Avoiding Online Investment Scams

By Lisa Smith AAA

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The internet is a great tool for investors, providing a source for researching investments and trading securities with unprecedented ease. Unfortunately, the lack of rules on the web also makes it the perfect place for fraud to flourish. To avoid getting burned, take precautions. We'll show you five ways to reduce your odds of becoming the victim of fraud.

1. Pay Attention
Just about anyone can build a website these days. There are a variety of tools available online that enable the creation of a basic website with little effort or money. The fact is, the bad guys know how easy it is to build websites, and they also know that many people pay little attention to details when the prospect of easy money is flashed before their eyes. To take advantage of this confluence of events, scam artists often slap together hastily designed websites, relying on simple math to make a buck. Regardless of how poorly the sites are put together, statistically speaking, it's a numbers game. A certain number of people will visit a given website and, out of that number, a smaller number will take the bait.

To screen out the scammers, pay attention to quality when you're surfing the web, especially when money and investments are involved. Typographical errors, content that doesn't make sense and poor graphic design are signs that a website may not be legitimate.

While legitimate sites aren't always perfect, they are usually pretty close. When major financial services firms decided to develop a web presence, a lot of time, talent, and money goes in to helping the company put its best face forward. While some scams sites are so detailed that they mirror legitimate sites, paying attention to quality will help you avoid the worst of the rogue sites.

2. Apply Common Sense
Scam artists understand greed and cater to it by promising to deliver something for nothing. Internet message boards, spam emails and online investment newsletters are three of the most common tools of the criminal trade. If you think you've found a "golden nugget" on an internet message board, or you have been the lucky recipient of an email from a foreign national desperate to give away millions of dollars in exchange for your help (similar to the Nigerian scam), remember that greed makes you gullible. (For more, read Stop Scams In Their Tracks.)

Sadly, even chief executive officers (CEOs) of major corporations have been caught using assumed names to talk up their companies' stocks and talk down their competitors in online forums. For example, in 2007, it was revealed that the CEO of Whole Foods Market (Nasdaq: WFMI), John Mackay, posed as a user named "Rahodeb" and had for years posted extremely favorable comments about the company on Yahoo! Finance's Whole Foods Market message board. Other fraudsters are even more brazen, intentionally promoting stocks in order to profit by selling when investors are buying. The proliferation of online investment newsletters touting what are supposed to be "hot" stock picks facilitates this type of fraud.

The best way to protect yourself from this type of activity is to apply common sense. No matter what you think you have learned online or how much you have convinced yourself that the information that you have uncovered is legitimate, if it looks too good to be true, it probably is.

3. Use the Internet
Not everything you read online is false or misleading. All U.S. companies with more than 500 investors and $10 million assets and all companies listed on major stock exchanges are required to file regular reports with the Securities and Exchange Commission (SEC). While scandals like those at Enron and WorldCom, among many others, have demonstrated that filing these reports doesn't guarantee legitimacy, a quick check of the SEC's Edgar website is always a good place to start when researching companies that interest you. At the very least, it verifies the company's existence. While this might sound pretty basic, more than a few scams have made millions of dollars from unsuspecting investors by touting companies that weren't real. (For related reading, see The Biggest Stock Scams Of All Time.)

In addition to the SEC's site, there are plenty of sites that track stocks, providing price quotes, corporate news, historical performance data and more. Most of these sites are easy to use and free. For a reasonable fee, there are also plenty of research reports that can be purchased online. These reports are created by reputable financial analysts and provide insight into the operations of the companies they cover. (To learn more, read Data Mining For Investing.)

4. Contact the Regulators
If a company that catches your interest shows up in the Edgar database, your next move is to check with your state securities regulator to see if there have been complaints filed against the company. If the company has been touted by a brokerage firm, something that is often seen in newsletters and email, check with your state regulator and with the Financial Industry Regulatory Authority (FINRA) to determine whether the brokerage firm has a good disciplinary track record.

5. Conduct Fundamental Research
If the hot company that you found online has passed all of the other screens, it's time to get serious and do some hands-on research. Get copies of the firm's financial statements and analyze them. Research the company's leaders. If the company claims to be the largest supplier of widgets to the world' largest grocery store chain, call the store and find out if the claim is true. Make every effort to learn as much about the company as you possibly can. Of course, if all of this sounds like too much work, buy a mutual fund and delegate the work to the professionals.

There Are No Shortcuts
Investing, like any other worthwhile endeavor, requires effort. There are no shortcuts, but there are plenty of pitfalls. The number and types of scams on the internet would take an army of accountants a lifetime to track and calculate, but most are variations on a theme. To minimize your odds of getting scammed, never make an investment decision based strictly on information that you obtained online.

To learn more about internet investment fraud, read our Online Investment Scams Tutorial.

Investing 101 - Click Here!

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