by Thomas Schipani

Created on: August 04, 2009

I think you can only be 100% sure of avoiding a stock scam by not investing at all. Given that you don't think total abstinence is in your future there are a couple of common sense things to keep in mind. A few examples can help illustrate these.

I first heard about the LASER ARMS company from some friends while riding to work on the Long Island Rail Road. They were speaking in hushed whispers, trying to be sure they were not overheard so as to keep the good news to themselves and a few close friends. "This invention is going to revolutionize the entire beverage industry, and we can still get in early." My curiosity piqued, I asked "And just how is it going to do that?" I was then presented with a brochure from the LASER ARMS company. The brochure claimed that they had invented a self-cooling soda can. The brochure claimed that the act of opening the can released a secret compressed gas that cooled as it dispersed and thereby left one with an immediately cold soda. "And the stock is still selling at one and three eighths, up from seven eighths last week - it's going to go up - we can get in now - but don't tell anybody." "Where did you get this thing?" "From my brother-in-law."

So what's wrong with this picture? Aside from the impossible physics and engineering issues, what possibly makes you think that a credit manager, a printer, a CPA and two systems analysts who had no contacts on the board or management were going to find out about such a thing? If it were true it would be as closely guarded a trade secret as the recipe for Coca Cola or Gulden's Mustard. Look at the source of the information and be very skeptical where you think you are getting in on the ground floor unless you are a venture capital professional. My friends actually invested in LASER ARMS and it did go up, but only for about a week. It was than revealed as one of the all time classic penny stock frauds.

This type of talking in hushed whispers, only telling a few friends etc - does it sound familiar? Maybe a bit like Bernie Madoff? It should, it is the classic way of getting people into any scam, not just a stock swindle. You think you are in on a big secret, or put less delicately, you let your own greed get the better of you.

But the Madoff example gives another good tip for staying out of trouble. Aside from his sales and marketing skills, Madoff kept the scam going for many years by handing out false account statements to his customers. You get a statement in the mail, it says you have money, you believe it - just like your bank statement. Any auditor or regulator worth their salt will tell you that segregation of duties is important. In the securities business you never have the same guy make the trade, clear the trade, and keep the accounts. If you do give all of that to the wrong guy the only way you will find out he is stealing is when your firm goes under. The same applies to you. If you have an investment advisor, make sure that someone else, somebody reputable, is keeping the books. If Madoff's investors had all done that, there would have been no scam.

All of this proves that it is just as hard to make money in securities as anything other field. It takes training, education, experience, smarts and lots of hard work. That's why these guys get all of their big bonuses - not because it's easy. So if something looks like a ground floor opportunity, or looks to good to be true, or people talk about in whispers at the water cooler or tell you "my investment advisor produces my statements", you should be very wary.

Of course these are only the illegal scams

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