“They set the tempo the minute they meet you,” former Toronto Metro Police fraud squad investigator Gary Logan comments. “After they get to know you well enough, they determine how they can use your confidence in them to victimize you.”
He’s talking about fraudsters, especially those who prey on middle-aged and older RRSP and RRIF owners. Over his 17 years of investigating, charging, and helping convict fraud artists, Logan has encountered every scheme and every tactic imaginable.
Logan’s point about criminals setting the tempo explains much of their success when dealing with cautious individuals who cannot believe they are in danger of being swindled—until they are.
“The most successful of the criminals posing as financial advisors,” Logan explains in his suburban Toronto office, “see their clients as opportunities. They have a knack of building confidence in their victims. They’ll make any promise necessary to get the other person’s money into their own pocket. Afterwards, they’ll deliver promises to retain the victim’s confidence, keep them happy, and delay the day when it all falls apart.”
Logan is employed with Garda Security, applying his experience earned from tracking frauds and their perpetrators to Garda clients concerned about recovering lost funds. He focuses on assembling material for civil actions instead of criminal courts, but his outrage at the antics of fraudsters has not abated. He has seen too many Canadians lose their life savings to people with too much greed and no conscience, and is intent on offering whatever advice he can that might reduce the number of victims.
His first suggestion sounds like a parental directive: “Do your homework.”
Before discussing an investment opportunity with anyone, Logan suggests, understand what is being proposed and how it works. Rely on another trusted source for information, not the one who is offering you the deal. “Go into it with your eyes wide open,” Logan says, “understanding the costs and the risks. Do not go into any investment opportunity with the idea of getting an education on the topic,” he emphasizes, “because the first lesson you’ll get is whatever the other person wants you to know.”
Making an investment decision immediately is also unwise. “If you have to act now,” Logan advises, “don’t.” You’ve spent years building your savings or portfolio; why take minutes to decide to pass it along to someone else?
His closing observation brings to mind the thousands of wealthy and intelligent people scammed out of billions of dollars by investment guru Bernie Madoff. “Once you’ve made some sort of commitment to them,” Logan says, “after you’ve shaken their hand and agreed to the deal, you’ll buy into almost anything the fraudsters will say or promise.”
“How could intelligent people fall for such obvious scams?” we may ask ourselves when reading about various investment frauds. Because they made a commitment built on trust, and that changes everything.
In early 2009, the biggest name in investment fraud was Bernie Madoff. He earned it. While the exact amount of investors’ money lost by Madoff may never be known, the figure appears to be in the neighbourhood of $50 billion, which is a very wealthy neighbourhood indeed.
More impressive even than the cost of Madoff ’s shenanigans was the list of people he bamboozled. These weren’t folks like you and me, hoping to squirrel enough in our retirement accounts to cover an annual trudge on a sandy beach each winter. Madoff ’s victims included the immensely wealthy, the impressively astute, and the witheringly skeptical.
The lesson to be learned is clear: If these people can be defrauded so completely, anyone is vulnerable to similar actions by similar miscreants. And while Bernie Madoff operated in the United States, preying upon generally wealthy individuals, antics like his occur frequently on this side of the border.
A study conducted in 2007* revealed that about 20 percent of Canadians had been offered an apparent fraudulent investment in the previous three years. Of these, fewer than one out of five bothered to report it to the authorities. Why? Because, most replied, they believed the offer was so blatantly fraudulent that no rational person would invest in it.
Ah, but they do. Nearly 5 percent of Canadians have been victims of investment fraud at some point in their lives. That’s more than a million of us who have fallen for a pitch that separates us from our money as efficiently as a carnival barker or a racetrack tout, and three out of four victims failed to recover any of the money handed over.
The extent of investment fraud in Canada could be even wider than the study suggests, because only a minority of victims actually report the incident to police. Perhaps they’re embarrassed at their own gullibility, or they believe fraud artists find a way to beat the justice system. On the latter point, they may be correct. About 70 percent of Canadians are convinced that fraudsters either avoid conviction or, if actually tried and found guilty, receive sentences so light they’re almost a joke.
There Are Frauds and Scams. And Then
There Are FREE SEMINARS!
Building a prospect list is hard work if you’re a broker or financial advisor. You can spend years assisting clients to structure their portfolios, trusting them to tell friends and family how pleased they are with your service and hoping you harvest business from their referrals.
You can always make cold calls, which involves spending hours with a telephone directory, calling people at random and being humiliated by a hundred hang-ups, with the faint hope of netting a single new client.
Or you can host a free investment seminar. All you need is a hall, a coffee maker, and an investment celebrity whose name and smiling face will attract a crowd.
The investment celebrity breed has shrunk somewhat since I dedicated an entire chapter to it in the original edition of The Naked Investor. Five years ago, Brian Costello, Garth Turner, and Jerry White were as unavoidable in the media around RRSP time as bank and mutual fund advertisements. Since then, Costello has been legally banned from the securities industry, Turner had another brief spin in Ottawa political circles and now spends his time cranking out books predicting a financial apocalypse, and the last I heard of White was a scheduled appearance at the Legion Hall in Melville, Saskatchewan.
In their place are local celebrities—the term shills is more accurate—with radio call-in shows or newspaper columns to dispense their opinions on investing. They form a tag team with unscrupulous advisors and brokers, both of them feeding fears of inadequate growth in RRSP investments. The appeal looks reasonable and even entertaining: A popular investment guru will appear at a seminar to teach you, without cost or obligation, how to maximize the return on your retirement investments.* Hey, it’s a night out with your spouse, right? Munch on a few snacks, sip some coffee or wine, and come home with your head full of great new investment ideas. Alas, you are likely to return with a mild sense of panic and a badly reconstructed investment portfolio.
The attack is usually two-pronged. First, the famous investment guru warns that most Canadians are ill-prepared to cope with retirement. Their RRSP contributions and balance are too low, their investments perform poorly, and their financial future is bleak. Without additional money and a more aggressive investment plan, the guru lectures, their retirement years may consist of eating cat food and sleeping alongside hot-air vents. Earning 7 or 8 percent annually on their RRSP investments is ludicrous. The rich don’t settle for that—why should you? Homeowners in the audience are reminded that they occupy an asset that’s doing nothing for them, referring to the $100,000, $200,000 or more in paid-up equity in their home. Why not put that equity to work by borrowing money against it, buying some high-yield investments, and writing off the interest payments against their income tax?
After the guru plants the bomb (and is paid several thousand dollars for his appearance), the brokers and advisors light the fuse. Armed with promotions and video presentations, the commissioned salespeople begin promoting whatever happens to be on the menu that day (some of these seminars are underwritten by mutual fund companies) as the means of achieving the guru’s promises. The seminar sponsor may even arrange to have a mortgage lender on the site, prepared to set up loans secured by homeowners’ equity. Many people who attend the seminars, believing them to be educational events and not the blatant marketing sessions they are, go home with the equity in their homes tied up in expensive and risky investments.
I detailed these shady events in the first edition of The Naked Investor, and a well-known investment writer explained the appeal and profit of these seminars to advisors:
If the advisor gets a hundred people to attend, and just 10 go along with the idea (of using home equity to finance an investment), each borrowing $100,000 to invest, that’s $1 million in mutual fund sales or $50,000 in commissions for the advisor. Not bad for a night’s work.*
This isn’t outright fraud and, given the recent volatility in house prices and the market generally, the seminars aren’t nearly as popular as they were five years ago. But the leveraged purchase of inappropriate investments in both registered and unregistered portfolios has led to disaster for thousands of Canadians.
By all means, educate yourself on basic investment skills and strategies, but do it from books such as this one that provide you with facts and permit you all the time you need to ponder your actions—not from “free” seminars sponsored by commission-based advisors whose pitch is set up by media celebrities.
Just When You Think You’re Older and Wiser,
You’re Also Most Vulnerable to Fraud
Anyone with pocket change is a potential target for a fraud artist, but RRSP and LIRA investors age 50 and older represent prime prospects. The reason? More money and more trust.
At that age and beyond, many Canadians are balancing costs for dependent children at home or in university while perhaps supporting an aging parent or two. Meanwhile, retirement looms just a few birthdays away. They may be at their maximum earning power, but they are also facing multiple demands on every dollar they make. And while they deal directly with the needs of both children and parents in a hands-on manner, they need help with their own retirement planning. Many are preparing themselves for Grandma’s house, a cozy little place in the woods where the grandchildren come to visit with picnic baskets in hand. That’s a lovely image. It’s the wolves that spoil it.
The wolves do not sport hairy faces, oversized teeth, and pointed ears. They tend to wear expensive clothes and warm smiles, like honest and competent business people of all stripes, so wearing a cloak of suspicion alone won’t keep you from becoming a victim.
Like the bedtime story of the wolf in Grandma’s bed, many of the schemes employed by investment fraudsters have their roots in a fairy tale. Once upon a time, someone somewhere heard about an exceptional investment offer, took advantage of it, multiplied their money 5, 10, 20, or maybe 100 times, and lived happily ever after.
For every person who actually succeeded at doing this, hundreds of thousands of others, trying to replicate earlier success, have lost everything. If you like these odds, skip the next few pages. If you’d prefer to deal with the real world, keep reading.
Let’s begin by identifying various types of investment fraud you could encounter.
Precious metals and gems. Diamonds, rubies, sapphires, and good oldfashioned gold may be offered at a price far below market value. Unless you’re a gemologist or gold dealer, walk away. The gems will be glass and the gold will be almost anything but.
Ponzi schemes. This won’t be labelled as such. In fact, you won’t be able to identify one until you find yourself in fiscal communion with the victims of Bernie Madoff, who appears to have orchestrated history’s largest Ponzi caper. (The trick’s title is derived from the name of its first practitioner, Charles Ponzi, who bilked investors of $10 million back in the 1920s.) A Ponzi scheme consists of promising exceptional returns to early investors, paid with new money that pours in when others hear about the supposed earnings. It can be maintained only as long as new victims keep adding money to the pot, and eventually collapses.
Oil and gas producers. You wouldn’t believe someone who claims to own land with large deposits of oil on it, and needs seed money to buy drilling equipment, would you? Thousands do every year, later discovering that neither the oil, the equipment, nor the land exists.
Foreign currency exchange (FOREX). Now, this one you can understand, you think. Your investment in Canadian money is used to purchase foreign currency at an exceptionally low rate of exchange. When the value of the foreign currency rises, it’s converted back to loonies for a profit. Best of all, it’s about real money. Or is it? The risk in dealing on the FOREX market is substantial, but don’t worry about fluctuating exchange rates affecting your investment. Chances are your money will disappear into the coffers of the promoter and never be seen again. Not by you, at least.
Cattle, mink, fish, and beans. Or any similar commodity. The come-on may be based on a promise to buy the creatures or food at harvest time, with a large profit for you. The only harvest will occur, regardless of contracts or agreements, when you hand over your money.
Clever tax shelters. Fraudsters persuade RRSP owners to withdraw their assets as one lump sum of cash, pay the applicable tax, and invest the balance in products, industries, or locations (have you visited the Cayman Islands recently?) where massive tax-free returns will quickly earn back the Canadian income tax. The products and industries may in fact be real, as will profits and commissions to the purveyors, but the tax-free status and the potential growth is illusory.
Special risk-free RRSP/LIRA loan. A variation on the above, this works when a promoter convinces you to invest all or most of your RRSP or LIRA in a new start-up company. It’s a sweet deal: You purchase shares in the company, keep them within your RRSP or LIRA, and the promoter loans you back 50 percent or more of the shares’ value in return for your support. That’s as much as you might keep after tax if you had withdrawn the entire amount as cash. Now, you have both the shares and the cash, tax-free. That’s the dream. Here’s the reality: The shares, if you receive them, are worthless; the cash loan will never appear; and the Canada Revenue Agency (CRA) will spot the scam and come calling, demanding you pay tax on the cash loan you never received.
These schemes are not rare, nor are the victims who fall for them. In March 2009, the CRA reported it had reassessed more than 5000 Canadians who had participated in these deals, resulting in additional taxable income of $250 million.*
Double dipping. This one is especially bitter because it works on people who have already been scammed. The fraudster who stung you in the past sells your name to other crooks who contact you with a deal: They know who defrauded you, the scoundrels! They’ll mention details only you and the original fraudster would know about to convince you of their credibility. Then they’ll offer to help you recover most or all of your loss. For a fee, up front, of course. Can you spot the danger here? Thousands of other didn’t and sent money to these phoney Robin Hoods, losing even more of their money and pride.
Pump and dump. You hear about a company whose stock is priced far lower than its actual value. If you act now and buy before the price rises, you’ll make a major score. The stock is real—you can track the price on an exchange—and the price may rise, but that’s only because others are falling for the same pitch. The person promoting the deal is holding a massive amount of stock. When the price gets high enough, the stock is dumped at a profit for the promoter, depressing the value to its true market level, which is substantially lower than the price you paid.
Affinity Fraud: Do You Know Who Your Friends Are?
In the late 1990s, about 300 members of a Seventh-Day Adventist church in Abbotsford, B.C., invested more than $11 million in a pooled fund investing in offshore companies. Joyfully declaring that he was an ex-pastor committing his life to spreading the munificence of the Lord among His believers, an American named Gary Stanhiser offered first the elders and later members of the congregation a blessed investment opportunity. Thanks to tax advantages between the B.C.–based pool and the foreign locations, Stanhiser explained, the profits promised to be immense. It was also, of course, quite legal, a concern for the devout churchgoers.
In fact, it was neither. None of the money was seen again, and for a number of years, hospitals in the Fraser Valley reported an inordinate number of cases of severe mental depression and stress-related injuries.*
Losing money you worked hard to acquire over years of effort is depressing on its own. Losing it to someone whose company you enjoyed and whose honesty you trusted can be devastating. Yet that’s how most fraudsters succeed—by exploiting the trust they have created among family, friends, and club members.* As a mark of the total absence of honour among these lowlifes, incidents of affinity fraud occur among religious groups following sermons declaring the need for love and respect among the members.
Many people find affinity fraud the most difficult crime to avoid for the very reason it succeeds. Your guard would be aroused by a telephone call pitching a once-in-a-lifetime opportunity or offers muttered out of the side of their mouths by shady characters on a dark street. But Brother Smith who passes the collection plate each Sunday? Or George at the lodge hall? Or your daughter’s brother-in-law? Surely they wouldn’t be involved in something illegal and exploitive, would they?
Sadly, they may. The incidence of affinity fraud in Canada grows year by year, especially among minority groups and new immigrants, often isolated from mainstream society. This separation, along with language difficulties, makes it difficult for the members to access information, guidelines, and warnings. In a foreign environment, they place their trust in familiar names and cultural practices.
It’s not necessary to suspect everyone with whom you have contact in your club, church, temple, synagogue, or gym. It’s wise, however, to raise your defences whenever any of the following occur:
• New arrivals to an organization pitch investment deals to prominent members of the club, gaining influential support.
• The pitch includes schemes such as offshore banking, unique ways of playing the stock market, or investments in precious stones or metals.
• Not everyone is offered the opportunity to take advantage of this method of getting rich.
• The promised returns are spectacular and the risk negligible.
• Requests for an explanation of the mechanics of the investment are met with scorn or confusing jargon.
Arm yourself against fraud with these attitudes and practices:
• Avoid being influenced by first impressions; con artists work hard to make a positive and memorable one.
• Never assume that anyone who holds the same religious beliefs as you must be as honourable as you.
• If someone pitches you an investment idea, ask, “What is the nature of the investment?” “Who receives my money?” “How will the money be used?” “What kind of security is provided for my money?” “How and when can I cash in my investment?” “Is there a prospectus?”
• Make a point of writing down answers, if any are provided.
• Do not permit yourself to be intimidated if the person making the pitch resents your questions, and don’t be sidelined by smooth responses that flatter you while conveying few facts.
• Do not make any decision exclusively on the basis of an investment closely tied to your faith, religious practices, club affiliation, or other association.
• Question the motive of any new member who quickly begins discussing investment or financial deals.
• It is not true that investments conducted within religious or fraternal organizations are not subject to regulations such as issuing a prospectus and licensing securities dealers; avoid anyone who disputes this fact.
• Check with your provincial securities commission to confirm that the individual promoting the investment opportunity is licensed.
• Do not allow yourself to be pressured into making an investment decision; if told you must decide immediately, walk away.
• Be skeptical of anyone who discourages you from obtaining advice from a lawyer, accountant, financial advisor, banker, or other professional.
• Never sign a document without reading it carefully; if any doubt or question persists, discuss its implications with a lawyer.
Here’s one of the most maddening aspects of affinity fraud: The perpetrators often get away with it. In many cases, victims refuse to believe that someone so genial could possibly be crooked, and they avoid pursuing the matter until long after their money has vanished. Others are so embarrassed they prefer not to contact law enforcement, and chalk up their losses to experience. Meanwhile, the fraudsters have pocketed (or usually spent) the money, and are moving on to a new group of victims.
Gary Stanhiser, who is alleged to have masterminded the $11 million theft from the Fraser Valley Seventh-Day Adventist congregation, returned to his native California where he cheerily ignored the penalties of a $100,000 fine and a lifetime ban from working in the B.C. securities industry. No criminal charges were pursued.
*Canadian Securities Administrators/Investor Education Committee, 2007 CSA Investor Study: Understanding the Social Impact of Investment Fraud, Innovative Research Group, Inc.
*For the record, I never have and never will participate in events of this kind.
*The Naked Investor: Why Almost Everybody But You Gets Rich on Your RRSP (Toronto: Penguin, 2005), p. 146.
*James Langton, “CRA Issues Warning on Tax-Free Withdrawal Schemes,” Investment Executive, March 17, 2009.
*Patrick White, “Meet God’s Fraud Squad,” The Globe and Mail, October 4, 2007.
*For a detailed recounting of a classic case of affinity fraud, read my book Free Rider: How a Bay Street Whiz Kid Stole and Spent $20 Million (Toronto: MacArthur & Co., 2001).