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Life Health > Annuities > Variable Annuities

These Are the Biggest Threats to Investors, State Regulators Say

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State securities regulators will be busy policing new and emerging scams in the new year.

The North American Securities Administrators Association has just released its annual survey of state securities regulators’  top five current investment practices, products or schemes they’ve encountered over the past year as well as what they see as “emerging” threats in the coming year.

NASAA conducted the survey in the spring and summer of 2017.

“In today’s ongoing environment of low interest rates, the lure of high-interest-bearing promissory notes continues to tempt investors, especially seniors and others living on a fixed income,” said Joseph Borg, NASAA president and Alabama Securities Commission Director, in releasing the findings.

Read on to see the top five threats as well as three emerging threats identified by securities regulators from 50 U.S. jurisdictions:

Promissory Notes

1. Promissory Notes

Seventy-four percent of regulators identified promissory notes as among their leading sources of complaints or investigations.

Used generally by companies to raise capital, legitimate promissory notes are marketed and sold almost exclusively to sophisticated or corporate investors with the resources to research the companies issuing the notes and to determine whether the issuers have the capacity to pay the promised interest and principal.

Promissory notes may require registration as securities with federal and state securities regulators.

“Average investors should be cautious about offers of promissory notes with a duration of nine months or less, which in some circumstances do not require registration,” Borg said. “Short-term notes that appear to be exempt from securities registration have been the source of most — though not all — of the fraudulent activity involving promissory notes identified by regulators.”

State securities regulators reported 138 formal enforcement actions involving promissory notes in 2016.

Real Estate and Ponzi/Pyramid Schemes

2. Real Estate and Ponzi/Pyramid Schemes

Tying for second place were frauds related to real estate or Ponzi schemes, with 54% of state securities regulators identifying both as the second-most frequent source of current complaints or investigations.

Real estate scams are “a perennial investor trap,” according to NASAA. State securities regulators caution investors about real estate investment seminars, especially those marketed aggressively as an alternative to more traditional retirement planning strategies involving stocks, bonds and mutual funds. Attendees at these seminars may hear testimonials from people claiming to have doubled or tripled their income through seemingly simple real estate investments. But these claims may be nothing more than hot air. Two of the most popular investment pitches involve so-called “hard-money lending” and “property flipping.”

State securities regulators reported 100 formal enforcement actions in 2016 involving real estate investments.

Oil and Gas Investments

3. Oil and Gas Investments

Oil and gas-related investments or interests were the third most cited source of complaints or investigations, identified by 50% of regulators.

Fraudulent oil and gas deals may be structured with a legal entity (such as a limited partnership) registered in one state but with operations and physical presence in a second state. Prospective investors in the venture may be solicited from still more states (with the obvious benefit to the perpetrators being a reduced chance an investor will ever seek to visit a well site or the organization’s headquarters).

Typically, in these types of scams, promoters invent false or misleading information about oil and gas properties to lure investors and keep them on the hook in bogus investments. The diffuse structure of such scams make it difficult for authorities and victims to identify them as frauds before it is too late.

State securities regulators reported 134 formal enforcement actions involving oil- and gas-related investments or interests in 2016.

Affinity Fraud

4. Affinity Fraud

Identified by 28% of the regulators, these frauds may involve people who attend the same church, belong to the same club or association, or share a common hobby. The con artist knows it is often easier for victims to trust someone who seems to be like them. And once trust is gained, it is easier to exploit that trust to perpetrate a scam.

Ethnicity, culture and religious beliefs also play a role in identifying us as members of unique groups that we often come to trust. In a world of increasing complexity, many people feel the need for a shorthand way of knowing whom to trust. This is especially true when it comes to investing money. Unfamiliar with how our financial markets work, too many people don’t know how to thoroughly research an investment or a salesperson.

State securities regulators reported 59 formal enforcement actions involving affinity fraud in 2016.

Such scammers may say: “You can trust me because I’m like you. We share the same background and interests. And I can help you make money.”

Variable Annuities

5. Variable Annuities

Unsuitable sales of variable annuities were identified by 26% of state securities regulators.

While these products are legitimate, they are not suitable for all investors, and state securities regulators are concerned about the risks of sales practice abuses. Senior investors, in particular, should beware of the high surrender fees and steep sales commissions agents often earn when they move investors into variable annuities.

Commissions to those who sell variable annuities are very high, which provides incentive for sellers to engage in inappropriate sales. Variable annuities also generally should not form more than a portion of an investor’s portfolio, and many not be suitable for seniors because of the steep penalties for early withdrawals. Investors should be especially wary of any broker who wants to sell a variable annuity to hold inside a qualified retirement plan, such as a 401(k) plan or IRA, as these types of retirement accounts will already benefit from tax deferment. Putting a variable annuity into a 401(k) or IRA adds a layer of expense and investment restriction without any additional tax benefit.

State securities regulators reported 21 formal enforcement actions involving variable annuities in 2016.


Emerging Threats

Emerging Threats

NASAA’s Enforcement Section identified three emerging threats that investors should watch for in 2018:

  • initial coin offerings (ICOs)
  • cryptocurrency contracts for difference (CFDs), and
  • identity theft for purposes of depleting investment accounts, especially among senior investors.

While ICOs have also been in the Securities and Exchange Commission’s crosshairs, CFDs are complex financial instruments that enable an investor to speculate on the price of an underlying asset and can be highly leveraged, which multiplies the impact of price changes on profits and losses.

Cryptocurrency CFDs allow investors to speculate on price changes in highly volatile cryptocurrency such as Bitcoin or Ethereum, NASAA explained.

CFDs, which are prohibited from being sold to U.S. citizens or residents, are marketed through internet platforms, and regulators caution that some of these platforms can be fraudulent themselves. “These speculative, high-risk products are prohibited in the United States for a reason — they are not suitable for investors,” said Keith Woodwell, Utah securities director and NASAA Enforcement Section chair. “There are red flags waving everywhere.”

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