February 12, 2017

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The stock market is soaring but it's a little early to sing, “Happy days are here again.” Uncertainty and risk surround us. We face chronic high unemp...


February 12, 2017

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One of the Great Recession's lasting legacies has been record low interest rates. Good news for borrowers, bad news for savers. In search of higher returns many people, especially seniors on fixed incomes, have turned to promissory note investments. But, be advised, promissory notes are a favorite tool of Ponzi schemers and investment thieves. 

A promissory note is a form of debt that companies and individuals use to raise money. The seller promises to return the buyer's principal along with interest payments. Promissory notes have set repayment periods, ranging from a few months to several years. They also have fixed interest rates. Usually, these interest rates are much higher than the rates of CDs and money market accounts. It's these higher returns that lure savers. 

All investments carry risks, including legitimate promissory note investments. For example, the company or person issuing the notes may have problems, unknown to the investor that makes it difficult or impossible for them to repay the principal or interest.

The sale of promissory notes to the public usually makes those notes a security that, absent an exemption, must be registered with the SEC or with the state in which they are sold. Even so, many promissory notes are not registered even if they should be. The lack of registration limits the amount of information available to enable investors to appraise a promissory note's risk. 

Another risk with promissory note investments is that they are often high risk. Some promissory notes are used to keep legitimate businesses afloat until times get better. Frequently, they are used to fund high-risk business ventures suitable only for wealthy, sophisticated investors. 

I have seen schemes where promissory notes were used to fund exotic stock market and futures market investment strategies. When the real estate market was booming I saw promissory notes used to fund real estate investment schemes like house flipping. When the real estate market crashed, there was no way to pay back the promissory note investors.

Worse, promissory notes are a favored tool for outright fraud. I have seen thieves sell phony promissory notes and just steal the money.

Promissory notes are commonly used in Ponzi schemes. All Ponzi schemes follow the same basic path. The thief promises great returns with limited risk. Usually those who buy into the Ponzi early do see the promised returns because the crook uses new investor's money to pay the promised interest to the earlier investors. The thief robs Peter to pay Paul until he runs out of new investors to keep the fraud going. It then collapses.

While the vast majority of financial professionals are honest, I have seen many registered professionals commit Ponzi schemes and theft. The financial services industry has changed dramatically in the past few years. Not only do we have the traditional stockbroker servicing the public but now, many investment firms hire financial planners, accountants, lawyers, insurance agents, or other service professionals to sell investments. Theses investment professionals often work in satellite offices on their own.

The good part of this is that these professionals have long-term relationships with their customers. This enables them to truly know their customers over the years and so tailor investment recommendations to their customers' changing needs. The bad part is that it is difficult for an investment firm to properly supervise an investment adviser who is working off-site; away from compliance scrutiny. This creates an opportunity for an unscrupulous person to steal customer assets or sell unapproved investments. 

Unfortunately, these victims tend to come in groups. Everyone, in some way, is connected to a group or association that serves their needs. For better or worse, people have a tendency to listen to and trust people with whom they have something in common.

Many con artists join groups to develop the affinity that creates trust. If the con artist is not a member of the group, they first sell to a few prominent members of the group and use those investors' names to gain credibility with the others. Often, these prominent members are so happy with the profits they receive they spread the word about the “investment” to others and become the thief's unknowing sales force. Many of the investment theft cases I have seen involve large groups of people victimized by the same thief.

Here are some things you can do to avoid being victimized:
● Check out the investment on the internet through Google or one of the other search engines. Determine if the investment is registered and, if so, with which regulator; the U.S.S.E.C. or a state's regulators. A good place to start is the United States Securities and Exchange Commission's EDGAR database at www.sec.gov . If the investment sold is through an exemption to the federal registration requirements ( small and limited public offering ) contact the State's securities department to see if any information on the investment has been filed with the state. If you cannot find the investment registered anywhere and cannot find any information about it, there is a good chance it is fraudulent or in the least, high risk.  
● Check out the investment professional's background. If the person selling the investment is a stockbroker he must be registered with FINRA. Use FINRA's broker check at www.finra.org/Investors/ToolsCalculators/BrokerCheck . If he is an Investment Adviser, currently you can use the S.E.C.'s website at: www. adviserinfo.sec.gov/IAPD/Content/Search/iapd_Search.aspx. For Investment Advisers with less than $25 million under management contact the State's securities department. 
● Compare the promissory note's returns with the latest CD rates or a conservative mutual fund benchmark. If the offered investment pays returns that are substantially higher, it might be an offer too good to be true. 
● Determine how long you have to hold the investment to maturity. In order to build trust many Ponzi schemes start out with an investment of short duration. Later, as more investors get in and have to be paid the thief will try to have the investor accept longer maturity dates. He might offer an investment where interest is automatically reinvested so he does not have to pay out too many interest payments at a time. Automatic rollovers and lengthening maturity dates are red flags of Ponzi schemes. 
● If you have invested in a promissory note, make certain to review the 1099 the seller must provide for your taxes. Many people first discover there is a problem when the broker or seller cannot provide a timely 1099.
● Be careful how you are asked to pay for the investment. Often, the thief will have the customer make the check payable to him personally or to a company he controls. Investors should never make checks payable to an investment professional or his company. Checks should be made out to the institution such as the brokerage firm the broker or adviser works for or the mutual fund company if the investment is a mutual fund.

Our low interest rate environment makes promised high return investments like promissory notes very appealing. But too often, broken promises lead to disaster.

Always investigate before you invest. Contact an attorney as soon as possible if you suspect you have been the victim of investment fraud. All cases have statutes of limitation that can bar your claims if you wait too long.

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