Investor Fraud Study Sponsored by the NASD Investor Education Foundation

1. Investor Fraud StudySponsored by the NASD Investor Education Foundation Completed for WISE Senior Services by The Consumer Fraud Research Group: Anthony Pratkanis, PhD; Doug Shadel, EdD; Melodye Kleinman, MPH; Bridget Small, JD; and Karla Pak, MS

2. Overview of Presentation • Understanding Investment Fraud Crimes • Describe the story of a victim who lost over $500,000 to an oil and gas scam. • Outline findings from the two-year-long NASD Investor Fraud Study being released today. • Discuss implications of the study’s findings for prevention efforts in the future.

3. One Victim’s Story • “Henry” (not his real name) was a successful businessman, married for 30 years, raised a family and lived a good life. He had accumulated a significant nest egg for his retirement. • Shortly after his wife’s death, he received a Federal Express package containing very professional, slick materials detailing an investment in oil and gas wells. • The next day, a salesman called him and used high pressure sales tactics (social influence) to persuade him to invest $40,000.

4. One Victim’s Story • Some examples: • “These gas wells are guaranteed to produce $6,800 a month in income.” • “Some of the most successful investors in the country are interested in these wells.” • “There are only two units left in this project.” • “We drilled a well in Texas that had these same early gas readings and the investors all made millions.”

5. One Victim’s Story • Once Henry invested the initial $40,000, his journey into the world of fraud was just beginning. • Within six weeks of making the first investment, he was contacted again by the same company. The caller told him the well was being dug, but in order to access the “vast gas fields” they would need another $50,000 to drill deeper. • Over a three-year period, Henry was re-contacted twelve times and invested his life savings in four different wells.

6. One Victim’s Story • Henry ultimately lost over $500,000 to this oil and gas scam, investing in wells that always seemed promising at first, but then ran into trouble and were all capped. • How did this happen? How can a successful, financially intelligent investor fall prey to such a scam and lose his life savings? These are among the questions the NASD Investor Fraud Study sought to answer.

7. Overview of Research Research Methodology and Design • Undercover Tape Analysis • Tapes provided to AARP by law enforcement agencies. • Detailed content analysis of 128 full-length transcripts to identify specific persuasion tactics. • Several different types of scams were represented in the tapes: investments, gold coins, lottery, travel, recovery and charity fraud. • Survey of Victims and Non-Victims • In-depth interviews with 21 victims and non-victims and two focus groups of victims and non-victims. • Conduct an extensive survey of 150 non-victims over 45 years old and 165 victims of investment and lottery fraud in order to determine how they differ and to develop clues for how to prevent future victimization. Victims were all determined by law enforcement to have lost more than $1,000 to fraud.

8. Finding One: Investment Fraud is Committed Using Sophisticated Social Influence Tactics.

9. Findings: Undercover Tape Analysis • Investment fraud criminals use a wide array of influence tactics. The research found 1,100 separate uses of the influence tactics in 128 transcripts. The most frequently-used tactics were: • Phantom Fixation – “These gas wells are guaranteed to produce $6,800 a month in income.” • Commitment – “You can vote to stop drilling, but if you do, all the rest of what you have invested will be lost.” • Authority – “I have been in the oil business for over 30 years and I have seen it all.” • Social Consensus – “I know it’s a lot of additional money to spend, but I am in this thing just as deep as you are and I say its worth every dime.” • Scarcity – “There are only two units left in this well.”

10. Findings: Undercover Tape Analysis Other common social influence tactics found in the tapes: • Friendship • Landscaping • Comparison • Reciprocity • Dependent • Source Credibility • Fear and Intimidation

11. Finding Two: Swindlers Bombard Their Victims With Complex Combinations of Tactics.

12. Findings: Undercover Tape Analysis • Investment fraud tapes utilize many more different tactics per transcript than other fraud tapes.

13. Findings: Undercover Tape Analysis • Investment fraud pitches used highest total number of tactics

14. Finding Three: Investment Victims are More Financially Literate than Non-Victims.

15. Findings: Survey of Victims and Non-Victims • Asked participants eight financial literacy questions: • The APR is the most important thing to look for when comparing credit card offers. True/False • Over a 40-year period, which do you think gave the highest return? Bonds, Stocks, Bank savings account, IRA, No answer • With compound interest, you earn interest on interest in addition to your principle. True/False • When an investor diversifies his or her investment, does the risk of losing money decrease, increase or stay the same? Decrease

16. Findings: Survey of Victims and Non-Victims • Financial literacy questions: • Mutual funds pay a guaranteed rate of return. True/False • A no load mutual fund involves no sales charges or other fees. True/False • What happens to bond prices when interest rates go up? Do bond prices fall, remain the same or go up? Fall • Which do you consider the most important factor in selecting a loan? The overall interest rate or the monthly loan payment? The overall interest rate

17. Findings: Survey of Victims and Non-Victims • Investment fraud victims scored higher on financial literacy questions

18. Finding Four: Victims are More Likely to Have Experienced a Negative Life Event.

19. Findings: Survey of Victims and Non-Victims • We asked about negative life experiences: Q7. Foreclosure on mortgage or loan Q8. Recent loss of employment for you or spouse Q9. Negative change in financial status Q10. Concerns about owing money Q11. Concerns about money for emergencies Q12. Problems with the upkeep of your home Q13. Concerned about money for basic necessities Q14. A recent change in your living arrangements Q15. Recently moved or changed residences Q16. Recent retirement of you or your spouse Q17. Change in social activities for the worse Q18. Change in your daily routine

20. Findings: Survey of Victims and Non-Victims • Negative Life Experiences Q19. Problems with transportation or traffic Q20. Problem with troublesome neighbors or co-workers Q21. Concerned about being lonely Q22. Legal problems Q23. Minor violations of the law Q24. Death of a spouse or partner Q25. Death of a close friend or family member Q26. Had a serious injury or illness yourself Q27. Developed a condition that limits your physical activity Q28. Had a serious injury or illness in the family Q29. Divorce or marital separation in the family Q30. Difficulties in relationship with a spouse or loved one Q31. Problems with children or grandchildren

21. Findings: Survey of Victims and Non-Victims • Investment fraud victims are more likely to have had a negative life event in the past three years.

22. Finding Five: Investment Fraud Victims are More Likely to: • Rely on Their Own Experience. • Be Optimistic. • Be Open to Listening to Sales Pitches.

23. Findings: Survey of Victims and Non-Victims • Investment fraud victims are more likely to rely on their own experience and knowledge when making investment decisions.

24. Findings: Survey of Victims and Non-Victims • Investment fraud victims are more optimistic about the future. • More likely to disagree with the statement, “In spite of what people say, the lot of the average person is getting worse, not better.”

25. Findings: Survey of Victims and Non-Victims • Investment fraud victims are more likely to listen to sales pitches.

26. Finding Six: Investment and Lottery Fraud Victims Have Widely Divergent Profiles.

27. Findings: Survey of Victims and Non-Victims • Investment fraud victims are more likely to: • Be male. • Live with one or more people. • Be married. • Make more than $30,000 per year. • Have at least a college degree. • Lottery fraud victims are more likely to: • Be female. • Live alone. • Be widowed. • Make less than $30,000 per year. • Have a high school diploma or less.

28. Findings: Survey of Victims and Non-Victims • Investment fraud victims are more likely to: • Believe their fate is totally up to them (internal locus of control). • Be optimistic about the future. • Be open to sales pitches from unknown sources. • Lottery fraud victims are more likely to: • Believe their fate is up to luck or chance (external locus of control). • Be pessimistic about the future. • Be skeptical of sales people; in past AARP studies, lottery victims were the least trusting of others.

29. Finding Seven: Investment and Lottery Fraud Victims Dramatically Under-Report Fraud.

30. Findings: Survey of Victims and Non-Victims • Investment and lottery victims dramatically under-report fraud. • Previous research shows victims under-report fraud (AARP, 2003.) • In present survey all victims surveyed had lost a minimum of $1000.

31. Conclusions/Implications • Con men use many different combinations of social influence tactics which suggests in order to defend against fraud, consumers must learn to identify such tactics. • Investment fraud victims score higher on financial literacy questions than non-victims which suggests that financial literacy education may not inoculate investors from fraudulent brokers. • Investment fraud victims are more likely to have experienced a negative life event. Such events may decrease the victim’s ability to defend against swindlers by using up cognitive resources. • Investment fraud victims are more open to sales pitches which may increase their vulnerability to coming into contact with a swindler.

32. Conclusions/Implications • Investment and lottery victims have divergent profiles which suggests that con men customize their pitches to match the profile. Prevention efforts must also be customized in order to be effective. • Investment fraud victims tend to rely on their own knowledge and experience which could create barriers to reaching them with prevention information.

33. Recommendations • What new approaches to prevention does the current research suggest? • Teach investors about social influence. • Expand financial literacy and fraud prevention efforts to include information about how persuasion tactics work. • Spread the word about life stresses. • Disseminate to family and friends of vulnerable adults and to law enforcement the knowledge that life stresses are related to victimization as a means of early warning. • Conduct research to: • Evaluate the effectiveness of social influence education as a deterrent to falling for investment fraud schemes. • Explore how victims and non-victims think about social influence situations. • Study resistance to influence in the context of “free seminar” and similar settings where multiple persuasion tactics are used.