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Can you spot the scam?

Every day there’s a new way to lose your money being invented by scammers. History tells the tales of huge scammers, like Bernie Madoff, Kenneth Lay and Jeff Skillings (Enron), Elizabeth Holmes (Theranos), and many others. 

If you think back through your own life, how many times were you able to spot a deceiver? A boyfriend/girlfriend who wasn’t what they seemed to be? An employer? A business partner? A church leader? A politician?

Usually, we’ve had lots of practice in having the wool pulled over our eyes, which is where we gain the wisdom to avoid similar situations in the future.


Why is it then that really smart adults still get deceived in the investment world?

What was your journey to disciplined due diligence? How were your lessons learned?


Affinity Fraud

I can’t delve into how investors get scammed by startup founders and crowdfunding sources, without some attention to affinity fraud. This is because smart founders are usually reaching out to people they know who are leaders, influencers, and subject matter experts for funding but also to lend credibility to their venture. Unfortunately, this tactic is also used by people who do not have good intentions. Including a guy named Robert Fain. 

Scheister. Fraud. Scammer. And I could easily add a few descriptive expletives as well. In 1988, Robert Fain moved to a small Central Utah community and introduced himself to my husband’s father, Max – the owner of the local weekly newspaper who also served on the city council. Before Robert Fain moved to the community, he had joined the church that the majority of the community belonged to, portraying himself as ‘one of them’. He would show minimum viable product inventions, with attractive prototype labeling that met a need. He was an attractive smooth talker and came across as deeply sincere and honest.

He worked with vendors in the community, including Max for publicity, and my husband and myself; we owned a small in-house printing and print brokerage company to provide services we procured from other printers if we lacked the equipment to produce it ourselves. 

On such large orders, our instincts were to get a deposit and have the balance in full at time of delivery. But Max suggested that businesses were built on trust and he’d never do business with someone who made him pay a deposit. He was from a time where business was conducted on a handshake. And it was a small community where people didn’t even lock their doors at night. 

So we took on the $15,000 job, which we delivered and picked up a check for partial payment and the balance would be available within a week. At the time, he also had me getting bids for about $160,000 worth of similar printed products. But then the check bounced. We immediately stopped considering taking additional jobs from him.  So he only got into us for $15,000. But for a couple of newlyweds with a small startup that only had 10% margins, that hurt!

Fain disappeared within a few weeks of us investigating our options in attempting to collect on the bounced check. After tapping out the life savings of several retired seniors in the community, he moved on to scam another community in Texas, which got him excommunicated from the church so he could no longer use that affiliation to steal from people. He moved back to Utah as a member of a different church and did it again!

This time he got caught, and the law got involved. Nine years after our first encounter, Robert Fain went to prison for 15 years and became Utah’s poster child for affinity fraud. Of course, affinity fraud occurs in every state. Alabama put together a list of cases from across the country, including Fain.  [source: affinity fraud]

Affinity fraud is especially prevalent in startups. Seed funding is typically an opportunity of who you know. 


Spotting a Scam

You don’t have to know somebody (affinity fraud) to get ripped off as an investor. Enron’s Kenneth Lay and Jeffrey Skillings ripped off 24,000 employees’ retirement plans, as well as untold numbers of shareholders, as well as the resulting SEC regulations that added burdens to publicly traded companies who hadn’t misbehaved, in the form of Sarbanes-Oxley Act compliance. Almost every investor and employee missed seeing the scam. The ones who saw it got out. 

Bernie Madoff fooled 37,000 victims. Some of them were known for their ability to ask really tough questions (Larry King, Elie Weisel) or had mad business skills – Steven Spielberg, and Jeffrey Katzenberg; all were among those who were ripped off by Madoff. [source:]

And of course, there’s the current case going against Elizabeth Holmes who managed to deceive two former secretaries of state, military high-ups, and most of the Silicon Valley elite. 

So are scammers just really good at concealing rip-off intentions or are investors slacking off on due diligence and failing to follow consistent investing rules?


Opening Our Eyes; Trusting Our Gut

The first time I heard about Theranos as an up-and-coming medical technology company, I loved the sound of what the company was about. I saw the Steve Jobs imitation in the stories. And had I been into startup investing at the time, I could have stopped at that point and put my own money into the kitty. If you look at who’s involved – who should have done their due diligence, and, trusting THEIR analysis, we’re neglecting to open our own eyes. We turn into lemmings instead of autonomous decision-makers who can study things out and come to our own conclusions. 

Back when I made my $15,000 mistake in providing printing services to a fraudster, I failed to open my own eyes. I ignored the feeling that gripped my gut as I took the order and obligated myself to my vendors to engage in this process with my own credibility and credit at risk. I took the word of my father-in-law of how business was done. And this was in 1988; before the internet; before Google made it easy to pull up information with a couple of keyboard strokes and mouse clicks. 


Dialing Down the Emotion

I’ve still been scammed since getting swindled on that huge printing job in 1988. I’ve gotten pulled into the emotion of the pitch – of the possible great outcomes and ignored my own rules. 

Dang!! = there’s that emotion trap, AGAIN! Sprung! Gotcha! 

And I knew better! I could see it happening. It took a few bangs, bumps, bruises, and serious losses before I really got it and put rules in place to avoid this most preventable error!

Angel investors are additionally at risk because we’re looking for opportunities that are at higher risk, lacking proven track records of returns, in the quest for a more successful outcome as a result.


Due Diligence – Check Yourself! 

There are many traps that cause us to take shortcuts in the due-diligence efforts required to take intelligent investment risks; traps that if you can recognize along the way and avoid, you can insulate yourself from the most common mistakes angel investors make. Here are just a few:

  • Unaccredited Crowdfunding Site. Last week, the SEC charged a crowdfunding site for allegedly selling unregistered securities, for a scheme to sell almost $2 million in unregistered securities in two crowdfunding offerings connected to cannabis and hemp companies.[source: pymnts] Checking to see if a security is properly registered, and the crowdfunding site has a track record with SEC filings via EDGAR helps reduce the chance of going down a rabbit hole with a fraudulent investment opportunity.
  • “Too good to be true”. This trap is where Theranos would-be investors could check themselves first. Hindsight being 20/20, comparing blood from capillaries vs blood from veins would be a good start. Then consider that Elizabeth Holmes was no Doogie Howser, MD – child medical genius that could overcome those issues as well as the lack of engineering expertise, and it would be easier to just say, “I’m out.” 
  • “That’s good enough for me!” While we always look at who the other investors are at the table, we don’t just follow their lead and buy-in. One of my “Oh! Duh!” mistakes was getting into an opportunity because someone I trusted spoke with passion and conviction about the purpose of the business, ignoring that one of the founders, who I knew personally, had once been charged with securities fraud. The charges had been dropped but still – there was enough smoke there that I should have investigated more. And it turned out to be a horrible business venture. Which leads me to the next trap:
  • Emotions hooked; disengage your inner skeptic! Every CEO I’ve ever listened to has the skill to hook your attention through stories that engage your heart. By engaging your inner skeptic, and recognizing the appeal to your emotions, you can step back, and review your personal investing rules. And then there’s…
  • Smoking Hopium. One of the biggest due-diligence failures happens when we’re emotionally hooked and we WANT to be blind to the bad, the nay-sayers – anything that might say something that dashes our hopes. So we ignore Google, SEC, Glassdoor, and other research resources that might have something negative to say about the potential startup. 

Which traps have you gotten caught in?


Bottom Line: 

Look for accredited sources who fully comply with regulations, along with founder transparency, appealing to logic rather than emotion, and openness to questions. “Crowdfunding offerings enable issuers to cast a wide net for potential investors, emphasizing the importance of full and honest disclosure”, said Gurbir S. Grewal, Director of SEC Division of Enforcement. “As companies continue to raise funds through crowdfunding offerings, we will hold issuers, gatekeepers, and individuals accountable and enforce the protections in place for all investors.” [source: Pymnts]

While accountability is fine and good, it might not get you your money back if you get hooked by a scam. So build relationships with subject matter experts in engineering, technology, medicine, medical technology, and other startup areas that interest you so that you can ask them for their opinions. And especially build relationships with other angels who are misers when it comes to jumping in; get a second or third opinion from these experts. Friends who will challenge your thinking are your best friends as an angel.

Question everything. Be skeptical. Before you release your money, check your emotions. Ask yourself if you are completely willing to lose 100% of the money you’re about to engage in the startup, with no regrets if that happens. If it passes your gut test, the smell test, the skeptic test, and the Spock test (no emotions/pure logic), and any additional rules you’d like to put in place to ensure a higher probability of investing success, engage!