NASAA Releases Its List Of Top Five “Investor Threats”: Same As It Ever Was

By Alan Wolper on December 30, 2015Posted in Annual Report, NASAA

Right around Christmas, NASAA, the North American Securities Administrators Association, which is comprised of the securities regulators from each of the 50 states, released its annual list of the top five threats to investors.  To compile the list, NASAA polled each state’s securities commissioner to learn the “the five most problematic products, practices or schemes.”  The five items described below topped the list.  What is remarkable, however, is not that these items represent new issues, but, to the contrary, that these are essentially the same issues that investors and regulators have been dealing with, well, forever.  Equally interesting, the list amply demonstrates some of the biases that securities regulators have against certain “alternative” investments.

Unregistered products/unlicensed salesmen.   NASAA helpfully warns that “[t]he offer of securities by an individual without a valid securities license should be a red alert for investors.” Well, who can disagree with that?  The problem is, con artists very rarely advertise the fact that they lack a proper securities license.  Moreover, and unfortunately, there are also lots of licensed securities salesmen who commit fraud.  So, while I appreciate that this is a problem, apparently common to states across the country, apart from identifying the problem, there is no real solution. With that said, I do agree with NASAA’s admonition that investors should be wary of any investment that is accompanied by the representation that it presents the holy grail of impossible combinations:  “limited or no risk” plus high returns.  It is just impossible to get these two characteristics in any single investment.

Promissory Notes.   According to NASAA, there is a real concern over the sale of high-interest-bearing promissory notes, especially to “seniors and others living on a fixed income.”  While that may be true, it sounds like a headline from 1995.  The sale of promissory notes has long been problematic, stemming from the fact that some promissory notes with a duration of nine months or less are, by definition, not securities, and, thus, need not be sold through BDs.  Accordingly, short-term notes are often offered by individuals who are not subject to regulatory oversight or the supervisory system in place at BDs.  Not surprisingly, some of these notes are fraudulent, and the promised returns are never realized.  To avoid, or at least minimize, potential problems, it makes sense only to do business with an appropriately registered broker at a registered broker-dealer.  At least then, even though there is no guarantee of any return, at least there is a clear avenue of redress in the event of a true fraudulent scheme.  Another lesson here, of course, is, again, that when something – in this case, the promised return – sounds too good to be true, it likely is.

Oil/Gas Investments.  While NASAA (begrudgingly) concedes that “[m]any oil and gas investment opportunities, while involving varying degrees of risks to the investor, are legitimate in their marketing and responsible in their operations,” it also observes that oil and gas deals are often “fraudulent.”  The message here is a clear one, and one I am called upon frequently to point out to my clients:  the further away an investment is from a simple buy-and-hold strategy employing something totally vanilla, like blue chip stocks or no-load mutual funds, the more nervous it makes securities regulators.  Merely to incant the words “oil and gas,” or “limited partnership,” the structure through which oil and gas deals are typically sold, to a securities regulator is to incite a lather.  It is important to remember the danger of generalizing.  Deals are different, as are the individuals who offer them.  I resent it, therefore, when a regulator presumes that my client must be guilty of something merely by virtue of the product sold.

Real Estate-related Investments: According to NASAA, “[n]on-traded REITS can be risky and have limited liquidity, which may make them unsuitable for certain investors.”  Like oil and gas deals, REITs, in the eyes of regulators, seem to be presumptively unsuitable due to their liquidity issue.  That, of course, flips the burden of proof on its head, as a recommendation should be presumed to be suitable unless proven otherwise.  Clearly, a customer’s need for liquidity is something that must be factored into any recommendation, but it does not mean that the sale of a product with limited liquidity is necessarily problematic; it always requires a case-by-case analysis.  A REIT’s limited liquidity is generally, if not always, explained in great detail, and in several places, in the typical set of offering documents, so it is nearly impossible to conjure up a situation where a reasonably intelligent investor considering a REIT investment is truly unaware of the liquidity concerns a REIT presents.  Despite this, regulators are very, very quick to conclude that liquidity was never adequately considered or explained when a complaint about a REIT is received.  Knowing this, anyone who deigns to sell REITs must document the heck out of the suitability analysis, in anticipation of being second-guessed by regulators.

Ponzi Schemes: Finally, NASSA includes Ponzi schemes on the list of horribles.  Well, duh.  Ponzi scheme, bad.  Unfortunately, as regulators would have to concede, a well-run Ponzi scheme doesn’t look at all like a scheme; it looks legitimate…until is discovered not to be.  So, it is of limited utility to offer counsel that “[i]nvestors should always be wary of unsolicited financial advice or investment opportunities,” because Ponzi schemes are generally only revealed after the loss has been incurred, and the fraudster has absconded.  Ask anyone who invested with Bernie Madoff or Allan Stanford.  The sad fact is, it is impossible to prevent someone from perpetrating a Ponzi scheme, especially when the fraudster looks, acts and sounds like anything but the kind of guy who would steal investors’ money.  I know that regulators hate Ponzi schemes and the devastating impact they can have on investors; I just wish there was something to do to stop them.  But, alas, there isn’t.

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