Con Artists Prey on Fearful Investors with 'Low-Risk' Deals
During the bull market, con artists capitalized on investors’ greed. Now, they’ve found an even more powerful emotion to exploit: fear.
Securities regulators say con artists who once tried to lure investors with penny stocks are peddling supposedly low-risk investments that pay above-average interest rates. The scams target investors who have been burned by the stock market and are unhappy with low-interest certificates of deposit and money market funds.
With savings accounts paying less than 1% in interest, con artists can attract a lot of attention by claiming products pay 8% to 10% a year, securities watchdogs say.
“Three or four years ago, that wouldn’t have caught anyone’s attention,” says Andrew Stoltmann, an Indianapolis attorney who represents investors in cases against brokerage firms. “But when the market is down, 8% a year sounds really good.”
And by promoting low-risk investments, bad actors can appeal to conservative investors who would never buy penny stocks or initial public offerings, says Bradley Skolnik, Indiana’s securities commissioner. “In some ways, these types of scams are even more insidious,” he says.
The investments themselves haven’t changed much (see box). Many con artists are selling brokered CDs, which often pay above-average interest rates but don’t mature for 15 to 20 years, Skolnik says.
In Delaware, investors have been conned into buying CDs issued by banks in the Caribbean islands, says James Ropp, Delaware securities commissioner. “Some may be legitimate, but many we’re seeing are not,” he says.
Promissory notes, short-term debt issued by little-known companies, are also thriving.
In Arizona, state regulators recently charged a boiler-room operation with bilking $ 6.2 million from investors who bought promissory notes in a chain of check-cashing stores, says Heather Murphy, spokeswoman for the Arizona Corporation Commission.
“We’ve been seeing a lot of people getting pitches for low-risk, high-return-guaranteed investments, and some really unbelievable claims being made,” Murphy says.Just Say No
To avoid getting ripped off, it’s useful to know where con artists lurk. Many continue to make cold calls, which is why it’s never a good idea to buy securities from a stranger who calls you at home. Others use Internet chat rooms and e-mail.
Some independent life insurance agents who aren’t licensed to sell securities sell some products.
If a pitch by a broker or insurance agent tempts you, call a few large securities firms and ask what kind of rates they’re paying on similar products. Chances are, their rates are considerably lower.
“It never hurts to check around,” Skolnik says. “There’s a reason the mainstream investment houses and reputable financial advisers aren’t selling these products.” Low price, high risk
Meanwhile, securities regulators warn that penny stocks are as risky as ever, even if they’re shares of a well-known company.
While it’s tempting to use spare change to scoop up shares of WorldCom, Enron or Global Crossing, there’s a good chance you’ll never see that money again, Stoltmann says. “There’s a reason stocks are trading for 10 to 15 cents a share — they’re bordering on going out of business,” he says. “You’re only paying 10 cents a share, but you could lose 100% of your investment.”
Be particularly wary of:
* Companies that have done a reverse stock split.
In a reverse stock split, a company reduces the number of its outstanding shares, thus boosting its stock price.
Some companies do reverse stock splits to avoid being delisted from one of the major stock exchanges, says Michael Goldstein, associate professor of finance at Babson College. But a reverse stock split doesn’t address the company’s underlying problems, he says.
* Companies that have sought bankruptcy protection.
Even if a company emerges from bankruptcy, shareholders could end up with nothing. Shareholders don’t get anything until all the company’s lenders and suppliers have been paid. By that time, there may not be any money left.
“Stockholders are at the bottom of the pile,” Goldstein says. “It’s a hugely risky bet.”