Avoiding Fraud with BNN's Larry Berman and Kelley Keehn

Avoiding fraud

Larry Berman, Berman's Call
12:13 PM, E.T. | March 24, 2014
Best of BNN, Investing

We are very excited to have one of Canada’s preeminent personal finance and literacy experts on the show today, Kelley Keehn. Her ninth book is titled Protecting You and Your Money -- A GUIDE TO AVOIDING IDENTITY THEFT AND FRAUD and can be purchased here. March is Fraud Prevention/Awareness month and the book covers three major areas:

• Financial & Credit Fraud
• Identity Theft
• Investment Frauds

Today’s focus is on investment frauds. The biggest fraud in history was Bernie Madoff who, despite whistle blowers and SEC investigations, was able to continue stealing money for years. Here is why it was so compelling and why so many people were taken in:

• Many of my friends (sophisticated investors like pension funds and endowments) who were smart investors were involved, so I would have expected them to have done their due diligence.
• I would have heard about my friends’ past success with their investment and felt I was missing out — after all, he’s been around for years
• Madoff was a professional and chair of NASDAQ, what did I need to research?
• Exclusivity. How could I say “no” when I offered an opportunity to invest? He built on that exclusivity and burning desire to be “in the club”
• In this case, the investment returns weren’t a major red flag. He was paying investors a 10% return, which is not unattainable, but to deliver this consistently is a potential red flag (as his critics pointed out over the years)

However, it still wasn’t the high level red flag return that many other Ponzi schemes offer (for example, 18%). Kelley admits that she probably would have been duped by this one, although she notes Madoff’s return were virtually impossible to achieve when you factor in volatility. Madoff also refused to explain what he did other than to say it was a complicated options strategy. Kelley’s research concluded that fear and greed (the basics of many investment decisions) were major contributors to people putting all their eggs in one basket.

Earl Jones (who was released from prison last week) and others were different. In most other famous Canadian cases, the advisors were never registered. To see if your planner/advisor is registered you can check out the following links:
http://www.fpsc.ca/
http://www.securities-administrators.ca/investortools.aspx?id=1128

Other Red Flags to consider:

• High pressure — must buy now! It won’t be available tomorrow (or next week)!
• Guaranteed high returns
• Risk free returns
• You heard about the “opportunity” from a friend, family member or at a social event
• There’s a “genius,” “guru,” “uber-successful” person at the helm
• It’s exclusive
• You’re asked to trust the promoter without a second opinion
• Very little (or no) documentation for the investment.

Last week we did a call out for viewers to tell us about investment frauds they were involved with or knew about. Thanks to all that wrote in, 10 books will be going out to the first 10 we received. Many of the e-mails were about various stock frauds, some of the more recent ones were Poseidon Concepts (PSN), Sino-Forest (TRE) and a few mentioned Bre-X. I’ve compiled a chart of some of the big US ones including Enron and Worldcom. When I was a market strategist at CIBC World Markets, all employees had to take a test so that we could report potential irregularities after CIBC paid a $2.4 billion fine (for hiding losses at Enron) and admitted no guilt. Citigroup and JP Morgan paid up big too—not guilty. It is deplorable sometimes how the system works against the individual investor.

If there is a question about quality of the company in any respect - especially earnings, management, unreasonable growth - just do not get involved. The best rule of thumb we can suggest is that you do not have to invest. I say it on the show all the time, you simply to not have to own it if you are not sure. However, if you do get involved with a company that goes bad, stop loss at an amount where it does not kill you. This is very hard for investors to do, nobody likes to take a loss, but it is the best thing to do. Move on, it did not work, you do not need to get your money back and the market/stock owes you nothing. To calculate a reasonable loss: If the position is 5% of your portfolio, you could see a 30% decline and it only costs you 1.5% of your overall account. That is not tragic: 30% gives you enough room to stay with it through most ‘corrections,’ but once it falls more than that, it tends to be worse than a correction and you should simply get out and move on.