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Securities Officials Act Against Promissory Note Fraud

June 1, 2000  -

Securities officials in Connecticut today joined other state and federal securities regulators in announcing a major crackdown on sellers of promissory notes, which promise investors high returns and low risk. The notes, often sold by insurance agents, are in fact very risky and often fraudulent.

State Banking Commissioner John P. Burke reported that he and former State Insurance Commissioner George M. Reider, Jr. warned local insurance agents last year about fraudulent schemes involving the marketing of promissory notes and commercial paper. According to Burke, the banking department’s Securities Division recently investigated and took administrative action against five companies involved in such illegal activity.

Two of the companies whose notes were sold to Connecticut investors, Sebastian International Entertainment, Inc. and World Vision Entertainment, Inc., based in Florida, are no longer in business. Another company, Corlogic Corporation, located in Madison, Connecticut, was the subject of a cease and desist order in February. Later, securities officials, in cooperation with State Attorney General Richard Blumenthal, filed suit in Hartford Superior Court to prevent the company from offering or selling unregistered securities and dissipating corporate assets. The case is still pending.

"Although low interest rates are great for the economy, they aren’t very profitable for people who rely on safe and predictable income from bank accounts, money market funds and dividends," says Burke. "This has provided an opportunity for frauds like we see with promissory notes."

Burke explained that investors are attracted to this type of investment because it has an aura of safety with a higher-than-market rate of return. But, investors must never forget the first rule of finance: The higher the reward, the higher the risk.

Last year, Connecticut securities officials joined with regulators in 37 states and the District of Columbia to form a task force that would promote communication and cooperation among state and federal agencies to combat this nationwide problem. The combined effort has resulted in 28 states taking scores of actions against marketers of promissory notes. These actions involved more than 3,000 investors. The cases, all brought in recent weeks and months, highlight what Burke says is a serious and growing problem. In addition, Burke said the U.S. Securities and Exchange Commission has filed charges in 13 enforcement actions against 38 individuals and entities involved in the sale of promissory notes. In all, the defendants named in these actions are alleged to have fraudulently obtained hundreds of millions of dollars from investors.

Connecticut securities officials say these promissory notes are often sold by independent life insurance agents--lured by high commissions--who may know nothing about the promoters of the investments beyond what they’re told. The agents may not realize that they must be licensed as securities brokers with state securities regulators to sell securities. Some notes are issued on behalf of companies that don’t even exist. Investors often get official-looking promissory note certificates complete with legal-sounding language and gold embossed seals. The agents told investors the notes were a safe investment since they were purportedly bonded or guaranteed by insurance companies. However, most of the surety companies were unlicensed and located offshore and could not financially stand behind the promised investment guarantees.

In January, Burke issued cease and desist orders against Global Insurance Company, Ltd, of San Jose, Costa Rica and New England International Surety, Inc., of Brussels, Belgium, for failing to honor the guarantees with respect to notes sold to Connecticut investors.

Connecticut securities regulators say a promissory note scam could work like this. A life insurance agent with whom you are familiar calls with an intriguing investment opportunity. A supposedly "well-established" company is looking to expand its business and needs capital. Instead of borrowing money from a traditional lender, it is offering investors an opportunity to purchase "promissory notes," typically with a maturity of nine months and an annual interest rate between 12% - 18%, far more than an investor could get elsewhere. Agents urge clients to "cash-in" their life insurance policies and "roll" them into these notes.

Some of the investments, regulators warn, are likely to be obligations of fraudulent institutions that either abscond with the clients’ money when the notes mature or use a "Ponzi scheme" to pay Peter with new money from Paul.

"Nationally, these promissory note frauds have cost investors tens of millions of dollars," said Burke. "In Connecticut, close to $10 million of investor funds has been lost."

Commenting on the joint regulatory effort, Burke said, "By working together, the states and the SEC can leverage their resources, bring more actions to halt these sales and shine an even brighter spotlight on a serious problem."

What’s the attraction of promissory notes? Burke says some investors "don’t want exposure to the risk of the general securities market and aren’t interested in traditional insurance products. They’re attracted to this type of investment that seems to offer safety with a higher-than-market rate of return."

Unlike traditional boiler-room cold callers, who solicit clients by telephone and usually have no prior relationship with them, insurance agents (some of whom are not licensed to sell securities) know their customers well. Many of the victims are elderly. Besides life insurance agents, out-of-state investment advisers also sell promissory notes, and some are promoted over the Internet.

Here are some tips to protect yourself and your money:

  • Before investing in any promissory note, investors should always check with the Securities Division to confirm that the notes are properly registered or legally exempt from registration. If you can’t verify that the notes are registered or exempt from registration, hold onto your money. Do research to determine whether the company whose notes are being offered is legitimate.
  • Agents selling these "notes" are usually required to be licensed by both the state and the National Association of Securities Dealers. To find out if the agents are registered or have a disciplinary history, contact the Securities Division at 800- 831-7225 or call the NASD Public Disclosure Hotline at 800-289-9999.
  • Be suspicious if the notes have an above-market interest rate with a maturity of less than a year. With a one-year FDIC-insured bank certificate of deposit yielding a little over 6% now, you should be very skeptical when someone offers you a nine-month "note" from an obscure firm promising 12%.

Additional information can be obtained by calling the Securities Division or by visiting the Connecticut Department of Banking’s web site.