International Law

The Discovery of a Fraud or Scam After the Fact

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The history of failed Ponzi schemes is similar to the failure of business opportunities frauds.

After the fraud is discovered, or there is an announcement of an official nvestigation, investors all of a sudden become super slueths in their due diligence.

I have seen this phenomena time and time again: after a investor say in USA Beverages becomes convinced that the business oportunity is a fraud or scam, they find it very easy to do the proper due diligence!

They know all about the FTC and the franchise rule, and have even learned how to google "vending fraud".

Why do people know how to research and discover that a business opportunity is a scam or fraud after they have been defrauded but not before?

When investing $20,000 or more, why would a person who obviously can perform due diligence not do so?

If you know how to perform due diligence after the fact, what prevents you from accessing that knowledge when it is most needed?

The answer to the puzzle is this: people generally seek information consistent with their beliefs and are not skeptical.

Cognitive psychologists have studied this extensively, and in particular have a snappy demonstration of the effect, the Wason Effect.

When faced with trying to determine whether a rule of the form All A's are B"s is true, individuals will look for confirmations of the Rule: find A's which are also B's.

The correct approach is however different: find an A which isn't a B. How are people taught to avoid the Wason Effect?

Interestingly, while people continue to do poorly on abstract problems, they do avoid the problem when the rule is well known.

For example, if the rule is: Everyone who is under 18, will not be served; people know to look for underaged drinker. Nobody spends time looking at underaged patrons who don't have an alcoholic beverage, unlike in the abstract case.

The violation of this Rule has serious consequences. This is why an individual performs the right due diligence test: they are naturally guided to look for failures of the rule - the underaged drinker.

How can this help the average investor with their due diligence and business opportunities, franchises or investments?

How can the ordinary person be encouraged to access their latent knowledge of proper due diligence steps prior to investing?

Simply approach the decision making as if you have made the investment and may have lost it - what would you do to recover it? I guarantee better results in your decision making.

Full post as published by Misleading Advertising Law on March 23, 2009 (boomark / email).