide the money to the organiser to invest and the person has custody over the assets, then serious problems could arise. In a unit trust scheme for example, the party who has custody over the assets is the trustee, and the job of the management company is to make investment decisions. If the organiser of an investment scheme also holds you money, there is a risk that you may not see your money again.

2.  Returns are high and consistent.
It is simply not possible to provide high returns of investment in a consistent basis (for example by providing fixed returns). You can get high returns over time but you have to accept volatility, meaning that you may lose money for a few years, generate high returns in some years and get no return in other years.

3.  You don't understand the investment strategy.
Not understanding the investment strategy is one thing but when the promoter of the scheme also don't really understand and cannot explain it properly, then stay far away. An investment and its returns, such as stocks, property and business, should be easily explained and understood. Once people start using fancy and complicated terms, there may be rats around.

4.  Benefits of exclusivity and membership, which does not affect investment results.
Some schemes will say that the membership is limited and only open to certain people only. So they will tell you that you are lucky to be selected. Basically this has got nothing to do with the investment results. Don't get distracted.

5.  Investors don't do their own due diligence but instead trust an intermediary.
Instead of finding out and researching about the scheme, investors are asked to trust the person promoting or recommending the scheme to them. Investors should always check and research and investment and if they cannot understand it, get the advice of an expert.

 6.  You have to recruit down-lines to obtain stipulated returns.
You should never have to recruit anybody in an investment scheme.  You invest money, accept the risk and either obtain profits or losses. Down-lines are only for an MLM type business. Beware of the money schemes posing as a genuine MLM business.   

7.  No approval from the authorities.
Many of the suspect financial schemes don't have approval from BNM to collect money from customers while some MLM based schemes just don't have the licence to conduct an MLM business. A simple check on whether they have the necessary approvals would save you a lot of trouble

8.  Difficult to contact the main organisers of the scheme.
While you can easily contact the agents, intermediaries, promoters or purported branches, you find it difficult to nail down who is actually running the scheme. Branches can close down in an instant and some of the intermediaries might not even know that they are collaborating in the fraud.

Investing in a business or instrument should be simple to explain and understand. You invest money at a certain level of risk for the probability of obtaining returns. The keyword here is probability. There are no such things as guaranteed high returns or shares that will always go up. When you hear the word guaranteed or fixed and high in the same sentence, then you can be sure that there are rats around.

Note: There are people I know who go to great lengths to expose these types of schemes. I admire their courage. I don't have time to do this. I tried once some time ago but people usually don't listen and you will end up making enemies. If people ask I will give my opinion. This article is just an indirect way of doing my part.