Affinity fraud

In short

A friend of mine once lost a good deal of money to a man who sat in the same pew she did. If you are holding an offer from someone you know and trust, please slow down before you say yes. Affinity fraud is a scam that spreads through a group you belong to, such as a church, a club, or a family. You can protect yourself by asking for written proof, checking the seller and the product, and refusing to be rushed. Your trust in your neighbors is a good thing. It just should not be the only thing you check. Call your state securities regulator or the SEC before you hand over a dime.

The whole of it

What it is

I once watched a kind old fellow tell a room full of his friends about a can't miss deal. Every one of them believed him, because he had never given them a reason not to. That is the whole trick of affinity fraud.

The scammer joins a group, or pretends to, and uses the group's trust as a shield. The group might be built around faith, language, heritage, work, age, or a hobby. The scammer does not have to prove much, because members vouch for one another. You have probably felt how hard it is to doubt a person who shares your table on Sunday.

Most often the scheme is a Ponzi scheme or a pyramid scheme. In a Ponzi scheme, early investors get paid with the money of later investors, so it looks like real profit when it is not. In a pyramid scheme, people earn mainly by signing up new members instead of selling something of real value. Both fall apart once the new money runs dry.

The Securities and Exchange Commission, which is the federal agency that polices the investment markets, has a plain guide on this. Its investor education site, Investor.gov, describes affinity fraud and the warning signs. I would read it with a cup of coffee and an open mind.

You are not foolish if a scam like this finds you. Trust is what makes a community worth having. The crooks only borrow it.

How it works

A friend of mine, a retired schoolteacher, told me how it began for her. A man she admired asked her to lunch, spoke warmly of the group, and mentioned an opportunity that was open only to members. Nobody had to twist her arm. The invitation felt like an honor.

That feeling is the hook. The scammer often wins over a few respected leaders first. Once those leaders invest, others follow, and each new person becomes a salesman without knowing it. They believe they are helping their friends.

The promises tend to sound the same. Big returns, little risk, and a need to act quickly. The pitch may lean on shared values, saying the money will do good for the group. Some schemes ask you to keep it quiet, which shuts off the very people who might ask a sharp question.

The money moves in a circle. Say you hand over cash and see a fine statement a month later. That paper may be made up. If a few early investors ask for money back and get it, they tell everyone how well it works. Those payments come from newer investors, not from any real earnings.

Then the well runs dry. New recruits slow down, or a few people ask for their money all at once. The scheme cannot pay, and the leader vanishes or gets caught. By then the damage has spread through the whole group.

The numbers, and where to find yours

You have probably wondered whether there is a magic number that marks a scam. There is not. Still, a few figures are worth knowing, and some are set by law or rule.

Before you invest, most sellers of securities and their salespeople must be registered. You can check a person or firm free on Investor.gov, which links to the SEC and to FINRA, the industry body that oversees brokers. You can also look up your state securities regulator through the North American Securities Administrators Association at nasaa.org.

Some investments are open only to certain people. The income or net worth needed to count as an accredited investor is set by rule, and the current threshold is the current figure, which the official source publishes each year in yearly income, per the SEC. If someone tells you a deal is exclusive, ask whether you actually qualify and why.

Bank deposits have a limit too. Federal insurance covers deposits up to the current figure, which the official source publishes each year per depositor, per bank, per ownership category, according to the FDIC. A scheme is not a bank deposit, and no such insurance stands behind it. Ask yourself whose promise protects your money if things go wrong.

Your own numbers matter most. Write down what you are being asked to invest, what return is promised, and how long until you can get your money out. Then compare the promised return with what safe options pay. A gap that wide should make you curious, not excited.

A worked example

Let me tell you about a man I will call Walter Reyes. Walter is 64, a retired bus mechanic, and he sings in his church choir. A fellow choir member, a warm and well liked man named Dale, told him about a fund that paid 2 percent a month.

Walter did the math on the back of an envelope. He had 40,000 dollars to put in. At 2 percent a month, that is 40,000 times 0.02, which comes to 800 dollars each month. Over 12 months, that is 800 times 12, or 9,600 dollars a year. Divided by his 40,000 dollars, that is 9,600 divided by 40,000, or 24 percent a year.

Walter stopped there, and I give him credit for it. Twenty four percent a year, with no risk, is a strange thing. He remembered that no honest seller promises a sure thing. So he called his state securities regulator and asked if Dale's fund was registered.

It was not. The regulator also told him that promised high returns with little risk are a classic warning sign. Walter kept his 40,000 dollars. He also quietly told two friends in the choir to check before they gave Dale anything.

Walter did not shame Dale or call him a crook. Dale may well have believed in it himself, having been fooled first. Walter simply asked good questions and let the answers speak.

Where it goes wrong

I have noticed that the hardest part is not the math. It is the shame. When a friend brings the offer, saying no can feel like an insult. So people say yes to keep the peace.

Another trap is the borrowed reputation. A trusted leader vouches for the deal, and everyone assumes he checked. Often he did not. He was told a nice story too.

Watch for pressure. If someone says the window closes tonight, that is a reason to wait, not to hurry. Honest deals can bear a few days of looking.

Watch for secrecy, too. If you are asked not to tell your spouse, your accountant, or your pastor, be careful. A sound investment does not mind being examined.

Do not lean on a promise of a sure profit. All real investing carries risk, and anyone who tells you otherwise has something to sell. Be wary of paperwork that is thin, vague, or missing.

If you have already put money in, do not lose heart. Stop sending more. Save every record, then report it to the SEC and your state securities regulator. Speak up early. It is not a weakness.

Questions to answer before you leave this page

Have I checked whether this person and this product are registered, using Investor.gov or my state securities regulator? Can I explain in plain words how the money is supposed to grow, and who pays for it? Am I being asked to keep this secret, or to decide in a hurry, and why? Would I still say yes if a stranger made this same offer? Do I have every promise in writing, and have I shown it to someone I trust who has no stake in the deal? If I lost every dollar I put in, could I still sleep and pay my bills?