WASHINGTON — Researchers say people are more susceptible to investment scams such as Ponzi and pyramid schemes after going through adverse life events — a job loss, foreclosure or some other financial hardship.
So it's not surprising that many experts think the nation's deepening economic crisis is creating a whole new universe of potential scam victims every day. In fact, it makes perfect sense.
An estimated $6 trillion in wealth has been lost since the housing bubble burst. Mutual funds suffered $191 billion in losses in January alone, according to the Investment Company Institute.
And the average 401(k) account fell 27 percent from about $65,000 to about $48,000 in the year ending in December 2008, according to the Employment Benefit Research Institute.
As more consumers look to shore up these and other dwindling assets, regulators and watchdog groups are warning them to look out for foreclosure rescue schemes, shady debt settlement firms and investment scams touting profits that seem too good to be true.
"Nothing concerns me more than the cold hard reality that hardworking Americans are being swindled," Sen. Jay Rockefeller, D-W.Va., said last week at a consumer protection hearing of the Senate Committee on Commerce, Science and Transportation. "The more people in distress, (the) more people want to take advantage of people in distress. It's really quite stunning."
High-profile investment schemes have received national attention recently due to the fraud charges against financiers Bernard Madoff and R. Allen Stanford, who are both accused of running multibillion-dollar Ponzi schemes disguised as legitimate investment firms.
Ponzi schemes, using promises of quick profits, collect money from new investors to pay supposed returns to other investors. Pyramid schemes focus on recruiting new investors to make money. After paying an "enrollment fee," the new member earns money by getting a cut of the enrollment fees paid by people they've recruited, who must in turn find new participants to pay the fee.
Both schemes play on investors' greed and trust. And older people, who've amassed more savings, are the typical victims of choice.
However, people who've cashed in their stocks and 401(k)s due to recent market losses also are vulnerable, said Fred Joseph, the president of the North American Securities Administrators Association.
"Two or three months later they'll decide, 'Now I need to do something with this pot of money I have.' That's when they're most at risk because that 8 percent, 10 percent, 20 percent (return on investment) sounds really good and they're very susceptible to getting conned into something," Joseph said.
Joseph, who's also Colorado's securities commissioner, said that fraud investigations are up 10 to 15 percent this year in that state, where the scams seem to follow the headlines.
Gas and oil schemes flourished during last year's oil price spike, Joseph said. This year, he's seeing gold mine investment scams trying to take advantage of the lure of higher gold prices.
While profit-starved investors are vulnerable to these scams in the current economic downturn, there is a bright spot: Ponzi and pyramid schemes are also more likely to unravel in bad economic times as more investors try to pull their money out and find there's none there.
That's what happened to James M. Nicholson, whose investment firm in Pearl River, N.Y., allegedly defrauded hundreds of investors out of millions of dollars by misrepresenting the value and profits of numerous hedge funds he managed.
The Securities Exchange Commission claimed Nicholson even created a phony accounting firm to provide bogus statements about the funds' financial health.
Last week, the SEC moved to freeze the assets of Nicholson and his company, Westgate Capital Management. Calls to Westgate weren't answered and messages couldn't be left.
With consumer desperation creating more opportunity for fraud, the Financial Industry Regulatory Authority issued an "Investor Alert" last week on how to avoid investment scams. The information outlines a variety of tactics commonly used in securities fraud. It also provides links to sites that help people conduct background checks on investment professionals, learn more about the investments they're considering and how to file a complaint if necessary.
"Using these tools can help investors shut the door on any con artists who might come knocking," said John Gannon, the regulatory authority's senior vice president for investor education.
At the Senate hearing on consumer protections, Rockefeller, the committee chairman, cited concern over a number of growing abuses in the area of personal finance. These include foreclosure rescue scams that collect hefty fees, but don't keep families in their homes; and debt collectors who use deceptive practices, such as threatening consumers with imprisonment, to compel payment.
Travis Plunkett, the legislative director for the Consumer Federation of America, testified that some debt-settlement firms that collect fees often fail to negotiate reductions on credit-card debt. While Pamela Jones Harbour, a commissioner with the Federal Trade Commission, said that some credit repair companies promise to remove negative information, such as delinquencies, from credit reports, even though they can't do so if the information is accurate.
"Unfortunately, experience teaches that some bad actors will seek to take advantage of consumers when they are down," Jones Harbour said.
And people are indeed down.
In the third quarter, the percentage of borrowers who are at least 60 days late on their mortgage loans increased for the 7th straight quarter, Harbour told senators last week. And in January, late payments on credit cards hit record levels.
To better protect consumers, Harbour said that new laws are needed. Specifically, she recommended giving the FTC rulemaking authority to declare certain financial practices unfair or deceptive; allowing the FTC to obtain civil penalties for dishonest acts and to sue in federal court to obtain those penalties.
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