Most people are familiar with Bernie Madoff, operator of the largest Ponzi scheme ever. Investors in the Wall Street elite lost tens of billions of dollars to Madoff’s scheme until it finally collapsed at the end of 2008.
What you may not know, however, is that Madoff’s Ponzi scheme is also one of the largest examples of affinity fraud to date. A sizable portion of his victims came from the wealthy Jewish community of which he was a part. Madoff leveraged his status within that community, along with his affiliations on Wall Street, to gain the trust of his victims. As a result, they never felt the need to vet thoroughly the “investment opportunities” Madoff presented to them.
Affinity fraud is particularly dangerous because it is based around the trust between members in a community; and unfortunately, it is more pervasive than many investors think. No matter how trusted a recommendation is, investors should always conduct due diligence. Doing so can help them avoid falling victim to affinity fraud.
What Is Affinity Fraud?
Affinity fraud is a type of investment fraud that targets members of a specific group with a common bond. While Madoff exploited his ties with a religious community, affinity fraud can also occur within professional organizations, ethnic identities, and age groups. Essentially, any identifiable group whose members trust one another as a result of their group membership can be subject to affinity fraud.
An affinity fraudster exploits this trust to lull their victims into a sense of security. For example, earlier this year a pastor was sentenced to six years in prison for his role in an investment fraud scam targeting members of his congregation. According to the Department of Justice, he used his status as a pastor to help convince victims they were making a legitimate investment. Instead, he pocketed the money and used it for his own personal gain.
How Affinity Fraud Happens
Affinity fraud starts with the fraudster gaining access to the targeted group. Like anyone else, stockbrokers may be involved with local professional groups, churches, or other community organizations. Sometimes, the fraudster actually is a member of the community they target. Other times, the fraudster merely pretends to be a member.
Affinity fraudsters may approach leaders within the community to seem more credible to other members. Presenting the investment opportunity through a discussion with the leaders allows the fraudster to exploit the trust community members share. In many cases, the community leaders themselves fall victim to the fraud as well.
When the fraudster pitches the investment, it’s usually in the form of either a pyramid scheme or a Ponzi scheme. In a Ponzi scheme, initial investors are paid returns using money contributed by later investors. In a pyramid scheme, early investors are encouraged to recruit other investors to get returns. With either type of investment scam, the fraudster doesn’t actually invest any of the investors’ money.
How to Avoid Affinity Fraud
Investors can avoid affinity fraud by taking the same precautions they should take for any investment. Investors should conduct their due diligence to properly vet an opportunity before money changes hands. This is especially important when investors know and trust the person making the recommendation. Here are some common signs that an investment may not be legitimate.
Never Invest Solely Because You Know the Person Recommending the Investment
What sets affinity fraud apart from other types of fraud is the exploitation of trust it uses. Even if the person is a competent stockbroker and someone you trust, take your time and approach any investment they offer just like you would any other investment. Ask yourself, Are they using their position as a leader as a reason why you should invest with them? If the answer is yes, then it is a good idea to investigate further before investing.
Avoid Promises of High or Guaranteed Returns
If a stockbroker in your community approaches you with an investment opportunity promising high or guaranteed returns, it is very likely fraudulent. When they make these promises, fraudsters may say they have inside information or a secret investment strategy.
Especially when these promises come from someone within your religious or ethnic community, it’s a big red flag for affinity fraud.
Avoid Opportunities Promised as “No Risk” Investments
Investing is inherently risky. While there are plenty of low-risk investment options, no strategy is truly without risk. Like other forms of investment fraud, affinity fraud scams make “no risk” promises alongside those of high or guaranteed returns.
Get Everything in Writing
Affinity fraudsters may be hesitant to document the investment when it is fraudulent. Legitimate stockbrokers will be able to provide a detailed outline of what they are offering you. Remember that if the opportunity seems to come out of nowhere, then it can disappear just as quickly.
Affinity fraudsters may say things to make you feel as though you need to give them your money right away or you will miss out. One of the worst investments you can make is one where you aren’t sure where the money is going or how you will get it back. Always take your time to investigate the opportunity, and never be afraid to walk away.
If the person who approaches you is a stockbroker themselves, you can use BrokerCheck to view their work and disciplinary histories. A BrokerCheck report will contain any required disclosures on the broker’s record, including certain liens and whether they’ve been subject to client disputes.
Be Aware of Email Spam
The Securities and Exchange Commission (SEC) warns that fraudsters increasingly use spam emails to market their bogus investment opportunities. If you receive an email advertising an investment to you and other members of your community, be careful, even if it appears to be from someone you know.
Victims of affinity fraud are often hesitant to report it because they fear doing so might damage their community. However, the issue is unlikely to resolve properly on its own; victims of affinity fraud may be able to recover their losses, but only if they report the fraud and hire an attorney.
If you are the victim of fraud by a person you trust, like a pastor, stockbroker, or another community leader, you may have a claim for affinity fraud. If you’re ready to step forward, an affinity fraud attorney can evaluate your options going forward. In addition, an affinity fraud lawyer can help you navigate the fallout within your community that may result from disclosing the fraud.
How to Report Affinity Fraud
The SEC, along with several state-level organizations, allows members of the public to submit tips or complaints of fraud. The SEC offers separate complaint systems for general complaints and for whistleblowers. If you’re unsure what you should report, hire an affinity fraud attorney first.
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