Scam artists aren’t so much artists as they are students of human nature. The common denominator that makes us all vulnerable is not just gullibility. To sucker us into scams, crooks manipulate the same psychological biases that often harm our investing decisions. The hook is baited as soon as we meet a well-dressed, articulate pitchman. Our first reaction is that this guy must be legit and his offer worthwhile. What we don’t realize is that this impression imbeds itself surprisingly deep in our gray matter. Pat Huddleston, a former Securities and Exchange Commission enforcement officer, says that we tend to assemble facts to support that first theory. “When we get a fact that doesn’t quite fit in the puzzle, we force it in,” says Huddleston.
Scam artists know we have a “confirmation bias,” and they’re happy to provide corroborating evidence to nudge it along. For example, Marc Dreier, who is currently serving a 20-year sentence for securities fraud, would arrange for an associate to pretend to be either an independent accountant or the CEO of another company to confirm, via phone calls, that Dreier’s offer could be trusted.
Another powerful bias that makes our getting hoodwinked more likely is the “optimism bias.” This is our tendency to overestimate the likelihood that good things will happen to us and underestimate the potential for unpleasant events. Crooks play to this tendency by making good things happen at first — say, an initial investment that pays off — to lull investors into a false sense of being in control.
Surprisingly, the illusion of control is heightened if the victim already has some expertise in the subject of the scam, according to a study of scam victims by the U.K.’s University of Exeter. So people who play lotteries or sweepstakes are more likely to fall for a lottery or sweepstakes swindle, and those with some experience in investing may fall for investment fraud.
But the most surprising finding may be that victims tend to put more effort into investigating a scam than non-victims. This may be the result of overconfidence. We think we know more than we actually do, often basing our conviction on the inflated importance of relatively little knowledge.
Crooks are plugged in to this, says Huddleston. “The person who’s convinced he’s too smart to fall for a scam is putty in their hands,” he says. His best advice: Admit that you’re vulnerable when someone approaches you with a deal that sounds too good to be true, and either trust your first instinct and walk away or suspect that you’re being conned and investigate accordingly.
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