Does the company exist?
Boiler rooms are illegal high-pressure operations that try to sell worthless – or even non-existent – shares to investors. The eZonomics story What is … a boiler room scam? explains in more detail. It says how the sales technique often puts on pressure by portraying an immediate need to invest in a “company” about to go public or whose share price is “posed for a spike”. Only after the investors have handed over cash do they discover the truth behind the scam.
Like many financial scams, boiler rooms play to the human fallibilities of greed and gullibility.
Be confident – but not overconfident
In addition to greed, several other behavioural traits play a part in frauds. It might be that investors duped by boiler rooms fall into a confirmation trap by looking for information that confirms their existing belief that they can make the unrealistic returns on offer. At the same time, the investors might ignore information that contradicts that belief. Overconfidence could also play a role if people overestimate their abilities to pick safe investments and to not be conned. As economist Chris Dillow blogs for eZonomics, overconfidence can be expensive for investors.
Ask questions before investing
Such biases are not uncommon. They mean it is important to be vigilant and ask questions before making investments, to examine risk factors and be sceptical. Fraud whistleblower Harry Markopolos urges in Bloomberg Businessweek questioning: “Whenever somebody has outstanding performance, Wall Street assumes genius. I assume fraud until genius is proven.” As ING Group chief economist Mark Cliffe says in his seventh lesson from the financial crisis, “don’t invest in something you don’t understand”.