For a certain segment of our society, dreaming up new ways to separate people from their money is a full-time job. For these hucksters, the current economy is a dream come true--lower investment returns have made many Americans extremely receptive when someone comes around promising big financial gains for just a little money up front.

To combat the rising tide of fraud and the selling of "inappropriate" investments that has resulted, the California Department of Corporations recently released a warning on what it calls the "dirty dozen"--12 of the biggest investment scams and unsavory schemes currently making the rounds. Some are familiar--such as pyramid schemes, bait-and-switch tactics, and "wrong number" hot stock tips left on answering machines-- while others like fake FDIC-insured deposit certificates or bogus financial planning seminars targeting seniors are newer and more sophisticated. From phony tsunami fundraisers to betting on dead people, the following are a few scams to be aware of.

Variable Annuities

Today, these long-term investment accounts are "sold more aggressively than fake Gucci handbags on the streets of New York City," according to SmartMoney.com. Basically, a variable annuity is an account that you pay into, which your broker then invests in stocks, bonds, or other instruments. At some point, you begin receiving regular payments out of the account. Variable annuities are tax-deferred, and differ from other, similar investments like IRAs and 401(k)s in that they have no annual contribution limit. These accounts also often come with insurance guaranteeing that you will get paid out for all money contributed into the annuity, even if the underlying investments lose money.

Doesn't sound too bad so far. But the problem is fees. According to Morningstar, the average variable annuity charges 2.3% of assets, whereas the average mutual fund charges 1.44%. Variable annuities also generally charge a "surrender fee" of several percent if money is withdrawn or transferred before a certain time, usually five years. The Securities and Exchange Commission reports that some brokers even pressure clients to switch money early to a supposedly better account, causing the investor to incur a surrender fee that goes straight into the broker's pocket. The kicker is that variable annuity gains are taxed at regular income tax rates--up to 35 percent--much higher than the maximum 15% charged on mutual fund gains. The California Department of Corporations therefore calls these investments "inappropriate for many investors."

Military Fraud

The U.S. military, with over 2 million employees, represents a substantial group of potential investors. Some investment firms have tried to tap into this market by touting financial programs "custom-made" for military personnel. NASD, a private regulator of U.S. securities, recently levied a $12 million fine against one such organization--Texas-based First Command Financial Planning--for selling unsuitable products to troops and then attempting to use the chain of command to silence complaints.

NASD found that First Command's employees, many of whom are ex-military, charged exorbitant fees--up to 50 percent--during the first year of an investment plan, telling plan holders that the towering charges "instill discipline." When one Air Force officer criticized the plan in an email, a First Command supervisor contacted the officer's superiors and suggested to the man that a pending re-assignment might be delayed if he pursued his claims against the company.

Viatical Settlements

Viaticals, or life insurance settlements, are one of today's most controversial investment options. Under such a scheme, you basically purchase someone else's life insurance policy, paying that person for the right to collect benefits upon their death. Viaticals became popular during the AIDS epidemic of the 1980s, with sick patients using them as a way to "cash out" their insurance policies before dying, providing money to pay hospital expenses. Such sellers hire a broker who then puts their insurance policy out to bids from other investment companies, which buy the rights on behalf of their clients.

Obviously, these investments come with a major (and somewhat ghoulish) risk-- investors don't get paid until the insured person dies. The payout can be large if the policy holder passes before their estimated life expectancy, but will shrink if the person outlives the date on their policy. The Securities and Exchange Commission reports that some viatical investors even lose money after paying additional premiums to extend a policy on a long-living holder. Other investors have seen their profits lost to steep premiums charged by viatical brokers, or have been left penniless when insurance companies refused to pay out on a deceased person's policy because of some technicality.

Online Escrow Fraud

The popularity of online auction sites like eBay has created new opportunities for criminals posing as escrow services--middlemen who receive goods and money on behalf of buyers and sellers. Generally a legitimate escrow service works in the following way: A buyer agrees to purchase a product and send payment to an escrow service, which notifies the seller that the money has been received. The seller then sends the product, receiving the cash from the escrow provider once the buyer confirms that the shipment has arrived.

Escrow conmen work by swiping a legitimate posting for some item from a website and then posting it on another site. For example, a car ad might be taken from AutoTrader.com and reposted on eBay motors. The hucksters, however, give their own email or phone number. When approached by a buyer, they agree to sell and ask the purchaser to send the payment through an "independent" escrow service they have set up--often complete with a website, phone number, and fake registration information. The would-be buyer sends the money but never receives the goods, and never hears from the thieves again.

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Posted 02-28-2005 8:53 PM by Doug Casey
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