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Fraud in the financial market

Watch out!

Very frequently, it takes a whole life to save a certain sum of money but these accumulations may be lost in a matter of minutes.

Fraud in the financial market is one of the most widely spread economic offences. In view of this, the Bank of Russia urges the population to be careful and remember about the dangers of being involved in various sorts of criminal schemes.

Most common frauds in the financial market

Financial pyramid schemes

The creation of financial pyramid schemes is one of the most widely spread types of fraud in the financial market.

While the Russian legislation lacks the notion of a financial pyramid scheme, the Bank of Russia distinguishes the following warning signs that an organisation or a group of individuals are a financial pyramid scheme:

  • payments to scheme participants out of the funds contributed by other depositors;
  • the absence of a licence from the Federal Financial Markets Service of Russia (the Federal Securities Commission of Russia) or the Bank of Russia to carry out operations to raise funds;
  • promises of high returns exceeding the market level by several times;
  • guaranteed returns (which is prohibited in the securities market);
  • mass advertising in the media and the Internet with promises of high returns;
  • the absence of any information on a company’s financial standing;
  • the absence of a company’s own fixed assets and other high-value items;
  • the absence of an exact definition of a company’s activity.

The Bank of Russia has distinguished five basic types of financial pyramid schemes operating in Russia at present:

  1. Projects that do not conceal that they are financial pyramid schemes. These projects are generally built on the principles of multilevel marketing, when a participant’s income is made from contributions by new members they add to the scheme. The websites of such pyramid schemes describe the mechanism of these projects quite logically and convincingly. Financial pyramid organisers point to the development of the Russian and global Internet space as the main argument supporting their schemes. In their estimates, this will make it possible to attract new participants and earn money for many years to come. The MMM project is a classic example of such pyramid schemes.
  2. Financial pyramid schemes that position themselves as an alternative to consumer and mortgage lending. These structures are designed for borrowers whom other financial institutions have denied loans. Clients are offered various programmes, including for the purchase of cars, apartments, land plots, etc. Interest rates on such loans are generally considerably lower than bank loan rates. These schemes attract individuals’ funds in the form of initial contributions for loan repayment equalling from 5% to 20% of the total amount.
  3. Various sorts of projects operating under the guise of microfinance organisations, consumer credit co-operatives and pawnshops. Most frequently, these organisations attract household funds in the form of loans or through the sale of various promissory notes to individuals with the aim to subsequently give loans to their clients at higher interest. These projects can exist in the form of virtual exchanges ensuring interaction between persons wishing to take out and give loans.
  4. Financial pyramid schemes offering services for refinancing and/or jointly financing individuals’ bills payable to banks and microfinance institutions. Under this pyramid scheme, a client transfers funds to a company in the amount of about 30% of the loan taken out from a financial institution while the company undertakes to pay a bank or a microfinance organisation the entire amount of the client’s obligations.
    This type of a pyramid scheme is especially dangerous as its crash affects both households and financial institutions that have provided loans.
  5. Financial pyramid schemes also exist in the form of pseudo-professional financial market participants actively advertising their services as organisers of trade in the forex market.

Forex can be different

Forex is the international interbank market for the trading of currencies at free prices. However, you can frequently find the advertisements of financial intermediaries, the so-called dealers, in the media and the Internet, which offer households to take part in speculative operations in the Forex. These advertisements may highlight the professionalism of a dealer company’s staff or the prospect to earn a whole fortunate with the staff’s assistance.

The Bank of Russia urges citizens to be careful and clearly distinguish between the international interbank foreign exchange market (Forex) and services offered to households under the guise of forex operations. Frequently, the name ‘forex\ is the only thing common for them. In reality, clients of dealer companies do not perform operations in the international market on their own as they have financial intermediaries to conduct these transactions for them. Besides, clients receive only partial information on current quotations or do not receive such data at all, which also makes it impossible for them to trade in foreign currency on their own.

Forex trade implies the availability of quite a large sum of money equivalent to no less than $US1 million. From the formal viewpoint, Forex operations are not speculative and are related to the conversion of one currency for another normally in the client’s interests. Credit institutions derive their main commercial interest from getting a fee for performing conversion operations for their clients.

Companies offering services in the Forex market operate on different principles. They derive their basic income from providing credits (loans) to their clients from among individuals. These credits (loans) are most frequently called leverage. Therefore, dealer companies are focused on providing credit leverage (calculated as the ratio of the sum of a transaction to own funds), which may reach 100:1. This means that a client can perform transactions worth 100 rubles per each ruble of own funds. This credit leverage is advertised as a major advantage (for a client to potentially earn more) but simultaneously this implies large risks as well. Specifically, with the credit leverage of 100, the market’s move against the player by just 1% means the loss of 100% of the player’s own funds! Considering that exchange rate movements equal about 1% per day on average (cross currency movements are even greater), it can be presumed that the market will sooner or later move against the player. Experience shows that the probability of losing your own funds comes close to 99% over two months with the credit leverage of 100:1. A dealer company, however, will always have time for speculative operations to earn its interest from credit leverage provision, irrespective of whether its client receives profit or sustains loss.

The scenario when the client receives big profits may have criminal implications: various fraudulent acts may occur, including the instances of causing various technical glitches and performing unauthorised transactions on the client’s account.

The main threat posed by Forex, however, is that the legislative framework for its transactions has not been developed up to this day in Russia. If a person agrees to cooperate with any of intermediaries operating in the forex market, all the risks will be borne solely by this person.

Market manipulation and insider trading

Market manipulation and the illegitimate use of insider information are another type of fraud in the financial markets. Most frequently, these frauds are committed in the organised market (exchange).

Market manipulation aims to derive profits from selling securities, for which artificial demand and/or artificial prices were created. The market can be manipulated in various forms, including through artificial (fictitious) trade activity or the spread of deliberately false information.

The illegitimate use of insider information also aims to derive profits from transactions with securities when a person takes advantage of insider information about their issuer (exact information, which was not disseminated or released officially and which may materially influence the prices of financial instruments).

The threat of market manipulation and the illegitimate use of insider information should necessarily be taken into account when making investments in the securities market. At the same time, this threat should not be a reason for refusing to make such investments as all necessary conditions have been created in Russia by now to counter this type of fraud. Specifically, Federal Law No. 224-FZ ‘On Countering the Illegitimate Use of Insider Information and Market Manipulation and on Amending Certain Laws of the Russian Federation’ was adopted on 27 July 2010. In addition, the Bank of Russia has established a special unit, the Main Office for Countering Malpractice in the Open Market, to fight against market manipulation and insider trading.

How to avoid losses from involvement in fraud

Whatever measures the state may take, it is unable to fully protect private investors from the risk of being involved in various fraudulent schemes in financial markets, if they are not interested themselves in this. First of all, citizens should have at least minimum financial knowledge and be careful enough when they select where to invest their savings. They should remember that most investments in the financial markets are risky, and are sometimes associated with the risk of the full loss of funds. They should act to ensure that investment risks always stay reasonable.

When you make investment, you also need to remember that other risks common for the global economy are present in financial markets, aside from specific frauds mentioned above. Therefore, you need to be careful and cautious enough, especially when you furnish other persons with information on passwords to access your investment accounts, numbers of your bank accounts, numbers of credit cards and any other similar confidential information, except for cases when you are fully confident that the recipient of such data acts on legitimate grounds and information disclosure is required for performing a transaction.

Report all suspicious proposals with regard to transactions to the police and the Service for Protection of Financial Services Consumers and Minority Shareholders operating in the Bank of Russia.

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Last updated on: 19.03.2020