New Laws May Provide Con Artists with Personal Economic Growth Plan
Iowa Insurance Division Identifies Emerging and Persistent Investor Threats
AUGUST 21, 2012, DES MOINES, IOWA– The Iowa Insurance Division (IID) today identified the financial products and practices that threaten to trap unwary Iowa investors. While this year’s list includes many long-standing or persistent threats, it also features practices that attempt to exploit new and existing federal laws designed to promote job creation and stimulate economic recovery.
“A con artist will use every trick in the book to take advantage of unsuspecting investors, including exploiting well-intended laws, in order to fatten their wallets,” said Securities Administrator Jim Mumford.
Mumford said the IID is particularly concerned about two provisions of the recently passed JOBS Act that could unwittingly open a floodgate of fraud. These include provisions to expand crowdfunding to allow businesses to raise money from investors and to allow the general solicitation and advertising of private placement offers.
The following listing of the Top 10 financial products and practices that threaten to trap unwary investors was compiled by the Iowa Insurance Division from its records and from those of the North American Securities Administrators Association (NASAA) Enforcement Section.
2012 Top Investor Threats
Mumford reminded investors to independently verify any investment opportunity as well as the background of the person and company offering the investment. The Insurance Division can provide detailed background information about those who sell securities or give investment advice, and about the products being offered.
“Iowa investors should insist on working only with licensed brokers and investment advisers in dealing with both traditional and alternative securities investments, and should quickly report any suspicion of investment fraud to the IID as the state securities regulator,” Mumfordsaid. “ In Iowa, we have regulatory authority over both securities and insurance products, companies and licensees, so consumers can come to one regulator when they have something to report or when they need assistance. That’s why we’re here.”
More information about each of the 2012 Top Investor Threats, is available on the agency’s website at www.iid.state.ia.us .
2012 Top Investor Threats
Crowdfunding and Internet Offers.The 2012 JOBS Act makes significant changes to the methods startup businesses and entrepreneurs may employ to bring their ventures to the investing market, and investors must be wary of the attendant risks. Also, many more rules and mechanisms must be put into place for those changes to actually take effect. For example, the relaxed rules governing registration of relatively small securities deals, public solicitation for private funds, and disclosure of information to investors over the Internet are not yet written. So the JOBS Act provisions related to crowdfunding, a much-publicized method for startups seeking capital, are not yet available – and will not be until sometime in 2013 – to legitimate businesses. Even when the relaxed rules and registration exemptions are effective, they will not make investments in small businesses less risky – just more prevalent. And the JOBS Act provisions do not eliminate fraud, an unfortunate common feature of Internet securities activity.
Some states have reported a recent increase in active investigations or recent enforcement actions involving Internet fraud, and JOBS Act-triggered activity is likely to elongate this trend. Investors must remember that small startups are among the riskiest of investment categories under the best of situations. The crowdfunding and Internet investing marketplaces in North America will develop and undergo major changes in the next year, and investors should monitor this emerging capital formation community with a wary eye.
Inappropriate Advice or Practices from Investment Advisers.The Bernie Madoff case opened a number of eyes and ears to the problems that could exist undetected in an investment advisory firm. Investment advisers are licensed to give specific investment advice and owe their clients a fiduciary duty, unlike brokers that may merely effect suitable securities transactions for their clients. The regulatory environment for investment advisers is shifting, and Madoff has led to increased scrutiny from both state regulators and the U.S. Securities and Exchange Commission. The 2010 Dodd-Frank Act laid the groundwork for a major regulatory shift, transferring thousands of mid-sized investment advisers to primary supervision by state regulators such as the IID, rather than the SEC. IID has already begun working with these mid-sized investment advisers, assisting them in complying with state registration requirements and applying already robust examination programs.
Nationally, state enforcement actions increased as well: in 2011, state actions against investment adviser firms nearly doubled over the previous year, and focused both on compliance in the firms’ general business practices and advice to clients. As the states implement regular examination schedules and analyze investment advisers that have not been audited in many years, more problems are likely to be discovered. The increased frequency of exams will benefit investors, however, as state regulators such as IID will work to ensure that investors have access to investment advisers who meet their fiduciary duty and cure discovered deficiencies.
Scam Artists Using Self-Directed IRAs to Mask Fraud. Scam artists, forever on the lookout for new ways to entice investors, are using self-directed IRAs to increase the appeal of their fraudulent schemes. State securities regulators have investigated numerous cases where a self-directed IRA was used in an attempt to lend credibility to a bogus venture. Fraud promoters pushing a Ponzi scheme or other investment fraud can misrepresent the responsibilities of self-directed IRA custodians to deceive investors into believing that their investments are legitimate or protected against losses. While a scam artist may suggest that self-directed IRA custodians analyze and validate investments, those custodians only hold the assets in a self-directed IRA and generally do not evaluate the quality or legitimacy of any investment.
Fraudsters also exploit the tax-deferred characteristics of self-directed IRAs, and know that the financial penalty for early withdrawal may cause investors to be more passive or to keep funds in a fraudulent scheme longer than those who invest through other means. Self-directed IRAs also allow investors to hold alternative investments such as real estate, mortgages, tax liens, precious metals, and private placement securities; financial and other information necessary to make a prudent investment decision may not be as readily available for these alternative investments. While self-directed IRAs can be a legitimate way to hold retirement assets, investors should be mindful of potential fraudulent schemes when considering investments for their self-directed IRA. Custodians and trustees of self-directed IRAs may have limited duties to investors, and generally will not evaluate the quality or legitimacy of an investment or its promoters.
EB-5 Investment-for-Visa Schemes.An immigration program linked to job-creation is growing in popularity, but investors must beware of promoters who falsely claim that an investment in their venture is safer or guaranteed due to an influx of foreign cash. The EB-5 immigration category is a 20-year-old program that grants a U.S. visa to foreign nationals who invest a minimum of $500,000 into a new commercial enterprise. This job-creation effort has attracted investors from around the world, and as with any investment approach, increased interest has been accompanied with new challenges. All investments with an EB-5 component are subject to traditional securities laws, and investors need to be alert to the foreign-funding feature. Unscrupulous promoters may seek to prop up the plausibility of their scheme by highlighting a connection with a federal jobs program. Similarly, investors may be intrigued by the prospect of big funding from investors in China or other foreign countries with traditional or growing economic power.
In a recent case, the developer of a failed artificial sweetener factory planned for a small Missouri town sought Chinese investors through the EB-5 program, and made that a key component in pitching and then selling the underlying government bonds issued for the project. While the existence of Chinese funding may have seemed promising to the city issuing the bonds and the investors who bought them, the developer defaulted on the first bond payment, leaving the city and investors out millions of dollars. Investors considering any enterprise with an EB-5 or IIP feature should make sure to obtain full information on every component of the venture, including all funding sources and the background of all promoters.
Gold and Precious Metals.The hype surrounding gold, silver and other precious metals continues despite both the fact that these investments are just as vulnerable to risk as others, and signs that some precious metal markets are declining or increasingly turbulent. The promise of continuing increases in value pitched by high-profile celebrities on television, radio or the Internet too often lure unsuspecting investors into any number of scams.
Often, scams begin with an unsolicited communication such as an email or telephone call offering to sell investors gold coins, bullion, bars or other forms of the precious metal that the promoter will hold in safekeeping for the investor. Far too often, the gold simply does not exist. Increases in the value of precious metals during the recession have led unwary consumers to believe that the value will perpetually increase. Like any risky investment, there are no guarantees. In fact, gold declined by 15 percent between March and June of 2012 (a drop in value of more than $200 per ounce), settling at its lowest point since July of 2011.
Risky Oil and Gas Drilling Programs.Investors considering alternatives to traditional securities may be attracted to the lucrative returns often associated with investments in oil and gas drilling programs. These investments may also appeal to those who are frustrated with the volatility of the stock market or skeptical of the culture of Wall Street. Unfortunately, energy investments often prove to be a poor substitute for traditional retirement planning. Investments in oil and gas drilling programs typically involve a high degree of risk and are suitable only for investors who can bear the loss of the entirety of their principal. Moreover, some promoters will conceal these risks, using high pressure sales tactics and deceptive marketing practices to peddle worthless investments in oil wells to the investing public.
In a recent survey of the states, oil and gas fraud was ranked as the fourth most common product or practice leading to investigations and enforcement actions. There are active investigations into suspect oil and gas investment programs in over two dozen states and in every region of the U.S. and Canada. Investors should therefore conduct thorough due diligence and appraise their own tolerance for considerable risk when considering the purchase of interests in oil and gas programs.
Promissory Notes.Promissory notes are often promoted as a safe and secure way for investors to earn returns in excess of those prevailing on conventional investments. Promoters flaunt high returns from private loan agreements, interim short term financing or startup capital opportunities. Investors must be wary of promises of security and liquidity in these promissory notes, which are very often false or overstated. Investments of this nature are highly speculative and the risk of total loss of the funds invested is high. But issuers often use notes and prior relationships with investors to downplay the true nature and risk of these investments.
Sales of promissory notes are very often the favored investment vehicle for Ponzi schemes. In a recent survey, 20 states identified promissory notes as one of the top five most common products or features in fraudulent schemes, and notes are a commonly reported violation to Canadian regulators. Promissory notes, for the most part, are securities and are subject to state regulation. As with all investment opportunities, Iowa investors are encouraged to do their due diligence, ask questions and check with IID.
Real Estate Investment Schemes.As news of a possible bottom being reached in the U.S. housing market has spread, the popularity of investment offerings involving distressed real estate has continued to increase. While legitimate real estate investments can be an important component of a diversified portfolio, investors should be aware that schemes related to buying, renovating, flipping or pooling distressed properties are also popular with con artists. In a recent survey of the states, real estate fraud was ranked as the third most common product or practice leading to investigations and enforcement actions.
Even with legitimate real estate investments, there are substantial risks with properties that are bank-owned, pending short-sale, or in foreclosure. And the field is littered with non-legitimate scam artists intent on fleecing middle-class investors. In October 2011, Utah regulators took action against a man that solicited $4 million from investors to purchase and refurbish properties and provide a “diversified portfolio” of hard-money loans. Investors were given personal guarantees and promised minimum returns of 18 percent per year in an investment with risk that was “literally zero,” but in reality, the funds were directed to a single, highly leveraged, development project that went bust. As with all investments, careful vetting and due diligence is a must with real estate investments.
Regulation D Rule 506 Private Offerings.In the most recent survey of state securities regulators, fraudulent private placement offerings were ranked as the most common product or scheme leading to investigations and enforcement actions. These offerings also are commonly referred to as Regulation D Rule 506 offerings (the exemption in federal securities laws that allows private placements to be sold to investors without registration). By definition these are limited investment offerings that are highly illiquid, generally lack transparency and have little regulatory oversight.
While Regulation D Rule 506 offerings are used by many legitimate companies to raise capital, these investment offerings are high-risk and may not be suitable for many individual investors. The 2012 JOBS Act significantly relaxed the restrictions on the manner in which Regulation D Rule 506 offerings can be marketed to the general public, eliminating the previous ban on general solicitations (advertising). Once the rules implementing this change are finalized by the SEC, investors will begin to see a variety of advertisements related to private placement offerings, evn though only a very small percentage of the population will be eligible to invest.
Victimization of Veterans by Self-Professed Experts. In recent years, the Insurance Division has become aware of a number of individuals making presentations in nursing homes, assisted living facilities and similar locations where older veterans may be in residence. Typically, a person professing expertise in veterans’ concerns urges veterans to shift their assets into areas not among those considered by the Veterans Administration when benefit determinations are made by that agency. The presenter may attempt to sell financial products to Veterans for the purpose of qualifying for pension by reducing a claimant’s net worth. In some cases, it has been reported an attorney accompanies the presenter to draft agreements. As a result, the VA benefits start to flow in a way that would have been impossible when the veteran still has too many assets to be eligible.
The presenters charge a fee for the advice. The Insurance Division and other agencies have learned that in some cases several thousands of dollars have been charged for this service.
The presenters may gloss over the fact that many of the filings can be made without cost through the services of the Veterans Administration itself. There may be adverse tax consequences, or create future situations that could put the person shifting assets at risk for Medicaid eligibility due to stringent ‘look-back’ provisions.
State agencies including the Insurance Division would prefer that consumers take their time and make money decisions only after making sure that they have all the facts. In addition to regulatory agencies, a person’s own tax advisor or attorney can help avoid mistakes being made. It is strongly recommended that veterans and their interested family members consult with persons that will look out for their own best interests, such as state regulators, the families’ attorneys or their tax advisers.
About the Iowa Insurance Division
The Iowa Insurance Division (IID) has general control, supervision and direction over all insurance and securities business transacted in the state, and enforces Iowa’s insurance and securities laws and regulations. The IID investigates consumer complaints and prosecutes companies, agents and brokers engaging in unfair trade practices. Consumers with insurance or securities-related questions or complaints may contact the IID toll free at 877-955-1212 or visit the Division on the web at www.iid.state.ia.