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MONEY MONITOR: Guarantees of low risk and high returns are too good to be true 
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Mon, July 27, 2009 


Whether it's a Ponzi scheme, e-mail or telephone scam, experts say every investment fraud case has the same red flags that were ignored by investors before handing over their money. 

The first and foremost is the guarantee of low risk and high returns -- a promise that cannot be made, said Patricia Bowles of the B.C. Securities Commission. 

The risk of investors falling for such promises is especially high when stock markets are volatile, Bowles said. 

"The scary thing right now for people is that because they have had bad experiences on the market they may be even more vulnerable to the high return promise because they are not consistently getting anything like that out of the stock market," said Bowles, director of communications and education at the BCSC. 

"You always have to watch for that, and its embedded in every piece of promotional material that's given to people that are lured into it." 

Another problem is so-called "affinity fraud," when investors follow their friends and family into an investment without doing their own homework. 

Bowles said it's a common characteristic in the recent fraud cases of Bernard Madoff, now in prison for masterminding a -billion Ponzi scheme, and Earl Jones, the Quebec money manager allegedly behind a -million plus Ponzi scheme in Canada. 

A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors rather than from any actual profit earned in the stock market or other investment vehicle. 

Such schemes usually offer abnormally high returns that other investments can't guarantee to entice new investors. But the scheme usually collapses because the returns require an ever-increasing flow of money from investors to keep the fraud going. 

The scheme is named for Charles Ponzi, who became notorious for using it after emigrating from Italy to the U.S. in 1903. He spent time in Montreal before applying the fraud in Boston. 

In such frauds, the victims are often friends, family or members of the same organization. 

"It really plays on your fear of keeping up with the Joneses and gives you false trust because your friends are in it," Bowles said. 

Katie Walmsley, president of the Investment Counsel Association of Canada, said the starting point with any relationship involving fraud includes building trust. 

"A scam artist will often recruit a trusted member of a community who is made to believe there is wonderful opportunity with high returns and low risk," Walmsley said. 

She said other members of that community then fall into the same trap by following the leader and skipping important steps, such as finding out whether the investment adviser is registered. 

Jones, for instance, was not a registered adviser. That means it is nearly impossible for regulators to track activity or handle complaints from investors that might be made against the adviser. 

Walmsley said other questions investors need to ask when dealing with an adviser is whether they conduct third-party audits of their activities, with what firm and how often. 

"As publicly accountable firms, they should have a third-party audit," Walmsley said. 

She also advised investors to ask their local securities commission if any complaints have been filed against the adviser. 

When that's done, Walmsley also suggests doing a quick Internet search of the money manager and seeing what comes up. 

Also, if the adviser asks for cheques to be made out to them personally, instead of a financial institution, beware. 

"In Canada, there is a third-party custodian, such as one of the major banks, that holds the assets." 

Walmsley said the warnings for investors are always the same, but scams continue. 

She believes that is due in part to a busy society, where people have time constraints and don't review documents as closely as they should. 

Investors are also often too emotional or subjective about their money, when they should be more objective. 

Lastly, investors have to trust their instincts when it comes to handing over their cash. 


Avoiding investment fraud 

The Investment Counsel Association of Canada has an investment firm selection checklist to help investors spot potential fraud. Key points include: 

- Is the individual or company whose business is trading, underwriting or advising in securities registered with provincial securities commissions? If so, which services are authorized? 

- Does the individual or company use an independent custodian such as a Canadian chartered bank, to hold client assets? 

- What are adviser's credentials/ qualifications? 

- Potential Red Flag: Any adviser/firm guaranteeing a high rate of return at zero or low risk. 

- Has the firm been audited (by a reputable auditor) and to what level of compliance?