Imagine getting an unsolicited phone call from a foreign-currency broker saying you could expect to earn at least 30% on every trade you make.
Suppose this person said you wouldn't lose money unless "something really major" happened -- such as a nuclear war.
Sound too good to be true?
It was for 240 customers of Florida-based Worldwide Forex and its associated firms, who lost substantially all of the $2.8 million they invested between April 2002 and February 2004.
During that period, president Steve Labell and his brokers used high-pressure sales tactics, urging customers to "invest immediately" in "highly profitable and virtually risk-free" trades, according to a complaint filed in a U.S. District Court by the Commodity Futures Trading Commission.
Despite their grandiose claim of profit and minimization of the risks involved, WWF brokers consistently lost money for their customers as they mistimed the market, while accruing over $1 million in trading commissions and other fees. The brokers also misrepresented their "abysmal" performance, according to the complaint.
Scams like this have becoming increasingly common over the past few years as the U.S. dollar has steadily declined against the euro, providing what seemed like a sure one-way bet. Since 2002, the greenback has lost 30% against the European currency.
While that pales in comparison with the
increase of over 50% over the same period, pitches like WWF's played to investors' uneasiness about lofty valuations in both stocks and real estate at a time when bond yields were at historic lows.
To watch a video of the president of the National Futures Association's thoughts on forex fraud, click here
somewhat analogous to what happened in the late 1990s when people quit their jobs to daytrade tech stocks," says Paul Winter, a principal with Five Seasons Financial Planning in Salt Lake City.
Unlike the stock market, where anyone can gain an edge by researching an overlooked company, foreign exchange leaves small investors at a distinct trading disadvantage. There are relatively few major currencies, and their movements are studied very closely by major players with deep pockets.
This is a market where some $2.5 trillion changes hands every day, and there's hardly a pause in trading from Monday morning in Asia through Friday evening in North America. And unlike the stock market, there are no trading halts when prices move too quickly.
"The chances are low, if not zero, that an amateur would do better than a professional in this market," says Winter.
How big of a problem is forex fraud? The 39 forex dealers currently registered with the National Futures Association account for 30% of enforcement and arbitration activity despite making up less than 1% of its membership.
By comparison, at the beginning of 2001, there was not a single forex dealer registered with the self-regulatory organization.
Customer funds held by the NFA's forex dealer members have ballooned to $1 billion from just $170 million as recently as 2003. And that doesn't include assets held by brokers who deal exclusively in the cash market and aren't required to register with the NFA.
The CFTC, which holds a roughly equivalent role in the futures markets to that of the
Securities and Exchange Commission
for stocks and bonds, says four of the 12 of enforcement actions listed in May were specifically related to foreign exchange.
One of those notices related to Labell and his companies, which were slapped with over $6 million in fines and penalties. It comes on top of $14.7 million of penalties he and his firm were hit with in 2006 for other infractions.
Part of the reason that foreign exchange is so attractive to scamsters is the general lack of regulatory oversight.
University of Maryland Law School professor Michael Greenberger explains that the problem dates back to the creation of the CFTC in 1974, when it was barred fromoverseeing any off-exchange currency trading. That means it has no oversight of cash trading, which takes place over the counter.
"I don't think there was an intent to open the door to any of this fraudulent activity against retail investors," says Greenberger. But that's exactly what happened.
Congress attempted to close the loophole in 2000, but legislation was undermined by a court of appeals ruling four years later. Greenberger says the decision provided a "road map" for con men to structure cash trading to look like futures trading and still fly under the CFTC's radar.
In both the cash and futures markets, it's possible to make big bets on currencies by putting a small amount of money down. Most brokers allow clients to deposit a small portion, or margin, of the dollar value of their overall position. This can multiply profits, but it also means you can quickly lose more than the amount you originally invested.
This leverage can catch newbies off guard. It can also be exploited by unscrupulous brokers who misrepresent price action to make margin calls.
Winter, the financial planner, says small investors are better off playing the weak dollar through foreign bond funds such as the
American Century International Bond (BEGBX) or the
T. Rowe Price International Bond (RPIBX). The securities these funds hold pay interest denominated in foreign currencies, so when the dollar declines, the dollar value of their returns increases.
Both have low expense ratios and don't hedge their currency exposure, he says.
There are also exchange-traded funds, such as the
Currency Shares Euro Trust
, and mutual funds, such as the
Rydex Dynamic Strengthening Dollar (RYSBX) and the
Rydex Dynamic Weakening Dollar (RYWBX), that offer direct exposure to movements in foreign-exchange rates.
If you're still determined to trade directly in the foreign-exchange markets, you should take some precautions -- ahead of time.
The Better Business Bureau is a good place to start. Steve Cox, spokesman for the Arlington-based Council of Better Business Bureaus, says the organization has files on 3 million businesses and says requests for information on forex dealers were up 75% in 2006.
The NFA recommends running a quick broker background check on its
President Dan Roth warns potential victims to be on the lookout for "the common elements of any sort of boiler-room investment scheme ... they offer large returns with no risk and urge customer to make an immediate decision."
One other scam his team is scouring the Internet for involves Web sites designed to entice people to wire money directly into the bank accounts of con men posing as brokers.
The NFA recently published a free booklet,
Scams and Swindles: An Educational Guide to Avoiding Investment Fraud
, and what the publication lacks in a snappy title it makes up for in sound counsel.
Other resources for spotting foreign exchange fraud can be found on the CFTC's
Web site, which includes a downloadable brochure and instructions on reporting suspected malfeasance.