The new Martin Scorsese film The Wolf of Wall Street is riding high. It has been nominated for an Oscar for Best Picture. And, crucially, the movie has made money, an estimated $76 million over its production budget of $100 million.
Billed as a black comedy, Wolf tells the story of a “pump and dump” scheme run by a ferociously talented young stock salesman in the 1990s, later convicted of pushing penny stocks. Investor losses reached approximately $200 million; the broker did 22 months for the crime.
Why do we pay to watch bad guys get rich off our savings? Every few years, some well-known actor picks up the part and rides it to cinema fame. Even Jordan Belfort, the actual “wolf” portrayed by Leonardo DiCaprio in the movie, is cashing in today as a motivational speaker, a portion of which he must pay in restitution to his victims.
Not long ago we wallowed in the misery of folks who invested through the now-imprisoned Bernard Madoff. And stocks scams are going global. In August of last year, U.S. investigators arrested one group in a $140 million penny-stock scheme that made victims of investors in 135 countries.
Some of the company names they traded were laughable: Liquid Gold International, Nikron Technologies, Blackout Media Corp. One is reminded of the ludicrous off-balance-sheet entities used by Enron and named after Star Wars characters — JEDI and Chewco.
You can’t make this stuff up, but often that’s exactly what fraudsters do. Prosecutors refer to penny stocks as “file cabinet businesses.” They have minimal assets and even more minimal prospects. They exist to attract neophyte investors.
How can you protect yourself from these kinds of scams? There are a number of real risks retirement investors face. Here’s how to spot them and avoid them:
Affinity fraud
You get invited to a lunch with friends with whom you share some background, a common faith, membership in a club or a cultural link. A speaker at the meal launches into a slideshow promising double-digit returns for a “select few” who “get in on the ground floor.”
Affinity scams count on the trust you already place in your friends. Pretty soon, your money is tied up in obscure, distant businesses with no accountability. Avoiding them is easily done: Stick to liquid investments in major companies that figure in broadly held indexes, such as the S&P 500. Public companies have to respond to a raft of securities law that your lunch speaker is trying to skirt by going directly to you and your friends.
Penny stocks
Never heard of XYZ, Inc.? Well, you’re about to get an earful. It went up 1,200% in the past six months. These scams, often perpetrated over the phone but also by email or through Internet sites, count on greed to work. Your greed.
Increasingly known by the less-threatening name “microcaps,” penny stocks are the investment equivalent of throwing money down a well. Highly volatile and sometimes completely fictional, it takes a huge amount of emotional stamina to be a buyer. Well-known brokerages, such as Fidelity or Schwab, do offer access to very small stocks, but they often take great pains to qualify investors in advance of such risky trading. Retirement investors should take a big step back.
Ponzi schemes
The kind of Ponzi schemer most people run into is a small-time operator who promises extraordinary returns from real estate or obscure, highly complex trading strategies.
You can steer clear of slick operators by preferring trusted principals, widely respected figures such as Professor Burton Malkiel of Princeton, former Yale endowment trustee Charley Ellis, and Jay Vivian, former director of the IBM Retirement Funds. All three are on the Investment Committee of my own firm, Rebalance.
Staying out of trouble in the markets is not that hard to do. You must disconnect your emotions from your holdings and become disciplined about buying quality and rebalancing your portfolio periodically, all the while keeping a realistic return in mind.
Above all, remember this simple rule: If it sounds too good to be true, frankly, it is.
