The Number of Investing Suckers Is Endless

Bernie Madoff made the other investing hucksters seem penny ante. It's still surprising how many fraudsters prey on investors. More surprising is the seemingly endless supply of willing victims.

The schemes are primitive. It's amazing anyone would fall for them. Yet, a review of some of the litigation releases issued by the SEC this past week (!) tells a very different story.

In SEC v. Jonathan R. Curshen, et. al (Litigation Release No. 21862), the defendants are charged with pumping up -- then dumping -- the shares of a sham company without significant assets or operations. The stock was quoted on the pink sheets (which, in itself, is a red flag). By using a false media campaign, and with the alleged assistance of an attorney who issued a fraudulent opinion letter, the defendants made profits of over $7 million.

While this conduct, if proven, is indefensible, the gullibility of the investors who fell for it is equally staggering.

Lessons learned:

• Don't buy penny stocks.
• The expected return of any individual stock is the same as the index to which it belongs, but with significantly increased risk.

The Amish are a pillar of honesty and integrity. It was particularly disturbing to learn they are not immune from "affinity fraud" perpetuated by one of their own.

In SEC v. Monroe L. Beachy (Litigation Release No. 21856), Mr. Beachy, a 77-year-old Amish man, is alleged to have raised more than $33 million from 2600 fellow Amish investors through the sale of "investment contracts." Mr. Beachy promised to purchase risk-free U.S. government securities, yielding higher than bank rates. How he could have achieved these excess returns is beyond me. He is alleged to have used the money to make speculative investments in high yield (junk) bonds, mutual funds and stocks. When he incurred the inevitable losses, he filed for bankruptcy.

Lessons learned:

• People who look, act, talk and pray like you, can abuse your trust;
• Higher returns means higher risk. There is no free lunch in the capital markets.
• "Risk free" (which is a misnomer) means U.S. government treasury bills and FDIC insured bank accounts.

In SEC v. Michael W. Perry and A. Scott Keys (Litigation Release No. 21853), the SEC charged three former senior officers at IndyMac Bancorp with securities fraud for misleading investors about its deteriorating financial condition. They are alleged to have issued rosy predictions in connection with a $100 million stock offering, without disclosing the deteriorating financial condition of IndyMac.

Lesson learned:

Protect yourself against this kind of risk by purchasing a globally diversified portfolio of index funds. Any one company can issue misleading reports. When you own thousands of stocks, this risk is effectively mitigated.

Finally, in SEC v. Neal R. Greenberg (Litigation Release No. 21852), a final judgment was entered against Mr. Greenberg, the former chief executive officer of a registered investment adviser. Mr. Greenberg (who did not admit liability) was alleged to have misrepresented the "safety, suitability and diversification" of a group of hedge funds, which were sold in many cases to conservative investors in or near retirement.

Lessons learned:

• Hedge funds are rarely suitable investments;
• Conservative investors need to be intensely focused on their asset allocation to insure they are not taking excessive risk.

There's an overriding message in SEC litigation releases:

I have never seen one involving an index fund or a registered investment adviser who recommends portfolios of index funds, passively managed funds or exchange traded funds.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

 

 

 

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Comments

[JoeWolfe]

12:58 AM on 04/09/2011

While I agree that penny stocks are fraught with fraudsters, I don't agree with your blanket statement of "don't buy penny stocks" as that is throwing out the baby with the bath water. There are methods the average investor can use to drastically reduce risk and find penny stocks that make for a very profitable investment. I wrote an article about this recently: http://ezinearticles.com/?Penny-Stocks:-How-To-Reduce-Your-Risk-and-Make-A-Lot-Of-Money&id=6116026

[SeanN]

09:54 AM on 03/05/2011

Great article, per usual. Dan Solin continues to point out the difference between investing and speculating. Investing means low-cost index funds from a shop that operates on a not for profit basis, like Vanguard or TIAA-CREF. Speculating means trying to time the market and is like playing craps at Vegas - you do it for entertainment value, not because it's a path reasonably likely to increase your holdings.

[George Lekatis]

06:28 AM on 02/25/2011

No, it is not surprising how many fraudsters prey on investors. It is not surprising that there is a seemingly endless supply of willing victims. There are so many investors that have no financial education and simply trust “experts” that almost always have not these investors in mind (there are so important conflicts of interests still in the market).

Schools must provide financial education. Investors also need to learn, and continue to learn every single day. Otherwise, they will continue to lose their money.

No, transparency (like the Basel II / III Pillar 3) is not going to help, unless we can understand what they are talking about. Disclosures are good for persons that have the financial knowledge (and time) to understand.

George Lekatis
http://www.risk-compliance-association.com

[CoachJM]

01:45 AM on 02/25/2011

Dan,

I got one for you.

The most "reputable" "investment banks" in the US knowingly securitized enormous quantities of fraudulently underwritten home mortgage loans, coerced the "ratings agencies" into giving them AAA ratings, aggressively marketed them globally, thereby cratering the world economy.

They were then bailed out by the US taxpayers' money (who, collectively, have suffered grievous material harm as a result of their fraud), though without their consent, and subsequently paid themselves record bonuses and recorded record profits, while contributing less than nothing to the health of the American economy or society. None of the perpetrators have been sentenced to jail (Bernie Madoff and the handful of insider trading convictees are "noise" in the scale of things) and have, at the extreme, paid nominal fines which are dwarfed by their ill-gotten gains.

Lessons learned:

- Using Neoliberal economic theories to guide governmental economic policy produces disastrous socio-economic results.
- With regard to the "financial services" industry, there is far too little regulation, rather than too much; enforcement of existing regulation is criminally negligent, and these parasitic financial behemoths who destroyed our economy should not be allowed to exist - by law.
- The business of government is NOT business - it's the well-being of the American people.

JM

[cassie reinara]

10:32 AM on 02/24/2011

This is why the Nigerian emails keep coming to US email accounts. Because they know there is an endless supply of ignoramuses to fleece. Wall Street and the Republican party operate on the same premise. What was that saying? "A sucker is born every minute..." If this wasn't the case, the Nigerian, Republicans and Wall Street would all be out of business.

[ynt]

06:24 PM on 02/23/2011

Greed makes people blind.

If it seems too good to be true, it probably is.

[cassie reinara]

10:34 AM on 02/24/2011

It's not blindness. It's stupidity. The two go hand in hand and unfortunately in the US, we have an overabundance of it. If we could harness it as an energy source, we could kiss foreign oil goodbye. Unfortunately, engines powered by stupidity have not been invented yet.

[lightningbolt]

11:56 AM on 02/23/2011

Invest in precious metals, durable goods, and land.  The stock market is a casino and only the well-connected can win.  I will not invest in the stock market unless it becomes completely transparent and mark-to-market accounting rules are restored.  Without mark-to-market accounting, a company's value is pure fantasy.  Gambling with fantasy numbers is even more risky and reckless than going to a casino.

[she343]

05:21 PM on 02/23/2011

and commodities aren't ? gold and others listed rise and fall on the greed and panic of investors--even if they can't go to zero-like some stock--they are manipulated by their own pump and dump players and under the table transactions are even easier

[Peter Combs]

12:31 AM on 02/23/2011

all good points to bear in mind...thanbk you.

Recently my office started getting calls from some guys pushing a "Penny" symbols WCOC (I think) it was a gold stock. went from 30 or 40 cents..leaped to over $2.00 and fell back the other day to 15 cents..classic "pump and dump"

We ignore ALL calls like this, 100% of the time.

[daveschwartz007]

09:46 PM on 02/22/2011

the truth is all investments over the long term are scams. Is the writer here being paid off by Vanguard? If you bought an SP500 index fund 12 years ago you are pretty much even too. The only way to make money is to time the market or be lucky(like with any gamble!) Timing is everything. Don't believe anyone nobody has your best interests like yourself! It does help to have money to invest when everyone is negative. If you started investing with Dow 9000 or SP800 you are already up 30%+ over last 18months and it wasn't popular to recommend buying things back then when the world was coming to an end according to all the experts who didn't see the crash coming from 2007-08! Listen to no one.

[Peter Combs]

12:39 AM on 02/23/2011

Agreed to a degree. You absolutely need to watch indicators on when to get out before corrections,

Vangaurd's NEVER time the market is BAD to rotten advice...we have a a dozen funds through them and closed them all out in May of '08..My FLagship Rep at Vangaurd tried to talk me out of it. I got back in April of '09, when things looked much better.

had I listened to them we would have lost a bundle

[KJN]

04:01 PM on 02/25/2011

"had I listened to them we would have lost a bundle" That is only partially true. I stayed all in during this time period with Vanguard funds. My portfolio of globally diversified index funds was down 32% at the March, 2009 low. Two years later this portfolio is up 65% for a +12% overall.

[SeanN]

09:45 AM on 03/05/2011

The scammers in the financial services industry hate Vanguard, which operates conservatively and on a not for profit basis. (During the financial crisis, all the major players in the financial services industry borrowed money from the Federal Reserve, with one exception - Vanguard.) They also hate passive management, because they make their money from trying to convince investors to engage in market timing, when anyone with a half a brain and some investment knowledge knows that's a sucker's bet.

[Linda from Deerfield]

08:24 PM on 02/22/2011

It does not seem to me that there is such a thing as a hedge fund that actually hedges. The idea of hedging against significant losses, at the price of significant gains, has appeal and ought to play a legitimate role, but as best I can tell, it is the case that the entire industry is misnamed.

[Peter Combs]

12:41 AM on 02/23/2011

You can hedge your own account...Hedge Funds nearly always nail their investors eventually, peope use them out of ignorance and greed,,,just like the folks with Bernie.