DOB: Promissory Note Scams

The Informed Investor

Promissory Note Scams

{investor on a wild roller coaster ride}

Promissory notes can appear to be safe, lucrative investments. But many investors have been left with only broken promises. Informed investors recognize that when an investment sounds too good to be true, it usually is.


What is a Promissory Note?

A promissory note is simply a form of debt - like a loan or an IOU - that a company may issue to raise money.  An investor typically agrees to loan money to a company in exchange for the company's promise that it will pay back the amount, plus interest, over a specific time period.

While legitimate promissory notes exist, they are not typically sold to the general public. Promissory notes marketed broadly to individual investors often turn out to be scams.

The Connecticut Department of Banking, and securities regulators around the country, have recently received numerous complaints about promissory notes from investors. The department estimates Connecticut investors have lost over $7 million in such investments.

You can avoid becoming a victim of a promissory note scam by being an informed investor.


How a Promissory Note Scam Works

Most promissory note scams follow a predictable pattern.

According to Connecticut securities officials, promissory notes are often sold by independent life insurance agents - lured by high commissions of up to 30% - who may know nothing about the investments beyond what theyíre told by promoters. (In some cases, insurance agents have themselves purchased promissory note investments). The insurance agents may believe - incorrectly - that the notes are not securities, and the agents may not realize either that they must be licensed as brokers with the Department of Banking in order to sell securities in Connecticut.

Some notes are issued on behalf of companies that donít even exist. Investors often get official-looking promissory note certificates complete with legal-sounding language and gold embossed seals. Insurance agents may tell investors the notes are a safe investment since they are purportedly bonded or guaranteed by insurance companies. However, most of the surety companies guaranteeing the notes are unlicensed, are located offshore and are not able to financially stand behind the promised guarantees. As an added risk, the companies who choose such means of financing invariably find it extremely difficult to pay investors their promised returns within the specified short timeframes.

Potential investors can be thrown off-guard since they often know and may have a long-standing, trusted relationship with the insurance agents selling the notes. In addition, out-of-state investment advisers may also sell promissory notes, and some are promoted over the Internet.

Whatís the attraction of promissory notes?  Many of the victims are elderly investors who donít want exposure to the risk of the general securities market and arenít interested in traditional insurance products. They may, however, be attracted to "promissory notes" because they seem to offer safety along with a higher-than-market rate of return.

According to the sales pitch, the promissory notes are from supposedly "well-established" companies who need capital to expand their businesses. Instead of borrowing money from a traditional lender, they instead offer investors an opportunity to purchase such "notes," typically with a maturity of nine months and an annual interest rate of up to 20%. Agents may urge clients to "cash-in" their life insurance policies and "roll" them into these notes.

Where does the money go?  The promoters may use a portion of the money raised from investors to pay agents their commissions or they may use a "Ponzi scheme" to pay Peter with new money from Paul.  Typically, according to regulators, they abscond with the rest, squandering it on personal expenses or high-flying life styles.

Read Department news releases: agency acts against note sellers, officials crack down on note sellers and agencies issue joint warning.


Tips To Avoid Promissory Note Scams

Here's how you can avoid becoming the victim of a promissory note scam:

  • Check out the sales person.
    Insurance agents or other persons selling "promissory notes" generally need to be licensed by both the State of Connecticut and the National Association of Securities Dealers. Contact the Securities Division at 800-831-7225 or call the NASD Public Disclosure Hotline at 800-289-9999 to find out if your salesperson is licensed and if he or she has a disciplinary history.
  • Check out the investment.
    Do research to determine whether the company offering promissory notes is legitimate and is healthy enough to pay its debts. The types of promissory notes typically offered in scams are usually securities. Before parting with any of your money, contact the Securities Division to determine if the notes are properly registered or legally exempt from registration.
  • Be wary of guaranteed investments.
    Be skeptical of promissory notes that are supposedly "insured" or "guaranteed," especially if a foreign insurance company is involved. Contact the Connecticut Department of Insurance to find out if the foreign insurance company can legally do business in the United States.
  • Be suspicious of "risk-free, high yield" investments.
    As a first rule in finance, the higher the reward, the greater the risk you must bear. Promises of "risk-free, high returns" exceeding the prevailing marketplace are usually the bait that con artists use to lure their victims.  Always remember that if it sounds too good to be true, it probably is.


What To Do If You're a Victim
:

If you believe you've invested in a promissory note scam, act promptly. Contact the Department of Banking for assistance.

Last updated June 8, 2005


Some of the information on this Web page was adapted
from a Securities and Exchange Commission publication.