Highlights in this issue:

*** Don't become a victim...
*** Boiler rooms uncovered...
*** Avoid falling for the Reg-S ploy... and more...

From the overworked laptop of Julie Brownlee...

Dear Investment Academy Reader,

Recently, the financial world has been marred with scams, conning those who probably should have known better out of large sums of cash. Bernard Madoff kicked it all off in the States, which led him to serve a 150 year sentence for his efforts.

So, in today's Investment Academy, we're going to see what you can do to protect yourself from becoming a victim...

Hang up on scam artists

The saying "there's no such thing as a free lunch" may be a cliché, but it's almost always true. So when that smooth talking American comes on the phone saying he has a stock that's "guaranteed to treble" and it's an "opportunity only available to a few sophisticated investors like you", most investors hang up immediately. But unfortunately, not all are that savvy - and with no shortage of fraudsters out there pounding the phones, far too many people fall victim to their traps every year.

One of the most common types of scams aimed at investors is known as the "boiler room" con (it gets it name because of the heat generated by the chaotic, high pressure sales environments in which these crooks operate). They set up in offshore locations where they can avoid detection and punishment by the Financial Services Board (FSB) here in South Africa, and cold call unwary SA investors with these jaw dropping promises.

These "victims" should know better

Even more unbelievable than the the crooks' spiel is who falls for them. According to the FSA (the Financial Services Authority, the UK's equivalent of our FSB), the typical victim of boiler rooms isn't a vulnerable widow who's found herself a nice inheritance, as you'd expect. In fact, it's more likely to be a seasoned investor, middle aged and male. They get sucked in by the promise of substantial returns and bamboozled by the need for expediency in their decision making. Salesmen will stress the importance of moving quickly on the stock, perhaps claiming to have inside information that the company's set to unveil a new discovery and that this is "just one of two remaining openings" to buy in. In order to dispel any fears you may have over their legitimacy, boiler rooms may offer you their contact address or a phone number for an office in Europe or America. But any calls will simply be routed back to the boiler room, in Barcelona, Tenerife or above a chip shop in Zurich.

In a typical scam, the boiler room approaches a small company and suggests raising capital by selling shares on the company's behalf. The boiler room then cold calls, selling them the shares at up to double the agreed price. And they'll keep ringing. In 2006, the FSA found that a quarter of boiler room victims were "groomed" for up to six months before being persuaded to hand over their money. The typical amount lost? A painful £20,000 (R250,000), says the FSA. Having got the money, the boiler room then vanishes - leaving both the investor and the company out of pocket. Another ploy is to sell Reg-S shares, obscure, illiquid warrants in US companies. The boiler room claims these shares are worth the same as the company's main listed shares, and are just trading at a temporary discount, but in truth, investors will have a hard time ever selling them. And even if they do, they'll do so at a significant loss.

Don't believe the hype

The FSB and the FSA have publicised arrests and prosecutions of boiler room operators as much as possible in the hope of getting the message across to the investing public. Earlier this year, the FSA called on all UK listed companies to help it warn investors by distributing a free leaflet among their shareholders warning about these scams. But ultimately, the onus is on every investor to exercise caution. Be extremely suspicious of anyone cold calling you trying to sell investment products: No reputable firm hawks stocks like this. And remember, even in the utterly unlikely event that the shares are legitimate, they should be available through a regular stockbroker, so there's never any reason to go along with the caller's hard sell approach, no matter how convincing they sound. Unfortunately, there's no compensation scheme for people ripped off by a boiler room, since these operators aren't authorised anyway.

Happy trading!

Julie Brownlee
for The Investment Academy

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*** This article was adapted from MoneyWeek.