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Investor Fraud and Education Essay Sample

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Investor Fraud and Education Essay Sample

Investor fraud or scam happen when investors are made to believe they are genuine and large gains to be made in they invest in a certain ventures. It could take many forms such as ponzi schemes or in well established investments securities dealers. Tricksters of these money making systems have are getting so sophisticated that even the rich and powerful could easily fall prey. Government authorities and some private entities try their best to educate the public on such programs but have never really succeeded in instilling the kind of understanding will be helpful to the public in the long run.

The failure has been cause by the fact that frauds are no longer being committed outlaw but by professionals with skills that can make schemes that will attract eyes on many investors. Detecting such frauds and educating the public on how to escape it will not be easy. It can thus be claimed that the best education is the one investors themselves cultivate themselves. They should never invest in schemes that they have not investigated fully no matter the income being promised. One such a case would involve securities and the stock market. Considering that stock trading is done legally, investors expose themselves in legal frauds by following poor investment decisions that end up eating into their investments. It is this kind of fraud that will be investigated in this paper; some advice on escaping the fraud will further be stipulated.

The New Face of Ponzi Schemes

For instance, the one operated by Eric Stein in Nevada before he was arrested in 1999 had professional telemarketers (Ruffenach, 2002, p. 4). This aspect made it more legit because many ponzis use personal contacts get new members. The only personal recruitment that was used only involved individuals at the top of the pyramid, who had already received interest that came from new contributors in the scheme. Showing other people the juicy earning received from the scheme as enough to attract new members into the system. Many would claim that Ponzi schemes are easy ways of making money used by cheap tricksters. But this is not true anymore. Some of the schemes are well thought by intelligent people who know their target market. In Stein’s scheme, he targeted new retirees and ambitious middle class that had been adversely affected by the bust of tech stocks in late 1990s.

Advanced marketing techniques used in mainstream financial organizations were used in the scheme, which is now common in the scam industry. His scheme used seasoned telemarketer to solicit information from prospective. To make the solicitation legit, the marketers were advised to collect information from public places likes shopping malls. Educating the general public on how to escape such attractive investment opportunities could easily lead to deaf ears. Public education on ponzi schemes concentrates on the idea that such systems are designed by starters. Little do educators know that ponzi schemes have become an wide industry that has been growing like all other industries. The best education that authorities together with the private sector can do is encourage people like Eric Steins to discuss their inside information regarding the industry. The bottom line, however, holds that only investors themselves can educate themselves fully regarding investment choices. After all, they are the ones that suffer most.

Inadequate Reports and Analysis

The news media and financial analysts have in the last half century been the primary source of market news for many, if not all investors. The less time that or space that the news media has to analyze and present findings compromises the quality of their presentation to the public. Retail investors keen on watching and reading on the media to make their investment decisions might therefore end up mis-educated and therefore make wrong decisions. This obviously leads to their loss in the market. This human error of failing to fully understand causations in the market and thus report erroneous analysis is what causes stock market bubbles in many financial markets (Shiller, 2001, p. 2). But investors should, however, not blame investment analysts for the errors that characterize their analysis, because investors, too, are somehow irrational when making investment decisions. For instance, the stock market bubble that hurts investors so much when it busts is caused by the very investors through speculative bidding.

The investors work from the assumption that rising stocks will keep rising because companies are reporting good results and promising even better in the coming years. This makes investors to start bidding on the price of the said companies’ shares with hope of getting better dividend and even bigger returns when they offload the shares—further assuming that other investors will be buying. This herd mentality ends when it becomes clear that stocks have been overpriced. Since such information gets to bigger class of investors at the same time, the herd mentality sets in and causes immense panic that leads to massive sell offs. The supply of affected stocks increases drastically while the demand either stays constant or falls, too. Stock prices in such markets could only go one directions: down. Those who benefit at this point are the investors who did not follow the herd, because they get a chance of buying discounted stocks that they can later sell to the herd in later years.

            The lesson: investors should make investments decisions as individuals, not on what the entire class of investors think should be done. Neither should investors put too much trust in investment managers they give privileges to manage, an d hopefully to increase, their wealth. These managers are well trained in their professional and can truly do greater jobs than individual investors could. However, there is a lot that these professionals have to handle in their day to day lives. There is also lots of information they have to gather in order to make the right decisions. This information is widespread across industries if not nations, which makes it hard for professionals to study, understand, and make right decisions; they have to rely on specialists in that field. As F. A. Hayek wrote in mid 20th century, the impossibility of having all information on professionals’ fingertips forces them to rely on other specialists in different fields (Hayek, 1945). Wealth professionals thus base their investment decisions on synthesized data that could have missed some important information.

Loose through Efficient Market Assumptions

            Most investors their wealth in the stock under the assumption of the efficient market theory, which holds that at market prices always to reflect the information made available to investment. This theory assumes that all market participants, whether small or large, receive information from companies at the same time through public media. This, the theory says, enables all investors to make investment decisions using the same information. The resulting decisions leads to selling of shares by some investors and buying by the others. It is therefore the balance between sellers price and buyers price (which are both made under same information) that result to stocks prices broadcasted through the media.

            This theory in only three decades old and it’s getting serious challenges from academia and investment professions. First, it claims that all classes on investors receive company information at the same time. This raises questions because there exists many instances where institutional investors sit on boards of several listed companies. Thus receive information earlier than retail investors and make decisions. Some critics argue this puts institutional an advantage. Secondly, the theory assumes that all investors analyze company shares the same way and thus arrive into the same conclusion regarding its future. This arguments is seen as a flop because different investors have different ways of valuing companies. Thus the true value of a share could hardly be realized through the efficient market assumptions; there are as many share values as the number of investing entities. The price stocks we see and read in the media are just arrived at through equilibrium processes. Thirdly, it would be hard for any investor to get higher annual returns than the marker because all investors made same decision. But as it turns out, there have been many companies that have succeeded in exceeding market averages for several consecutive years. Efficient theory’s enthusiasts have not been able to successively answer to those queries.

            Owing to the fact that individual investors are at a certain disadvantage because they do not get prior information than their corporate counterparts, it such happens that they make less earning compared to institutions. The investor education that is needed to counter that disadvantage is that of indexing. This involves buying stocks in indexed funds that are tied to the performance of  the entire market or industry. The opportunity of investing even in markets outside the United States is being necessitated by this indexes. There are even special indexes that invest in emerging markets, especially those classified as BRICS (Brazil, Russia, India, China and South Korea) that have been performing exceptionally.

             The Theory of Behavioral Finance can be used to address the short comings in the efficient market theory. It addresses reasons behind people’s behavior in the stock market, that is, why most market participants, even the seasoned ones, are so irrational, inconsistent, and incompetent with the methods they apply while investing. It accomplishes that task by investigating emotions and the subsequent errors made by investment professionals and their clients, which leads to upturns and downturns in markets. First, it asserts that investors tend to overreact tom positive and negative market news, which may lead to poor market decisions that can fuel market booms and bursts.

            According to behavioral theory, people behave irrationally in the market because of the very they think will bring success. First, they express their herd intuitions by wanting to be part of a groups, because will hardly  wrong. Should the group go wrong, its member think they will feel the pain as a group, not as individuals, which is always wrong. It is not easy for investors to get out of the herd once they are in it. This is because they feel as if they are the odd one out,  that is, the minority, which makes them feel inferior. Secondly, some people feel so confident in the assets the are buying either because of being players in the industry or having what they call reliable contacts. Others feel more confidence because of certain information they have regarding specified stocks that other market players do not have access. They end up being burned because the information could be utterly wrong, thus burn their investments further. After all, most of the information that this people have about certain company is hardly enough to make proper investment decision.

Third, people get into the problem of anchoring their investment decisions on nonexistent pretexts, which makes them loose on gaining more from their investments. For instance, investors who fail to buy shares when they are low tend not to buy the same share s in the coming years on assumption. They anchor their decision on previous year’s price that was lower, and thus miss on capital gains when the said stocks keep climbing. Getting out of this habit is hard and requires discipline from investors side, because no education, despite how intensive it could be that will help individuals to shed off old habits that are seen as second to human nature. Investors, especially retail ones, should understand that it is discipline and consistency that can lead them to good results they see in their institutional counterparts. Their resistance to change or move from group mentality should be faced with the seriousness it deserves. It is vital for them to understand that success or failure will not affect the group but individuals themselves.

            ‘Knowing thyself’ should be the beginning for individuals tied in the group mentality to start relying on their own intuitive. That will also be the first lesson they can teach themselves. These individuals should however push themselves through the change process notwithstanding the resistance  they could undergo. Investment professionals are also encouraged to understand behavioral finance so they can help clients sail through the change process. These professionals can also use the theory to understand what they have to do in order to avoid being tied in the herd band wagon that cripples their abilities to exercise their skills and increase productivity  for their firms. These professionals can advice their clients to practice behavioral finance in the following ways: First, investors should have the courage to accept the fact that they can be wrong in their investment decisions and can learn from those ,mistakes how to make good decisions, that is, they do not have to rely on the group mentality for success.

Secondly, they should understand that emotions in the market are the one that cause panic of selling and buying stocks all the time. This equates to donating money to stockbrokers and authorities through taxes and fees. Patience in this case would serve them well. Some come to the market looking for quick riches that leads to frustrations. Again, patience is the key. Also, investors should be open to new opinions and not just stick to their own beliefs, what was said on TV or what their investment advisor said. They should instead get different opinions from different quarters. Further for those ho lack enough self confidence in investment and financial matters, looking for a trustworthy partner could be a right move. This will accord them the flexibility to lean how to make importance decisions without relying on the herd that has taken many investors astray.


Barberis, N. and R. Thaler, 2003, `A Survey of Behavioral

Finance` in: G. Constantinides, M. Harris, and R. Stulz, eds., Handbook of the Economics of Finance (Elsevier) 1053-1128.

Hayek, F. A. (1945) “The Use of Knowledge in Society”. Library

of Economics and Liberty. Retrieved February 27, 2008 from http://www.econlib.org/Library/Essays/hykKnw1.html

Malkiel, B. 2005, `Reflections on the Efficient Market

Hypothesis: 30 Years Later,’ The Financial Review, 1-9.

Ruffenach, G. (2004). Confessions of a Scam Artist. Philadelphia:

Pennsylvania Securities Commission.

Barberis, N. and R. Thaler, 2003, `A Survey of Behavioral

Finance` in: G. Constantinides, M. Harris, and R. Stulz, eds., Handbook of the Economics of Finance (Elsevier) 1053-1128.

Shiller, R. (2001). Bubbles, Human Judgment, and Expert

Opinion. New Haven: Cowles Foundation for Research in Economics at Yale University.

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