Investment Scams: Why The Fall?

People fall for investment scams for a variety of reasons. According to Robert Cialdini, formerly Regents' Professor of Psychology and Marketing at Arizona State University, the root cause of people falling victim to financial fraud is their uncertainty about the financial environment. When people feel uncertain about financial decisions, they look outside themselves, which sets them up for fraud. Scammers are skilled at exploiting this uncertainty by posing as experts or people with inside knowledge, preying on their targets' desire for reassurance. They may also create a false sense of urgency, tricking investors into acting immediately without researching the investment. Scammers often use promotional videos, social media, email, phone conversations, and in-person meetings to lure victims. They promise get-rich-quick schemes, with little risk and high returns, preying on the target's greed and desire for exclusivity.

Victims feel uncertain about financial decisions and look outside themselves for guidance

According to Robert Cialdini, formerly Regents' Professor of Psychology and Marketing at Arizona State University, the root cause of people falling victim to financial fraud is their uncertainty about the financial environment. When people feel uncertain about financial decisions, they look outside themselves for guidance, which is what sets them up for fraud.

To seek reassurance and reduce their uncertainty, people often turn to those who appear to be experts or those who proclaim to be experts. Expertise and trustworthiness are the two components that constitute a great authority in most people's minds. Certifications and diplomas are symbols of expertise, and while they can be genuine, they can also be easily counterfeited to convince people that the holder is knowledgeable. For instance, Bernie Madoff, who likely perpetrated the greatest financial fraud in history, sat on a governing commission that was designed to offer policing policies for the financial industry. This gave him an air of authority, which he used to deceive people.

The second place people look when they are uncertain is their peers. This is why investment scams often turn out to be affinity scams, targeting groups that share some kind of connection. People use groups they belong to as a source of good information. They think, "What are people like me doing and telling me to do? I can usually trust that." Madoff, for example, had people selling access to his funds to their friends within Jewish congregations and golf clubs. It is awkward to say no to a friend who comes to you with a proposition, especially when they are staking their reputation and status on it.

People want to feel special, exclusive, and one-of-a-kind, and fraudsters play on this psychological need. Madoff, for instance, gave the appearance of running an exclusive operation, making each customer feel like they were part of a very exclusive club. He kept his investment formula secret and threatened to kick people out if they challenged him.

Fraud victims often fall for the scarcity principle, especially when they have recently lost money on another investment. They are told that they must act now or lose the opportunity, and this fear of missing out can lead them to make impulsive decisions.

Victims seek reassurance from those who appear to be experts based on qualifications and certifications

Victims of investment scams often seek reassurance from those who appear to be experts. This is because they are uncertain about the details of the financial environment and financial decisions, and they look outside themselves for guidance. In doing so, they are more susceptible to falling prey to financial fraudsters.

Expertise and trustworthiness are the two main components that constitute authority in the minds of most people. Certifications, diplomas, and other qualifications are symbols of expertise that lead people to believe that someone is an "expert". These qualifications can be counterfeited to convince victims that the scammer knows what they are talking about. For example, Bernie Madoff, who perpetrated one of the greatest financial frauds in history, sat on a governing commission designed to offer policing policies for the financial industry. This position of authority and expertise helped him gain the trust of his victims.

It is important for individuals to be cautious and verify the qualifications and credentials of anyone offering investment opportunities. They should also be wary of high-pressure sales tactics, promises of guaranteed returns, and opportunities that seem too good to be true. Seeking information from public websites and trusted sources can help individuals make more informed decisions and avoid falling victim to investment scams.

To protect themselves from investment scams, individuals should also be cautious about doing business with people they know only casually. Just because someone attends the same church or social group does not mean they are qualified to manage your money or have your best interests at heart. It is recommended to select a money manager by interviewing multiple candidates and making an informed decision.

Additionally, individuals should try to avoid making investment decisions based on emotions. Taking a step back and making dispassionate decisions, especially when significant resources are involved, can help counter emotional decision-making. Being vigilant, cautious, and informed can help individuals avoid falling victim to investment scams.

Victims trust their peers and are influenced by their investment decisions

When people are uncertain about financial decisions, they tend to look outside themselves for guidance, which is what sets them up for fraud. According to Robert Cialdini, formerly Regents' Professor of Psychology and Marketing at Arizona State University, the second place people look when uncertain is to their peers. This is why investment scams often turn out to be affinity scams, targeting groups that share some kind of connection. People tend to use groups they belong to as a source of good information. They think, "What are people like me doing and telling me to do? I can usually trust that."

This is supported by a study from Yale School of Management, which found that people's financial decisions are influenced by their social networks. The study identified two channels of social influence: social learning and social utility. Social learning is observational; when someone hears that a friend wants to purchase a certain asset, they think that it must be of high quality because they trust their friend's judgment, so they buy it too. Social utility, on the other hand, refers to the desire to keep up with the Joneses. When a friend buys an asset, it doesn't necessarily change someone's beliefs about its quality, but the fear of falling behind in terms of wealth motivates them to buy it anyway.

In addition, people tend to be willing to say "yes" to their friends because they think their friends are steering them in the right direction, and it can be very awkward to say "no" to a friend who comes to them with a proposition. This dynamic was observed in the Bernie Madoff scandal, where Madoff had people selling access to his funds to their friends within various organizations.

Victims want to feel special and be part of an exclusive club

Robert Cialdini, formerly Regents' Professor of Psychology and Marketing at Arizona State University, notes that people fall for investment scams because they feel uncertain about financial decisions and, therefore, look outside themselves for guidance. This sets them up for fraud.

Cialdini explains that people are drawn to exclusive opportunities that only a select few are allowed into. This plays into their psychological need to feel special and be part of an exclusive club. Fraudsters like Bernie Madoff, who was responsible for the greatest financial fraud in history, master this deception by keeping their investment formula secret and threatening to kick people out if they challenge them.

Madoff gave the appearance of running an exclusive operation, but in reality, he represented thousands of people. He made each customer feel like they were part of a very exclusive club. This is a common tactic used by fraudsters to exploit people's desire for exclusivity and their fear of missing out.

Cialdini also notes that people are more susceptible to falling for the scarcity principle when they've recently lost money on another investment. They feel a sense of urgency to recoup their losses and are more likely to fall for the promise of exclusive, high-return opportunities.

To avoid falling for these scams, it's important to be cautious when doing business with people you don't know well, even if you share a connection through a group or organization. It's also crucial to make investment decisions based on facts and logic rather than emotions.

Victims are pressured to invest quickly and without research due to false urgency

Investment scams are often hard to spot and can feel legitimate in the moment. Scammers can use professional-looking websites, advertisements, and apps, and even impersonate legitimate companies. They are skilled at convincing you that the investment is real, the returns are high, and the risks are low.

Con artists often claim an investment opportunity will be gone tomorrow. They create a false sense of urgency so investors turn over money “right now”, without researching the investment. They may trick investors into believing that the investment “opportunity” is limited to a certain number of investors or that it has a deadline triggered by an event that will soon occur. Some promotional videos may impose a deadline or feature a fake countdown (for example, “only 12 spots left…11…10…9…”).

In SEC v. Petersen, the SEC brought charges against the owners and operators of several boiler room-like call centers for defrauding investors. The SEC’s complaint alleges the call centers’ employees passed themselves off as “brokers” and “financial advisors” despite having little or no relevant experience. These so-called “brokers” and “financial advisors” allegedly also tried to trick investors into making additional and often large deposits by creating a false sense of urgency. The SEC alleges that the defendants’ training materials stated that “you need to create urgency at the beginning of the call” and defined “urgency” as “giving the client a reason to proceed today and not tomorrow.”

According to the SEC’s complaint, the so-called “brokers” and “financial advisors” created this “urgency” by telling investors about supposed imminent market events that created profitable trading opportunities but only if the investor acted immediately. The defendants’ alleged high-pressure sales tactics included citing upcoming earnings announcements by well-known public companies or expected public disclosures of economic news (for example, the jobless rate) to trick investors to invest more money.

To avoid falling prey to such scams, it is important to be cautious and do your research before investing. Check the background of anyone selling or offering you an investment and confirm that the person is currently registered or licensed. It only takes a few minutes using free and simple search tools on websites such as Investor.gov. Before you hand over any money or share your contact information, verify that the person is currently registered or licensed and find out if they have a disciplinary history.

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