Promissory Note Fraud
A promissory note
is a form of debt – similar to a loan or an IOU – that a company
may issue to raise money. Typically, an investor agrees to loan
money to the company for a set period of time. In exchange, the
company promises to pay the investor a fixed return on his or
her investment, typically principal plus annual interest.
notes can be legitimate investments, those that are marketed broadly
to individual investors often turn out to be scams. The SEC and
state securities regulators across the nation have joined forces
to combat the fraudulent sale of promissory notes to investors.
But we can't stop every fraud.
That's why you
should ask tough questions – and demand answers – before
you consider investing in a promissory note. Be sure you understand
how they work and what risks they pose. These tips will explain
how promissory note fraud can occur and will help you to spot
Anatomy of a Promissory
the nation have recently begun to use promissory notes as vehicles
to defraud investors out of hundreds of millions of dollars. Most
promissory note scams follow predictable, fraudulent fact patterns:
- The fraudsters
– who may or may not be affiliated with the company – persuade
independent life insurance agents to sell promissory notes,
luring them with lucrative commissions of up to twenty or even
thirty percent. These agents often do not have a license to
sell securities. And in selling the notes, they frequently rely
solely on the information the company gives them – which later
proves to be false or misleading.
- Investors purchase
the promissory notes, enticed by the promise of a high, fixed-rate
return – up to fifteen or twenty percent – with a very low level
of risk. The promissory notes may appear all the more attractive
because the seller falsely claims that they're "guaranteed"
or insured. And few investors ask tough questions about these
investments because they know and trust the sellers, insurance
agents with whom they've done business in the past.
- The fraudsters
use a portion of the money they collect from investors to pay
the sellers their commissions. But they typically abscond with
the rest, squandering it on personal expenses or high-flying
- They may also
use some of the proceeds to support an elaborate "Ponzi" scheme
in which money coming in from the sale of new notes pays the
interest on older notes. Some fraudsters try to avoid repaying
investors' principal by convincing investors to "roll-over"
their promissory notes upon maturity. These investors may, for
at least a time, continue to receive interest payments – but
they rarely get their principal back.
scams often target the elderly, bilking them of their retirement
savings at a time when they can least afford to lose it. But no
one is immune. Fraudsters rarely discriminate when it comes to
separating investors from their money. And most investors don't
even realize their investment dollars are at risk until it's far
Tips To Avoid
Promissory Note Scams
Here's how you
can avoid the costly mistake of investing in a sham promissory
- Bear in mind
that legitimate corporate promissory notes are not usually sold
to the general public. Instead, they tend to be sold privately
to sophisticated buyers who do their own "due diligence" or
research on the company. If someone calls you up or knocks on
your door trying to sell you a promissory note, chances are
you're dealing with a scam.
- Find out whether
the investment is registered with the SEC or your state securities
regulator – or whether it's exempt from registration. Most legitimate
promissory notes can easily be verified by checking the SEC's
or by calling your state
securities regulator, which you can find at the website
of the North American Securities Administrators Association.
If the promissory note is not registered, you'll have to do
your own thorough investigation to confirm whether the company
has the ability to pay its debt.
- Be skeptical
if the seller tells you that the promissory note is not a security.
The types of promissory notes involved in promissory note scams
usually are securities and must be registered with either the
SEC or your state securities regulator – or they must meet an
- Make sure the
seller is properly licensed. Insurance agents can't sell securities
– including promissory notes – without a securities license.
Call your state
securities regulator, and ask whether the person or firm
is licensed to sell securities in your state and whether they
have a record of complaints or fraud. You can also get this
information by calling NASD's public disclosure hotline at (800)
289-9999 or by visiting their
- Beware of promises
of "risk free" returns. These claims are usually the bait con
artists use to lure their victims. Always remember that if it
sounds too good to be true, it probably is.
- Watch out for
promissory notes that are supposedly "insured" or "guaranteed,"
especially if a foreign insurance company is involved. Be sure
to call your state
insurance commissioner to find out whether the foreign insurance
company can legally do business in the United States.
- Compare the
rate of return on the promissory note with current market rates
for similar fixed-rate investments, long-term Treasury bonds,
or FDIC-insured certificates of deposit. If the seller promises
an above-market rate on a short-term note, proceed with caution.
What To Do If
You Run into Trouble
If you believe
you've invested in a promissory note scam, act promptly. By law,
you only have a limited time to take legal action.
Contact the SEC's
Office of Investor Education and Advocacy. You can send us your
complaint by using our online complaint form. Or you can
reach us as follows:
U.S. Securities &
Office of Investor Education and Advocacy
100 F Street, N.E.
Washington, D.C. 20549-0213
Fax: (202) 772-9295
You should also
contact your state
securities regulator and, if an insurance agent sold you the
promissory note, your state
Learn More About
For more information,
visit the website of NASD, where you can read an alert on Promissory Notes Can Be Less Than Promised.