Note Investment Frauds and How to Avoid Them

Note investors are a natural target for con artists. The pitches promise high yields, sound sophisticated and lean on financial jargon most people don’t question. This lesson walks through the frauds that come up most often around notes and investing, the warning signs of each, and how to protect yourself.

The common thread is simple: if an opportunity looks too good to be true, it probably is.

Letter of credit fraud

Legitimate letters of credit are never sold or offered as investments.

Real letters of credit are issued by banks to guarantee payment for goods shipped in international trade. Payment generally requires that the paying bank receive documents certifying that the goods ordered have been shipped and are on their way to their destination.

Some letter of credit frauds target banks, using false documents to show goods were shipped when nothing, or something inferior, was shipped. Others target investors: con artists offer a “letter of credit” or “bank guarantee” as an investment and promise returns on the order of 100% to 300% a year. Such investment “opportunities” simply do not exist.

How to avoid letter of credit fraud

If an “opportunity” appears too good to be true, it probably is.
Don’t invest in anything unless you understand the deal. Con artists rely on complex transactions and faulty logic to “explain” fraudulent schemes.
Don’t invest in or try to “purchase” a letter of credit. Such investments do not exist.
Be wary of any investment that promises extremely high yields.
Independently verify the terms of any investment, including the parties involved and the nature of the investment.

Prime bank note and bank guarantee fraud

International fraud artists have invented a scheme that promises extremely high yields in a short time. They claim access to “bank guarantees” that they can buy at a discount and sell at a premium. By reselling the guarantees several times, they say, they can produce exceptional returns.

For example, if $10 million worth of “bank guarantees” can be sold at a 2% profit on ten separate occasions, or “traunches,” the seller would supposedly earn a 20% profit. This is often called a “roll program.”

To make the pitch more enticing, the promoters say the guarantees are issued by the world’s “prime banks,” hence “prime bank guarantees.” Other official-sounding names include “prime bank notes” and “prime bank debentures.”

The paperwork often requires the victim to sign nondisclosure and noncircumvention agreements, promises returns in “a year and a day,” and claims to use forms required by the International Chamber of Commerce (ICC). In fact, the ICC has warned investors that no such investments exist.

The goal is usually to get the victim to send money to a foreign bank, from which it moves to an offshore account controlled by the con artist. From there it pays the perpetrator’s personal expenses or is laundered so it disappears.

Foreign banks do use instruments called “bank guarantees,” in the same way U.S. banks use letters of credit to secure payment in international trade. But those guarantees are never traded or sold on any kind of market.

How to avoid prime bank fraud

Think before you invest. Be wary of any “roll program” that offers unusually high yields by buying and selling anything issued by “prime banks.”
As with any investment, do your due diligence. Independently verify the people involved, the truth of the deal and the existence of the security.
Be wary of deals that require nondisclosure or noncircumvention agreements designed to stop you from verifying the investment independently.

Advance fee schemes

In an advance fee scheme, the victim pays money up front expecting something of greater value, such as a loan, contract, investment or gift, and then receives little or nothing.

The variety is limited only by the con artist’s imagination: products, services, investments, lottery winnings, “found money” and many other “opportunities.” A common version is the promoter who offers to find financing for clients who pay a “finder’s fee” in advance. Victims often learn they don’t qualify for financing only after they’ve paid. These agreements may be legal unless it can be shown that the “finder” never intended, or was never able, to provide the financing.

How to avoid advance fee schemes

If an offer appears too good to be true, it probably is. Follow common business practice: legitimate business is rarely done in cash on a street corner.
Know who you’re dealing with. If you haven’t heard of a person or company, learn more. Depending on the amount, visit the business, check with the Better Business Bureau, or consult your bank, an attorney or the police.
Make sure you fully understand any agreement you sign. If the terms are complex, have an attorney review them.
Be wary of businesses that operate from PO boxes or mail drops with no street address, and of people with no direct phone line who are never “in” when you call but always call back later.
Be wary of deals that require nondisclosure or noncircumvention agreements. Con artists often use noncircumvention agreements to threaten victims with a civil suit if they report their losses to law enforcement.

The Nigerian letter, or “419” fraud

This fraud combines impersonation with a twist on the advance fee scheme. A letter or email from abroad (often claiming to be from Nigeria or the Philippines, but it could be anywhere) offers you a share of millions of dollars that the writer is trying to move out of the country. The writer usually poses as a current or former government official, an official’s relative or a banker, and gives various reasons why the money is “unclaimed.”

You’re asked to send information such as blank letterhead, your bank name and account numbers and other identifying details. Then come requests for money, in installments of increasing size, for taxes, bribes to officials and legal fees, all described in great detail with the promise that every expense will be repaid once the funds are out of the country.

The millions don’t exist, and the victim ends up with nothing but losses. Once the victim stops paying, the perpetrators have been known to use the personal information and checks they received to impersonate the victim, draining bank accounts and credit cards.

Most people see these letters as a laughable hoax, yet the schemes cause millions of dollars in losses every year. At the time of writing, the fraud was estimated to be the second-largest revenue-producing industry in Nigeria, after oil exports.

Some victims have been lured to Nigeria and held against their will, on top of losing large sums. The Nigerian government has little sympathy, since the victim was conspiring to move funds out of Nigeria against Nigerian law. The schemes violate section 419 of the Nigerian criminal code, hence the name “419 fraud.”

If you get a letter or email from another country asking for personal or banking information, don’t reply in any way. Send it to the U.S. Secret Service or the FBI.
If you know someone corresponding with one of these schemes, encourage that person to contact the FBI or the Secret Service as soon as possible.
Never believe people claiming to be Nigerian or other foreign officials who want your help placing large sums in overseas bank accounts.
Guard your account information carefully.

Ponzi schemes and why note investors fall for them

A Ponzi scheme is an investment fraud in which the operator promises high returns or dividends that traditional investments can’t match.

Instead of investing the money, the operator pays “dividends” to early investors out of the money put in by later investors. The scheme usually collapses when the operator runs off with the proceeds, or when there aren’t enough new investors to keep paying the old ones.

It’s named after Charles Ponzi of Boston, who guaranteed investors a 50% return on “international postal coupons.” He paid his first investors, but the scheme fell apart when he couldn’t pay those who came in later. It didn’t help that there were no such things as international postal coupons. Hundreds of investors, drawn by the 50% return, never checked whether the coupons even existed before handing Ponzi their money.

Note investors are especially prone to Ponzi schemes. There were several high-profile cases involving notes in the years before this was written, and investors lost millions of dollars.

In at least one case, the promoter apparently didn’t set out to defraud anyone. He offered auto paper at very high yields and was flooded with investor money, so much that he couldn’t find enough paper to buy. So he “temporarily” paid investors their interest out of other investors’ cash while he looked for more paper. That broke the law, and he spent several years in the Atlanta Federal Penitentiary.

It doesn’t matter to the federal government whether anyone loses a dime. The mere existence of a Ponzi scheme is illegal, and the promoters can be prosecuted.

How to avoid Ponzi schemes

As with all investments, use due diligence in choosing both the investment and the people you invest with.
Make sure you fully understand the investment before you put money in.

MLM and pyramid schemes

Some note and real estate companies promote these too.

Multi-level marketing pyramid schemes, also called franchise fraud or chain referral schemes, are marketing and investment frauds in which you’re offered a distributorship or franchise to market a product or service.

The real profit comes not from selling the product or service but from selling new distributorships. Because the emphasis is on selling franchises, the supply of new investors eventually runs out and the pyramid collapses.

At the heart of most of these schemes is a promise that new participants can recoup their investment by getting two or more prospects to make the same investment. What the promoters don’t say is that this is mathematically impossible for everyone, since some participants drop out while others recoup their money and then drop out.

How to avoid pyramid schemes

Be wary of franchises or investments that require you to bring in new investors to increase your profit or recoup your investment.
Independently verify the legitimacy of any franchise or investment before you invest.

High-pressure telemarketing and seminar pitches

Some note and real estate seminar promoters use telemarketers and high-pressure sales meetings. Horror stories about their tactics are common, and when they meet resistance some of these salespeople become verbally abusive.

It’s generally a bad idea to attend a “free” seminar at a hotel. The point is to get you into a room where they can pressure you to buy a very expensive seminar.

What the salesperson may tell you

“You must act now or the offer won’t be good.”
“You’ve won a free gift, vacation or prize,” but you have to pay “postage and handling” or other charges.
“You must send money, give a credit card or bank account number, or have a check picked up by courier,” often before you’ve had a chance to consider the offer.
“You don’t need to check out the company with anyone,” including your family, lawyer, accountant, Better Business Bureau or consumer protection agency.
“You don’t need any written information” about the company or its references.
“You can’t afford to miss this high-profit, no-risk offer.”

If you hear these lines, or anything like them, just say “No, thank you” and hang up or walk away.

How to protect yourself

It’s very difficult to get your money back once you’ve been cheated, especially over the phone. Before you buy anything in a seminar or by telephone, remember:

Don’t buy from an unfamiliar company. Legitimate businesses understand that you want more information and are happy to provide it.
Always ask for written material about any offer, and wait until you get it. Have someone whose financial advice you trust review brochures for costly investments. Not everything written down is true.
Check unfamiliar companies with your local consumer protection agency, the Better Business Bureau, your state Attorney General, the National Fraud Information Center or other watchdog groups. Not every bad business can be identified this way.
Get the salesperson’s name, business identity, phone number, street and mailing address and business license number before doing business, and verify them. Some con artists give false ones.
Before you send money, ask yourself: “What guarantee do I really have that this person will use my money the way we agreed?”
Be wary of anyone who sends a messenger to your home to pick up money “as part of their service.” They’re taking your money without leaving any trace of who they are.
Take your time. Legitimate companies won’t pressure you into a snap decision, and it’s never rude to wait and think.
Decide in advance what financial information you will and won’t give out on the phone.
Talk over big investments with a trusted friend, family member or financial advisor.
Never respond to an offer you don’t thoroughly understand.
Never send money or give out credit card numbers and expiration dates, bank account numbers, dates of birth or Social Security numbers to unfamiliar companies or people. Personal information is often sold to telemarketers through third parties.
If you know of a fraud, report it to state, local or federal law enforcement.

The Inside Scoop on Note Frauds