The Top 10 Scams, Schemes & Scandals for 2004

State securities regulators forecast that investors will be challenged with increasingly complex and confusing investment frauds and identified the Top 10 schemes investors are likely to see in 2004. New to the NASAA annual survey of state securities enforcement officials are mutual fund practices, senior investment fraud, and variable annuities.

“Investors face a complex maze of scams, schemes and scandals," said Ralph A. Lambiase, NASAA's president and director of the Connecticut Division of Securities. "Our fight against fraud never stops because each year con artists discover new ways to fleece the public. Sadly, many of the age-old scams still work to cheat victims of their hard-earned savings as well. It pays to remember that if an investment opportunity sounds too good to be true, it usually is."

The following ranking of NASAA's Top 10 scams, schemes and scandals for 2004 is based on the order of prevalence and seriousness as identified by state securities regulators:

  1. PONZI SCHEMES.

    Named for swindler Charles Ponzi, who in the early 1900s took investors for $10 million by promising 40 percent returns, these schemes are a perennial favorite among con artists. The premise is simple: promise high returns to investors and use money from previous investors to pay new investors. Inevitably, the schemes collapse and the only people who consistently make money are the promoters who set the Ponzi in motion. When regulators shut down these schemes promoters even go so far as to blame investors' losses on government intervention -- rather than admit their own deceptions.

    In Mississippi last year, a Tennessee attorney and a Mississippi securities dealer pleaded guilty to 58 counts of investment fraud for their role in a Ponzi scheme that bilked 41 investors from four states out of $10.2 million.

  2. SENIOR INVESTMENT FRAUD.

    Volatile stock markets, record low interest rates, rising health care costs, and increasing life expectancy, have combined to create a perfect storm for investment fraud against senior investors. State securities regulators said older investors are being targeted with increasingly complex investment scams involving unregistered securities, promissory notes, charitable gift annuities, viatical settlements, and Ponzi schemes all promising inflated returns.

    Pennsylvania and Delaware securities regulators last year shut down a “Ponzi” scheme that targeted seniors, but not before 13 Philadelphia-area investors had lost nearly $2 million from their pensions and IRAs. In Arizona, the Arizona Corporation Commission ordered a Scottsdale company and four individuals to return more than $15 million to mostly senior investors and pay penalties of $45,000 to the state in a case involving “CD alternatives” earning up to 8.5 percent. “Behind these schemes are opportunists with products and pitches that may sound tempting to many seniors who’ve seen their retirement accounts and income dwindle in recent years,” Lambiase said.

    To learn more, visit the Senior Investor Resource Center on the NASAA website at http://www.nasaa.org/nasaa/sirc/sirc.asp

  3. PROMISSORY NOTES.

    A long-time member of the Top 10 list, these short-term debt instruments often are sold by independent insurance agents and issued by little known or non-existent companies promising high returns – upwards of 15 percent monthly – with little or no risk. When interest rates are low, investors often are lured by the higher, fixed returns that promissory notes offer. These notes, however, can become vehicles for fraud when the issuer of the note has no intention, or capability, of ever delivering promised returns.

    In November 2003, Grammy-nominated polka star Jan Lewan pled guilty to charges that he defrauded investors in 21 states through the sale of promissory notes. State authorities said Lewan, who defected from Poland in 1979 and launched a successful career that included performances before President Reagan and Pope John Paul II, illegally persuaded investors to invest in a series of failing business ventures. Lewan offered promissory notes that were supposed to pay an interest rate of 12 to 20 percent.

    Authorities said investors lost between $2 million and $2.5 million. Lewan sold the promissory notes during a period of time when he was under a five-year ban by the Pennsylvania Securities Commission barring him from selling securities in the state. New Jersey authorities acted against Lewan in 2003, fining him $950,000 and prohibiting him from selling securities in the state. Connecticut securities regulators are also investigating Lewan.

  4. UNSCRUPULOUS BROKERS.

    Despite the stock market’s rebound in 2003, state securities regulators say they are still receiving a high level of complaints from investors of brokers cutting corners or resorting to outright fraud to fatten their wallets. “I give credit to the increasing numbers of investors who are giving their brokerage statements a closer look and asking the right questions about unexplained fees, unauthorized trades or other irregularities,” Lambiase said.

    In October 2003, US Bancorp Piper Jaffray agreed to pay $2.6 million to settle a complaint by the state of Montana alleging unethical business practices and fraudulent securities dealing by the investment firm and one of its brokers. State regulators accused Thomas J. O'Neill, who was a broker in the firm’s Butte office, of making more than 6,000 unauthorized trades for mostly elderly customers between 1997 and early 2001. They said some trades were made for a customer who was in a coma and again after he died. Authorities said O'Neill generated commissions for himself and the firm through the illegal trades that transformed mostly conservative retirement investments into risky portfolios.

  5. AFFINITY FRAUD.

    Con artists know that its only human nature to trust people who are like yourself. That’s why scammers often use their victim’s religious or ethnic identity to gain their trust and then steal their life savings. No group seems to be immune from fraud.

    In November 2003, authorities arrested five people accused of defrauding evangelical Christians of $160 million in three years and using the money to live extravagantly with a yacht and a helicopter. Federal and state investigators charged that an Alta Loma, California, family promoted an affinity fraud scheme through evangelical leaders and organizations, targeting people who shared religious beliefs and common ethnicities. In a joint effort involving the FBI, the Securities and Exchange Commission, the Internal Revenue Service and the Texas State Securities Board, criminal and civil charges were filed to halt the scheme, which promised returns of 25 percent within three months.

  6. INSURANCE AGENT SECURITIES FRAUD.

    While most independent insurance agents are honest professionals, too many are lured by high commissions into selling fraudulent or high-risk investments, such as promissory notes, ATM and payphone investment contracts and viatical settlements. “Scam artists continue to entice independent insurance agents into selling investments they may know little about,” Lambiase said. The person running the scam instructs the independent sales force – usually insurance agents but sometimes investment advisers and accountants – to promise high returns with little or no risk. For example:

    Arizona securities regulators in 2003 obtained a $4.3 million final judgment against a Scottsdale company and two insurance agents who fraudulently sold charitable gift annuities to mostly senior investors who were told their money would be invested in secure accounts. Instead it was placed in high-risk, speculative investments while the insurance agents helped themselves to $1.3 million in commissions.

    California authorities in 2003 ordered several insurance agents to stop selling viatical investments – interests in the death benefits of terminally ill patients that are always high risk and sometimes fraudulent. The agents promised returns as high as 150 percent in three years, and guaranteed the investment through a “fidelity” bond, but failed to tell investors that the bond was issued by a company incorporated in Vanuatu, South Pacific that is not licensed by to issue bonds in California.

  7. PRIME BANK SCHEMES.

    A perennial favorite of con artists who promise investors triple-digit returns through access to the investment portfolios of the world’s elite banks. The negative publicity attached to these schemes has caused promoters in recent cases to avoid explicitly referring to prime banks. Now it is common to avoid the term altogether and underplay the role of banks by referring to these schemes as “risk free guaranteed high yield instruments” or something equally deceptive.

    In 2003, five Oklahoma men were convicted on fraud charges stemming from a prime bank scheme in which 5,000 investors lost $14.6 million. In another case, two California men were sentenced to prison for the role in a prime bank scheme that cost more than 30 victims approximately $3.45 million. In March, the FBI announced it had targeted 100 people involved in prime bank scams that had cheated investors out of $500 million.

  8. INTERNET FRAUD.

    With the Internet becoming a common part of daily life for increasing numbers of people, it should be no surprise that con artists have made cyberspace a prime hunting ground for victims. Internet fraud has become a booming business. The most recent figures show cyberfraudsters took in $122 million in 2002, according to the Federal Trade Commission. “The Internet has turned from an information superhighway to a road of ruin for victims of cyber fraud,” Lambiase said. The Internet has made it simple for a con artist to reach millions of potential victims at minimal cost. Many of the online scams regulators see today are merely new versions of schemes that have been fleecing offline investors for years.”

    In November 2003 various federal, state, local, and foreign law-enforcement agencies targeted cyberfraudsters and netted 125 arrests and more than 70 indictments. Operation Cyber Sweep identified more than 125,000 victims with losses estimated to exceed $100 million. Lambiase also warned investors to ignore e-mail offers from individuals representing themselves as Nigerian or West African government or business officials in need of help to deposit large sums of money in overseas bank accounts. “Don’t be dot.conned. If you get an e-mail pitching a deal that can’t be beat, hit delete,” Lambiase cautioned.

  9. MUTUAL FUND BUSINESS PRACTICES.

    Although mutual funds play a tremendous role in the wealth and savings of our nation, ongoing scandals throughout the industry clearly demonstrate that some in the mutual fund industry are putting their own interests ahead of America’s 95 million mutual fund shareholders. State securities regulators, the SEC, NASD, and mutual-fund firms themselves have launched a series of inquiries into mutual fund trading practices. To date, more than a dozen mutual funds are under investigation and several mutual fund employees have either pleaded guilty, been charged or settled with state regulators. “These investigations demonstrate a fundamental unfairness and a betrayal of trust that hurts Main Street investors while creating special opportunities for certain privileged mutual fund shareholders and insiders,” Lambiase said. “We will continue to actively pursue inquiries into mutual fund improprieties and are committed to aggressively addressing mutual fund complaints raised by investors in our jurisdictions.”

    State and federal investigations have uncovered sales contests where investors have been steered to funds paying higher commissions to brokers; abusive trading practices, such as “market timing,” that may cost tradition buy-and-hold investors more than $5 billion each year; and illegal trading practices, such as “late trading,” that may cost investors $400 million each year.

  10. VARIABLE ANNUITIES.

    Sales of variable annuities have increased dramatically over the past decade. As sales have risen, so too have complaints from investors. Regulators are concerned that investors aren’t being told about high surrender charges and the steep sales commissions agents often earn when they move investors into variable annuities. Some investors also are misled with claims of guaranteed returns when variable annuity returns actually are vulnerable to the volatility of the stock market. The benefits of variable annuities – tax-deferral, death benefits among others – come with strings attached and additional costs. High commissions often are the driving force for sales of variable annuities. Often pitched to seniors through investment seminars, regulators say these products are unsuitable for many retirees. “Variable annuities make sense only for consumers willing to invest for 10 years or longer, but they are not suitable for many retirees who cannot afford to lock up their money for a long time,” Lambiase said. Variable annuities are considered to be securities under federal law and the laws of 17 jurisdictions. Most states consider variable annuities to be insurance products. NASAA is encouraging changes in state laws that would allow state insurance regulators to continue to oversee the insurance companies that sell variable annuities while authorizing state securities regulators to investigate complaints about variable annuities and to take action against the companies and individuals who sell them. “Those who buy variable annuities should not be denied the protections enjoyed by every other class of investor,” Lambiase said.

    Mississippi securities regulators moved last year against a licensed securities broker in the state who rang up commissions of approximately $1 million within a 15-month period largely through sales of variable annuities.

Lambiase also announced that NASAA has created an interactive Fraud Center on its website (www.nasaa.org). The center features details of NASAA's Top 10 scams, schemes and scandals; tips on how to detect con artists and avoid becoming a victim; an Investor "Bill of Rights;" instructions on how to file an investment-related complaint; and contact information for each state securities regulator. "Education and awareness are an investor's best defense against fraud," Lambiase said.


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