Investment fraud uncovered - what advisers need to know

There has been increasing coverage in the press over recent months reporting that the pandemic has led to an increase in fraud and, in particular, investment fraud. However, little has been said on the various types of schemes in operation. Investors and financial advisers need to keep ahead of the game, and it’s crucial to understand the warning signs and the best ways to respond when the worst happens and one of your clients is a victim of fraud.

Rise in investment fraud

Action Fraud (the National Fraud & Cyber Crime Reporting Centre) reported in November 2020 that there had been a 27% increase in reported investment fraud in the year to September – 17,000 reports amounting to £657.4M in reported losses. This is likely to be the tip of the iceberg with many frauds going unreported because victims are too embarrassed to report it.

Criminals are increasingly sophisticated and continue to find new ways to trick people out of their money. The term “investment fraud” encompasses activities including:

• Cryptofraud, where investors are encouraged to purchase cryptoassets that subsequently disappear or are held to ransom;
• Affinity fraud, where fraudsters infiltrate identifiable groups (such as religious communities, the elderly or certain professionals) and promote Ponzi or pyramid schemes;
• Advance fee fraud, where fraudsters seek advance or upfront payments for goods, services and/or financial gains that do not materialise (such as the Nigerian Prince scam);
• High-yield investment programmes, which promise incredible returns for little or no risk and the offer of guaranteed returns; and
• Pump and dump schemes, where share prices are ‘pumped up’ using false information to encourage investment before the fraudster ‘dumps’ their own shareholding making a personal gain and causing duped investors to make a loss.

Individuals often have a false sense of security, confident in their belief that they would never fall for a fraud. However, everyone is a potential target for criminals. With interest rates at an all-time low, the economy in a state of flux and more business than ever before being conducted remotely the chances of being duped are higher than ever.

Spotting the red flags

In an ideal world, a client considering making a new investment would always seek advice from you before doing so. In reality, fraudulent investment schemes are set up to put pressure on clients to relinquish cash quickly, before seeking advice. Marketing credentials and reviews can be faked with a high degree of sophistication. Prevention is always better than cure and a great deal can be done to educate clients as to the warning signs of fraud. Clients need to be cautious of contact out of the blue and on an unsolicited basis; being rushed to make decisions because an opportunity is about to disappear; and promises of unrealistic returns either in amount or time period.

Encouraging clients to research investments (including checking the Financial Service Register, Companies House and the FCA warning list) or seek your help to do so can be helpful. However, it is important to recognise that a particular combination of circumstances can catch out even the most sophisticated investor. This leads us to the question, what do you do when a client approaches you for advice and you suspect fraud?

Act immediately

Fraud is often uncovered because of the cessation of all communications or the disappearance of funds. Immediate action is necessary to maximise the chances of recovery. Your clients may well take steps to report the matter to the police, notify their bank and tighten their online security. However, they should also seek urgent advice as to their civil recovery options. In particular clients should not rely on Action Fraud (who are inundated with reports) to take action to recover funds. Nor should clients assume that their bank is doing all it can to recover funds or assist with disclosure of information. Often the bank may be looking to protect its own position.

If investors do take matters into their own hands, potential options to trace assets and recover funds through the civil courts include:

• Norwich Pharmacal or Bankers Trust Orders. These are types of court order sought against a third party (such as a bank) requiring it to disclose information. This information can then be used to plead a case against the fraudster, trace funds or bring proprietary claims. Without such an order the duty of confidentiality a bank owes to its customers will prevent it disclosing where funds have gone.
• Freezing Orders. This restrains the suspected fraudster (whether their identity is known to the victim or not) from dealing with or disposing of assets. A worldwide freezing order can extend to assets located anywhere in the world and is a particularly draconian measure, but a powerful tool to deploy against fraudsters.
• Search Orders. These allow the client’s representative to search the defendant’s home or business to secure evidence to assist in recovery of assets.

These remedies are expensive to obtain and at their most effective when sought in the short hours after discovery of a fraud. If too much time has passed, the funds are likely to have been dissipated too widely to allow effective recovery.

Options on the table

A particular problem with investor fraud is that it targets individuals and the sums lost may be too small to make legal action economically viable. However, depending on the number of investors affected, there is strength in numbers and if individuals can co-operate and pool resources, results are easier and cheaper to obtain. For more complex investor fraud, third party funding may be available to help impecunious investors recover their losses.

Where there is little or no prospect of recovering assets from the fraudster it may well also be worth considering claims against third parties involved such as banks. The courts have historically been reluctant to impose a duty of care on a bank where the victims are not its customers but there are signs that this position may be evolving, particularly where the victim can point to evidence of negligence by the bank, which has contributed to the fraud.

This article was first published in IFA Magazine, read here.