Last week newspapers carried a story of how a mother and daughter from Negombo fraudulently collected money from the public. They deceived people by making the victims believe that the money was invested in the stock market. They even promised to pay dividends. Subsequently, the couple allegedly disappeared with the money. We cannot help but wonder the plight of the innocent victims who fell off the precipice of financial misfortune.
Many initiatives are taken to increase financial literacy in the market by the Securities and Exchange Commission of Sri Lanka (SEC). The SEC, through its investor education initiatives has emphasized the importance of becoming an informed and vigilant investor. Yet, investors continue to be victimized by fraud. Hence, it is appropriate to educate our readers on the importance of safeguarding their money when investing in the market.
The stock market is undoubtedly a lucrative investment. Yet, there may be times when some tend to misuse the market place for personal gains. They may act in a fraudulent manner in the market. These fraudsters can turn on a dime when it comes to developing new pitches but while the wrapper or hook might change, there are common grounds they work on. It is said that it takes two to tango. Similarly, it will be a tedious task for fraudster to function if investors are vigilant. Shortcomings of the investor make their work much easier. Thus, it is imperative to infer into the psychology of scam and judge how vulnerable you will be to such misconduct.
The most common form of misconduct falls into the scheme of pump-and-dump. In pump and dump an individual deliberately buys shares of a very low-priced stock of a small, thinly traded company and then spreads false information to drum up interest in the stock and increase the stock price. Believing they’re getting a good deal on a promising stock, investors create buying demand at increasingly higher prices. The individual then dumps his shares at the high price and vanishes, leaving many people caught with worthless shares.
There may be also times where individuals impersonate as reliable and well respected individuals and deceive you. Whatever form it may take, an intelligent investor should be able to guard evade fraud and thereby maximize returns.
Psychology of misconduct
The common thread that binds these different types of misconduct is the psychology behind the pitch. We’ve all heard the timeless admonition “If it sounds too good to be true, it probably is”—which is great advice, but the trick is figuring out when “good” becomes “too good.” There’s no bright line. Investment fraudsters make their living by making sure the deals they tout appear both good and true.
They are masters of persuasion, tailoring their pitches to match the psychological profiles of their targets. They look for a week point by asking seemingly compassionate questions—about your health, family, political views, hobbies or prior employers. Once they know which buttons to push, they’ll bombard you with a flurry of influence tactics, which can leave even the savviest person in a haze.
Some of the most common tactics include:
The ‘Phantom Riches’ Tactic - dangling the prospect of wealth, enticing you with something you want but can’t have. “This company will guarantee to generate a revenue of Rs.60 million a month and you could purchase your dream car.”
The ‘Source Credibility’ Tactic - rying to build credibility by claiming to be with a reputable firm or to have a special credential or experience. “Believe me, as a senior vice president of XYZ firm, I would never sell an investment that doesn’t produce.”
The ‘Social Consensus’ Tactic - leading you to believe that other savvy investors have already invested. “This is how they started. I know it’s a lot of money, but even I have invested. So did my mother.”
The ‘Reciprocity’ Tactic - offering to do a small favour for you in return for a big favour. “I’ll give you a break on my commission if you buy now—half off.”
The ‘Scarcity’ Tactic - creating a false sense of urgency by claiming limited supply. “There are only few days left, so I’d sign today if I were you.”
If these tactics look familiar, it’s because legitimate marketers use them, too. However, when we are not prepared to resist them, these tactics can work subliminally. Victims often say to regulators after they have been scammed, “I don’t know what I was thinking” or “it really caught me off guard.” That’s why an important part of resisting these common persuasion tactics is to understand them before encountering them.
Red flags you should watch out for
To stay on guard and avoid becoming drawn into a scam, look for the warning signs of investment fraud:
Guarantees: Be cautious about people who provide a guaranteed that the investment will generate fixed returns. All investments carry some degree of risk.
Overly consistent returns: Any investment that consistently goes up month after month—or that provides remarkably steady returns regardless of market conditions—should raise suspicions, especially during turbulent times. Even the most stable investments can experience hiccups once in a while.
Complex strategies: Avoid anyone who credits a highly complex investing technique for unusual success. Legitimate professionals should be able to explain clearly what they are doing. It is critical that you fully understand any investment you’re seriously considering—including what it is, what the risks are and how the investment makes money.
Missing documentation: If someone tries to sell you a security with no documentation—-that is, if you do not obtain brought /sold notes sent by the stockbroking firm or statements sent by Central Depositary System (CDS), he or she may be not actually investing in stocks.
Account discrepancies: Unauthorized trades, missing funds or other problems with your account statements could be the result of a genuine error—or they could indicate churning or fraud. Keep an eye on your account statements to make sure account activity is consistent with your instructions. Rethink if you should give out discretionary power to your advisor to trade on your account.
A pushy salesperson: No reputable investment professional should push you to make an immediate decision about an investment, or tell you that you’ve got to “act now”. If someone pressures you to decide on a stock sale or purchase, steer clear. Even if no fraud is taking place, this type of pressure is inappropriate.
It is important for investors to be open minded and vigilant to spot red flags of investment misconduct.
Who is vulnerable?
As an investor, it is natural for you to wonder if you would be vulnerable towards such misconduct. Hence, this section will elaborate on the characteristics of a vulnerable investor.
Neglecting to check out the investment advisor/stockbroking firm - You are not alone if you’ve never checked out your investment professional. A majority of investors haven’t. But smarter investors take time to check whether their adviser is properly licensed and to verify his or her disciplinary history.
Neglecting to check out investments - All investing involves some degree of risk, but some investments are riskier than others. A smart step is to evaluate the risk return trade off with your financial goals before entering a stock.
Inability to spot persuasion tactics - One in five investors can’t spot persuasion. For example, a claim that an investment will pay “guaranteed” returns—or yields far above historical averages—is a type of influence tactic known as “phantom riches”. The seller dangles the prospect of wealth and claims that the investment made hundreds of people extremely wealthy using the persuasion tactic of “social consensus” to make you want to get on the bandwagon.
Tendency toward self-reliance when choosing investments - Known victims of investment misconduct, purchased an investment based on the recommendation of a friend, relative or co-worker. They also tend to be self-reliant, preferring to act on their own instinct rather than seeking the advice of a professional. Smarter investors always get a second opinion from trusted sources that don’t have an interest in the deal.
Over reliance on recommendations - When it comes to hiring an investment professional, it’s smart to get recommendations from friends, family and other trusted sources. But smarter investors will also take time to check the person’s background and license. The truth is that word-of-mouth is the best vehicle to make new contacts and tap investors. Most individuals who are entangled in misconduct are likely to work with a salesperson recommended by a friend or any other known party.
Openness to sales pitches: Vulnerable investors are more likely to listen to sales pitches and to read sales material they get in the mail than non-victims. Smarter investors can keep an open mind to new ideas as long as they ask questions and verify the answers.
Overreliance on the Internet: The Internet brings the world to our fingertips. It increases greater dissemination of information which is a key to efficient markets. Nevertheless, investors should be cautious about web-based promotions, equity blogs, etc.
Deal with registered investment advisors
According to the existing legal framework individuals interested in investing in the market should do so through a stockbroking firm licensed by the SEC. The stockbroking firm will open an account under your name in the CDS in order for you to invest in the market. However, convincing, one may sound, never handover you’re hard earned money to people who claim to invest on behalf of you,
In conclusion, it is important to reiterate that the stock market is an ideal engine for long-term wealth creation. Nevertheless, investors should be mindful to protect their interest by acting vigilantly.