Experienced Investor Falls Victim to Misrepresentation: What You Can Do to Avoid It

By: Patricia Uceda, Spring 2014 Student Intern

misrepAlan Grayson is one of the wealthiest members of Congress, thanks to his long record for picking winning stocks. With a net worth of $16.69 million and years of investing experience, he’s probably the last person you would think to fall victim to misrepresentation. Unfortunately that’s exactly what happened recently as he lost $18 million in a multi-million dollar investment fraud scheme run by Dean William Chapman.

Chapman promised to hold onto stocks for his borrowers in return for a loan worth a portion of the stocks’ value. If the stocks did badly, borrowers could keep the money they were loaned; but if the stocks performed well, they would repay the loan with interest and Chapman would return the stocks to the investors at their increased value. Unfortunately, Chapman was secretly selling the stock and ultimately had no way to repay his clients if their stock portfolio did well. As a result of his misrepresentation, he is now in prison and Grayson is out $18 million dollars.

What is Misrepresentation?

Your financial adviser may be liable for misrepresentation if they make an untrue statement of material fact or omit a material fact in the recommendation and purchase of a security. A statement is considered material if it would be important to your decision to purchase. Clearly, Chapman made some very big misrepresentations and omissions to his investors that ultimately backfired on him. While it may be too late for the investors who trusted Chapman, it’s not too late for you. In order to protect yourself from fraud, it is important to learn about the common tactics used by investment fraudsters.

Common Fraud Tactics

The “Phantom Riches” Tactic – The fraudster dangles the prospect of wealth in front of you.

Example: These stocks are guaranteed to produce $5,000 per month in income.

The “Source Credibility” Tactic – The fraudster tries to build credibility with you by claiming to be with a reputable firm or to have special experience.

Example: As CEO of XYZ Firm, I would never sell an investment that didn’t perform.

The “Social Consensus” Tactic – The fraudster leads you to believe that other savvy investors have already invested in the product.

Example: All of my friends and family have already invested.

The “Reciprocity” Tactic – The fraudster offers to do a small favor for you in return for a big favor.

Example: I’ll give you a 50% discount on my commission if you buy right now.

The “Scarcity” Tactic – Fraudster creates a false sense of urgency by stating that there is a limited supply.

Example: There are only two shares left so I’d buy today if I were you.

What to Do If You Hear One of Those

If you feel as though your financial adviser is using any of these tactics on you, you should end the conversation and take the time you need to check it out and get a second opinion. Don’t succumb to the pressure to buy immediately. Instead, try to independently verify the information you are given by looking at annual reports, brochures, or other documentation. Lastly, make sure to record notes of all your conversations with your broker.

Additional Tools

FINRA Broker Check is a great tool to use to make sure the financial adviser you are dealing with is a registered FINRA representative. Additionally you can look at their customer dispute and disciplinary history.

Risk Meter is a tool provided by FINRA which asks you questions about your characteristics and behavior traits in order to determine whether you may be vulnerable to investment fraud.

Scam Meter is another tool from FINRA that asks you questions about the investment you are considering in order to determine whether it might be a scam.