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Could you fall for an investment fraud?

If someone whose family once owned the New England Patriots, an independent director of several Dreyfus funds and a man who said he was a respected South African banker promised you above-market returns, would you hand them your money?
/ Source: The Associated Press

If someone whose family once owned the New England Patriots, an independent director of several Dreyfus funds and a man who said he was a respected South African banker promised you above-market returns, would you hand them your money?

You might say you'd be skeptical, but administrative and civil proceedings around Brite Business Corp. show that many investors weren't. They invested at least $52 million with a gang of frauds. A piece of the Securities and Exchange Commission's case against the crew, which began in 2002, moved ahead on July 28, when one of the participants settled with the commission.

The proceedings are a reminder that when anyone, no matter how pedigreed, how important sounding and how well-connnected, promises you extraordinary returns, your response should be ice-cold skepticism. Once the bad guys have your money, you may never see it again.

Some deals that come your way may simply be too risky for normal middle-class investors. Others are outright frauds. If you think you're too smart to be tricked, would you believe any of the following:

  1. Advisers who work with a name-brand investment house must be trustworthy.
  2. A mutual fund director with a well-known family of funds tells you a trading program that, among other things, purchases Treasury bills on margin is “absolutely safe.”
  3. An investment you don't completely understand called “credit enhancement” or “balance sheet enhancement” is a good idea.
  4. You could get a nearly 300 percent return on your money in 12 banking days.
  5. You can trust your advisers because one has an apartment on Central Park West, another “converted, leveraged, compounded and traded assets for some of the most well-known and influential industrialists, financial magnates such as the world-renowned gold trader, Mr. Jack Lazar,” and one served for eight years as chairman of the National Football League.

The correct answer is none of the above. All are from litigation and regulatory proceedings surrounding Brite, which Brenda P. Murray, chief administrative law judge at the SEC described in a 2005 decision as “a non-public company set up to defraud investors.”

Consider them point by point.

1) Brite did business with Raymond James Financial Services Inc., which must have impressed investors. But later administrative court proceedings would show that some managers at Raymond James thought Brite's proposals “didn't pass the smell test” and that it was too difficult “to understand the economic justification for the deal.” After the SEC began pursuing Brite, the president and chief operating officer of Raymond James was moved to another job in part because Raymond James' holding company believed the SEC wanted him removed, Murray wrote.

One of Brite's principals, a Raymond James broker, was eventually arrested in Bermuda and pleaded guilty in 2004 to criminal charges of wire fraud. He was sentenced to 188 months and ordered to make restitution of more than $13 million, according to Murray's decision.

Raymond James took subsequent steps to try to avoid a repeat of the Brite incident. Remember that no name brand can offer you complete protection. If something sounds wrong to you, trust your gut. An SEC administrative law judge in March found Raymond James liable for fraud and failure to supervise in the case and ordered it to pay a penalty and disgorgement that totaled $6.9 million. Raymond James did not immediately return calls seeking comment.

2) Meet any promise of safety with skepticism. There are very few investments that are “absolutely safe” and borrowing money to buy a security, known as buying on margin, is not one of them, no matter who says so. In this case, in at least one transaction, interest rates were higher than the return on Treasury bills, so the investment was a sure loser.

3) Never make an investment you don't understand.

4) If someone offers you interest far above the prevailing rate, run. If you're putting $100,000 or more in the bank tomorrow, you should expect an interest rate around 5 percent. To make substantially more than that, you'll have to take on more risk. If you don't understand the risk, see above.

5) If the principals are well-known on another continent or tangentially connected to the famous, ask yourself why they aren't relaxing on a yacht somewhere. As for the Dreyfus director who was part of Brite, he quickly became a former Dreyfus director. Never trust someone because of who they are or who they say they are.

In the latest developments at the end of July, Farouk A. Khan, who had told investors he was involved in a bank in the Middle East, settled with the SEC but didn't admit or deny the allegations the agency brought against him, including the “fraudulent misrepresentations” to an investor whom he promised a 107 percent annual return.

Khan had signed Brite documents with the title Assistant Secretary. The SEC's final judgment found him liable for a total of $284,358.82, which the SEC had alleged was the result of the fraud, plus interest. The SEC determined not to impose a civil penalty and waive the payment, "contingent upon the accuracy and completeness of Khan's financial statements." He could not be reached for comment.

If you want your financial statements to stay accurate and complete, avoid name droppers with big promises and hard-to understand plans.