Taking on the problem of affinity fraud

Last Friday, the Department of Justice and the Consumer Protection Working Group held their annual summit on consumer protection. The summit highlighted the latest scams and what consumers can do to protect themselves.

The Internet and social media have made it easier for scammers to contact and fool unsuspecting individuals with lottery scams, romance scams, unlawful debt collection practices, and health scams. Common features of all of these scams are unsolicited contacts and advance fees paid to an organization the individual has never dealt with before.

These common features—unsolicited contacts and advance fees—distinguish these frauds from securities crowdfunding offerings that will soon be possible under the JOBS Act. A legitimate crowdfunding offer under the JOBS Act must be conducted through a registered crowdfunding intermediary, there can be no solicitation except for directing potential investors to the crowdfunding intermediary, and payments may only be collected after an offer is fully subscribed. Through this statutory architecture, scammers will not be able to use their principal weapons of unsolicited contacts and advance fees.

Nevertheless, scammers intent on scamming will find ways to exploit crowdfunding, some of them familiar to consumer protection advocates. One method may be affinity fraud. Affinity fraud refers to the practice of preying upon members of identifiable groups, such as religious or ethnic communities, the elderly, professional groups, or alumni associations. These fraudsters infiltrate and utilize the trust built into networks of like minded individuals to encourage more people to participate in the fraud.

Affinity fraud is a big business for fraudsters. According to The Economist, as of June, 2012, the FBI and state securities regulators were investigating over 1,000 affinity fraud investment schemes. Interestingly, the state of Utah has the highest per capita rate of affinity fraud, much of it relying on relationships within the Mormon Church.

When it comes to investment crowdfunding, affinity fraud may be the vehicle that fraudsters use, because they are not allowed to engage in general solicitation of the terms of their investment scheme. Instead, they will rely on the affinity network to help spread information in a way that is disconnected from the required disclosures posted by the crowdfunding intermediary. Community leaders may unwittingly become the mouthpiece for crowdfunding scammers as they did for Bernie Madoff.

Because scammers will still be scammers, the first line of defense is an informed investor. When presented with investments that rely on an affinity network, employ the Cold War motto “trust, but verify”. Don’t rely on shorthand information to vet a potential investment.

All potential investors should become educated on the various types of scams out there and how they could be applied to crowdfunding. Then, look for marks of trust, such as third-party due diligence, and get informed about the issuer through its disclosures.

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