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Saturday, 21 November 2009

Transcript: How To Spot An Investment Scam

This is a transcript of David Kuo's recent podcast with Jonathan Phelan of the FSA. Here they talk about common investment scams and how to avoid them.

David:

This is Money Talk, the weekly podcast from the Motley Fool. I'm David Kuo, and today I'm joined by Jonathan Phelan, Head of Retail Enforcement at the Financial Services Authority, and today we'll be having a look at scams. Welcome to the Money Talk podcast, Jonathan.

Jonathan:

Hi David.

David:

Right, as obvious as it may seem to a lot of people, what exactly is a 'scam', and is money always involved in a scam?

Jonathan:

Ultimately money is involved, but really a scam starts with the con, and con doesn't stand for con, con stands for confidence, and they gain your confidence by sweet talking you, taking an interest in you, your family, your wife, your kids, your car, your job, that sort of thing, and you could have many many conversations or a few emails before they even ask you to part with money, but ultimately they're after you, your personal details, and ultimately your money or a way of getting to money.

David:

So when somebody is contacted by a scamster, what are the things that they should be looking out for? -- what are the things they should be aware of?

Jonathan:

I think the first thing to be aware of is, why has this guy contacted me? People don't do that out of an abundance of benevolence, they contact you because they're trying to sell something, and sometimes you've got a legitimate salesman; in the investment world that we're concerned with at the Financial Services Authority, people shouldn't cold call, so you should have invited that call, so the first red flag for you is, where you get a call out of the blue from someone you didn't expect to call you, a legitimate broker or a legitimate advisor shouldn't be calling you out of the blue -- that's a red flag to start off with.

David:

But he's offering you something, his job is to sell, and what is so wrong with that? I mean, sometimes, you know, I quite welcome people coming up to my door and knocking on it, and saying, "I've got some dusters, I've got something to sell you" -- what is so wrong with that?

Jonathan:

There's absolutely nothing wrong with it, if he is a legitimate, honest broker, if he's authorised by the FSA, but as I say, an authorised legitimate honest broker won't be calling you out of the blue, they won't be knocking your door selling shares instead of dusters.

David:

Sometimes those shares do turn into dusters, don't they?

Jonathan:

Yes indeed, and that’s the problem we're trying to address, yes.

David:

OK, so in your experience, what are the kind of people that normally get targeted?

Jonathan:

Well, one of my biggest remits is share fraud, often known as "boiler room fraud". With share fraud, the most likely victim there is someone who's got a long history of investment, they're not the naïve investor, they're actually the experienced investor. The profile of your average victim for a share fraudster is over 50, male, ten plus years' worth of share buying experience.

David:

So, what you're talking about is a particular group of people that these scamsters will be targeting. Now, how do they get hold of that information in the first place? How do they know you are a 50 year old and above, that you have got investments and that you are male?

Jonathan:

There's two principal ways of fraudsters getting hold of your details, with share fraud anyway. First of all, as a shareholder your name will be the company's shareholder list, so if you invest in xyz plc, a perfect legitimate company, you'll be on its shareholder list, and that shareholder list is, by laws of the land, freely available, and if it gets into unscrupulous hands, they can phone down the list of shareholders, it must be a mainly sort of losing game, as you phone thousands and thousands of people, but occasionally somebody will fall for it, that's one way.

The other way is they might send you an email and invite you to receive a bit of research on some shares. It might not look like a sales pitch first of all, it might look like a perfect piece of benevolence -- "I want to help you out, I’ll give you some research notes on a share", and you might, by replying to the email, give them your email address of course, and they're away, they can contact you by further email, or if you give them your phone number, they contact you again, and sell.

David:

So right at the very beginning, it doesn't feel much like a scam, does it? I mean, if somebody is offering you a research report on a company, that doesn't really feel much like a scam to the victim?

Jonathan:

No, that's the important thing, because you don't feel you're being scammed. A lot of people say, "Well, why would these people give their money to someone they've never met before?", but the reality is, for the first three or four phone calls, they're not being sold to, it feels like there's a guy who really cares for your financial health, as it were, and they're looking after you, so you're drawn into a con, confidence trick.

David:

So, let's have a look at some of the typical scams, I mean one that will be, I think, at the forefront of a lot of people's minds is pyramid selling, particularly in the case of Bernard Madoff. Now, how do these pyramid schemes work? A lot of people have heard about them, but they say, "What exactly is a pyramid or a Ponzi scheme?"

Jonathan:

Well, they can work in different ways, I'll illustrate it with one fairly typical example, which might be that I know someone who says, "You're only getting one and a half percent saving interest in your bank, that's a bit rubbish, isn't it? Why don't you give it to me and give me £1,000, and at the end of the year I'll give you £1,500" It sounds fantastic, so you give him the money, and then he goes to someone else, or I tell my friends, and they give him £1,000.

David:

So far, I'm actually sort of into this deal.

Jonathan:

Yeah, absolutely.

David:

Sounds good to me, yeah?

Jonathan:

Yeah, I might go away with a bit more money in my pocket if I do this well. What actually happens, though, is when the first guy asks for their interest, their £500, or everything back, their £1,500, the con man, the fraudster, just takes it, not from any investment return he's made (he's not that good), he just takes it from a new investor, so the new guy who gives him £1,000, he takes that £1,000, gives it to the first guy who gave him £1,000 a year ago, so he's robbing Peter to pay Paul.

That con can go on for quite some considerable time, everyone gets very excited by the 50%, 100%, 200% interest they're going to make that he's promised, everyone gets very excited; the more people that give the money to the scheme, the more he can pay off the first people in the scheme, and if he's really good, he will convince the first people in the scheme to leave their money in the scheme to earn more interest, so he doesn't even have to pay them back, so the pyramid builds and builds and builds, but it will, it definitely will fall over at some point.

David:

So is the lesson there to be the first guy to actually sign up for it then?

Jonathan:

The lesson there is to not put your money in at all!

David:

It strikes me that the guys who actually get in early are the ones who are going to make the most amount out of it.

Jonathan:

No, because what actually happens is, normally the con man is good enough to convince the first guys to leave their money in, and that normally happens, they might take out a bit of interest, but essentially they leave their money in as well, and what everybody sees is a paper profit; we see the conmen, they'll give a fancy spreadsheet, they'll open up a laptop, show a graph, and say, "That's what your money was at the beginning" (pointing to the low point of the graph) "and that’s what your money is now" (pointing to the high point of the graph), it looks fantastic.

David:

That's called the stock market index, isn't it?

Jonathan:

It's called a con, in this case -- so something quite different.

David:

Right, so if you know that these things go in, what is the FSA doing about it? Why aren't you clamping down? Why wasn't Bernard Madoff found out for what he was doing? Surely people must have known?

Jonathan:

Well, I can't talk about that particular case, because that's in a different jurisdiction, and there are different law enforcement agencies involved in that. The FSA does come across these sort of scams, we do go in, we freeze the assets, we restrain the activity, which is a lovely technical legal term, but it's essentially involving a judge telling the individual, "Don't do this again, otherwise you're in contempt of court, and you can go to prison."

The most important thing that we can do is freeze the assets, we make the individuals bankrupt or we put firms into liquidation, and we try and get as much money back for the investors as we can, but I'll jump straight in on myself there, and say, you often lose most, if not all, of your money. We do our best to get that money back, but we often find it's been spent by the conman.

David:

So typically, how long does that take? -- from the investigation to somebody getting something back out of their investment?

Jonathan:

That's one of those piece of string answers, I'm afraid, or questions. It can take some considerable time, because there is a court process, because there is an investigation process, it's a piece of string answer, because if the money's in his local bank account, local bank bank account, that's grand, we can go and grab it; if it's gone into ten different foreign bank accounts and it's gone into buying Ferraris, Porsches, mansions and helicopters, then we have to appoint somebody to call all of those assets in, sell all those assets, draw as much money in as possible, and get it back out to investors. So it can take quite a while.

David:

Well, apart from pyramid selling, at this time when lots of people are facing redundancy, you quite often see posted on, well lampposts and most other places, "working from home" schemes, where people can sign up and they can stuff envelopes and things -- that is another scam, isn't it?

Jonathan:

It's outside of the FSA's remit, it's not an investment scam, the FSA's involved in investment scams. I do meet very regularly with law enforcement officers from different agencies, I met last year with the assistance of the National Fraud Strategic Authority, the NFSA, who acts really to draw all law enforcement agencies together that deal with fraud; met last year, we talked about scams like this, yes that can be a scam, it's not always a scam, I have to be careful there, obviously because there could be some perfectly legitimate working from home opportunities, just like there are perfectly legitimate authorised stockbrokers, so by all means working from home, not always a scam.

If people want a bit of advice on where the red flag might be, the warning signs to look out for, it's where you're asked to part with money up front, and when I talk to my colleagues from the Office of Fair Trading, I look at this sort of thing, the NFSA, the City of London Police, the Serious Fraud Office, a lot of the hallmarks of all of these scams that we talk about is parting with money up front -- you get a letter or an email saying, "You've won the lottery in Canada -- send us £20 and we'll send you your winnings” -- thousands of people might send £20, that's a lot of money for the conman, nobody's won the lottery – well rarely!

David:

One person does, don't they?

Jonathan:

Well, of the people contacted by the conman, I'm not so sure, well the conman isn't necessarily going to send any money to a winner, that winner's probably been contacted directly by the Canadian lottery or whatever, and that can be the con. Working from home, again talking to colleagues at the OFT, City of London Police, SFO and so on, yes the con with working from home can be, "We'll send you a starter pack if you send us £50", you know -- you send the £50, you never see your money or the starter pack, or you get five brown envelopes or something.

David:

So, in your experience, I was recently contacted by somebody who said he would make me a male model, and I had to put some money up front – does that sound like a con to you?

Jonathan:

It may be that the story's a con there, but I don't want to cast aspersions on your abilities as a male model! If you send money up front, that is a classic hallmark of a potential con, I can't say that every phone you make where someone says, "Send us some money" is going to be a con, that would be wrong.

David:

But frame your answer in the context of the way that I look at the moment, I do show some potential, I can see myself as a model for Abercrombie and Fitch, for instance, yeah?

Jonathan:

There's a limit to what I can comment on, I probably shouldn't go that far.

David:

Is this out of the remit of the FSA as well?

Jonathan:

It's definitely outside my remit, yeah!

David:

Now, can we have a look at boiler room scams, because this is something that interests I think a lot of the people at the Motley Fool, because we even have a discussion board dedicated for boiler room scams. Can you explain to us how that actually works, a boiler room scam?

Jonathan:

It's got all the hallmarks that I've mentioned so far, you get a phone call out of the blue from someone who sounds like the real deal, sounds like a proper stockbroker; if you're going to be a victim, it's like likely that you've got shareholding experience, and you as a shareholder feel that this guy sounds just like the real deal, sounds just like a stockbroker, they never sell on the first call, the second call, even the third call -- they befriend you, they ask about wife, kids, family and so on, and they will often mention a couple of shares that they think might be worth a punt, they don't even try and sell you at that stage.

When they phone you the next time, they'll mention one of the shares that has done well, they'll forget to mention the one that didn't do so well, they'll mention that you can then go and look that up and think, "Ooh, this guy not only sounds like the real deal, but he gave me a piece of advice, if I'd have taken it, it would have gone up."

He's gained your confidence, he's a conman though -- he's called you out the blue, a proper stockbroker shouldn't do that, you've not invited him to call, and ultimately, fourth phone call, fifth phone call, he will try and sell you. The average investor that we hear from has lost a few thousand pounds from dealing with that conman; the average investor's dealt with him four or five times, so ultimately they've lost about £20,000. We hear from about 3–4,000 people a year who've fallen for that con. That's essentially how it works, the red flag is you've got that call out of the blue.

David:

So are these companies registered with the Financial Services Authority?

Jonathan:

No, these share fraudsters, they're often based abroad, because they know if they're based in this country, we'll go out and get them, we'll close them down, make them bankrupt, put them into liquidation, get the money off them, so they base themselves abroad, outside of our jurisdiction where we haven't got the power to go after them, so we have to focus our attention not on taking the criminal away from the victim, but on taking the victim away from the criminal, and that's why we're speaking to you.

David:

Have you practised at home before?

Jonathan:

Indeed.

David:

It’s very good!

Jonathan:

There are two ways of approaching law enforcement, and quite often the clamour, the call is for law enforcement officers to take out the criminal, and that's great, you can put the criminal in prison. I often say, if you want another line I've practised before, I often say that, when it comes to share fraud, shareholders, they're on a register, people know that they own shares, people therefore know that they've got money, to me that's like they've got a pot of gold in their window, OK?

Now we can take out the criminals as law enforcement agencies, imagine taking out the burglar who wants to get that pot of gold in the window, they take out the burglar, but another burglar will see that pot of gold, and another burglar will, and another burglar will, so you can take out the criminal but another criminal, burglar will take their place; you can take out a share fraudster, but another one will take their place.

From my point of view, it might not sound as great, not putting someone behind bars or whatever, but when they're outside the jurisdiction, you can't anyway, I can't arrest anyone in Spain, so the most important thing for me is to tell the victim how to take that pot of gold out of their window, to remove the temptation. If all potential victims can look after their money, it doesn't matter how many criminals try and get it, the money is safe, and that’s the most important thing for me, from a law enforcement point of view.

David:

So are you saying that anybody that deals with a company that is FSA registered is therefore going to be 100% safe?

Jonathan:

If you deal with an FSA registered company, you've got a few layers of protection -- you've got an ombudsman scheme, you've got the FSA itself supervising the firm, and you've got a compensation scheme, if the firm that you're dealing with gets into trouble, so there are some layers of protection. We all know that not everything is 100% safe, so I'm not going to give any guarantees to say things are 100% safe; people have to be aware of the advice that they're being given, they have to be aware that sometimes the advice might not be absolutely fantastic, but there are compensation schemes and ombudsman schemes to deal with that, with an authorised firm.

I think the important thing from a share fraud point of view is that these share fraudsters, they're not authorised by the FSA, they go outside our jurisdiction to stay as far away from the FSA as possible, because they know what we'll do to them if we can get them, so they go as far away -- now, if you deal with one of those, you've got no protection at all, if you send that guy £4,000, you lose £4,000, there’s no ombudsman, no compensation scheme, no victim support.

David:

That's terrible, isn't it?

Jonathan:

It is, it is, and that’s why we do as much as we possibly can to keep the victims away from the criminals and the criminals away from the victims.

David:

You're using that line again?

Jonathan:

I am indeed.

David:

It's very well rehearsed, that line! Right, can we talk a little bit about "pump and dump" -- what do you understand by pump and dump, in the context of investing?

Jonathan:

You might need to tell me what you mean by pump and dump, but people have different meanings for it.

David:

I mean, people who contact you trying to sell you shares in their company that they have already bought, and what they then do is to try and get as many people afterwards to buy the shares, consequently they are pumping up the share price, after which it's gone up, they will dump the shares, and of course the last person holding the shares will be the person that's carrying the very expensive shares, and because the share price is never worth anything in the first place, the share price falls and of course the last person standing is the last person that makes the biggest lost. Now, that is what I understand by pump and dump, so what can the FSA do to try and prevent things like this from happening?

Jonathan:

It's a very similar piece of advice to the one I've already given, again dealing with an unauthorised firm, that's a common feature of the share fraud that we've already talked about, they might be selling an existing share, sometimes share fraudsters are selling a non-existent share, sometimes they're selling Regulation S stock from the USA, sometimes it's a pump and dump arrangement. It's all the same thing, I think, going back to the classic line, take the victim away from the criminal …

David:

Third time now!

Jonathan:

… yeah, third time now, I'll keep doing it -- the important thing is, I think you can overcomplicate it by describing all these schemes? – pump and dump is one, pyramid scheme is another, classic hallmarks, what's the red flag -- the red flag is the call out of the blue, the red flag is you're not expecting this, what do you do? -- that's easy as well, hang up the phone, slam the door, don't respond to the email. Pump and dump, you've described perfectly well, I don't need to redescribe it; what do you do about it? -- hang up the phone, slam the door, don't answer the email.

David:

What about people who have been scammed? -- I mean, what kind of recourse do they have, apart from going to the FSA and just whingeing, and saying, "I've just lost some money"? I mean, what are the various things that people can do? You've already mentioned things like the financial ombudsman scheme, you've also mentioned Financial Services Authority, but if people have lost money, is there any chance that they can get the money back by contacting these people, and somehow trying to recoup that loss?

Jonathan:

By "these people", you mean the conmen?

David:

By the conmen themselves, yeah.

Jonathan:

Conmen are often out of reach, out of jurisdiction, so I've not, I don't think, come across anyone who's successfully managed to get their money back from say an overseas boiler room share fraudster. Yes, contact the FSA -- people don't do that, I would like them to, the more intelligence we get, the more we can do, and your discussion boards are a fruitful source of information for us, we go to those discussion boards to see what activity's going on in the share fraud market.

Often we're a little disappointed that people have gone to the trouble of discussing them on the discussion board, and not also telling us, it'd be great if they told us, because there is a fruitful source of information. If people told us when they'd been approached by one of these conmen, particularly if they tell us where they've been asked to send the money, if they've been asked to send the money to a bank account with a sort code and account number, then we can trace the money, and that’s really really useful intelligence for us.

David:

Can I just ask you one other question before we end, and that is, why are so many of these boiler rooms situated in Spain?

Jonathan:

Well, they're not all, or so many in Spain, Spain is a fairly common jurisdiction.

David:

Is it because the weather is quite nice over there?

Jonathan:

Well, there is a lifestyle to it, our top three are USA, Switzerland and Spain, not necessarily in that order, the orders switch from time to time in popularity. What they're looking for are places with the right kind of timezone to call into the UK, with an English-speaking population, of course in Spain, they don't speak English, but they have quite a large ex-pat, they can convince people to go and get on a plane and go over and live in Spain for six months, so that's fairly straightforward.

They can do that around Europe, and of course it's straightforward in the USA, they've got English-speaking, and essentially that's it, they've got to have the right timezone, English-speaking salesforce, as it were, or conmen, as I prefer to call them, and they call into the UK and try and rip you off.

David:

So why don't you work more closely with the people in Spain, with the authorities in Spain, to try and close these fraudsters down?

Jonathan:

The effort is as wide as that, last November I met with, in fact the FSA chaired a boiler room conference, which called together …

David:

Did you invite all the boiler room fraudsters along as well?

Jonathan:

That would have been nice, because we might have arrested a few, but I don't think they'd have taken up the invitation, but we had law enforcement agencies from Spain, from 80, well there were 80 or so people in the audience from many jurisdictions from around the world, I think probably all continents were represented at that conference, and it was a very useful conference, a rare conference in law enforcement terms in that there's a global fight and a co-ordinated global fight against share fraud, it is a big problem.

David:

So that is good news for investors in the future, isn't it? -- I mean, if all of you guys just get together and sort of clamp down on this kind of fraud sting going on?

Jonathan:

I'd love to say, "Yes, that's fantastic news for investors", but let’s go back to victims and criminals, the law enforcement people traditionally were about arresting the criminals, the criminals know that, and they go outside jurisdictions, they make themselves as scarce as possible, often all we’ve got is a telephone line, they give false addresses on their literature or websites, so you’ve just got a telephone line and they move very frequently, so even with the best co-operation in the world from foreign law enforcement agencies, taking out the criminals is one of those tasks that is not going to give investors that much comfort, so I’m not going to give investors that much comfort from the point of view of taking out the criminals; we do what we can, and we do a good job, I think. The most important thing, though, is taking the victims away from the criminals, and helping people understand that, if you get a cold call out the blue, what’s the answer? – slam the phone down.

David:

Yeah, well I think that's a good point in which to end, so as the sands of time slip through the egg timer of enrichment, we have to bring this podcast to an end. That was really cheesy, wasn't it? But I end each podcast with a quote, and today's quote I actually found, I think sums up fraudsters and con merchants quite nicely, it says: "Tell a man that there are 300 billion stars in the universe, and he'll believe you; tell him a bench is wet, and he'll have to touch it just to be sure" and I think quite often people are contacted and they just think, "Well, maybe I might not be the person that's going to be conned", and they just fall for it. Thank you Jonathan, for joining us today, I hope you have had as much fun as I have.

Jonathan:

Indeed, tremendous, thank you.

David:

And if you have a comment about today's show, you can post it at www.fool.co.uk/money-talk/. If you have a suggestion about future shows, and if you have any scams that you want to alert us to, email moneytalk@fool.co.uk.

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