Sunday, September 28, 2008

Four Red Flags

Since there are many more scams than these 10 common types we discussed, we have four “red flags” or things that should increase your suspicion and make you aware of a possible scam. These four warning signs are 1. the solicitor fails to give you or is reluctant to disclose all the terms of the “deal”; 2. you hear the words “good deal” or “free”; 3. the salesperson engages in high-pressure tactics and demands immediate action; and 4. the salesperson promises unrealistic high returns or earnings.

#1. The solicitor fails or is reluctant to give you all the terms of the “deal”

Legitimate businesses will always give you more information than you want concerning their products and services. If you find any resistance at all in producing information about the “deal” then you should become concerned. Federal laws require extensive disclosure especially in the areas of securities regulation and land sales. If you receive any pressure at all to commit yourself before receiving complete information you can assume that you are the victim of a scam. For example, if you have ever purchased stock through a legitimate stockbroker or opened a money market account you know that you’re provided with many documents explaining your investment in detail. You should immediately become alarmed if this detailed information is not available.

Sometime ago, my parents, who are in their 70s, were in the process of purchasing a new home to be constructed. When presented with the purchase documents, my father, who had practiced law for nearly 40 years, began to read the documents. He quickly discovered that the seller, the local real estate developer, was requiring, my father, the purchaser, to assume the construction loan. Normally, the developer borrows the funds for construction that are then repaid when the house is completed. In this case, the developer was attempting to transfer the risk of the construction of a home to my father. Further reading of the documents disclosed that the funds provided by my parents would be used to pay off other lots in the subdivision. Obviously, my father objected to using his credit to finance the developer. When my father called this fact to the attention of the real estate salesperson, she said that she “hated working with attorneys, accountants, and doctors because they read all the documents.” Needless to say, my parents did not purchase the house.

One tactic commonly used in lieu of full disclosure, is to present a pile of documents for signature in a high-pressure environment giving the impression that there is not time to read the documents. This amounts to the same thing as if all of the terms of the deal had not been presented in the first place.

#2. You hear the words “good deal” or “free”

It is almost impossible to pick up a newspaper or magazine without finding an ad with the words “good deal” or “free.” Not every free offer is a scam but the word “free” is certainly overused. In fact, nothing is “free.” There is cost associated with every offer and product. Commonly, the cost of the “free” item is covered by the ever present “shipping and handling charges.” Scam artists use free offers to get the attention of their victims. The simple rule is that if you have to pay‑it isn’t free. Sometimes “free prizes” are given away for advertising purposes or are sponsored by a business. In these cases, someone else is paying for the item.

In a scam, the free item is either never produced or has little or no value. Sometimes, the enticement of the free item is simply a ruse to obtain personal information about the victim, such as credit card numbers or bank account numbers. Occasionally, free offers are used to generate sales leads so that high-pressure salesman can close a sale or engage in other scams.

Other commonly-used phrases include:

“You have won a valuable, free prize.”

“You have been selected for this special offer...”

“As a special added bonus you will receive...”

“There are very few of these special items left.”

“You must make up your mind right away.”

“Hurry, this offer can’t last.”

“This is a special low-risk investment with an extremely high return.”

“You can only receive this special offer by calling this number right now.”

“This investment has a higher return than any other available at this time.”

“We know you won’t want to miss this special offer.”

#3. The salesperson engages in high-pressure tactics and demands immediate action

Good deals sell themselves. There is no room for high-pressure sales tactics in legitimate businesses. Scam artists know that if the victims are allowed time to think things over they will see through the scheme and fail to be victimized. If there isn’t time to consult with friends, relatives or professional advisers then you are probably about become a victim.

#4. The salesperson promises unrealistic high returns or earnings

Every investment has a risk and a rate of return. In most scams, the rate of return is zero. Therefore, the risk is infinite. You are absolutely going to lose your money in a scam. There is no chance that you’ll get a return on your investment. If you are unfamiliar with the investment and have no way of judging the risk or potential return, then you should use extreme caution. For example, if the normal rate of return on a certificate of deposit at local bank were 6%, a promised rate of return of 12% would be unrealistic. Even though 12% interest is not remarkably high, speaking in the context of a certificate of deposit, it is unrealistic. Some friends of mine, were convinced to put $50,000 into a 12% certificate of deposit. The only problem was that the bank was non-existent. They lost all their money. The simple rule here is: “the higher the return‑the higher the risk.” In many scams the promised returns are so high that the victims have to leave commonsense behind to believe that they are possible.

Before paying any money to anyone with the promise of a high return, it is extremely important to investigate thoroughly. Make sure all offers are in writing and that you understand everything. Talk the deal over with an attorney or trusted financial adviser. Think through the consequences of losing all your money. Can you really afford to make the investment? Understand that any financial institution making the same investment would require substantial collateral. Collateral is something of real value used to secure the investment or loan. Financial institutions such as banks take collateral in real estate or valuable personal property. In both cases, the financial institution will require an independent appraisal of the collateral property before investing or making loan. It is also normal practice to require the principals of the business to sign personal guarantees. If any of these elements of the normal investment or loan transaction are absent you should be very wary. It is not unusual for the scam victim to think far enough through the transaction to require collateral but fail to require an appraisal. Collateral in worthless property is worthless.

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