This article on binary options fraud is part four of a series on some of Wall Street’s biggest frauds and how to avoid them. Click here for part one on the “Wolf of Wall Street” and microcap stocks. Click here for part two on pre-IPO scams. Click here for part three on precious metals fraud.
Now that the internet has become an essential part of life, binary options trading is easier than ever. However, it also means scam artists have easy access to investors who are seeking investment gains through virtually any route possible. If you’ve been thinking about investing in binary options, you can’t be too careful about who you invest with.
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The Securities and Exchange Commission describes binary options as "a type of options contract in which the payout depends entirely on the outcome of a yes/no proposition and typically relates to whether the price of a particular asset will rise above or fall below a specified amount." An investor who buys a binary option has no other decision to make about exercising it because binary options exercise automatically. Holders don't have the right to buy or sell the asset on which they have purchased the binary option on. When the contract expires, the investor receives either a set amount of cash or nothing, depending on the outcome of the yes/no proposition.
A case of binary options fraud
First, let's discuss a criminal case of binary options fraud. A U.S. court convicted Israeli Lee Elbaz, who served as CEO of a major binary options company, Yukom Communications, on three counts of wire fraud and one count of conspiracy. She was charged with defrauding clients of almost $150 million, according to news reports. A whistleblower revealed her actions in November 2016. The Bureau of Investigative Journalism, which was among the first to expose the fraud, describes the scam as "a high-tech variant of boiler room scams."
The scam involved cold-calling potential investors in other countries and convincing them to put money on whether a particular asset's price would go up or down. At first, the investor saw the money in their account growing, which often encouraged them to invest even more. When they tried to withdraw their money, the company stopped taking their calls.
According to the FBI, the true extent of binary options fraud is unclear, but it has been growing rapidly. In 2011, the agency's Internet Crime Complaint Center received four complaints about this kind of fraud. Just five years later, the number of complaints had jumped into the hundreds with millions of dollars being reported lost. However, these numbers only reflect investors who have reported their losses to the agency. The agency adds that some European countries estimate that binary options fraud complaints are now 25% of all the fraud complaints they receive.
SEC complaints about trading platforms
The SEC and FBI have both issued warnings to investors about binary options fraud. The SEC has received fraud complaints from investors about internet-based binary options trading platforms. Most complaints fall into three categories.
The first is platforms which simply refuse to credit their customers' accounts or reimburse their funds. Lee Elbaz's scheme appears to have fallen into this category. Most customers who report this issue to the SEC have deposited money into their online trading account to purchase binary options and then been encouraged to deposit even more money. Fraudsters typically cancel any customer attempts to withdraw their money and sometimes stop taking their phone calls.
The SEC has also had reports of identity theft related to the use of binary options trading platforms. The agency recommends that investors do not provide personal data to such online trading platforms. Among the information some fraudulent companies have collected are copies of customers' credit cards, passports and driver's licenses, and their use is often not specified.
The third category reported by the SEC is a bit more high-tech: manipulation of software to generate losing trades. Customers who report this problem claim that the binary options trading platform they used is manipulating the software to distort prices and payouts.
"For example, when a customer's trade is 'winning,' the countdown to expiration is extended arbitrarily until the trade becomes a loss," the SEC explained.
Binary Options Fraud - Red flags to watch for
The SEC advises investors to be wary when offered binary options with overstated claims of investment returns. For example, the regulator said a customer might be asked to pay $50 for a binary option contract which supposedly promises a 50% return if the stock price is higher than $5 per share when the contract expires. In reality, the return on this is negative, and here's why:
"Assuming a 50/50 chance of winning, the payout structure has been designed in such a way that the expected return on investment is actually negative, resulting in a net loss to the customer. This is because the consequence if the option expires out of the money (approximately a 100% loss) significantly outweighs the payout if the option expires in the money (approximately a 50% gain). In this example, an investor could expect — on average — to lose money."
The SEC also advises investors to check the background of any firm or professional they invest with. You can view licenses and registrations in the SEC's Investment Advisor Public Disclosure database via Investor.gov and the National Futures Association Background Affiliation Status Information Center's BASIC Search. The Financial Industry Regulatory Agency's BrokerCheck is another good option for checking their background. If you can't verify the person or firm's registration, then it's not a good idea to trade with them, give them money, or share personal information with them.
The FBI advises investors to check and make sure that the binary options contract you have been offered is actually registered with the SEC. In addition to making sure that the offer itself is legal, checking the registration should provide you with more information about it. You can do this via the SEC's EDGAR Company Filing website.
You can also check if the trading platform is registered as an exchange at the SEC's Exchanges website here or if the Commodity Futures Trading Commission has designated it as a contract market here. According to the FBI, although thousands of entities offer binary options trading in the U.S., the CFTC has only authorized two of them to do so.
In general, it's also a good idea not to invest in anything you don't understand. Fraudsters often entice victims with promises of stellar investment returns on confusing schemes.
The SEC has more information about binary options fraud here.
This article first appeared on ValueWalk Premium