Financial Scams: How to spot the warning signs

27 March 2013

There will always be scam artists out there looking to take advantage of ignorant consumers. Angelique Ruzicka finds out how investors can avoid these rogues and protect their hard-earned money.

Last year, investors were shocked to learn that hedge fund manager Herman Pretorius killed himself after allegedly shooting his business partner Julian Williams. But for those who had invested in Pretorius’ Relative Value Arbitrage Fund (RVAF) there was an even greater shock in store as it was revealed that the fund was nothing more than an alleged Ponzi scheme.

Originally, it was estimated that Pretorius’ scheme owed about R1.8 billion to around 3,000 investors, but now reports say that that figure stands at around R3.1 billion. To date, investors of the RVAF fund are still fighting to get their money back.

Identifying the scam

But what is a Ponzi scheme and how can you avoid falling victim to them? Gavin Came, chairman of the financial planning committee of the Financial Intermediaries Association of Southern Africa (FIA), explains that Ponzi (or pyramid schemes) cannot be classed as investments. “These are not investments but elaborate scams that enrich the founder while eroding investors’ capital in order to pay out unsustainable returns. As soon as new investment dries up the Ponzi scheme collapses leaving most participants severely out of pocket.”

The latest scheme to hit the headlines is that of Net Income Solutions which, it is alleged, collected as much as R500 million from investors through an opportunity marketed as Defencex. Investors were promised 2% per day on investments for five months subject to a complicated points-based assessment system. They could enhance these returns by earning commission on the amounts invested by people who they introduced to the scheme.

It is essential that the financial services regulators keep a close watch on questionable financial activities says Came. “The FIA welcomes the registrar of banks’ decision to investigate the Defencex scheme and the ensuing court action. We are also grateful that the Western Cape High Court ordered Net Income Solutions’ bank accounts be frozen pending further submissions.”

“It is a sad fact that the majority of victims of these scams are struggling pensioners who have failed to make sufficient provision for retirement and are now looking to these get-rich-quick offerings for salvation,” says Came.

Warning signs

“Warning signs that you are dealing with a Ponzi scheme are that the promised returns offered are way over those achieved in bank deposits, unit trusts and other regulated savings and investment products,” explains Came.

One way to protect yourself and your savings is to consult a professional financial adviser and ask their advice as to whether an investment is a good idea or not. “A good advisor should be able to identify a pyramid scheme,” feels Came.

However, even the experts can get it wrong and since Pretorius’s death it has come to light that a few advisers had recommended the hedge fund manager’s RVAF scheme to their clients. “In every industry there are bad eggs,” admits Came. “But if you seek the advice of a registered financial advisor you do get the protection of the Ombud for Financial Services Providers (FAIS Ombud) and the FAIS Act.”

“Although we cannot deny that brokers have erred by steering investors to quick money opportunities in the past, the industry has taken steps to weed out its ‘bad apples’ and mitigate the risk of similar mistakes being made going forward,” adds Justus van Pletzen, CEO of the FIA.

Don’t become a victim

The sad reality is that there will always be scam artists out there looking to earn a quick buck from consumers who have saved lots of money. The key is not to be fooled by these conmen and women and to arm yourself with as much information as possible. “Nothing will stop it [scams] other than consumer vigilance. You can pass as many laws and regulations as possible but these people make their money by finding ways around the law,” warns Came.

Came has the following advice for investors who are considering an investment that may sound ‘too good to be true’:

1. Speak to your financial advisor before committing your cash. “An FIA intermediary will be able to see through the smoke and mirrors that are used to lure consumers in,” he says. “The value of financial advice exhibits in preventing costly mistakes as early in the investment process as possible.”

2. Ask the person offering the investment and your advisor what it is that makes the fund different from normal bank deposit. A bank deposit account can earn your between 5-6% in interest and if the someone is offering you more than that, you should find out how the scheme operates and why it can produce such returns. There may not always be a sinister reason as to why the fund may perform better than the average bank deposit account. “You may find with these returns that your capital isn’t guaranteed or that you need to lock your money away into the fund for a number of years,” explains Came.

3. If your financial advisor recommends an investment that you are unsure about get their recommendation in writing. Getting their advice in black and white provides you with extra protection in the future should something go wrong. “This is a requirement of the FAIS Act anyway,” says Came.

4.Came’s final advice is that if it all still sounds unreasonable, then don’t invest in the scheme.

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