Lessons from 5 shocking Wall Street scams

If only investors in these schemes had recognized the red flags, they might have saved themselves billions. Here are the warning signs they missed.

By InvestingAnswers Jul 2, 2013 2:53PM
digital Vision Ltd., SuperStock, SuperStockBy Miranda Marquit                                                         

They say it's better to learn from others' mistakes than to have to go through the agony of learning the hard way. So we wondered what can be learned from some of the biggest investing mistakes in history.

In recent years, we've seen plenty of Wall Street scams fall apart. Many of these scams bilk investors out of billions of dollars.

We wish we could say that those who are duped deserve their fate. After all, some of them are so amateurish or commonly known now that it makes you wonder how anyone could fall for them anymore. (Take the Nigerian email scam, for example.) 
However, the reality is that some of these scams are rather sophisticated. They often appear to be official or legitimate. And many of them succeed for years.

And yes, even you might fall for a scam, no matter how careful you are.

But to reduce the chances of being taken in by a Wall Street scam, here is a rundown of the five biggest Wall Street scams, and what you can learn from them:

5. Bayou Hedge Fund Group
Hedge funds were all the rage back in the mid-1990s, and Sam Israel had his own hedge fund group. To raise the money, Bayou Hedge Fund Group promised that $300 million invested would grow to $7.1 billion in 10 years. However, things didn't go as planned. As returns didn't match expectations, Bayou sent out fake accounting reports that indicated their investments were growing on pace. In the end, Israel was ordered to pay $300 million back to investors (hedgeco.net), and is serving a 22-year sentence.

What can you learn? As an investor, be wary of those who promise you a set return -- especially if the results are so dramatic. No one can guarantee what the market will do. Additionally, be aware of what is held in any funds you have. If the news you follow indicates that certain investments held in the fund are doing poorly, but your fund is still doing phenomenally, it's time to get suspicious.

4. Qwest Communications International
Even while his company tanked, CEO Joseph Nacchio promised that Qwest was on target to reach its revenue goals. While he painted a rosy picture of Qwest, though, encouraging the stock price to improve, Nacchio was selling his stock for huge profits. His insider-trading plan, which was based on artificially inflated stock prices, resulted in huge losses for others. At one point, the company fraudulently reported approximately $3 billion in revenue (sec.gov).

What can you learn? Rather than just listening to the protestations of a company big shot, learn how to read a company's financial statement. Understand fundamental analysis, and recognize the signs associated with looming trouble so that you aren't taken in by these types of scammers.

3. Bernie Madoff
You knew this one was going to be on the list. Bernie Madoff was the mastermind behind what is considered the biggest Ponzi scheme in history. Madoff promised regular returns, and for decades, he delivered. Investments grew like clockwork. However, subpar returns were masked as Madoff took money from new investors to pad the accounts of old investors. Following the crash of 2008, when a number of investors attempted to pull their money out, the whole thing fell apart. Even actor/musician Kevin Bacon lost a great deal of money from this scheme. Madoff would eventually say that $50 billion was lost (forbes.com).

What can you learn? Watch out for investments that grow predictably from year to year. Thanks to market realities, there is always some volatility. Any investment is going to have years of poor performance. If your advisor promises that he or she has a "system" that offers predictable returns every year, it's time to look for something else.

2. Enron
Do you remember the Enron scandal? This is another case of company executives lying about the health of a company, all while profiting from insider trading and committing securities fraud. Enron bilked investors and others out of billions when they fudged balance sheets to make it look like they owned things they didn't, and put liabilities on the balance sheets of shell companies in order to make Enron look like it had better financials than it really did. Enron would eventually lose about $75 billion in market value (Chicago Tribune)

What can you learn? Once again, it's important to be skeptical of what executives say when they are acting as company cheerleaders. Try your best to follow the money, and watch out for those who can't adequately explain what is happening. Also, watch out for irregularities in auditing, since members of accounting firm Arthur Andersen were part of the Enron scandal.

1. WorldCom
By rapidly acquiring smaller companies, WorldCom grew into a powerhouse of a company. However, even after all these acquisitions, CEO Bernie Ebbers insisted that there were plenty of assets. It seemed a little odd to think that WorldCom had plenty of cash; how could all these acquisitions be paid for? Of course, there weren't enough assets for all of these acquisitions. Ebbers was using margin calls on WorldCom stock to finance other ventures, ranging from yachting to timber. Eventually, it was all called in, and Anchor stockholders and bondholders were left with billions in losses. Investors would lose $100 billion all totaled (Time.com)

What can you learn? Know some of the basics of accounting, and pay attention to the news. You don't buy up other companies without incurring debt. If what you're seeing the company do in public doesn't jive with what the company is claiming, watch out. The company could be headed for a fall.

The Investing Answer: You can't always avoid a Wall Street scam. However, if something seems too good to be true, it probably is -- and that could mean big losses for you.

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