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On Scams
It has been said that if an investment product is too good to be true – than it probably is. If a product can give 50% guaranteed over 2 years (for example), look no further as this is definitely a scam.
Why? It is important to understand the meaning of the word “guaranteed.” In the financial jargon, the word “guaranteed” and the English word “guaranteed” does not have the same meaning. While the English word “guaranteed” means “certainty”, the financial jargon “guaranteed” simply means a contractual obligation by a counterparty to deliver the promised return. Does it mean that if the return is contractual in nature, it means it is safe? No I am afraid not. While the counterparty can be a person or an institution, if the counterparty breaches the contract, in financial jargon it means that counterparty defaults. If the counterparty defaults, investors can sue. However, if the counterparty is already insolvent (meaning its asset is less than liability), than depending on what kind of “creditor” you are, you may or may not get anything back. Even if you could get something back, it may not be your entire promised amount. After netting off legal fee, you could actually be getting nothing or even incurring more losses for pursuing legal recourse. That is why, if the amount is not extremely large, most investors would not seek legal suit to get back their money when a counterparty defaults. Therefore, does it mean that the word “guaranteed” return carries no meaning in the financial world? Not really. If the counterparty is highly reliable and reputable, than the word “guaranteed return” carries more weight. For example, if a bond is issued by the Singapore Government Bond, the guaranteed coupons and repayment of par value on maturity has the same meaning as the English world “guaranteed return.” On the other hand, if the counterparty has a “C” credit rating, this means that the issuer is likely to default. Thus, this counterparty is not likely to deliver its promise. In this case, the word “guaranteed return” is as good as no return.
Many scam play with the word “guaranteed return.” Technically, it is true that they “guarantee” their return of 50%pa over 2 years (figures for illustration only). However, chances of defaulting on their promise is also guaranteed (no pun intended.) This means that the counterparty will certainly default on their promise. If the counterparty will certainly default on their payments, then the seller or the introducer is selling you a scam. For reference purposes, the current risk-free return using Singapore Government Securities for a 2 years maturity time frame is 1.46% yield to maturity. Thus, any investment which “guarantees” its return over 2 year time frame should not have a return too far from this reference. Thus, if the guaranteed return is 2% pa (for example), it is realistic. If the guaranteed return is 20%pa over 2 years, it is a scam and a police report should be made immediately.
Scammers will play on the emotions of unsuspecting individuals. The most common is a Ponzi scheme. Let’s say you were asked to invest $1000 and promised $125 per quarterly payout. This works out to be 125*4/1000 = 50% in current annual yield. The figure already shows this is a scam as it is too far from the reference risk-free return mentioned above. But to trap the investor, the scammer will actually give out $125 quarterly to the victim for a period of time. The victim will be convinced it works and hence would likely invest more money and introduce others into the scheme. How does the scammer give this money? It is easy: the money that is given to the victim comes from future victims. However, future victims’ need to be given this high payout as well and hence their payouts come from future victims too. Soon, a very large pyramid is formed in which the top of the pyramid benefits but the last to join the pyramid will be the one to suffer. Eventually the pyramid will collapse due to cash flow problem as the rate of recruiting future victims is not fast enough to pay the pioneer victims. Due to increased knowledge and information availability, many so-called “victims” knew all along that they were participating in a scam. But their hope is to benefit from the scheme before the pyramid collapses. Thus, some “victims” are not that innocent after all. This is dangerous because future victims could sue earlier victims. That is to say that the “victim” could end up be suit by other “victims.” Therefore, it pays not to participate in a scam. If in doubt, do not invest in it.
Is it true that scammers work in the dark alley ? Unfortunately no. Many scammers give seminars in reputable hotels. Other scammers have registered offices in Singapore. Far from working in the dark alley, these days scammers are out in the open. Examples of well-known scams (all of which are ponzi scheme) are:
Swiss Cash – I wrote about this in my blog (HERE) and now Swiss Cash is on MAS Alert list
Sunshine Empire – See articles: http://en.wikipedia.org/wiki/Sunshine_Empire and it is on the MAS Alert list too.
Powder River Petroleum (through OilPods) – See newspaper appended to this blog. Also see links compiled by my colleague HERE
Certain land banking – See research done in this link HERE
Were the above only available in the dark alley? No, far from it I saw all of the above in the open. Some were actively selling their products in exhibitions and some were openly having seminars in hotels.
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