"Crowdfunding" set to be biggest investment scam threat in 2013: Internet Scambusters #528
A couple of years ago, no one had ever heard of crowdfunding -- but now it's the number one investment scam threat of 2013.
Law changes are likely to make this Internet-based way of raising project funds more popular -- with crooks as well as entrepreneurs.
We have the details in this week's issue, along with a throw-forward on other big investment scam risks in the coming few months.
And now for the main feature...
Internet Funding Projects Lead to New Investment Scam
With interest rates still stuck in the doldrums and the constant search for more lucrative returns, investment scam tricks remain high on the list of fraud risks.
Many of the old familiar scams like Ponzi schemes, bogus precious metal and currency investments, and high-pressure "boiler room" pump-and-dump schemes are still raking in a fortune for the crooks.
You can read about these in one of our earlier reports, 7 Deadly Sins: Investment Scams Promise Shortcut to Economic Recovery.
Since we produced that and other issues, though, a number of new tricks have emerged.
For instance, in its latest annual Top 10 Investor Threats list published a couple of months back, the North American Securities Administrators Association (NASAA) identified crowdfunding as the new number one danger.
Crowdfunding is such a new activity that many people likely have never heard of it!
Basically it involves using the Internet to attract large numbers of people to invest in a specific project -- like a new product or service -- instead of going the old route of borrowing from a bank or getting backing from venture capitalists.
A number of crowdfunding websites already operate. In fact, the number leapt from a few hundred to 8,000 in 2012. Many of these sites are currently "parked" -- not yet in use -- just waiting for the opportunity.
In the main, the sites that are operating don't promote just a single idea or product.
Instead they act as portals or platforms, publicizing scores or even hundreds of projects from which investors can choose.
The site operators themselves take a fixed fee or a percentage of the money raised.
In the past, the payoff for investors usually has meant getting one of the products for "free" -- in reality, heavily discounted from the retail price, in return for what is legally labeled "a donation."
So, for example, you invest $50 and get a product that will eventually retail for $120.
How Law Changes Will Affect Crowdfunding
However, the new Jumpstart Our Business Startups (JOBS) Act, which comes into force during 2013, will turn crowdfunding into a true investment model, offering regular financial returns.
A donation now becomes an investment that buys you shares instead of products.
The portal operators are supposed to vet the projects they promote but already several scammers have duped them. Plus, of course, there's the risk that an entire purported crowdfunding site could turn out to be phony.
NASAA has set up a task force to investigate and report on the new crowdfunding sites and develop an investor education program. Given the scale and swiftness of the growth of crowdfunding however, this seems like a daunting challenge.
"Investors soon can expect to be inundated with crowdfunding pitches, legitimate or otherwise," says NASAA President, Heath Abshure.
The Association has produced initial guidance for investors, which you can read at Informed Investor Advisory: Crowdfunding.
As with other investment scams, being skeptical about any program offering an extremely high rate of return should be the number one rule.
However, the problem is that startups by their very nature often are highly risky and speculative and, as a result, sometimes do offer potential returns well above the norm.
So the best rules of thumb here have to be that first you should take all possible steps to check out the legitimacy of a crowdfunding project. And second, even then, never invest money that you can't afford to lose in a speculative project.
Among increasing threats for 2013, NASAA has expressed concern about mid-size investment advisers -- a subject we also addressed in an earlier issue, Investing Safely.
Bogus advisers have been around forever but, again, changes in the law, which sees states rather than the Securities & Exchange Commission (SEC) take over supervision of advisers, has highlighted concerns about some of their abilities and credentials.
In fact, actions to control or shut down investment advisers in this category have doubled in the past couple of years.
According to Robert Stammers, a director of the Chartered Financial Analysts (CFA) Institute: "There's plenty of advisers out there who just shouldn't be in business."
For more information on how to check out a financial adviser, see this earlier Scambusters issue, What to Ask Your Potential Financial Advisor.
Just time to highlight a couple more investment scams to beware of in the coming months:
* Self-directed Investment Retirement Accounts (IRAs): These allow investment in a broader range of assets than traditional IRAs.
The SEC says the large amount of money held in these plans -- said to be about $94 billion -- makes them attractive targets for scammers.
Crooks even try to persuade people with regular IRAs to switch to the self-directed variety.
In both cases, they then funnel the money into Ponzi schemes.
The SEC has a useful explanation and set of guidelines in a downloadable PDF: Investor Alert: Self-Directed IRAs and the Risk of Fraud.
* Variable annuities. We mentioned this in our recent report on scams targeting seniors.
Not enough space to explain this extremely complex contract under which an insurance company makes regular payments to you in return for giving them a lump sum.
As its name suggests, the value of the annuity varies according to the underlying value of the supporting investments.
They also offer death benefits and tax advantages.
Read more about them at Variable Annuities: What You Should Know.
But the very complexity of variable annuities has led to some so-called financial advisers putting clients' money into annuities that are entirely unsuited to their needs and, in some cases, highly risky.
Or they may suggest returns are guaranteed, when, as the name implies, they are not. That's because they're linked to the stock market.
In other cases, the contracts on which they are based fail to disclose high surrender charges and additional fees for death benefits.
Check that SEC document mentioned above for more guidance.
And stick to the rule that the higher the promised returns, the more your money is at risk, and the higher the likelihood that you're being lined up for an investment scam.
Time to close today, but we'll be back next week with another issue. See you then!