DOB: Connecticut Department of Banking Investor Bulletin: Business Opportunity Fraud

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 Business Opportunity Fraud

July 1995 -  Con artists are cashing in on the rapidly changing American workplace. A record number of Americans are now self-employed business owners. Millions more find themselves out of work as the result of corporate downsizing. Still others must seek second jobs in order to make ends meet. All are prime targets for the growing ranks of fast-buck operators pushing worthless "business opportunity" schemes involving vending machines, amusement games, pay telephones, and display racks for greeting cards, CD-ROM computer software, and other items.

Lured by deceptive promises of independence and easy income, many would-be entrepreneurs are jumping into the arms of con artists who claim: "we are not just selling you a business, we put you IN business." The recent rise of dozens of telemarketing "boiler rooms" pushing pre-packaged small business "deals" has yielded an astounding surge in business opportunity scams across America. Though precise numbers are not available, state and federal regulators estimate that well over $100 million a year is now disappearing into worthless business opportunity rip-offs. The actual figure most likely is substantially higher; in just three recent cases handled by the Federal Trade Commission (FTC), almost $64 million in losses were sustained by the unwary victims.

ENTER "PROJECT TELESWEEP"

In 1995, the FTC, the U.S. Department of Justice, 20 state securities regulators, attorneys general, franchise and business opportunity regulators, and consumer protection offices, announced an unprecedented federal-state assault on business opportunity scams. This coordinated crackdown effort is known as "Project Telesweep." The following cases illustrate the nature and extent of the business opportunity fraud epidemic in America:

  • Staggering losses. A Mercer Island, Washington, woman who is the single mother of three daughters fell into a business opportunity trap in late 1993 when she resolved to supplement her income to pay for her children's education, according to the Securities Division of the State of Washington, Department of Financial Institutions. After responding to a classified ad in the Seattle Times and traveling to Colorado to meet the promoter, she invested more than $13,000 in "video pool" and "video bowling" games that broke down within 90 days. Rather than fixing the equipment, the promoter sent her two new units that she had not ordered. The machines are now gathering dust in the woman's garage.

In a case brought by the FTC, a women from Pennsylvania responded to an advertisement for a pizza vending machine business opportunity. The promoter promised huge earnings and the best locations in the area. The women ended up losing her entire investment of $72,000. In order to make up the loss, she and her husband had to mortgage their home and sell off a dairy cow herd. They are now working multiple jobs in a struggle to avoid losing their family farm.

  • Promises of instant riches. One trademark of a business opportunity scam is an overblown promise of easy money. In one ad for a pay telephone scheme, a promoter promises: "Get 96 sites for $7,795. Then Retire! Call 1-800/XXX-XXXX." A brochure for a Utah snack vending machine company reads: "Many People Earn $36,000\year in Income, But . . . Very Few Earn $30,000/year working only five-six hours per week." In another case, a promoter for a gumball machine business opportunity claimed that one operator had earned $14,000 from four machines . . . in just seven days!
  • Unproven concepts. In a case handled by the Securities Division of the Maryland Attorney General, an in-state company ran ads in Income Plus magazine and other publications for a business opportunity involving an overhyped solar-powered car battery recharger. According to the Income Plus ad, distributors for the company were "making in excess of $200,000 in their first year with the business." The state handled more than 70 complaints from investors around the United States, many of whom reported that the solar-powered rechargers did not work at all. When one investor took the recharger to an electrician, he was told that it would take weeks to recharge a battery with the device. Nonetheless, the recharger had been touted in ads with the line: "In seconds, you're off and running . . ."

In one case brought by the Federal Trade Commission (FTC), a promoter touting a vending machine known as the "Alcohol Neutralizer" offered investors packages of five machines for $4,500. Installed in taverns and other places where liquor is served, the "Alcohol Neutralizer" was to dispense an herbal pill containing an active ingredient that was supposed to be able to reduce blood alcohol count (BAC) levels. Supposedly, the pills had been endorsed as safe and efficacious by the Food and Drug Administration and were backed up by the work of Harvard Medical School researchers. In fact, the FDA had taken action to stop the manufacturing of the pills and the Ivy League scientists in question denied ever having produced the supportive findings linked to them by the promoter. An independent study by an Indiana University scientist found that the herbal ingredient in the pills might actually keep BAC levels higher for a longer period of time than if a drinker had never taken the pill!

  • Shoddy merchandise. In one investigation of a business opportunity scheme, investors complained about a soda vending machine that looked like a small refrigerator. Not only did the vending machine have to be opened from the front, but customers had to turn a crank in order to get out their sodas. Complicating matters was the fact that the inferior vending machines required exact change . . . and only in a certain combination of coins!
  • Another business opportunity scheme promising six-figure earnings in the display rack sale of discount CD ROM computer software lured customers with promotional materials implying that the low-priced software in question would feature such major brand names as IBM, Corel, and Microsoft. In fact, the business opportunity, for which some customers paid up to $40,000, featured "junk software," including cheap shareware, service and installation disks, and promotional samples marked "not for resale."

WHAT ARE BUSINESS OPPORTUNITIES?

A business opportunity involves the sale of goods or services that enable the novice entrepreneur to begin a business. Typical business opportunities involve vending machines, amusement games, pay telephones, and display racks for such items as greeting cards and CD-ROM computer software. Ideally, the vending machines or display racks are located in high-traffic areas, such as malls, airports, or bowling alleys.

The promoter of a business opportunity is responsible for providing vending machines or display racks and finding locations for investors. The promoter may offer to locate the machines for investors, may assist the investor in locating the machines, or may refer the investor to a professional locating service. The promoter may also represent that it will repair or replace broken machines. The promoter may also supply marketing plans, training, or other general guidance. Generally, the operator of the business opportunity is responsible for cleaning and restocking the machines or display racks, making sure needed repairs get done, and collecting the money.

Under federal law, the promoter of a business opportunity is required to provide potential investors with complete pre-sale information in the form of a disclosure document. Some states impose additional licensing and disclosure requirements.

In a world where McDonald's is one of the best known of all household names, the "franchise" is probably the most familiar type of business venture package. A business opportunity is considered a franchise when its name is identified by a common trademark or trade name and the promoter offers investors significant assistance in operating the business or exercises significant control over the investor's method of operation. Federal law deals with franchises and business opportunities in much the same way. A total of 15 states have some type of franchise disclosure regulation; 24 states have laws that specifically address business opportunity promotions.

THE SURGE IN BOGUS BUSINESS OPPORTUNITIES

Business opportunities have received considerable attention in recent years, owning in large part to the decline of traditional job security and the increasing number of individuals who have lost jobs due to corporate downsizing. Always quick to seize on a new way to make an illicit buck, con artists have picked up on the changes in the traditional American job. The result: fraudulent telemarketing operations are now pushing overhyped or worthless small business deals on unsuspecting entrepreneurs, individuals looking for a second income to make ends meet, and people who have lost jobs and cannot find replacements for them.

Investigations show that victims are lured into the telemarketing "boiler room" by small ads that appear in the classified sections of newspapers and magazines. If an unwary investor makes the mistake of calling, the high-pressure "boiler room" sales tactics begin immediately. In the typical illicit telemarketing operation, the phone operators play a number of different roles. The first person to take the call is known as the "fronter" and has the task of making the initial pitch and determining if the potential "mooch" has the money to invest. Once qualified, the caller encounters a second person, usually referred to as the "owner/manager," who turns up the heat and urges the caller to check out the firm's references. The call may also be handed off to a "closer" who pulls out all the stops in attempting to extract payment.

Peddlers of bogus business opportunities do not seem to have a care in the world about a potential investor contacting existing operators. That is because many rely upon what are know as "singers," people who get paid to pose as reference givers or who are existing operators enticed with the prospect of additional goods and services in exchange for their high praise. In the case of one Miami company offering a business opportunity deal involving candy vending machines, existing operators were promised one free vending machine for each positive testimonial.

SIGNS OF BUSINESS OPPORTUNITY SCAMS

How can you tell a legitimate business opportunity from a promotion that is a scam? Investigators in "Project Telesweep" report that the following are hallmarks of fraudulent business opportunity schemes today:

  • Use of classified ads that urge the prospect to call an "800" number.
  • Wild and unsubstantiated claims about potential earnings.
  • Claims about "proven" concepts.
  • Suggestions that no experience is necessary.
  • Promises about exclusive territories.
  • Assurances about good locations for vending machines or display racks, or the assistance of a professional locator.
  • Reliance on references hand-picked by the company (instead of being provided a list of current business opportunity owners).
  • Failure to provide prospective investors with a complete disclosure document containing pre-sale disclosures about their experience, lawsuit history, audited financial statements, and substantiation for any representations made about earnings.

STEPS YOU CAN TAKE TO PROTECT YOURSELF

If you detect signs of a problem in a business opportunity that you are reviewing, you should proceed with extreme caution. If you have concerns about how you are faring with an existing business opportunity and believe that some of these hallmarks are at work in your deal, it may be time for you to complain to a regulator. Unfortunately, the nature of business opportunity fraud is that it may take six or more months for an operator to recognize that he or she has been duped. The problems may drag on because of stalling tactics on the part of promoters who promise to make repairs or partial refunds. The best way to avoid being taken by a business opportunity scam to begin with is to research any potential investment thoroughly with an eye to signs of possible trouble. Anyone who is considering an investment in a business opportunity should review the following key pieces of advice:

  • Be skeptical about earnings claims that sound too good to be true. The "bait" on the "hook" of a business opportunity scam is that a person with no experience may be able to work only a few hours a week and earn $50,000, $100,000 . . . or more . . . a year. The truth is that making money almost always requires hard work . . . and lots of it.
  • Exercise caution when it comes to newspaper and magazine ads that contain little more than glowing promises and an "800" number. This is very likely a "come-on" pitch to lure you into calling a high-pressure telemarketing boiler room operation! Keep in mind that just because an ad appears in a reputable newspaper or magazine does not mean that the information it contains is accurate or legitimate. As in recent sweepstakes and travel scams, the phone con artists pushing bogus business opportunities will make any statement necessary to separate an unwary individual from his or her savings.
  • Obtain and review the required disclosure document before money changes hands. Keep in mind that business opportunity and franchise promoters are required to present you with a disclosure document before you sign a contract or pay a fee. If this document is not made readily available, beware! When you get the document, carefully review the portions dealing with: risks; the business experience of the company and directors; history of lawsuits, including those alleging fraud; fees to be paid and conditions under which fees and deposits will be returned; audited financial statements containing balance sheets for the three previous years; and substantiation for any earnings claims made to you.
  • Make sure that the business opportunity has complied with applicable state registration laws. Even if a business opportunity promoter complies with the laws in your state governing such deals, there is no guarantee that you will make money. However, it is one easy way to screen out bogus operators who are trying to "fly below radar" in order to evade detection by regulators. To check out a business opportunity in your state, see the information at the end of this release.
  • Talk to current investors . . and watch out for "singers." You should always take the time to speak with several people who are current investors in the business opportunity that you are considering. The disclosure document must contain a list of the business opportunities' current operators. But be on your guard! A scheming promoter of a bogus business opportunity may line up "singers" who provide phony testimonials.
  • Be suspicious if you cannot reach references by phone. In one case investigated by the FTC, a promoter used three aliases and out-of-state voice mall boxes to return calls in which he posed as an investor to woo prospects. The best way to avoid "singers," is to get the names and addresses of the retail locations where the vending machines or rack display are purportedly located and visit the locations in person. You can then judge for yourself the quality of the machines, their state of repair, and the traffic volume in the store. Take the time to interview at least five references. You may wish to ask them the following questions:
  • Are you happy with your investment?
  • Has the promoter come through for you?
  • Are you making the money you thought you'd be making?
  • Would you make this investment again, knowing what you now know?
  • What do you like and dislike about this business opportunity?
  • What are the names and addresses of the retail locations where your machines are currently located?
  • Research the business and the market. Make sure that you have a clear grasp of how the business opportunity will work and what demand (if any) there is likely to be in your territory. Don't rely only on glowing promises from telemarketers who claim that consumers are clamoring to get your product. In one case where a business opportunity claimed to have a "worst case" net return of $1,220 a month, investigators found that the investor who was doing the best only made about $200-$300 monthly.
  • Get professional advice if you need it. Don't lose your life savings just because you failed to spend a few hundred dollars to talk to a lawyer, an accountant or other expert. These people will sometimes be able to spot key details that you are missing. Since they are not caught up in your dream and hope for success, outsiders are also in a better position to review a business opportunity from a neutral vantage point.
  • Don't automatically assume that promises of prime sites, speedy repairs, and ongoing assistance will be there when you need them. Remember that a bogus business opportunity promoter will promise you the sun and the moon in order to get your money. Be cautious when you sign up with a firm that is supposed to identify prime sites for your vending machines, pay telephones, display racks, or other items. Keep in mind that many who get burned in business opportunities lose their money when promoters fail to come through with promised repairs and other ongoing assistance.

FOR MORE INFORMATION ...

Contact the Securities Division to determine if a business opportunity is registered or to report a possible business opportunity scam. Review our publication on Understanding Business Opportunity Investments on this web site. You may also file a complaint with the Federal Trade Commission (FTC). The FTC also has publications on business opportunities and franchises.


What Every Investor Should Know