2014
The State Securities Board today released a list of the most common types of fraudulent investment schemes and offered strategies to avoid becoming a victim.
Emerging red flags on this year’s list include digital currency transactions, stream-of-income investments, and new ways in which unregistered securities are being offered to the public.
Others have been persistent problems for years and show no sign of abating: Phantom oil and gas projects or those that dupe investors with exaggerated claims about the expected output and profits; promoters selling “guaranteed, no-risk” promissory notes which promise to pay inconceivably high rates of returns; and investment contracts in real estate loan programs or projects that fail to generate sufficient revenue from the rehabilitation and sale of distressed property.
The State Securities Board and the Enforcement Section of the North American Securities Administrators Association compiled the list. Additional material comes from the State Securities Board’s Texas Investor Guide: Strategies for Investing Wisely and Avoiding Fraud.
Unregistered Individuals are a three-story tall red flag for investors. Generally, anyone acting as a sales agent for a company selling stock, bonds, or other investments to the public must be registered to do so – a fact many investors don’t realize. A promoter also can’t simply set up a website or YouTube channel and sell investments without the investments themselves being registered or qualified to be sold under very limited exemptions from the registration.
Registering with the State Securities Board involves testing requirements, background checks, and periodic review. To see if a person is registered to sell investments, visit the Agency’s website or call 1-888-663-0009. A sales agent who isn’t registered is likely violating the law. Almost all criminal actions undertaken by the State Securities Board involve unregistered persons.
A Stream-of-Income Investment is an emerging investor threat that involves a company acting as a middleman for buyers and sellers. Companies introduce investors to individuals who may want to sell income based on pension payments or government disability payments.
These transactions hold risks for both buyers and sellers.
Laws may prohibit the assignment of the stream of income/benefits. The seller typically maintains the legal right to redirect the payment, and if the seller does redirect the payment, the investor may be left with an unenforceable contract right. In addition, the benefits are contingent on the life of the seller, and even life insurance policies on the seller’s life may be cancelled and do not protect an investor if a seller simply redirects the income stream. Persons who sell their benefits are often veterans and disabled persons. These individuals may be solicited when they are in financial distress, selling much needed future benefit payments at a significant reduction.
Digital Currency and Cybersecurity Risks. Digital currencies such as Bitcoin are often touted as a sophisticated, online alternative to traditional currencies, but investors should realize these currencies are not tangible, they are not issued by a government, and are not currently subject to traditional regulation or monetary policy. Bitcoin and other digital currencies present significant risks when part of a securities offering:
- Questionable security of the exchanges dealing in digital currencies, highlighted by Mt. Gox, the Japan-based Bitcoin exchange that imploded earlier this year among massive security breaches. In addition, digital currencies exist only on computers and transactions are effectuated through cyberspace – a combination that may provide fertile ground for hackers.
- Unscrupulous promoters may be able to exploit the anonymous nature of certain digital currencies to conceal their true identify and assist in the concealment of a fraudulent investment offering.
- The value of digital currencies can rise or fall dramatically in a short period of time – volatility that is particularly dangerous to investment programs tied to the demand for digital currencies or their price.
- Securities offerings that incorporate digital currencies may be highly dependent on their growth and acceptance in the retail and commercial marketplaces, changes in consumer confidence, and government regulation.
State Securities Board Investor Alert on digital currencies
Emergency Cease and Desist Order Against Balanced Energy LLC
Private Placement Offerings are used to raise capital without having to comply with the registration requirements of securities laws. The exemption from registration allows companies to raise an unlimited amount of money, but only from investors who meet the definition of "accredited"-- net worth of $1 million, excluding the value of the primary residence, or annual income of $200,000 or more. Companies raising money through private placements often have a limited operating history, however, and the investments themselves generally lack transparency.
In a recent report by the Enforcement Division of the North American Securities Administrators Association, state regulators said private placements were among the most common products or schemes leading to enforcement actions.
Changes in federal law last year lifted the ban on general solicitation of investors in private offerings. The offerings can now be advertised on the Internet, in publications, and through free dinner seminars, telemarketing, cold-calling – you name it. The offerings can still only accept funds from accredited individuals, but investors should be careful they’re not putting money into an unlawful private placement or dealing with a promoter who isn’t verifying the accredited status of investors.
Disciplinary Order Against Mark Allan Plummer and Chestnut Exploration Partners Inc.
Emergency Cease and Desist Order Against FlippingYourMoney.com and Brian Keith McLain
Disciplinary Order Against Dale Lewis Stringer
Social Media has been the weapon of choice for unscrupulous investment promoters for at least a decade, and its danger only grows. There is no limit on the number of investment scams that can be promoted on standalone websites and via Facebook, LinkedIn, YouTube, CraigsList, and other online networks.
Investment promoters can just as easily lie to and mislead investors online as in print, however – maybe even easier. The apparent sophistication of a promoter and the professionalism of a website or social media channel are meaningless.
Emergency Cease and Desist Order Against Quixote Exploration LLC
Promissory Notes and High-Yield Investment Programs. Low yields on safe and secure products such as certificates of deposit and money market accounts have prompted some investors to look at alternative sources of income. A promissory note is basically an IOU from a company or individual. The notes are sold to fund everything from property development to oil and gas exploration, or as a way to buy interests in a business partnership.
Sophisticated investors and corporations are likely to have the resources and expertise to evaluate the terms and conditions of promissory notes.
Individual investors may not have the skill to evaluate the creditworthiness or prospects of a project that is supposed to generate enough revenue to pay the promised return on the notes.
State of Texas v. Eddie Lacy Stivers III
State of Texas v. William Charlton Mays IV
Life Settlement Contracts are complex financial arrangements in which a company sells a third-party’s life insurance policy to an investor. The investor receives an interest in the death benefits, and the benefits are paid to the investor when the third party dies. Risks abound:
- You will not have access to your principal or any returns until after the insured person dies.
- Returns can’t be guaranteed because there’s no way to reliably predict when a person will die.
- Investors face steep fees and costs, including commissions to salespeople.
- Policy premiums must continue to be paid on the policy until the insured individual dies. An investor may have to pay more in premiums than expected. If the premiums aren’t paid, an investor risks losing some, or all, of the principal.
State of Texas v. Howard Glen Judah, Gregory F. Jablonski Jr.
State of Texas v. Retirement Value LLC, Richard H. "Dick"Gray, et al.
Real Estate investment opportunities are often sold through investment contracts, notes, and other securities. Promoters promise steady returns from a variety of investments. Examples include the purchase, rehabilitation and sale of distressed houses and other property; the purchase of mortgage notes and real estate assets; and the development of shopping centers and other projects.
Investors should be skeptical of claims that real estate investment carries minimal risk because it is backed by a “hard asset.” Depending on the structure of the offering, risk factors may include the illiquidity of the investment; the impact of changes in interest rates on the profitability of the investment or the ability to sell or refinance property; and the effect that demographics, property valuation, or rental rates of inventory of existing properties may have on the revenue projects generate.
Some promoters of fraudulent real estate investments also claim to have special expertise that guarantees investors unrealistically high returns on investment.
U.S. v. Robert Roland Langguth
State of Texas v. Richard Dewayne Hicks
Affinity Fraud. Churches, community organizations, retirement communities – all are fertile ground for affinity fraud, where a con artist exploits an affiliation with a group as a way to win an investor’s confidence. A fraudulent investment scheme often spreads quickly among members of the group. Besides ensnaring members of the group, an affinity fraud can extend to trusting family members and friends.
Affinity fraud can turn into a Ponzi scheme, where early investors may – but not always – received their promised returns with the money coming from later investors in the fraud. The fraudster may be a member of the group or may just pretend to be.
U.S. v. Kurt Barton and Triton Financial LLC
Oil and Gas investments are highly speculative and complex. It is difficult for a potential investor to investigate a promoter’s claims about how much oil or gas will be produced, the time it will take to start production, and how the investment is structured will affect revenue and potential profits. In addition, not all investors in oil and gas projects have the expertise to decipher geological maps, production reports, and filings with state energy regulators.
Investors should not rely solely on the promoter’s promises about any aspect of the investment. It’s also critical to know the background of the promoters – some may be inexperienced or have repeatedly failed in previous ventures, but not disclosed those facts to investors.
Even if the underlying project is legitimate, any revenue realized can be negated by commissions and other fees or expenses skimmed off by the managing partner, who typically sets the terms and timing of payments to investors. Interests in general partnerships or joint ventures are often non-transferable and illiquid.
State of Texas v. Kelly Gordon Rogers
U.S. v. Bruce Kyle Griffith