Illustration about moneyEkaterina Panova
Have you been duped by an investment scam? If you have, blame it on your brain.
We are hard-wired with a "coping mechanism" by which we don't think horrendous things – such as being taken in by a financially devastating investment fraud – could happen to us, says Pat Huddleston, a former Securities and Exchange Commission enforcer.
"The mere fact that when we read about an investment scam we're tempted to chalk it up to the gullibility and the stupidity of the victims is a symptom of a cognitive bias," and we're not aware of that hidden mental process, says Mr. Huddleston, whose book, The Vigilant Investor: A former SEC enforcer reveals how to fraud-proof your investments, is being released this month. Read a book excerpt here.
"Nobody likes to feel vulnerable so when we read about something horrible happening to people ... our minds want to separate us into a category of people to whom that could never happen," Mr. Huddleston says in an interview.
The problem is that people who think they won't ever be a victim of a financial fraud then won't take precautions to ensure it doesn't happen, he says.
But if people are aware that their brains play this trick, they can use that to their advantage to protect themselves as they invest their hard-earned cash, he explains.
Mr. Huddleston, a lawyer, spent the early 1990s as enforcement branch chief at the SEC and he watched countless individuals lose their life savings. At his law office in July, 2006, an elderly investor who had lost everything to a fraud complained bitterly that Mr. Huddleston wasn't doing anything to prevent fraud. That hit Mr. Huddleston hard. Soon he started his own company Investor's Watchdog LLC which began with a database of scams and bad brokers. It investigates investments and stockbrokers. He also has a blog about investment scams.
Today, investment scams can be global and are cleverly hidden (recall YBM Magnex International, which originated in Budapest and was a stock listed on the Toronto Stock Exchange.) Or they can involve a financial adviser who is capable of gaining people's trust (Bernie Madoff in the U.S., Earl Jones in Canada).
Investors need to investigate advisers and investments with the idea that they're looking for fraud, Mr. Huddleston says, and then be happy if they don't find it.
Choosing an adviser
Start with who you choose to help you invest your nest egg, and realize it requires more scrutiny because the consequences of failure are so dire.
"With a house painter or a plumber, it's one level of mistake, but with somebody who's handling your nest egg, it's a whole different level," he says.
Investors need to do their own research and "make that call and find out if they are registered to sell you investments," he says. Do this even if the person you choose is a respected member of your family.
Be mindful of fraud
Fraud artists are clever and they won't promise you the moon, he says, but they'll promise you a decent return of 4 or 5 per cent. "Things that look perfectly legitimate can be fraudulent," he says. If the person gives a "guarantee" or a "personal guarantee" or says there's "no risk" then it's likely a scam. Also, be wary if "someone seems to have the perfect product for you," he says. "Scam artists are in the business of giving you exactly what you want."
Watch out for the elderly
The elderly often aren't as critical as they age, so baby boomers need to take care of their aging parents and have the dreadful "money talk," he says. Alert your parents to fraud, ask about their broker or adviser, let them know they're often a target, and show them stories in the news. Make sure their adviser is registered, talk about power of attorney with them, and ask whether their adviser has ever borrowed money, given them large gifts, asked to be part of their will or offered to be their executor. Get the name of their adviser and do some investigation.
Get educated about scams
"Part of becoming a vigilant investor is reading about these things, learning about how these scams operate," Mr. Huddleston says. That way you might recognize one if someone is trying to defraud you. And if you find something fishy, alert the regulators. "Ordinary investors, if they learn what to look for, can be a big solution to this problem. They can help the investigators [find scams]"