But How Could They Do That to Us? The Growth of Affinity Frauds

Whether due to increased investor skepticism, regulators’ need to demonstrate active enforcement, the financial media’s search for a good story, an increase in fraud in the current economy, or a combination of all of the above, affinity frauds have been coming to light more and more frequently.

The scams, most of them classic Ponzi schemes, involve investment in diverse vehicles, including securities, hedge funds, real estate, investment clubs, wines, medical businesses, and others. Many, though, have one thing in common: the victims share some trait with the perpetrators of the fraud. This element in common with the fraudster lulls the victims and makes them more readily trusting of the con artist’s pitch. The perpetrator preys upon that inherent trust of a shared bond. After all, the fraudster is “one of us” and must be “looking out for me.” These are called “affinity frauds.”

In the past year, multiple scams have targeted specifically identifiable groups of victims all around the world. Targets have included those who are geographically connected, such as high-net-worth individuals resident in Portland, Ore., and Los Angeles; investors from certain religious faiths, such as the Evangelical Christian and Mormon communities; members of ethnic groups, such as Persian Jews, or Cuban-, Chinese-, or Korean-Americans; and even the elderly or those with disabilities. Affinity fraud can be based on almost any common bond. Victims in the past have come from groups of pilots, former professional football players, divorcees, wine aficionados, and members of specific interest clubs.

Of particular concern, Harry Markopolos, a forensic accountant who provided the SEC with information regarding Bernie Madoff’s fraud years before he was ultimately caught, just last month warned on ABC News that there are three new multibillion-dollar Ponzi schemes he is tracking and that one of them is bigger than Madoff’s $65 billion fraud. Markopolos has declined to disclose details of the frauds, stating that he wants to provide information to regulatory and enforcement authorities first.

Recently, the Securities and Exchange Commission (SEC) moved against numerous investment frauds targeting specific communities of victims:

• A man, who split his time between California and Hong Kong, was charged with fraud after he raised over $65 million in investments from members of the Asian and Latino communities in the U.S. and abroad for a multi-level marketing company selling cloud computing, promising returns of 100% or more in 100 days.
• Two individuals in southern Florida were charged with defrauding senior citizens in a scam involving stock in a company that allegedly developed “ground-breaking technology” they said would be used by the National Football League. One of the pair even had previous run-ins with the SEC regarding fraud and had settled the earlier case.
• A man in southern California, claiming to be a hedge fund manager, was charged with fraud after raising $7.5 million from Persian Jewish community members in Los Angeles. Instead of investing the money, he spent it on luxury goods, as well as his own wedding and honeymoon.
• Even when affinity fraudsters do not share a common trait with their victims, they can work to co-opt influential members of the target group. These community leaders are typically duped into believing in the investment opportunity, which then spreads by word of mouth through the rest of the community.

Fortunately, most of these situations can be avoided with a combination of a common sense and due diligence. Here are some red flags to watch out for:

• If an investment opportunity promises returns that sound too good to be true such as incredibly high rates of return or overly consistent returns despite volatile market conditions it most likely IS too good to be true.
• If the investment opportunity cannot be explained to you in a way that readily makes sense, be suspicious. Keep asking questions until you feel comfortable that you understand the opportunity fully.
• If the opportunity is a “secret” one, with very limited participation, run the other way.
• Check with your state securities regulator, the Financial Industry Regulatory Authority, or the SEC to see whether the person offering the investment is registered or has a disciplinary history.
• Listen to your instincts. You would be surprised how accurate that little voice can be. If you have cause for concern, or simply want to ensure that you are avoiding a trap, consult a professional firm to perform a little due diligence.

An earlier version of this article appeared in the Kroll Global Fraud Report 2009-2010