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Avoid Falling Prey to Investing Scams

Wall Street Journal

I recently spent some 18 months sifting through the wreckage of a massive securities fraud. What I found was every investor’s scariest nightmare.

Masquerading as a brilliant stock trader, Martin Frankel stole over $200 million, first from individual investors in Ohio, Florida and Texas and then from a chain of southern insurance companies he bought with their money.

He’d promised to invest the money, assuring his clients that his trading philosophy involved precious little risk. In fact, he did almost no buying and selling of stocks and bonds. Instead he allegedly used the money to buy two mansions in Greenwich, Conn., $1.8 million in cars and to support the numerous women who drifted in and out of his life.

None of that, of course, showed up on the account statements that Mr. Frankel dutifully sent clients. They believed the impressive results Mr. Frankel reported, which sometimes topped 15% even in the market’s off years.

Scams similar to Mr. Frankel’s have been going on as long as people have been investing. Mr. Frankel himself idolized Robert Vesco, the notorious financier who fled the U.S. after being accused of looting investors of hundreds of millions of dollars.

Last month it was revealed that Frank Gruttadauria, a Lehman Brothers broker from Cleveland, may have stolen as much as $125 million from clients over a 15-year period by inflating account statements by as much as $300 million. After being at large for four weeks, Mr. Gruttadauria turned himself in to authorities in Cleveland.

Not Pulled In

How do these scamsters get away with it? How did a nerdy guy like Marty Frankel, who operated two illegal funds from the bedroom of his parents’ Toledo home, convince so many people he could make them rich? My curiosity about that was one reason I decided to write a book about Mr. Frankel, one of the most successful con men of the past century, and certainly one of the most improbable. But as I progressed with my research, another question piqued my interest: Why was it that some people courted by Mr. Frankel and his associates did not fall under his spell?

The answer offers lessons for all investors.

Ted Bitter, an investor from Millbury, Ohio, got off to a good start with Marty Frankel.

Literally overnight, the broker made Mr. Bitter $18,000 in a single trade in the mid-1980s. But then came some ominous signs for anyone paying attention to Mr. Frankel’s activities.

For one thing, Mr. Frankel was fired from his brokerage-firm job, in part because he was unproductive. Then, operating out of his bedroom, he whined endlessly to Mr. Bitter that he was suffering from a “trading block,” which prevented him from making further investments. Nonetheless, Mr. Bitter stuck with him, believing that if Mr. Frankel had done it once with an $18,000 windfall, he could do it again.

John Herlihy, a retired salesman for Sears, Roebuck, invested over $200,000 with Mr. Frankel in 1987. In return, Mr. Frankel scrawled a receipt in all capital letters on a blank piece of paper. Mr. Herlihy didn’t get nervous until a year later, when he wasn’t getting his statements on a regular basis and had trouble reaching Mr. Frankel. After Mr. Herlihy said he wanted his money back, Mr. Frankel paid him a visit in person and brought him gifts. He then promised to guarantee him against losses. “Furthermore,” he wrote, “this letter guarantees that your principal shall earn an annualized rate of return of 10 percent.”

Mr. Frankel’s investors had come face to face with some classic warning signs of broker wrongdoing. Any sort of irregularity when it comes to account statements should prompt questions by the investor. Mr. Gruttadauria, for example, allegedly sent his clients phony statements. Guarantees against losses, or a promised rate of return on an investment that would ordinarily experience price fluctuations are often signs that a broker is flirting with the wrong side of the law.

But Messrs. Bitter and Herlihy believed in Mr. Frankel, who will be tried on multiple criminal charges later this year. They were wowed by his knowledge of the stock market and by his unassuming personality. They lost everything. In 1992 they won an arbitration against Mr. Frankel, who claimed he didn’t have the money to pay them back. They settled for a portion of their losses.

You don’t have to be a market wizard to detect a fraud artist at work. Sometimes just a little bit of research is enough. A Toledo broker who worked with and invested with Mr. Frankel decided to take a closer look at how he operated in 1990. Among other things, he made the troublesome discovery that Mr. Frankel was not properly registered with regulatory authorities. Such registrations are easily checked through public records, including those kept by the National Association of Securities Dealers. He severed his ties with Mr. Frankel, recouping his money.

Not long before Mr. Frankel fled his Connecticut mansion and went on the lam in Europe in 1999, he became interested in acquiring a stock-brokerage firm in Tennessee. He sent some of his well-heeled associates to Memphis to meet with James Pauline, vice president of Duncan-Williams Inc.

Immediately, Mr. Pauline’s antenna went up. “The minute I met them I literally counted my fingers to make sure my fingers were all there,” he later joked. To his mind, his visitors were excessively slick and evasive. One visitor’s shirt, he thought, looked custom made. And everybody’s watches seemed a little too expensive. Mr. Pauline sent them back to their private jet.

“Good business people are not flashy,” Mr. Pauline recently said. “You’ve got to read people and you’ve got to know the people you’re doing business with.” Although cold calling by stockbrokers trolling for business is pretty common, Mr. Pauline says he’s usually suspicious when he gets those calls at night at home. “If you’re such a successful broker, why are you in the office at seven o’clock at night calling me up trying to sell me on $1,500 in stock?” he asks.

Wishful Thinkers

Vincent DiCarlo, a Sacramento, Calif., lawyer who represents investors, says that people who fall prey to unscrupulous brokers often are victims of their own wishful thinking.

“The way con artists work is they tell you what you want to believe,” he says. Sophisticated con artists, he notes, figure out their targets’ special dreams — providing for an ailing spouse, paying for a child’s college — and promise to meet those needs.

As a first line of defense, lawyers such as Mr. DiCarlo recommend carefully scrutinizing every account statement to spot any kind of sale or purchase that you haven’t authorized.

Be aware that forging account statements is a favorite technique of scammers. Mr. DiCarlo recalls a case he handled where a broker made unauthorized trades, then tried to cover it up by preparing phony statements. He hoped to make up the losses, but ended up losing $3 million.

David Robbins, a New York lawyer who also handles cases against brokers, advises investors who see any unusual activity on their statements to complain to the broker’s branch manager. If that doesn’t work, he advises, “go higher and put it in writing.”

Mr. Robbins thinks investors should even examine the envelopes in which account statements come. For example, if the broker has used an ordinary postage stamp rather than a company’s meter stamp, which could be traced, it could be a sign that something’s amiss.

“If the money you give your broker is not absolutely reported on your monthly account statement, then it probably never went into an investment. It probably went into his pocket,” Mr. Robbins says.