Bernard Madoff scammed 11,000 investors out of billions of dollars over a 20 year period. Many of his victims were sophisticated investors who should have known better. But, the reality is not even the SEC or FINRA knew about this scam.
The bottom-line is sophisticated scam artists can fool anyone. The more you know about the structure of scams the easier they are to avoid.
Affinity Marketing
Madoff preyed on two affinity groups: Affluent golfers at private country clubs and members of his church. He knew people tended to trust people like themselves, for example, they belong to the same country club or church.
This is a popular sales tactic is called affinity marketing. It works because common interests create trust faster and trust makes it easier to sell investment products.
Emotion-Backed Investment Decisions
Scam operators know people make emotional investment decisions. These emotions help them sell scams because investors are more susceptible to sales pitches that are designed to appeal to these emotions. The two primary emotions are greed and fear. For example, there are investors who are greedy and want high returns and there are investors who are fearful and want to avoid risk.
Since Scam operators want to appeal to all types of investors, they tell them they can produce high returns and low risk from the same investment. Then they produce fake reports that show the types of returns they promised to produce.
Friendship & Trust
Victims of scams frequently lament, “I thought we were friends” or “I thought we had a personal relationship.” The scam artists know people tend to trust people they like. When this occurs they let their natural defenses down.
Unscrupulous advisors use their personalities and sales skills to develop relationships with investors by pretending they care about them. Once “like and trust” are established it is much easier to sell bad products that may be legal or illegal scams.
References
References are worthless. No advisor will give you a bad reference. And, more ominously, references can be friends or associates of the advisor, and references can be coached to only make positive statements. Even professional references are suspect. For example, a financial advisor and an accountant agree to act as references for each other.
The Referral
All scams rely on referrals to bring in new victims. This is a popular sales tactic for Ponzi schemes because early investors believe they are receiving exceptional returns and want to tell friends, family, and associates. What they don’t know is their performance reports are fake and their distributions are coming from newer investors in the scam. It is a natural tendency for people to let their guard down when someone they like and trust tell them about the “world’s greatest money manager”.
The Custodian
Who has physical possession of your assets? A key part of every scam is creating an investment that requires you to turn your assets over to the bad guys. This is a critical part of scam because they can’t steal your assets if they don’t have physical possession of them.
Some of the more sophisticated scams use the services of real custodians (banks, broker/dealers) on an interim basis to make investors feel more secure. For example, you write a check to a bank and the bank forwards your assets to scam operators.
Be particularly cautious if the name of the custodian is an acronym. For example, the name of the custodian is FTC. The advisor tells you FTC is Fiduciary Trust Company, but your assets end up in the account of Fred’s Trucking Service. You will never see those assets again.
