Mutual Funds:Internet Fraud, The Pyramid Scheme, How to Avoid Investment Fraud

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Management of Financial Institutions - MGT 604

Lecture # 26

Mutual Funds

Navigating the Investing Frontier: Where the Frauds Are

Many fraudsters rely on the telephone to carry out their investment scams. Using a

technique known as cold calling (so-called because a caller telephones a person with whom

they have not had previous contact), these fraudsters will hound you to buy stocks in small,

unknown companies that are highly risky or, sometimes, part of a scam. In recent years, the

Internet has also become increasingly attractive to fraudsters because it allows an individual

or company to communicate with a large audience without spending a lot of time, effort, or

money.

You should be skeptical of any offers you learn about from a cold caller or through the

Internet. Here's what you need to know about cold calling and Internet fraud.

Cold calling

For many businesses, including securities firms, cold calling serve as a legitimate way to

reach potential customers. Honest brokers use cold calling to find clients for the long term.

They ask questions to understand your financial situation and investment goals before

recommending that you buy anything.

Dishonest brokers use cold calling to find "quick hits." Some set up "boiler rooms" where

high-pressure salespeople use banks of telephones to call as many potential investors as

possible. Aggressive cold callers speak from persuasive scripts that include retorts for your

every objection. As long as you stay on the phone, they'll keep trying to sell. And they won't

let you get a word in edgewise.Our advice is to avoid making any direct investments over

the phone.

Internet Fraud

The Internet serves as an excellent tool for investors, allowing them to easily and

inexpensively research investment opportunities. But the Internet is also an excellent tool

for fraudsters. That's why you should always think twice before you invest your money in

any opportunity

you learn about through the Internet Anyone can reach tens of thousands of people by

building an Internet Web site, posting a message on an online message board, entering a

discussion in a live "chat" room, or sending mass e-mails. It's easy for fraudsters to make

their messages look real and credible. But it's nearly impossible for investors to tell the

difference between fact and fiction.

Types of Investment Fraud

The types of investment fraud seen online mirror the frauds perpetrated over the phone or

through the mail. Here are the most common investment schemes and the "red flags" you

should watch for:

Management of Financial Institutions - MGT 604

The "PUMP and DUMP" rip-off

It's common to see messages posted on the Internet that urge readers to buy a stock quickly

or to sell before the price goes down. Cold callers often call using the same sort of pitch.

Often the promoters will claim to have "inside" information about an impending

development or an "infallible" combination of economic and stock market data to pick

stocks. In reality, they may be insiders or paid promoters who stand to gain by selling their

shares after the stock price is pumped up by gullible investors. Once these fraudsters sell

their shares and stop hyping the stock, the price typically falls and investors lose their

money. Fraudsters frequently use this ploy with small, thinly traded companies because it's

easier to manipulate a stock when there's little or no information available about the

company.

The Pyramid Scheme

In the classic "pyramid" scheme, participants attempt to make money solely by recruiting

new participants into the program. The hallmark of these schemes is the promise of sky-

high returns in a short period of time for doing nothing other than handing over your money

and getting others to do the same. Money coming in from new recruits is used to pay off

early stage investors. But eventually the pyramid will collapse. At some point, the schemes

get too big, the promoter cannot raise enough money from new investors to pay earlier

investors, and many people lose their money. Table 1 shows how pyramid schemes can

become impossible to sustain.

How to Avoid Investment Fraud

To invest wisely and avoid investment scams, research each investment opportunity

thoroughly and ask questions. Get the facts before you invest, and only invest money you

can afford to lose. You can avoid investment scams by asking-and getting answers to-these

three simple questions:

1. Is the investment registered?

Many investment scams involve unregistered securities. So you should always find out

whether the company has registered its securities with the SEC or your state securities

regulators. You can do this by checking the SECP's website database or by calling SECP.

Some smaller companies don't have to register their securities offerings with the SEC, so

always make background check and ask for referrals etc.

2. Is the person licensed and law-abiding?

Try and find out whether the person or firm selling the investment is properly licensed and

whether they've had run-ins with regulators or received serious complaints from investors.

This information may be difficult to get in Pakistan.

3. does the investment sound too good to be true?

If it does, it probably is. High-yield investments tend to involve extremely high risk. Never

invest in an opportunity that promises "guaranteed" or "risk-free" returns. Watch out for

claims of astronomical yields in a short period of time. Be skeptical of "offshore" or foreign

investments. And beware of exotic or unusual sounding investments. Make sure you fully

understand the investment before you part with your hard-earned money. Always ask for-

Management of Financial Institutions - MGT 604

and carefully read-the company's prospectus. You should also read the most recent reports

the company has filed with its regulators and pay attention to the company's financial

statements, particularly if they do not say they have been audited or certified by an

accountant.

Mutual Funds - The Logic behind Investing in Them

Mutual funds are investment companies that pool money from investors at large and offer to

sell and buy back its shares on a continuous basis and use the capital thus raised to invest in

securities of different companies. This article helps you to know in depth on:

Is it possible to diversify investment if invested in mutual funds?

Find more on the working of mutual fund

Know more about the legal aspects in relation to the mutual funds

At the beginning of this millennium, mutual funds out numbered all the listed securities in

New York Stock Exchange. Mutual funds have an upper hand in terms of diversity and

liquidity at lower cost in comparison to bonds and stocks. The popularity of mutual funds

may be relatively new but not their origin which dates back to 18th century. Holland saw

the origination of mutual funds in 1774 as investment trusts before spreading to Anglo-

Saxon countries in its current form by 1868. We will discuss now as to what are mutual

funds before going on to seeing the advantages of mutual funds. Mutual funds are

investment companies that pool money from investors at large and offer to sell and buy

back its shares on a continuous basis and use the capital thus raised to invest in securities of

different companies. The stocks these mutual funds have are very fluid and are used for

buying or redeeming and/or selling shares at a net asset value. Mutual funds posses shares

of several companies and receive dividends in lieu of them and the earnings are distributed

among the share holders.

Are Mutual Funds Risk Free and what are the Advantages?

One must not forget the fundamentals of investment that no investment is insulated from

risk. Then it becomes interesting to answer why mutual funds are so popular. To begin with,

we can say mutual funds are relatively risk free in the way they invest and manage the

funds. The investment from the pool is well diversified across securities and shares from

various sectors. The fundamental understanding behind this is not all corporations and

sectors fail to perform at a time. And in the event of a security of a corporation or a whole

sector doing badly then the possible losses from that would be balanced by the returns from

other shares. This logic has seen the mutual funds to be perceived as risk free investments

in the market. Yes, this is not entirely untrue if one takes a look at performances of various

mutual funds. This relative freedom from risk is in addition to a couple of advantages

mutual funds carry with them. So, if you are a retail investor and planning an investment in

securities, you will certainly want to consider the advantages of investing in mutual funds.

Lowest per unit investment in almost all the cases

Your investment will be diversified

Your investment will be managed by professional money managers.

Management of Financial Institutions - MGT 604

There is no one method of classifying mutual funds risk free or advantageous. However we

can do the same by way of classifying mutual funds as per their functioning and the type of

funds they offer to investors. This Course makes you aware on:

What are the reasons that make the close ended mutual finds more attractive?

What are the factors that determine the prices of exchange traded funds?

Find out the features of open ended mutual funds

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