Regulators Report that Investment Scams are on the Rise


Scams will always be with us but they are especially plentiful when traditional investments like stocks and bonds are not doing well, according to John Waggoner of USAToday in his August 5, 2010 article, “Investment Scams Thriving.”
“It’s pretty bad out there,” Texas Securities Commissioner Denise Voigt Crawford was quoted as saying. The primary victims are those trying to make up losses in their 401(k) plans and stock portfolios, she added.

The North American Securities Administrators Association (NASAA) recently released its annual Top 10 Investor Traps, which can be viewed at Products and practices that NASAA says warrant heightened scrutiny include, without limitation, the following:

Exchange-Traded Funds (ETFs). Leveraged and inverse ETFs are complex bundles of highly leveraged exotic financial instruments, including options and other derivatives. Given their volatility, illiquidity, and the fact that they are designed for day-trading, these securities are unsuitable for most investors.

Private Placements. Private placements, often recommended as an alternative by investment advisers in smaller towns that are outside the financial industry mainstream, have recently come under increased scrutiny. Unlike public offerings, most private placements are not registered with the SEC, and because state laws and enforcement capabilities vary widely, many of these investment offerings fly beneath the regulatory radar until a scandal erupts. Common abuses are misclassifying investors as “accredited” (i.e., financially able to assume the risk) when they are not, misrepresentation of the risks, which are typically higher than for public offerings that must be registered with the SEC, and failure to disclose material facts?that is, information, that would cause an investor not to invest were that information fully disclosed in advance. Perhaps the most common abuse is the failure of the broker or financial adviser to make sure that the investment is suitable, both generally from the standpoint of the investing public and specifically in relation to the investment objectives of the individual customer. Medical Capital notes sold by Securities America and VSR are examples of private placement scams.

Some other products deserving scrutiny that are not on NASAA’s list include:

Municipal Arbitrage Securities. MAT/ASTA was a series of leveraged municipal arbitrage hedge funds offered by Citigroup Fixed Income Alternatives and sold through Smith Barney and Citigroup Private Bankers. MAT/ASTA was marketed only to high net worth clients of the firm as a fixed income alternative. In truth the MAT/ASTA funds were risky investments that exposed investors to a 100 percent or more loss of principal. The funds imploded in early 2008 causing catastrophic losses to investors.

So-called “Principal Protected” Notes Issued by Lehman Brothers. These structured products were sold and described by UBS AG to investors as an elaborately-engineered vehicle that had been created to provide both upside returns and downside protection. The title of this investment product prominently announced the existence of safety ? “principal protection.” In truth, however, this product was a derivative that was really just the unsecured debt of Lehman Brothers, which went bankrupt in September 2008. The result is that instead of having stock investments with principal protection ? what investors thought they had ? they now have nothing except claims as general unsecured creditors of the bankrupt Lehman Brothers Holdings, Inc.

Reverse Convertibles. These securities are marketed by UBS and others as short-term notes paying above-market interest. According to the Financial Industry Regulatory Authority (FINRA), however, a reverse convertible is, in substance, the investor selling a put option to the issuer! It is a structured product consisting of a high-yield short-term note linked to the performance of a reference asset, usually a stock or a basket of stocks. If the price of the reference asset stays above a predetermined “knock-in” level, the investor earns interest and receives his full principal back at maturity. But if the price of the reference asset dips below the “knock-in” level, the issuer can “put” the depressed (and possibly worthless) reference asset back to the investor in lieu of returning his principal in cash. “In effect, the investor in the reverse convertible is selling the issuer a put option on the reference asset in exchange for an above-market coupon during the life of the note. Generally speaking, the higher the coupon rate, the higher the expected volatility of the reference asset, which in turn means a greater likelihood that the knock-in price will be breached and the investor will receive less than a full return of principal at maturity.”

In short, the climate is right for investment scams, and there are plenty of them out there. A good rule of thumb for investors is don’t buy anything you don’t understand well enough to explain in plain language to a 12 year old. A good rule of thumb for brokers and advisors is don’t sell anything you don’t understand well enough to explain in plain language to an arbitration panel. And before investing, always check out your broker on FINRA’s Brokercheck at, and the Securities and Exchange Commission’s Investment Adviser Public Disclosure web page at

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 35 occasions. Page Perry’s attorneys are actively involved in representing clients who are victims of investment scams. For further information, please contact us.