Certain types of investments—and investment promoters—should always get your common sense tingling.
Recognizing fraudulent and inappropriate investments is one part of the equation for safe investing. Knowing what to do — the questions to ask, the steps to take — is the second. As you wade into the investing world in 2020, here are threats to your financial health and how to combat them:
Threat: Precious Metals Investments
RISKS TO INVESTORS: Investments in gold, silver, and other precious metals are often sold as a supposed hedge against stock market crashes or some other economic calamity.
The industry is notorious for its aggressive, highly targeted cold-calling tactics, which include the use use of social media and data mining to target potential investors on the basis of their political beliefs and age.
Investing in precious metals is not as straightforward as a salesperson might make it sound. The precious metals industry employs a variety of confusing pricing terms — does a Main Street investor know what "melt value" is, or how "ask price"differs from "purchase price"? — that can result in the actual value of the metals you purchase being significantly less than you thought. In addition, you may pay substantial fees if you are cashing in existing assets like stocks and bonds and using the proceeds to invest in metals in a new account such as a self-directed Individual Retirement Account.
WHAT TO DO: Avoid cold calls, period. Investments of any kind should be purchased by you and not sold to you, especially not over the phone in a scripted hard sell.
Deal with registered individuals. If a sales representative is advising you to sell or buy certain securities, then they must be registered to do so in Texas. If not, they are violating the law by acting as unregistered investment adviser representatives.
Be absolutely certain of all costs and fees associated with precious metals investments.
Threat: Unregistered Individuals
RISKS TO INVESTORS: If you buy an investment from someone who is not registered to sell securities in Texas, chances are high you’re putting your money into a fraud. Almost all criminal actions undertaken by the State Securities Board involve people unregistered with the Securities Commissioner.
Remember, in general anyone acting as a sales agent for a company selling stocks, bonds, or other investments to the public must be registered to do so. Registering with the State Securities Board involves qualifications testing, background checks, and periodic review.
WHAT TO DO: Always check to confirm that a person you are considering investing with is actually registered to sell investments. You can do this by visiting the State Securities Board website or call our main office at 1-512-305-8301. If an individual is registered, you can request a free regulatory background check on him or her.
Threat: Targeting the Elderly
RISKS TO INVESTORS: Older people sometimes accumulate substantial assets after a lifetime of working and saving. They may also be experiencing cognitive decline. That’s the main reason fraudsters target them.
Cold calls remain a staple of investment fraud. The longer a fraudster can get someone to stay on the line, the greater the chances he or she can steal their money. Older people who welcome a chance to engage with others may be especially susceptible to this type of scam.
The State of Texas passed a law in 2017 requiring financial firms to report suspected financial fraud involving vulnerable adults. According to the law, “vulnerable” is defined as a person who is 65 or older or who has a mental or developmental disability. Investigations into suspected elder fraud consistently comprise a significant part of the enforcement workload.
WHAT TO DO: Get a reality check from a trusted family member. Money is often a touchy topic within families, but for an older person a family support network is ideal.
No matter our age, most of us could use a trustworthy and informed friend or family member to give advice on large financial transactions or a change in investment strategy. A financial professional could help, too, whether it’s a certified public accountant, attorney, certified financial planner, or registered investment adviser.
Sometimes older people delay reporting fraud out of embarrassment, thinking it is an admission that they can no longer handle their own affairs.
So it’s important to report suspected fraud as soon as possible. Consult the resources on the For Seniors section of the State Securities Board Investor Education site.
Threat: Oil and Gas Offerings
RISKS TO INVESTORS: Private oil and gas offerings are highly speculative, complex, and full of unfamiliar, technical terms. It’s very difficult to determine how much oil or gas will actually be produced or to assess the promises and background of the promoter.
You may be required to pay high commissions and other fees, significantly reducing the return on your investment.
Interests in these partnerships may be illiquid or not transferrable, so your money may be locked up for a long time.
WHAT TO DO: Be very cautious when considering all private oil and gas investment offerings.
Ask for and carefully review all documentation.
Check on the background of the promoter and all companies involved in the project. Make sure the promoter offering the investment is registered to sell securities.
Consult with an independent, registered financial professional as to the appropriateness and risk of the investment for your portfolio.
Threat: Cryptocurrency Offerings
RISKS TO INVESTORS: Cryptocurrency offerings are extraordinarily volatile—meaning risky—and almost impossible for a layperson to understand.
Investments tied to cryptocurrency hit everyone’s radar in 2017 when the price of one bitcoin reached a record high of $19,891, an increase of 1,800% for the year. But less than two months later, the price had dropped to $6,846. Cryptocurrency prices continue to be in a constant cycle of boom and bust.
Promoters of these investments look to take advantage of people who are swayed by the idea of virtual currencies as a quick path to wealth.
Even seniors and retirees, who traditionally prioritize security over speculation, are being persuaded to invest in initial coin offerings and cryptocurrency mining pools.
WHAT TO DO: Do not invest in cryptocurrency offerings unless you can determine some basic facts about the company.
Make sure you can identify the principals of the company and its physical location. If you don’t, you will be transferring funds to anonymous third parties at undisclosed locations. Also ask to see audited records or other financial information to back up any claims of high profits.
Most important, deal with registered parties. The state of Texas’ rigorous registration requirements apply equally to traditional securities and emerging securities, including investment products tied to cryptocurrencies.
Keep in mind that you will have little or no recourse if your money is stolen. For extra motivation, take a look at the astounding facts detailed in the growing list of cryptocurrency enforcement actions the State Securities Board has taken to protect investors.
Threat: Promissory Notes
RISKS TO INVESTORS: Promissory notes are basically IOUs from companies and individuals who often have limited operating histories.
It’s difficult for an investor without special expertise to analyze promissory notes that are broadly marketed to the public to fund projects such as oil and gas exploration or real estate, or as a way to buy interests in a business partnership.
Legitimate promissory notes are generally marketed to sophisticated or corporate investors who have the resources and expertise to evaluate the terms and conditions of notes and the companies behind them.
WHAT TO DO: If you are considering investing in a promissory note, first make sure the person selling the note is registered to sell securities in Texas.
Recognize that promissory notes are often marketed as high-yield, no-risk sources of income. They’re intended to entice investors looking for an alternative to low yields on products such as certificates of deposit and money market accounts.
Threat: Private Placement Offerings
RISKS TO INVESTORS: Private placement offerings are used to raise capital without having to comply with the registration requirements of securities laws.
This exemption from registration allows companies to raise an unlimited amount of money, but only from investors who meet the definition of “accredited”—net worth of $1 million, excluding the value of the primary residence, or annual income of $200,000 or more ($300,000 together with a spouse).
Accredited investors may get pitched seemingly exclusive offers that are supposedly limited to sophisticated investors of means. But the pitches may be slim on important details, and the investments may turn out to be illiquid.
WHAT TO DO: Be cautious when considering these types of investments, even if you have a high net worth. Because private placement offerings aren’t registered, they are more likely to be unsuitable, or even fraudulent, investments.
Threat: Talking Heads
RISKS TO INVESTORS: It’s easy to believe that someone who dispenses financial advice on the radio, online, or in books, has special expertise that can put you on the safe and secure path to wealth. Not bloody likely.
The airtime for many investment radio shows is bought and paid for by the hosts, who may or may not have legitimate financial credentials. The content may not always be objective but slanted to benefit the host or guest speakers.
The Internet is even more of an ethics-free zone for posting financial content, and there are many alleged financial experts who tout their books. One such book sounded particularly appealing: Robbed With a Pen Again: A Guide to Protecting Your Assets.
The author, who also hawked his investment wares on radio shows, was sentenced to 12 years in state prison for fraud in 2018.
WHAT TO DO: Listen to, and read, pundits with skepticism.
Some base their advice on risky investments that aren’t suitable for most investors. Some don’t disclose conflicts of interest and the fees they get for making certain recommendations.
A lot of pundit talk is just noise, and it’s best to tune out anything that distracts you from sound investing principles.
Threat: Real Estate
RISKS TO INVESTORS: Depending on the structure of the real estate investment offering, risk factors may include:
• the illiquidity of the investment;
• the impact of changes in interest rates on the profitability of the investment or the ability to sell or refinance property;
• the potential effect of demographics, property valuation, and rental rates on the revenue generated.
Some promoters of fraudulent real estate investments also claim to have special expertise that guarantees investors unrealistically high returns on their investments.
Another type of investment, the non-traded Real Estate Investment Trust (REIT), invests in the same assets as publicly traded REITs but carries the following risks not found in REITs listed on the major stock exchanges:
• they are highly illiquid, long-term investments that must be held for 7 to 10 years on average;
• some have limited redemption programs, but they are not required and may be suspended at any time;
• significant front-end fees and commissions may be charged, reducing the amount of money that is actually invested in real estate.
WHAT TO DO: Be wary of claims that a real estate investment carries minimal risk because it is backed by a “hard asset” such as a parcel of land or a home or commercial building. Because non-traded REITs often require investors to meet minimum net worth and/or income standards, check the prospectus to make sure you meet those standards.
Threat: Alternative Investments for Self-Directed IRAs
There are many non-traditional investments you may consider for a self-directed IRA, but with these choices come greater risks.
RISKS TO INVESTORS: Investing for retirement usually means buying stocks,bonds, and mutual funds through a workplace plan, like a 401(k) or 403(b), or establishing your own Individual Retirement Account (IRA).
If you want to buy “alternative assets” for a retirement account—such as precious metals, real estate, virtual currencies, and promissory notes—you will likely have to open a self-directed IRA account.
All IRAs provide investors with tax benefits for retirement savings, and all IRA accounts are held for investors by custodians.
The difference is that in a self-directed IRA, the custodian generally has only limited duties to make sure the alternative assets—and the promoter selling them—are legitimate.
WHAT TO DO: Avoid unsolicited investment offers, especially for riskier, alternative assets.
Always ask if the person offering investments for your self-directed IRA is licensed and if the investment is registered. Always check the answers with the State Securities Board.
Fraudulent promoters can misrepresent the responsibilities of self-directed IRA custodians and claim that the investments are legitimate or protected against loss. In fact, the custodians of self-directed IRAs generally do not evaluate the legitimacy of any investments in the account.
Threat: High-Yield Trading
RISKS TO INVESTORS: Active trading of stocks, bonds, foreign currency, and cryptocurrency is a tough way to consistently earn profits.
Foreign currency is a vast global market where prices are volatile, and losses can pile up in a few hours. There’s a huge risk in buying into investment promoter promises that predict the prices of currencies and guarantee enormous profits with little or no risk.
Promoters often solicit investors with outsized claims of profitability—3% a week, or 30% a month—that may tempt investors to start counting their expected windfalls.
WHAT TO DO: Make sure the trader and the firm are registered to sell securities, currencies, or commodities.
Currency traders, for example, must be registered with one or more federal regulatory agencies and in many cases licensed by the Texas State Securities Board.
Keep in mind the unusual complexity and skill involved in earning consistently high returns in the rapid trading of any asset, as well as the fees you're likely to pay.