The Psychology of Investment Fraud

If something sounds too good to be true, it probably is. But scammers often use psychological tricks to influence potential investors to buy into fraudulent investment schemes making in difficult to recognize the difference between a legitimate investment opportunity and a fraudulent scheme. Understanding the psychology of investment fraud can help investors recognize legitimate investment opportunities.

Providing a Credible Source

One of the most prevalent techniques used to convince people to invest is creating the impression of a credible source. According to the Financial Industry Regulatory Authority (FINRA), an independent regulator of securities firms conducting business in the U.S., many people who seek to defraud investors attempt to build their credibility by claiming association with a reputable firm or having a special credential. For example, a person may claim that, as vice-president of the company, he or she would never sell an unreliable investment.

In addition, federal or state securities laws require brokers, investment advisers, and their firms to be licensed or registered. Another common trick involves assurances that an investment has been registered with the proper agency.

FINRA reports that scammers will purport to provide an agency's telephone number to potential investors and invite them to verify the registration themselves. However, even if the agency listed is real, the contact information may be false, and the telephone number may connect to another person involved in the fraud, who gives the company, promoter, or opportunity a strong recommendation. But even where the telephone number is legitimate, the simple fact that a security is properly registered does not eliminate the possibility that the entity issuing the security is not a fraud.

The Appearance of Propriety

Claiming that an opportunity comes from a reputable source and representing that a security is properly registered are two ways people use psychology to commit investment fraud. A third technique exploits the appearance of propriety to bolster the credibility of investment offers.

Using modern technology, almost anyone can create impressive websites and letterheads. According to FINRA, some people copy regulators' official seals or create fake seals for fabricated agencies and put them on promotional materials.

The U.S. Securities and Exchange Commission (SEC) does not allow private companies to use its seal, even as a legitimate link to the SEC's website. In addition, the SEC does not approve or endorse any particular investment, issuers, companies, or promoters. Nonetheless, scammers often misuse the SEC's seal or create fake approvals to influence potential investors.

The Halo Effect

According to HealthTechnica, another psychological influence is the halo effect, which is when the positive character traits of the person offering an investment carry over to the investment itself. If the person selling an investment is believed to be trustworthy, reliable, and reputable (think Bernie Madoff and his 20-year Ponzi scheme), the halo effect causes people to believe the investment is also trustworthy and reliable.

People rarely think that a person who appears to have integrity would lie, cheat, or steal. Accordingly, potential investors may not fully examine offers. This is exactly what allows many scammers to succeed in their schemes.

Other Common Scam Tactics used in the Psychology of Investment Fraud

There are several other scam tactics and psychological tricks that people who commit investment fraud use to influence investors. The following strategies are based on information provided by FINRA:

  • Phantom riches: enticing investors with the prospect of future wealth and promises of guaranteed income
  • Social consensus: leading investors to believe that other savvy investors have already bought into the opportunity
  • Reciprocity: offering to cut the commission in half in exchange for investing
  • Scarcity: creating a false sense of urgency by claiming there is a limited supply

Some of these strategies are employed in legitimate offers, so it is important to investigate before investing.

Tips to Avoid Investment Fraud

By taking precautions and performing independent research, investors can prevent and detect stockbroker fraud.

It is important to deal only with regulators who are listed with the North American Securities Administrators Association (NASAA) or International Organization of Securities Commissions (IOSCO). If there is uncertainty over the authenticity of a regulator, investors can inquire with the SEC by directly accessing the SEC website.

Investors should verify whether the promoter or company offering an investment is licensed to do business in the state or country. By contacting the state's securities regulator or visiting FINRA's website, people can confirm whether the firm is real and has current registration as well as check the background of an individual promoter or company.

Be wary of unsolicited offers, claims of government endorsement, and impressive seals or stationery. And if an opportunity seems suspicious or unbelievable, you can always say no or ask for more time to make a decision.

If you think you have been the victim of investment fraud, contact an experienced stockbroker fraud lawyer to discuss your case.

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