More On Legal & Compliancefrom The Advisor's Professional Library
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
Advisors and investors beware: Even though Bernie Madoff is gone, economic uncertainty and volatile stock markets still breed con artists itching to trap the unwary or merely desperate.
During turbulent economic times like we’re currently facing, “con artists follow the news and seek ways to exploit the headlines to their advantage while leaving investors holding an empty bag,” says David Massey, president of the North American Securities Administrators Association (NASAA) and North Carolina deputy securities administrator.
To help advisors alert their clients of the latest scams, NASAA recently released its listing of the Top 10 financial products and practices: five of each.
“Promoters often offer investors an opportunity to get in on the ‘ground floor’ of new technology or ideas to help others and make a great economic return,” says Massey. “Unsuspecting investors can be lured into these schemes, especially if they sound familiar. These offerings require careful research and a strong reminder that if it sounds too good to be true, it probably is not true, nor will it be profitable to anyone but the promoter.”
Read on for more details about these scams du jour.
PRODUCT SCAM #1: Distressed Real Estate.
Investment offerings involving distressed real estate have been on the rise following the collapse of the real estate bubble. While many legitimate investment offerings are tied to real estate, investment pools targeting distressed real estate have become increasingly popular with con artists as well as investors. Investments in properties that are bank-owned, in foreclosure, pending short sales or otherwise in distress inevitably carry substantial risks and should be evaluated carefully.
Check out this scam: In February, a Florida man pleaded guilty to conspiracy to commit mail and wire fraud in a scheme that solicited $2.3 million from 39 investors nationwide to purchase and refurbish distressed properties and, in turn, sell them for a profit. Investors were issued corporate promissory notes with returns of up to 12%.
PRODUCT SCAM #2: Energy Investments.
Swindlers continue to attempt to trick investors by using high-pressure marketing tactics touting the mystique associated with untapped oil and gas reserves and bountiful production runs. Even genuine oil and gas investments almost always bear a high degree of risk. Energy investments tend to be poor alternatives for those planning for retirement and should be avoided by anyone who cannot afford to strike out when trying to strike it rich.
Colorado securities regulators issued a cease-and-desist order earlier this year against a Texas oil and gas company for allegedly violating state securities registration and licensing provisions. The case came to light after a company sales agents unwittingly “cold called” an employee of the Colorado Division of Securities and offered a joint venture interest in two Pennsylvania oil wells with next to no drilling risk.
PRODUCT SCAM #3: Gold and Precious Metals.
Higher precious metal prices and the promise of an ever-appreciating, “tangible” asset have lured unsuspecting investors into a variety of scams. Many recent schemes are variations on old themes: a promoter seeking capital for extraction equipment to reopen a long dormant mine in exchange for a full refund plus interest and a stake in the mine. Despite ubiquitous promises to the contrary, there are no guarantees with gold or precious metals, even in legitimate markets.
In 2011, the founder of Florida-based Gold Bullion Exchange pleaded guilty to fraud charges in a scheme that collapsed on more than 1,400 investors who lost $29.5 million. Investors were solicited through a sophisticated telemarketing operation to purchase precious metal bullion using purported “leverage” financing. Investors were led to believe that they would need only to provide a fraction of the total cost of the purchased metals, with the remainder of the purchase price to be covered by margin-type financing, which would purportedly be extended to the investor by a “clearing firm.”
PRODUCT SCAM #4: Promissory Notes.
Investors seeking safety in uncertain economic conditions or those enticed by the promise of big returns through a private, informal loan arrangement may suffer deep losses investing in unregistered or fraudulent promissory notes. These notes give investors a false sense of security with promises or guarantees of fixed interest rates and safety of principal. However, even legitimate notes carry some risk that the issuers may not be able to meet their obligations.
A former FBI agent was convicted in Alabama this year after an investigation by Alabama securities regulators revealed that he used promissory notes guaranteeing returns as high as 12% to lure investors into a Ponzi scheme. The funds were to be invested in real estate and medical technology ventures, but investigators determined that the former agent used most of the funds, more than $4 million, to pay Ponzi-style returns to previous investors and for his personal use.
PRODUCT SCAM #5: Securitized Life Settlement Contracts.
Life settlement contracts are investments in the death benefits of insurance policies that insure the lives of unrelated third parties. Legitimate investments in life settlement contracts involve a high degree of risk, and investors may be responsible for routinely paying costly premiums for policies that insure people who outlive their life expectancies. Outside the legitimate offerings, crooks are embracing new schemes to deceive even cautious investors.
For example, in 2011, two executives of National Life Settlements of Houston were indicted on charges of securities fraud and the sale of unregistered securities after an undercover investigation by Texas securities regulators determined the pair had sold $30 million in unregistered promissory notes secured by life settlement contracts. One of the executives was a three-time convicted felon with a long history of investment fraud. The promise of a safe investment with annual returns as high as 10% served as bait to lure investors into what a court-appointed receiver testified was a Ponzi scheme.
PRACTICE SCAM #1: Affinity Fraud.
Marketing a fraudulent investment scheme to members of an identifiable group or organization continues to be a highly successful and lucrative practice for Ponzi scheme operators and other fraudsters. The most commonly exploited are the elderly or retired, religious groups and ethnic groups.
A 73-year-old North Carolina man pleaded guilty this year to 19 felony counts of securities fraud following an investigation by North Carolina securities regulators that determined he had collected more than $18.5 million from more than 100 investors, many of whom he knew from church or other social circles. The investments for venture capital investments in various unspecified companies came with a promissory note guaranteeing annual returns of between 10% and 50%.
PRACTICE SCAM #2: Bogus or Exaggerated Credentials.
Since 2008, 29 states have adopted laws or rules preventing misuse of credentials or designations intended to imply special expertise or training in advising senior citizens on financial matters.
Now, state regulators are noting an increase in the use of other bogus credentials or exaggerated designations. State securities regulators have encountered salesmen pitching financial services or products with nonexistent law degrees or CPA certificates and expired or nonexistent CRD numbers.
Securities regulators in Utah came across a broker who listed “C.H.S.G.” after his name on his business card. When asked, the broker told regulators the initials stood for “Certified High School Graduate.”
PRACTICE SCAM #3: Mirror Trading.
The securities market is constantly evolving to provide investors with new products, different platforms and a variety of choices. The latest evolution is “mirror trading,” which is promoted as an automated trading platform that ensures investors will participate in real-time transactions placed or executed by a skilled and knowledgeable third party.
Whenever the third party executes a trade in his or her account, the same trade is mechanically placed on behalf of the investor in the investor’s account. Investors should not be lulled into a false sense of security, and they need to continue to objectively evaluate and carefully consider all new or popular investment platforms.
PRACTICE SCAM #4: Private Placements.
Even in the case of legitimate issuers, private placement offerings are highly illiquid, generally lack transparency and have little regulatory oversight. In the United States, the federal exemption for private placement offerings provided under Rule 506 of Regulation D continues to be abused by criminals.
This year, U.S. and Canadian authorities convicted three individuals of criminal fraud charges related to the sale of $33 million in oil and gas private placement offerings. The defendants claimed the securities were exempt from registration under Rule 506. Securities regulators also have taken civil fraud actions against private placement issuers, Medical Capital Holdings Inc. and Provident Royalties, which raised more than $500 million from investors through private offerings sold by dozens of broker-dealers.
PRACTICE SCAM #5: Securities and Investment Advice Offered by Unlicensed Agents.
State securities regulators have identified a consistent increase in investor complaints regarding salesmen unlicensed as securities brokers or investment advisors giving investment advice or effecting securities transactions.
For example, insurance agents offering securities or investment advice without a securities license have not demonstrated sufficient expertise to legally recommend that an investor liquidate securities holdings in favor of insurance products.
In 2011, an insurance agent unlicensed to sell securities and his manager were barred from working in the Missouri securities industry for five years after Missouri securities regulators uncovered a complex scheme that saw the liquidation of more than $7 million in securities investments from 180 customer accounts. Agents had moved most of these funds into proprietary fixed or equity indexed annuities.
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