The Dangers of Affinity Fraud

By Kelsey Paine

Between 2005 and 2012, according to SEC allegations, investment manager George Elia met with South Florida residents at expensive Fort Lauderdale restaurants to persuade them to invest millions in private equity funds that purported to buy and sell stock in public companies. In reality, these funds were owned by Elia, who used the funds of later investors to produce returns for earlier investors in a pyramid scheme. Elia told the investors that he had a successful trading record, promised 26 percent returns, and even fabricated account statements reflecting inaccurate profits for at least one investor. Despite warning signs of a large return and lack of available information on the investment, the investors continued to turn over funds to Elia. Additionally, all of his target investors were referred by friends through word-of-mouth and were members of the same gay community in Wilton Manors, Florida.

When brokers make potentially unrealistic promises to investors or attempt to rush investors into decisions, investors may be alerted that the broker is promoting a scam. However, when the no-risk investment with huge returns is promoted by a member of a group to which the target investor belongs, then the investor is much more likely to ignore the warning signs and invest without taking time to research the investment or the broker.

This type of fraud is called affinity fraud, where a promoter of a scam either pretends to be a member of a community or convinces a leader of the community to encourage members to invest in the scam. Members of the community are particularly susceptible to the scam because of the trust that exists within the community; for example, affinity scams have preyed upon groups of African-American Christians, current military members and veterans, Lebanese communities in Texas, and even friends of the broker promoter.

Because the information comes from a trusted source, investors are more likely to invest without doing research. Groupthink may also play a role in encouraging targets to invest. Because members of target groups often share common identities or beliefs, the members are more likely to make decisions based on what other group members decide, without carefully considering consequences themselves. In the context of affinity fraud, members are more likely to invest because other trusted members have joined and they have a desire to be a part of the group.

This same sense of community that encourages group members to invest in the first place can also inhibit discovery and prosecution of the scheme. Because influential leaders of community organizations are often targeted by the schemes to convince members to invest, the members are less likely to report the fraud and will instead attempt to resolve the situation internally. This desire for internal resolution makes close-knit organizations an even more appealing target for promoters of these scams.

To avoid becoming a victim of affinity fraud, the potential investor should thoroughly research the broker, brokerage firm, and investment product before investing, regardless of the source of the investment promotion. The investor should also take care to read the written prospectus on the investment and not be rushed or pressured into a decision. Useful tools include the Financial Industry Regulatory Authority (FINRA) Broker Check, FINRA investor alerts, Securities and Exchange Commission (SEC) Investor Alerts, and the SEC website EDGAR. Anyone with knowledge of a scheme can also report it to the SEC.