FINRA has some common sense advice for avoiding investment scams

  1. Guarantees: Be suspect of anyone who guarantees that an investment will perform a certain way. All investments carry some degree of risk.
  2. Unregistered products: Many investment scams involve unlicensed individuals selling unregistered securities, ranging from stocks, bonds, notes, hedge funds, oil or gas deals, or fictitious instruments, such as prime bank investments.
  3. Overly consistent returns: Any investment that consistently goes up month after month, or that provides remarkably steady returns regardless of market conditions, should raise suspicions, especially during turbulent times. Even the most stable investments can experience hiccups once in a while.
  4. Complex strategies: Avoid anyone who credits a highly complex investing technique for unusual success. Legitimate professionals should be able to explain clearly what they are doing. It is critical that you fully understand any investment that you are considering, including what it is, what the risks are and how the investment makes money.
  5. Missing documentation: If someone tries to sell you a security with no documentation, such as a no prospectus in the case of a stock or mutual fund, and no offering circular in the case of a bond, he/she may be selling unregistered securities. The same is true of stocks without stock symbols.
  6. Account discrepancies: Unauthorized trades, missing funds or other problems with your account statements could be the result of a genuine error or they could indicate churning or fraud. Keep an eye on account statements to ensure that activity is consistent with your instructions, and know who holds your assets. For instance, is the investment adviser also the custodian? Or is there an independent third-party custodian? It can be easier for fraud to occur if an adviser is also the custodian of the assets and keeper of the accounts.

Identity theft remains on top of FTC’s national complaints list

Identity theft continues to top the FTC’s national ranking of consumer complaints, with American consumers reported as losing over $1.6 billion to overall fraud in 2013, according to its annual report released last month. The FTC received more than two million complaints overall, of which 290,056 or 14%, involved identity theft. Thirty percent of these were tax or wage-related, which continues to be the largest category within identity theft complaints. Debt collection followed identity theft with 204,644 or 10% of total complaints, and banking and lending was number three with 152,707 or 7%.

Florida was noted as the state with the highest per capita rate of reported identity theft and fraud complaints, followed by Georgia and California for identity theft complaints, and Nevada and Georgia for fraud and other complaints.

Accuracy issues top credit reporting complaints

The Consumer Financial Protection Bureau (CFPB) last month released its report regarding approximately 31,000 complaints filed between October 22, 2012 and February 1, 2014, by consumers frustrated with credit reporting companies. The majority of the complaints pertained to accuracy and completeness of credit reports.

Scrutiny of predictive scoring products is on the FTC’s agenda in 2014

According to the Federal Trade Commission (‘the “FTC”) and media reports, companies are using predictive scoring for a variety of purposes, ranging from identity verification and fraud prevention to marketing and advertising. The scores, are touted to predict, for example, the likelihood that a person has committed identity fraud or that a certain transaction will result in fraud; the credit risk associated with mortgage loan applications; whether contacting a consumer by mail or phone will lead to successful debt collection; or whether sending a catalog to a certain address will result in an in-store or online purchase.

Consumers are largely unaware of these scores, and have little or no access to the underlying data. As a result, predictive scoring products raise a variety of privacy concerns and questions that the FTC intends to explore. Among the issues, are what consumer protections exist or should be provided, and whether certain scores are considered eligibility determinants that fall under the ambit of the Fair Credit Reporting Act.

SEC’s whistleblower program gains momentum

On November 15, 2013, the SEC released its third annual Whistleblower Report to Congress. According to the report, In the fiscal year 2013, the SEC paid four major awards, one of which was for over $14 million for information leading to an enforcement action that recovered substantial investor funds. Three other payments totaling $832k were made for information regarding a bogus hedge fund.

The report states that the number of complaints and tips increased from 3,001 in the 2012 fiscal year to 3,238 in 2013. The three most common complaints or tips were about corporate disclosures and financials, offerings fraud, and manipulation.  The number of FCPA-related tips also rose, from 115 to 149.

Issuers should ensure that investors are not criminals

The JOBS Act requires that issuers wishing to engage in general solicitation take “reasonable steps” to verify the accredited investor status of purchasers. Rule 506(c) sets forth a principles-based method of verification which requires an objective determination by the issuer or its representatives that the steps taken are “reasonable” in the context of the particular facts and circumstances of each purchaser and transaction. But perhaps a question whether the investor is a felon should be added to the list.

A case decided in 2011 by California’s Court of Appeal, Second District, suggests that indeed it may be prudent for issuers to ensure that investors are not criminals. The plaintiff in this case intended to purchase units in a limited liability company, but was rejected after the mezzanine lender would not accept the plaintiff as a member due to his status as a former felon. The plaintiff subsequently sued the lender, alleging a violation of the Unruh Civil Rights Act. After a dismissal by a trial court, the case was appealed, resulting in a conclusion that  (1) status as a felon is not a personal characteristic similar to those enumerated in the statute; (2) criminal convictions raised legitimate questions about the honesty and trustworthiness of the plaintiff, and the lender had legitimate business reasons justifying its decision; and (3) the potential consequences of allowing the plaintiff’s claim would improperly involve the courts in second-guessing a lending institution‘s expertise in determining loan and investment criteria. As lenders are absolved from potential liability under the Act, issuers who unwittingly accept convicted felons as investors may be jeopardizing their funding.

FINRA issues investor alert about calls from brokerage firm imposters

The Financial Industry Regulatory Authority (“FINRA”) issued a new alert on August 6, 2013 labeled as Cold Calls from Brokerage Firm Imposters—Beware of Old-Fashioned Phishing to warn investors of calls from scammers claiming to be representatives of at least one well-known brokerage firm. In this latest twist on phishing scams, the fraudsters are cold-calling investors claiming to offer information about certificates of deposit with yields well above the best rates in the market in an attempt to get potential victims to divulge their personal or financial account information.

FINRA is reminding investors who receive unsolicited calls to never provide personal information or authorize any transfer of funds to any unknown person, and encourages anyone who believes that he/she has been scammed to file a complaint using its online Complaint Center or send a tip to FINRA’s Office of the Whistleblower.

Disciplinary action serves as reminder of due diligence requirement in Reg. D offerings

A recent disciplinary action reaffirmed FINRA member firms’ obligations to conduct a reasonable investigation of the issuer and the securities it recommends in offerings made under the SEC’s Regulation D, commonly known as private placements. Regulation D provides exemptions from the registration requirements of Section 5 under the Securities & Exchange Act, but it does not exempt these transactions from the antifraud provisions of the federal securities laws. A broker-dealer thus has a duty—enforceable under federal securities laws and FINRA rules—to conduct a reasonable investigation of the securities it recommends. Moreover, any broker-dealer that recommends securities offered under Regulation D must meet the suitability requirements under NASD Rule 2310, and comply with the advertising and supervisory rules of FINRA and the SEC.

A broker-dealer’s reasonable investigation must be tailored to each Regulation D offering, as its scope will depend on factors such as the sophistication of the investors, the broker-dealer’s affiliation with the issuer, and other facts and circumstances of the offering. The investigation, at a minimum, should include background checks of the issuer and its management, the business prospects of the issuer, the assets held or to be acquired by the issuer, the claims being made, and the intended use of the proceeds.

A firm that engages in Regulation D offerings also must have supervisory procedures under NASD Rule 3010 that are designed to ensure that its personnel and representatives conduct an inquiry that is sufficient to comply with the legal and regulatory requirements; that they perform the suitability analysis required by NASD Rule 2310; that they qualify the investors’ eligibility to purchase the securities; and that they abide by the antifraud provisions of the federal securities laws and FINRA rules regarding the preparation and distribution of offering documents or sales literature. And a broker-dealer has a further duty to adequately investigate any information located during the investigation that may be considered a “red flag.”

SEC announces new enforcement initiatives to combat fraud

The Securities and Exchange Commission, (the “SEC”) announced today three new initiatives that will build on its Division of Enforcement’s ongoing efforts to concentrate resources on high-risk areas, as follows:

  • The Financial Reporting and Audit Task Force will concentrate on expanding and strengthening the Division’s efforts to identify securities law violations relating to the preparation of financial statements, issuer reporting and disclosure, and audit failures. Its principal goal will be fraud detection and increased prosecution of violations involving false or misleading financial statements and disclosures. 
  • The Microcap Fraud Task Force will investigate fraud in the issuance, marketing, and trading of microcap securities. These abuses frequently involve serial violators and organized syndicates that employ new media, especially websites and social media, to conduct fraudulent promotional campaigns and engage in manipulative trading strategies to amass ill-gotten gains, largely at the expense of less sophisticated investors. The task force’s principal goal will be to develop and implement long-term strategies for detecting and combating fraud especially by targeting “gatekeepers,” such as attorneys, auditors, broker-dealers, and transfer agents, and other significant participants, such as stock promoters and purveyors of shell companies.
  • The Center for Risk and Quantitative Analytics (CRQA) will support and coordinate the Division’s risk identification, risk assessment and data analytic activities by identifying risks and threats that could harm investors, and assist staff nationwide in conducting risk-based investigations and developing methods of monitoring for signs of possible wrongdoing. A central point of contact for risk-based initiatives nationwide, CRQA will serve as both an analytical hub and source of information about characteristics and patterns indicative of possible fraud or other illegality.

13 Things to Know About Investing

The Securities & Exchange Commission (the “SEC”) recently released an educational bulletin to help investors make informed financial decisions and avoid common scams. Its 13 points include:

  1. Check the investment professional’s background.
    Details about experience and qualifications are available through the Investment Adviser Public Disclosure website and FINRA BrokerCheck.
  2. Be mindful of fees associated with buying, owning, and selling an investment product.
    Expenses vary from product to product, and even small differences in these costs can translate into large differences in earnings over time. An investment with high costs must perform better than a low-cost investment to generate the same returns.
  3. Diversification can help reduce the overall risk of an investment portfolio.
    By picking the right mix, you may be able to limit losses and reduce the fluctuations of investment returns without sacrificing too much in potential gains. Some investors find that it is easier to achieve diversification through ownership of mutual funds or exchange-traded funds rather than through ownership of individual stocks or bonds.
  4. Paying off high-interest debt may be the best “investment” strategy.
    Few investments pay off as well as, or with less risk than, eliminating high-interest debt on credit cards or other loans.
  5. Promises of high returns, with little or no associated risk, are classic warning signs of fraud.
    Every investment carries some degree of risk and the potential for greater returns comes with greater risk. Ignore the so-called “can’t miss” investment opportunities or those promising guaranteed returns or, better yet, report them to the SEC.
  6. Any offer or sale of securities must be either registered with the SEC or exempt from registration.
    Otherwise, it is illegal. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
  7. Do not invest in a company about which little or no information is publicly available.
    Always check whether an offering is registered with the SEC by using the SEC’s EDGAR database or contacting the SEC’s toll-free investor assistance line at (800) 732-0330.
  8. Investing heavily in shares of any individual stock can be risky.
    In particular, think twice before investing heavily in shares of your employer’s stock. If the value declines significantly, or the company goes bankrupt, you may lose money and there’s a chance you might lose your job, too.
  9. Active trading and some other common investing behaviors actually undermine investment performance.
    According to researchers, other common investing mistakes include focusing on past performance, favoring investments from your own country, region, state or company, and holding on to losing investments for too long and selling winning investments too soon.
  10. Con-artists are experts at the art of persuasion, often using a variety of influence tactics tailored to the vulnerabilities of their victims.
    Common tactics include phantom riches (dangling the prospect of wealth, enticing with something you want but can’t have), source credibility (trying to build credibility by claiming to be with a reputable firm or to have a special credential or experience), social consensus (leading you to believe that other savvy investors have already invested), reciprocity (offering to do a small favor for you in return for a big favor) and scarcity (creating a false sense of urgency by claiming limited supply).
  11. Some investments provide tax advantages.
    For example, employer-sponsored retirement plans and individual retirement accounts generally provide tax advantages for retirement savings, and 529 college savings plans also offer tax benefits.
  12. Mutual funds, like other investments, are not guaranteed or insured by the FDIC or any other government agency.
    This is true even if you buy through a bank and the fund carries the bank’s name.
  13. The key to avoiding investment fraud is using independent information to evaluate financial opportunities.
    Many investors may have avoided trouble and losses if they had asked questions from the start and verified the answers with sources outside of their family, community, or group. Whether checking the background of an investment professional, researching an investment, or learning about new products or scams, unbiased information is a significant advantage for investing wisely. 
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