Cockroaches of the Investment Business
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What's a Boiler Room?
Boiler rooms generally sell registered and unregistered securities — frequently start-up penny stocks — using high-pressure sales techniques and egregiously misrepresenting the risks associated with those securities. They may employ a mix of registered and unregistered sales reps who tend to cold call potential victims from the firms' offices. Some boiler-room firms change their names periodically to try to cover their tracks. And a lot of them don't even bother with the pretense of legality — they set up a fake broker/dealer with no NASD registration at all. They're named boiler rooms, because originally, these firms would try to find the cheapest place to rent — often enough that happened to be in the basement, where the boiler was, says Peter Henning, a professor at Wayne State University Law School and a former attorney in the Division of Enforcement at the SEC, where he worked on cases involving penny-stock fraud.
Smarts Don't Help
It has long been an assumption that if investors were only educated enough — knew the basics about financial instruments and markets and how they work — well, then investment fraud would be wiped out. Everyone, from regulators to Alan Greenspan and Warren Buffet, have stumped for the investor education cause, and today there are hundreds, if not thousands, of financial literacy programs in the U.S.
But now that premise has been thrown into doubt. An Investor Fraud Study, prepared by the Consumer Fraud Research Group and released by the NASD Investor Education Foundation in May, showed that investment-fraud victims are actually more financially literate than non-victims. Victims outscored non-victims on an eight-question financial literacy test: 58 percent to 41 percent.
How could this be? The study came up with three possible explanations:
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The Knowing-Doing Gap. “Investors may actually have enough knowledge about financial investments to avoid trouble, but for some reason they do not employ that knowledge when it's needed the most.”
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The Expert Snare. There is an influence tactic con criminals use in which they praise the victim for their expertise. “Since most people like others to think of them as experts, this puts the victim in the position of not wanting to ask tough, probing questions, and be accused of not knowing the answer.”
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Lower Persuasion Literacy. “Having content knowledge of the nuts and bolts of financial instruments and investing may help one make better investing decisions with legitimate brokers, but it doesn't inoculate them from the persuasion tactics used by con criminals.”
Researchers suggested that No. 3 is most plausible, and that maybe financial literacy programs should include fraud-prevention education. The researchers also found out that investment-fraud victims are more often men, tend to live with others or be married, tend to be more educated and have higher levels of income than non-victims. They're also more likely to have suffered from more “negative life events” than non-victims. Oh, and they “dramatically” under-report fraud.
