‘Buyer Beware’ Is Insufficient Fraud Protection

> Posted by Jami Solli, Independent Consultant and Founder of the Global Alliance for Legal Aid

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Happy World Consumer Rights Day (WCRD)! Every year on March 15 WCRD serves as an opportunity to promote the basic rights of all consumers and as a chance to protest against the market abuses and social injustices which undermine those rights. The theme for this year is ‘Building a Digital World Consumers Can Trust’. The following post spotlights the increasing need for regulatory attention on online financial frauds.

No country in the world is free of financial fraud. And, every nation seems to have its own Bernie Madoff. Yet, Madoff’s $50 billion did not do systemic damage to the U.S. financial system, nor did it harm financial inclusion efforts in America. Unfortunately, when ponzis occur in developing countries, they do cause systemic risk and untold damage to financial inclusion efforts.

For example, Albania was plagued by ponzi schemes during the 1990s, and funds stolen were estimated to be worth 79 percent of the country’s GDP. When these schemes in Albania collapsed, so did the existing government, causing civil unrest. Other regions have also experienced financial frauds worth significant portions of their countries’ GDPs. In 2008-09, an estimated 12-25 percent of Jamaica’s GDP was stolen, and in the little island nation of Grenada, the SGL Holdings scam netted 5 percent of the country’s GDP.

Often, these scams take the form of ponzi, pyramid, or even multi-level marketing frauds (MLM). Ponzi schemes are characterized by investors getting paid via new capital paid to the scheme’s operators by new investors instead of from profit earned through legitimate sources. Pyramid schemes focus on payments to participants for recruiting others to join the scheme rather than for the sale of products or services. MLM frauds are a pyramid-shaped scheme, deemed in some cases as actual pyramid schemes, with this same emphasis on participant payment for recruitment rather than for sales. There are a variety of names and unique fraud ‘methodologies,’ but the common denominator in all of these scams is that there is no real, underlying business.

Largely speaking no one is selling a product or a service. If you ask to see the companies’ books, that reality may become clear immediately. Profits are generated only because new investors are continually lured into participating, such that the new investors’ money is used to pay off the earlier investors. These schemes always promise great and unrealistic returns. Often, the promoter of the scheme is a well-liked, prominent member of the community. His victims are made to feel that they would be stupid to not get in on this deal early. 

However, when the pyramid grows so large that too few new investors can be found to pay off the older investors, the pyramid always crumbles. And, rarely do the victims get any of their funds returned. In the worst cases, a few participants have committed suicide following severe losses.

These crimes are preventable and stoppable, but currently regulators are not putting forth the effort to do so. The scams are increasing in volume and scope, and thanks in part to the internet, social networking, and mobile technologies, they’re increasingly going digital and hopping borders. Ponzi schemes were at the center of Ghana’s presidential election campaign this year, and demonstrated this trend of schemes border hopping and venue shopping. For example, the Mavrodi Mondial Movement (MMM) scheme, which originated in Russia in 1994 has been in almost continuous existence, operating in Bangladesh, Ghana, India, Kenya, and Nigeria, among other countries. In fact, consumers in Ghana were still investing in MMM shortly after its collapse in neighboring Nigeria.

Yet the regulatory mechanisms to prevent these frauds and monitor markets are not keeping pace. Instead, regulators simply advise consumers to ‘beware.’ Unfortunately, vulnerable financial consumers are paying the price, and national financial inclusion efforts are thwarted as well, as a major fraud scheme can undermine trust in fraudulent and legitimate financial service providers alike. Certainly, more can and should be done to protect consumers.

Financial sector regulators cannot say they have not been warned. These frauds have been with us for centuries. However, as digital schemes, they are becoming even more virulent with the power to harm more consumers. Therefore, regulators need to step up their digital market monitoring efforts.

Because fake investment opportunities are usually unlicensed by financial sector regulators, this presents a few straightforward opportunities for regulators to make a difference. One such opportunity is for regulators to create an online system where consumers can search to see if the company, or promoted investment opportunity does indeed have a license and publicize it widely so consumers can conduct at least minimal due diligence. If regulators do not have the bandwidth to perform these tasks themselves, then they should outsource the work to a consumer protection organization.

A new collaborative preventative strategy is needed, capitalizing on the internet and the many eyes of consumer advocacy organizations, working in partnership with public authorities, including financial and telecommunications regulators. Consumer organizations could be trained to monitor financial markets to identify potential frauds and warn regulators who have the mandate to investigate and shut down unlicensed investment opportunities.

Regulators also need to work with consumer organizations to conduct outreach campaigns to educate consumers. Regulators should take a page from the con artists’ play book. Criminals use social networks and social events like church gatherings to sell their scams. They fund sports events and donate to charities. Regulators need to be present online as well as at these same physical venues with their message of how to spot a fraud, how to verify that an investment offer is licensed, and how to get in touch with regulators. If regulators cannot or will not do this, then they should fund consumer organizations to do the job for them.

Simply telling consumers caveat emptor with no further outreach or enforcement is a not acceptable. Regulators can empower consumers to be a part of the solution to financial frauds, including digital fraud.

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