Small-business owners work very hard for their money. When a business becomes successful, it’s either sold for a large profit or it produces significant amounts of cash that can be taken out of the business instead of reinvested. In either case, the owners must decide what to do with the money.
Unfortunately, many wealthy entrepreneurs lack the skills to evaluate investment opportunities, falsely thinking that being a good entrepreneur makes one a good investor. It’s seldom the case.
Scam artists know this and they act accordingly, separating business owners from their fortunes even in the post-Madoff world. The three examples that follow are of scam artists who have pulled off their shenanigans quite recently.
3 successful scam artists
John Mattera, the head of Praetorian Global Fund, claimed to own millions of dollars in stock in Groupon, Facebook, Zynga and other private companies. He offered to sell these shares to investors before the companies completed an initial public offering (IPO). And he claimed that they would be able to sell their shares at a huge profit on the day of the IPO.
Mattera collected $11 million in capital from investors through intermediaries like Spartan Capital Partners, which did most of the direct marketing to potential investors. But Mattera did not own any shares in the companies and used the proceeds to fund a lavish lifestyle until his arrest.
Philip Baker, principal of Chicago hedge fund Lake Shore Asset Management, was recently sentenced to 20 years in federal prison for bilking investors of nearly $150 million. The fraud in this case was subtle and quite damaging. Baker lied to investors about the profitability of the hedge fund, reporting gains while he was losing money. He took $30 million for his personal discretionary and investment use.
Claudio Osorio, using his company InnoVida, promoted perhaps the most painful and ludicrous recent case of fraud. Osorio's company claimed to have developed a cost-effective method for fabricating housing for impoverished people that could improve the lives of millions around the world. He even promised to donate 1,000 free homes to poor Haitians as part of a 32,000-home-development project in that country. Osorio recruited investors by inviting them to his lavish $12 million estate on Miami's Star Island and showing them financials that indicated the company had more than $100 million in assets, including $25 million in cash.
Few investors could resist the temptation of investing in a well-financed company making large profits by helping poor people. Osorio was able to secure more than $30 million from entrepreneurs, financiers, athletes and celebrities. It turns out that the company had only $100,000 in cash, the mansion was mortgaged to the hilt and there was no revolutionary process. Now in bankruptcy, Osorio has not disclosed what happened to the tens of millions of dollars he took from investors.
How to avoid becoming a victim
Despite the disparate types of frauds presented in these recent scams, several key themes unite them and are part of most frauds that target investors. These are clues that can help you detect a fraud before you hand over your money. Ask the following three questions to determine if a potential investment has any of the telltale themes.
How do you make money exactly?
Most frauds claim to make their money through secret, unexplainable or extremely complex means. A clear indicator that something is wrong is the "trust me" response when an investor asks how money is made. Genuine investment opportunities are transparent, understandable and explainable.
What is your track record for investor returns since inception?
Investing is a complicated endeavor and even the most successful investors never have a perfect track record. If someone offers you an investment opportunity that claims to have never lost money or never performed below expectations you should beware. The only investments that are truly risk-free have virtually no return.
Walk me through how performance information is prepared and communicated.
A warning signal of a fraud is an absolute control of information by insiders. As an investor you should have access to data from reputable third parties such as auditing firms, custodial banks and performance evaluators. If your only source of information is the person asking you for money, it’s better to walk away.