A promissory note is a written promise that one party makes to pay another party at some point in the future.
If you have taken out a loan in the past, whether a student loan or an auto loan, you have likely signed a promissory note. Though, promissory notes are not only for individuals.
Corporations also issue promissory notes to raise money from investors. Unfortunately, in recent years, corporate promissory notes have become a conduit for fraud (ie.promissory note fraud).
In this article we’ll examine what investors need to know about common scams involving promissory notes.
Promissory Notes are Often Securities
Typically, when promissory notes are offered to the public, investors are not informed that the promissory note is a ‘security’. Yet, under American law, specifically the Securities Exchange Act of 1934, many promissory notes qualify as securities.
This was further clarified by the Supreme Court of the United States in the 1990 case of Reves v. Ernst & Young.
In that case, the court noted that all corporate-based notes that have a maturity time in excess of nine months are presumed to be securities. Yet, despite being securities, many promissory notes are unlawfully offered by non-registered individuals, outside industry regulations.
Understanding Promissory Note Scams
All too often, fraudsters use promissory notes as a tool to perpetrate financial scams. In some cases, fraudsters have even taken in tens of millions of dollars from investors. While all promissory note fraud schemes are unique, they do share some common characteristics.
Who Commits the Fraud?
In some cases, the fraudsters try to sell illegitimate promissory notes directly to investors. In other cases, fraudsters try to run their fraud through life insurance agents, or other similar professionals, who do not have experience in the securities industry.
Very often, despite promissory notes qualifying as securities under the law, they are illegally sold outside of any member brokerage firms. Insurance agents are often used, because these professionals have developed relationships with investors.
How are Investors are Drawn In?
Similar to most other investment fraud schemes, promissory note fraud relies on luring in investors with unreasonable promises. Specifically, promissory note investors are often told that they can expect:
- High rates of return;
- A fixed rate of return; and
- Very low risk, or perhaps even a guaranteed return.
Promissory Note Scams: Ponzi Schemes
In many cases, promissory note scams are tied to underlying Ponzi schemes. Fraudsters will take the money coming in from the scam, siphon off some for personal use, pay a certain percentage in commissions to their sales staff (usually either independent insurance agents, or ‘brokers’ at their company), and then they will use the rest to pay off older investors.
A Real World Example of Promissory Note Fraud
Success Trade Securities, Inc.: In 2014, the SEC and FINRA uncovered a $19 million promissory note fraud scheme that was targeted at 58 investors, mostly young professional athletes. Success Trade Securities offered 10-year promissory notes that carried annual interest rates that exceeded 50 percent. Not only were these rates of return completely unrealistic, but investor money was not used for the intended purpose.
Indeed, representatives repeatedly made misrepresentations and outright false statements to investors. To keep the scheme going, investors were encouraged to ‘roll over’ their investment. Eventually, like all promissory note fraud scams, the new money stop rolling in, and the scheme came crashing down.
How to Protect Yourself from Promissory Note Fraud
While promissory notes can certainly be legitimate investment opportunities, investors must always be careful. Before investing in a promissory note, please keep the following four tips in mind:
- Be skeptical of aggressive sales representatives: Legitimate corporate promissory notes are often targeted at highly sophisticated, high net-worth investors. If a sales representative is aggressively ‘pushing’ you into a promissory note, you should not invest. A pushy sales representative is a major red flag.
- Do not trust abnormally high or guaranteed returns: Remember, promissory notes are a loan. If you are offered a very high rate of return, that, by definition, means that the underlying corporation must not have a better way to access capital. In other words, no bank or other investor was willing to loan them money at a lower, more normal rate. This means that investment is extremely risky. Do not invest in promissory notes that offer unusually high interest rates and guaranteed returns.
- Confirm that the notes are registered: You should avoid unregistered promissory notes. Before buying, please always check the SEC’s database to ensure that the notes are properly registered.
- Avoid notes that are not offered by a brokerage firm: Finally, if you are investing in a promissory note, ensure that the note is overseen by a FINRA registered brokerage firm. If the note is being ‘sold away’, you should walk away.
Were You a Victim of Promissory Note Fraud?
If you have already been the victim of promissory note fraud, you deserve fair compensation for your losses. At the Sonn Law Group, we have extensive experience handling promissory note fraud cases.
To learn more about what we can do for you, please call us today at 844-689-5754 to request your free initial consultation. From our main office in Aventura, Florida, we serve wronged investors in Miami-Dade County and throughout the United States.