Promissory Note Scams: Too Good to Be True
By: Source: AARP.org Date Posted: 2006-04-19 12:17:53.452858-04:00
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When Joan sold her condo, she had money to invest. She went to a broker with a reputable company. He referred her to another broker who she didn’t know. The second broker persuaded her to make a short-term investment in a growing company. It was guaranteed, he said, that she would get her money back with 20% interest in just three months. He claimed the investment was backed by the Small Business Administration. It was a “sure thing,” he said, “another MicroSoft.” Joan signed the papers and handed over $50,000. But within a couple of months, the company went bankrupt and the broker – who wasn’t really an employee of the investment company – disappeared. Joan’s money disappeared as well.
An offer like the one Joan fell for is a form of promissory note.
Thousands of people each year get caught in similar costly investment scams. But if you know what to look out for, you can avoid them.
What is a Promissory Note?
With a promissory note, the investor is in effect making a loan to a company. The company promises to return the investor's money and make fixed interest payments over a certain period of time.
Promissory notes are a form of security. With some exceptions, they must be registered with the state securities regulator or the Securities and Exchange Commission (SEC). The person selling the security must have a securities sales license. The person selling it might deny that what they’re selling is a security, but don’t take their word for it. It is.
Promissory notes can be legitimate investments, but genuine ones are almost never available to the general public. Simply the fact that an offer like this was made available to her should have made Joan suspicious.
How Promissory Note Scams Work
In Joan’s case, the investment fraud was being pulled by someone posing as a broker. But often in this type of scam, the con artists stay behind the scene. They persuade honest, independent life insurance agents to sell promissory notes by promising them large commissions. The agents often rely on the information they’ve been given. They may not know that the information is false or misleading. The life insurance agent may not even know that their insurance license doesn’t allow them to sell promissory notes. The promised high sales commissions can cloud their ability to determine if the investment is right for you and your need for a secure investment.Don’t let the lure of a so-called “guaranteed” high rate of return keep you from doing your homework before you invest.
Red Flags
Several red flags should alert you that a promissory note may be a scam:
- Claims that investing in a promissory note is “risk free.”
- Promises of quick, guaranteed double-digit returns. Compare the promissory note’s rate of return with market rates for similar fixed-rate investments, Treasury bonds, or certificates of deposit. If the seller promises an above-market rate on a short-term note, be careful.
- Labels of “prime quality” on a start-up company’s promissory notes.
- Notes that are for a period of nine months or less.
- Notes that are offered to the general public.
Do Your Research
People offering honest investments welcome questions. They give you time to do some research.
- Check the product. Most promissory notes must be registered with state securities regulators or the SEC.
- Check the person. People selling most promissory notes must be licensed by state regulators.
- Read everything you can. Get on your computer or go to the library to look up articles about the product being offered and the person offering it.
- Don’t be pressured to act quickly. Be ready to say, “I’m not making a decision today.”
AARP Resources:
AARP on Investment Fraud
Check out other common investment scams.
AARP on Financial Planning
Guidance on how to wisely invest.
| Because your Money Matters, get more tips and action steps on Choosing Suitable Investments - PDF file |
AARP Message Boards
We've all seen "hot offers" that are too good to be true. If you have helpful ideas on how to avoid scams–or have learned the hard way–share your smarts with others.
Other Resources:
Securities and Exchange Commission
“Broken Promises: Promissory Note Fraud”
The SEC warns investors about the risks of investing in promissory notes.
Financial Industry Regulatory Authority
“Promissory Notes Can Be Less Than Promised”
FINRA talks about regulatory protections for investors and actions against promoters of promissory notes.
State Securities Regulators
You can locate your state securities regulator by going to the National Association of Securities Dealers website and click “Contact Your Regulator.”
Have you or a friend ever been contacted about what you thought was a scam? Tell others about it so we can all be prepared if it happens to us.
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