Spotting an Investment Scam

Advice and insights from former SEC enforcer Pat Huddleston.
3:00 | 11/22/11

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Transcript for Spotting an Investment Scam
To feel like the safest place for your money is under -- actress. -- things like the Madoff scandal and the collapse of firms like MF global recently certainly don't build investor confidence. But there are warning signs that we can all look out for here to share his knowledge is former SEC -- -- -- pat Huddleston. Author of the book -- the vigilant investor pat thanks so much for joining us today. In my pleasure Stephanie so to start with the Bernie Madoff scandal because we just got some new headlines this week what -- Madoff employees recently admitted taking part in the Ponzi -- since the early seventies. Just surprise -- that this scam went unnoticed for thirty years. Well it does surprise me I mean in the SEC has been forthcoming I think about the lapses there at the agency. I mean they have a lot of successes but this was one big failure and I think they've changed. -- corrected but the thing that this latest development points out Stephanie. Is how often these big scams are joint productions that these people have cohorts folks who help them. -- their scam and that what what that means for investors is that you can't just assume that you're going out looking for. Evidence of legitimacy that you're actually running into somebody who's given you confirmation what you the person you might be running into. Is you know -- in the scam somebody who was in place just be there when you called -- try to seek confirmation. What I find interesting -- you -- your book that it's because of the Madoff scheme that investment scams will now be harder. To spot why is that. -- the future of fraud is a lot scarier I think we're -- a perfect storm that might threaten to make us forget Bernie Madoff if you can believe it. First of all they're going to be harder to spot just because technology makes it so much easier. To produce phony account statements Madoff did very well with the technology he had and it's only getting better. Next we've got people who everybody remembers that number that they thought they needed in order to retire. Ever forgotten and we just got -- back in 2008 right. But nobody remembers it and they want to get to that number still and so they are susceptible to folks who say -- -- can still get to to that retirement you always dreamed up. Ever get to -- your tips and a second -- MF global a recent -- in the headlines we're now being told there's up to one point two billion dollars. Possibly missing from customer accounts -- warning signs for customers and that scenario. You know I don't I don't know about MF global I think what the lesson to take from that is that commodities. Trading is. Risky. And that diversification -- got to take care some of these things and if you had all your eggs in that commodities basket -- in. You're in a world of hurt right now but the thing that it also bomb highlights is that. You know you need to pay attention what sort of back stops there are -- I'm not aware of -- things like Pacific. That steps in takes control in the commodities contacts and so you just need to be aware I mean how much -- -- how many -- -- -- -- -- -- -- single -- yeah. That needs to my personal question which what is the difference these days between scam a legitimate scam of the Madoff variety vs. Bad investors. And investors like -- perhaps not knowing the difference. Well you mean bad investors bad advisors are folks like him -- global and that. -- investment vs legitimate scams that are possibly illegal. -- you know here's the difference I mean from your standpoint Stephanie there may be absolutely no difference in and -- global. Highlights this -- mean certainly there are people out there. Who are it's going in to a business opportunity so called in order to defraud you may know from the outset these people are career criminals. The MF global situation is really scary and it might highlight what happens in more than half of the cases that is. People -- really trying to do something that they promise to do do they really think they're legitimate. They reach a hard place or a point where the gonna have to tell you that they've lost a lot of money -- rather than do that they decide that they're just gonna. Borrow your money for a little while -- Let's let's actually get to your five kinds of -- -- that lets go through. This list that you talk about in your book and the first is the career criminal which you've just mention. But the second is the golden boy what do you mean by that. Well these these are often -- folks who want to very prestigious schools they tend to be young in their late twenties and thirties. They do everything right they live a very flamboyant lifestyle they are the person that you believe. His figured it out right has cracked the code and has come up with this algorithm -- -- trading method. That is finally done what nobody else could do -- bound to wait. To give -- secure profits without an awful lot of awful lot of risk and they're just very flamboyant charismatic -- OK the second -- third that you talk about is the -- I imagine that somebody that just tell small lines. But the -- is interesting the bungle -- the Butler that we need to be even this out for. Well this is really fascinating it turns out that people who were really bad -- any thing. Often times are bad because they lack the capacity to diagnose their own incompetence. And so their people out there who tell you they're great asset managers that the great stock pickers and they actually believe that they have a lot of confidence in that. But the truth is they aren't -- lousy and they lacked the capacity to understand that. On the flip side it turns out that highly competent people tend to underestimate their abilities. And so you have to look really hard to make sure you don't run into the hands of somebody who thinks he's here she is terrific. But he's just flat wrong about that and lacks the capacity -- -- this type of -- that you -- in your book seems quite obvious the flat out -- Yet do -- -- we distinguish the thief from the Faber is in way that the thief or just somebody who forges account state account documents. Takes your money out of your account and flees the country you wouldn't believe often that happens I have prosecuted the guy at the SEC who was on the run for. For more than ten years before he was caught running a scam in in Dubai we talk about him in the vigilant and. Just sort of the smash and grab kind of them now okay here's the important question. What are the warning signs pat. -- you believe it or not Stephanie the first warning insiders in your own brain the reason people continue to fall victim to this as they don't yet understand. How we perceive and process information in the investment context it turns out that we are almost pre wired. To be susceptible to this kind of thing it's not that people are gullible or greedy or stupid it's that they're just human. So having said that that's the thing you must understand before any other advice is going to be any good to you but beyond that. Warning signs promises of a guarantee these days anything that involves a promissory note you need to be. Especially suspicious and I tell people if you're afraid of fraud if you want to avoid fraud and fraud has to be what you look for. And their resources we -- in the book of how you look for evidence of fraud what people tend to do instead Stephanie is look for evidence of legitimacy. And we like to think that that's the same inquiry but it's really not so keep in mind if you want to avoid a fraud you gotta get out -- look for one. Right so we have to avoid the pitfalls of her on psyche. What's easiest way in a practical sense to protect yourself from investment scam. You know Stefan -- but we could probably lop off 20% of all investment scam losses if we could just train people to call other state securities commissioner. And confirm that the person trying to -- to them has a license. So often these guys have been kicked out of the business or never bothered to get the license. And their personnel injured personality personality just keeps them in the game and you never think to make that call also. First -- call your state securities commissioner and make sure that their license to do what they're doing. That's good advice it's like the wild west out there I didn't realize that you could just call up and find out. Pat Huddleston former SEC enforcement author of the book the vigilant investor pat thanks so much for sharing your insights my -- Stephanie.

This transcript has been automatically generated and may not be 100% accurate.

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