Why is fraud so hard to avoid? I have spent over six years interviewing several hundred people in the U.S.A. and Canada who have lost their entire investment when purchasing a business opportunity. The investments range from payphones, vending machines, and various distributorships.
I have formed the hypotheis that there are common flaws to their due diligence.
For example, I always ask if they contacted their local BBB or some other BBB. Over 85% proudly state that this was part of their "due diligence".
They report that since the BBB didn't have anything bad on the company, then they felt comfortable with investing. I have explained elsewhere why this is a poor approach, contacting the BBB is unlikely to detect fraud.
The reliance on the BBB is another demonstration of what psychologists know as the Wason effect. Cognitive psychologists have devised a number of experiments to test our naive decision making abilities. One effect, the Wason effect, is extremely important for puchasers of business opportunities and franchises.
When presented with a hypothesis, such as all A's are B's, people tend to to find confirming cases and do not look for disconfirmation. Thus, in the Wason test the tendency is to look for examples of cards with a vowel on one side and an even number on the other side. The correct methodology is look for a card with an vowel on one side and an odd card on the other side. Disconfirmation as a decision making strategy is underused.
Investors fail detect fraud because they are looking for confirmation that the company is genuine. And believe me, the scam artist will leave plenty of "clues" which "confirm" the company's "genuineness".