Finra Finds People Really, Really Want to Be Defrauded

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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There are so many complicated flavors of financial fraud and near-fraud that it's good to be reminded that there are plenty of simple flavors, too. An oldie but a goodie is:

  • Tell someone you have a great investment opportunity for them.
  • "It returns 110% a year! Guaranteed!"
  • They get excited and give you money.
  • You take it.

"But that would never work," you say for some reason. Maybe you're hard at work designing complex derivatives to eke a tiny bit more edge out of your clients and you can't believe it could be that easy.

Nope, it's that easy.

Here are a pretty amazing news release and report from the Investor Education Foundation of the Financial Industry Regulatory Authority; the themes are basically (1) you can't fool an honest man but (2) that's OK because you can't find one either. People are dumb! And greedy! From the report, which surveyed 2,364 Americans age 40 and older:

Many Americans lack an understanding of reasonable returns on investments, leaving them vulnerable to fraudulent investment pitches promising unrealistic returns or guarantees of returns.
-- Nearly half of respondents found a daily rate of return of over 2% appealing.
-- Claims of achieving "typical" returns of 110% per year were found appealing by 42% of respondents.
-- A majority found a statement in an investment pitch that guaranteed the safety of the principal of an investment to be appealing.

Now: I would find 110 percent returns appealing, too, to be clear, but the survey actually showed people two very dicey sample fraud pitches* and found that people liked them, misspellings, wild claims and all.

It also found that people are getting these pitches constantly. The market for financial fraud is very efficient, and supply has arisen in response to demand:

-- 67% said they had received an email from another country offering a large amount of money in exchange for an initial deposit or fee.
-- 64% had been invited to an "educational" investment meeting that turned out to be a sales pitch.
-- 36% had received a letter stating they had won a lottery in another country, including a cashier's check as an advance payment.
-- 30% had received recommendations to purchase a penny stock.
-- 24% had been cold-called by a stranger offering an investment opportunity.
-- 18% had been asked to participate in an investment that offered a commission for referring other investors.

And "at least 16% of all respondents invested money in response to at least one of the likely fraudulent offers," though only 4 percent said yes when "asked directly whether they had ever participated in a fraudulent investment." Even after being defrauded people seem to be in denial about it. Which is great news if you defrauded them: If they're too embarrassed to report fraud in an anonymous survey, they're probably not going to the police.

Obviously it's less great news if you want to prevent fraud.** Finra and the SEC actually do great work in putting out investor alerts saying things like, "No one should ever make an investment based on the advice of an unsolicited email," but of course the number of people who (1) might do that and (2) spend a lot of time reading the Finra or SEC websites, is basically zero.

Everyone else lives in a culture that retains a strong primitive belief in the possibility of financial magic. Why can't this investment return 110 percent a year? Why shouldn't special, not-available-to-anyone-else, high-return, zero-risk investment opportunities be offered only to me? Am I not special? Do I not deserve it?

Finance is sort of magical: It allows societies to abstract real human activity into lists of numbers, to move wealth and consumption backward and forward in time, to act on the world at a distance. People make and lose huge amounts of money doing things that most people have trouble understanding. You can sort of see how people with no direct connection to it misunderstand and overestimate its magical potential.

But, for the record, no, it's not that kind of magic. The nice stranger on the phone will not make you rich. There are trade-offs between risk and return. If you're not Warren Buffett, you are not getting a look at opportunities that are better than the ones he gets a look at. Of course you knew that already. Most people apparently don't.

* Here's Pitch 1:

My friends informed me about a very reliable high-yield investment program I've been extremely impressed with. The program pays from 2% to 3.4% daily depending on the investment plan you choose. The minimum term of investment is 180 days, after which you can either recover the sum of your initial investment or continue further participation in the project. You can also invest on a compound basis and get huge returns. It guarantees the safety of the invested amount and even pays a 5% referral commission.

Sadly "These statements were taken from websites pitching questionable investments"; Finra didn't, like, hire someone to write them.

** One idle thought here is that, if you're confronted with some convoluted financial product dreamed up by a bank, and you can't quite tell what is going on in it, and you're wondering whether its purpose is to defraud investors, you should remember how very, very, very easy it is to defraud investors. You don't need complex contracts with impenetrable payout profiles to defraud investors; a straight face and a guaranteed 2% daily return should do it. So the convoluted thing you're looking at is probably up to something else. This is not an infallible rule, but perhaps it argues for the essentially ethical nature of the big banks.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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Matthew S Levine at