Top 10 Investment Warnings for 2011 (Utah Division of Securities)

01/03/2011

Utah Division of Securities identifies Top Ten Investment Alerts for 2011

Francine A. Giani, Executive Director for the Utah Department of Commerce announced that the Division of Securities has released a top ten list of investment warnings for 2011. The list details fraudulent activity tracked by the Division of Securities over the past year and offers predictions on which investment schemes to watch for in 2011.

“Securities fraud continues to make headlines so we are asking citizens to add financial resolutions to their New Years list,” said Francine A. Giani, Executive Director of the Utah Department of Commerce.

“During fiscal year 2010, our office had over $5.3 million dollars in total fines for fraud cases which is more than twice what was assessed in 2009,“ said Keith Woodwell, Director of the Division of Securities, ”As consumers look to re-energize their retirement investments in the New Year, we urge investors to protect their nest egg by checking out a promoter’s background and any investment offer with our Division.”

Utah Division of Securities Top Ten Investment alert predictions for 2011

1. Affinity Fraud - Affinity fraud is when someone abuses membership or association with an identifiable group to convince a potential investor to trust the legitimacy of the investment. Common affinity groups include religion, ethnicity, profession, education, common handicaps, language, age and any other common likeness or shared characteristics that allow investors to trust members of the group. Rather than trusting a person or company due to a common affiliation with a given group, investors should obtain and review a disclosure document that explains the investment opportunity, the background of the management, the amount of money to be raised, the intended use of the money raised, and all the risks associated with making an investment. Upon receipt, investors should review all disclosures with an independent accountant, attorney, or investment professional to receive an unbiased opinion of the investment and the person offering the investment.

2. Inverse and Leveraged ETFs - Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track—or both—are growing in number and popularity. While such products may be useful in some sophisticated, short-term trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis. Due to the effect of compounding, their performance over longer periods of time can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time, particularly in volatile markets. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session.

3. FOREX Trading Programs - The most successful perpetrators of investment scams cloak their scam in a veil of legitimacy. FOREX is a term used to describe the legitimate foreign currency exchange market. The value of one nation’s currency, as compared to another nation’s currency, fluctuates on a continuous basis. These fluctuations can sometimes be quite dramatic and depend on innumerable complex factors. Due to the complexity of factors affecting the exchange rate of one currency to another, speculative FOREX trading bears a high level of risk. Despite the risk inherent in FOREX trading, there is always someone new who thinks they can simplify this complex market into a “fail-safe,” “low risk” or “no risk” system that “guarantees” the preservation of capital and significantly higher rates of return than can be achieved investing elsewhere. These FOREX trading programs are often designed to automatically engage in currency trades based on predetermined events or algorithms that the designer has “developed after years of personal experience and working with the top minds in the financial services industry.” The FOREX trading program designer may simply want an individual to purchase this trading system as an investment. Then it is up to the investor to generate the returns or, more likely, discover the flaws in the “fail-safe” system. The investor may also be enticed to invest directly with the individual who has developed this system, who will then trade on investors’ behalf. Unfortunately, under these common circumstances, the person who collected the money may or may not ever invest the funds before they regrettably inform investors some tragic unforeseen event has caused the loss of capital. In fact, in several cases investigated by the Division of Securities, promoters who have promised “guaranteed” returns in their “proprietary” FOREX trading programs have simply stolen the money and spent it on supporting their own lifestyles.

4. Structured Investment Products - Structured investment products are securities derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance and/or a foreign currency. As the definition suggests, there are many types of structured products from market-indexed CDs offering protection of the principal invested, to a multitude of other structured notes and investments that offer limited or no protection of the principal. The Division’s greatest concern with structured products is the investors’ ability to fully understand the investment. Structured product disclosures are generally complex, making it difficult for the average investor to comprehend them. Without an effective understanding of the investment the investor can have a difficult time knowing the risks, costs, liquidity, and tax-consequences associated with the investment.

5. Promissory Notes - Promissory notes are a written promise to pay a specified amount, to a specific entity at a specific time or upon demand, with or without interest. Promissory notes offered to retail investors carry significant risk. When investing, higher returns are accompanied by a proportionate amount of risk. A track record of paying high interest and even repaying principal is not an assurance that you will get your money back if the company fails. Early investors in a Ponzi scheme often receive interest payments and in some cases principal. Promissory notes are rarely suitable for retirement money, or money borrowed against equity in ones home.

6. Start-up Companies on the Verge of “Going Public” - The lure of getting in on the “ground floor” of a hot start-up business is a classic temptation for investors. Promoters know this, but they also know the deal will be much sweeter if they can promise not only great profits, but also a way for the investor to cash out those profits relatively quickly, if necessary. Unscrupulous persons will often claim that the shares being sold to investors are on the verge of “going public” and will be freely traded on a major exchange. Frequently, promises are made that the shares will trade at a specific future price of $5.00 to $10.00 or more per share. In most of these cases, the reality is that no such public offering is being seriously pursued. “Going public,” in the sense promised by these promoters, is actually a highly expensive and time-consuming process that requires considerable assistance from legal, accounting, and investment banking firms. Only larger, more well-established businesses are usually in a position to register their shares for trading on a major exchange and to pay the ongoing regulatory costs of public registration. If approached by promoters making such promises, investors should contact the Division of Securities and the Securities and Exchange Commission to verify that the required registration statements have been filed.

7. Investment Pools Purchasing Non-Performing Loans - By the time the housing bubble burst, the mortgage and banking industries had made many loans they shouldn't have. As the housing and commercial real estate markets folded, those loans (and pools of those loans) stopped producing revenue, freezing lines of credit in the economy and contributing to the Great Recession. Many financial institutions have since collapsed under the weight of these non-performing loans, leaving the institution's assets to be auctioned off to willing buyers. The Division of Securities has seen a rising number of Utahns seeking to earn big returns by purchasing these non-performing loans. However, as with all investments, investors should remember the risk-reward principal: the greater the potential return, the greater the risk. Despite the ads on late-night television and the Internet, or the stories told during seminars and sales pitches, turning a profit on non-performing loans is a complicated and difficult undertaking. Enterprising individuals have created funds to pool investor money and purchase these non-performing loans. These pooled investment funds present additional risk to the investor and should be fully disclosed in a disclosure document (e.g., private placement memorandum). Investors should read the disclosure document carefully before investing in any pooled investment fund and only invest funds which they can afford to lose. Lastly, investors should always verify whether their investment professional (or the fund manager) is properly licensed and whether the fund itself is properly registered by contacting the Division of Securities.

8. Automatic Trading Software Packages - Some investors have resorted to using a computer to make investing decisions for them. Companies are selling computer software programs that analyze the market and make trades for the investors. Typically, an investor purchases the program, sets up a brokerage account, and places money into the account. The computer program will “track” and “analyze” the market and decide which trades to make. The account is linked up to a brokerage firm which will then make the actual trades based on the computer’s recommendation, using the funds from the investor’s account. Often, a promoter will not just sell the computer package, but will have “openings” for investors to participate in the program. Investors are charged a start up fee and commission fees in addition to the investment funds. Investors should be cautious when evaluating offers of such automatic-trading software packages. The Division encourages investors to do their own due diligence on those selling the programs or promoting them and ensure that you are dealing with licensed professionals. The Division of Securities also cautions any purchasers of such packages against the common practice of allowing family members or friends to “piggy back” on the purchaser’s account by co-mingling funds. The purchaser of the package may expose himself to liability for acting as an unlicensed investment adviser.

9. Iraqi Dinars - Since the beginning of the Iraq War in 2003, speculators have sought to profit by purchasing Iraqi Dinars. Unfortunately, the likelihood of investors seeing any return on their dinars is slim to none. This scam comes in three parts: the hyped returns that play on an investor's greed, the deceptive practices of Iraqi Dinar dealers, and the fundamental misunderstanding of international finance. Currently valued around 1,200 dinars to 1 U.S. Dollar, any appreciation in the value of the Iraqi Dinar would theoretically generate profit, but many websites selling Iraqi Dinars boast these returns could reach up to 1000 percent. Investors need to understand these figures for what they are: speculation and hype. Websites selling dinars also exaggerate or misrepresent history as proof that such profits are possible, but history teaches a vastly different lesson. First, the rapid appreciation of any currency's value is extremely rare (the opposite is much more likely), meaning investors should consider this a long-term gamble not a short-term guarantee. Second, investors may confuse the appreciation of a currency's value with demonitization, which is the process of governments replacing their old currency with a new currency. While Iraq is not likely to do so again (Iraq demonitized from October 2003 to January 2004), exchanging old currency for new currency still keeps the value in U.S. Dollars roughly the same. So new currencies do not generally indicate a new value. While hard currency scams are not new, the methods have evolved. Currency dealers previously avoided regulation by relying on the currency's numismatic value (treating the currency as a collector's item), now these dealers often register with the U.S. Treasury as a Money Service Business (MSB). An MSB registration is nothing more than a check-cashier or a money transmitter; it does not reflect any experience in trading currency nor entail any qualifications on the part of the dealer. The reason dealers seek this meaningless registration is to lend legitimacy to their scam and avoid proper regulation, which would entail oversight and require full disclosure be made to investors. Additionally, since no exchange exists for the Iraqi Dinar, dealers can charge whatever they want to sell and buy back the dinars. Investors should fully understand that a small increase in value will not likely be enough to breakeven after these fees are considered. Worst of all, some websites have even been selling counterfeit dinars. Ultimately, however, the power of hard currency scams come down to a subject most are unfamiliar with: international finance. The market determines currency values based on numerous factors. In the case of Iraq, many of these factors are political and unpredictable, making dinars a risky bet at best. Of all the risks though, inflation is the greatest. As an economy improves, workers find jobs and earn more money, increasing demand and, therefore, prices. As prices rise, the value of the currency falls. Another inflationary pressure may be the Iraqi government itself. As the Iraqi government seeks to improve conditions, it may be tempted to monetize their debt (essentially, print more money) and drive inflation further. Combating inflation is difficult for established governments and economies, let alone one emerging from a dictatorship, a war, and an ongoing insurgency, so even the best scenario of an improved Iraqi economy may not lead to profits for investors in Iraqi Dinars.

10. Unsuitable Variable Annuity Sales Practices - Aggressive marketing of variable annuity insurance products are a concern, especially when seniors are targeted. Sales pitches, which are frequently offered in conjunction with free lunch seminars, are sometimes used in an attempt to scare or confuse investors by claims that these products will protect or insure them against any market losses. While variable annuities can be appropriate as an investment in some circumstances, investors should be aware of restrictive features including potential surrender charges, tax penalties for early withdrawals, and limitations on the insurance guarantees. Brokers and investment advisers recommending variable annuities must collect information about your financial status to assess if a variable annuity is suitable for your individual circumstances. Protect yourself by asking the sales person to explain guarantees, liquidity issues, fees and market risks.

Three questions every investor should ask:


1.Is the person offering the investment licensed? Find out by calling the Division of Securities at (801) 530-6600.
2.Is the stock offering registered? All securities sold in the state must be registered or exempt. Before you invest your money, call the Division of Securities to make sure it is a legitimate offering.
3.Did the promoter give you a written prospectus summarizing the investment? Did he or she give you a copy of the financial statements showing how the company is doing? Has the promoter disclosed his or her prior business success or any previous criminal convictions or bankruptcies?

The Seven most common warning signs of investment fraud are:


1.Promises of high returns. Any claim that you can double your money in six months is a fraud.
2.Claims that the investment is guaranteed or that it has little or no risk.
3.Pressure to invest immediately because there is a deadline or only a few openings left.
4.Encouraging you to borrow money from equity in your home to maximize the profit you can make. Because all investments involve risk, no legitimate securities broker will recommend using home equity to make an investment.
5.Vague descriptions about how your money will be used or what the company does.
6.Claims that other people have already checked out the investment and are investing. These may include well-known members of the community or people within your affinity group (your church, workplace, or service organization).
7.The assertion that this investment involves new technology that can solve a problem that big companies in this industry have been unable to solve (such as drilling for oil in new places, new pharmaceuticals that cure well-known diseases, or high-tech inventions).

Investors should do business with licensed securities brokers and advisers and report any suspicion of investment fraud to the Utah Division of Securities by calling (801) 530.6600; toll free at 1.800.721.7233 or logging on to www.securities.utah.gov.

When is an annuity a good retirement strategy? SPIA advice (Forbes.com)

For Some Retirees, This Annuity Makes Sense
Mel Lindauer, 07.30.10, 12:00 PM ET

We've talked about a number of different types of annuities in our previous columns. We discussed nonqualified deferred variable annuities in the first and second columns in this series on annuities. We covered qualified deferred variable annuities in our third column, and in our fourth column we talked about fixed deferred annuities.

Based on these previous columns, you might be getting the feeling that Bogleheads are against all types of annuities, but you'd be wrong. We're against high-cost annuities that trap investors into substandard investments for long periods of time using often-hidden surrender periods and the associated high surrender fees. We're also against annuities that are sold by unscrupulous salespersons who sometimes "hoodwink" (often older) investors into investing with them by providing false or misleading information about the annuity products they're selling.

However, despite all the negatives and cautions we've mentioned in our previous columns, we do feel that annuities can be appropriate in certain situations. In earlier columns we listed some situations where a low-cost variable annuity may make sense in both non-qualified and qualified situations.

In this column, we'll talk about another type of annuity which could play a role in some retirees' overall investment planning, and that's a single premium immediate annuity or SPIA.

A single premium immediate annuity offers an income stream that will last as long as the annuitant (or joint annuitant, if that option is selected) lives or for a predetermined period, depending on the option selected at the time of purchase. The fixed immediate annuities include nominal, graded and inflation-adjusted payment options. There is also a variable option in which the payout is determined by the returns on the investments chosen by the investor.

In exchange for these payments, the annuitant surrenders a specific amount of money to the insurance company. These payments can be based on a single or joint life. Normally this purchase is irrevocable, and the money used to make the SPIA purchase is not available to one's heirs, even if the annuitant dies shortly after purchasing the annuity, unless a predetermined payment period was selected. However, selecting one of the available term-certain payment options will result in lower payments.

An SPIA is probably one of the easiest annuity products to understand. You give the insurance company a specific sum of money in exchange for an income stream that you can't outlive. The SPIA can offer peace of mind in bridging income shortages. For example, if a retired couple needs $4,000 per month to cover their living expenses, and Social Security and pensions provide $3,000 per month, they could purchase an SPIA that would pay out the needed $1,000 per month for as long as either one of them lived. However, they would need to keep in mind that most annuity payments aren't indexed for inflation, so over the long term, the spending power of that $1,000 would decrease.


Should the couple choose to purchase one of the few inflation-indexed SPIAs available, they'd have to either pay a higher premium or receive a lower initial payment. And since inflation-indexed annuities are only offered by a few insurance companies, there's not a lot of competition to help make those rates attractive for the annuitant. Finally, it's important to remember that the return of your principal is included in the promised payment stream.

An SPIA can also provide a "bridge" that could allow an investor to delay taking Social Security until later in life. Doing so could mean larger Social Security payments to both the recipient and his/her spouse. Boglehead Ron explained his use of an SPIA this way: "In our case, we used it as ‘SS gap insurance' since I retired at 59 but will not claim SS till age 70 (primarily for the benefit of my wife)."


Using a period-certain SPIA as a bridge to Social Security may be a valid strategy for some folks like Ron. However, for many relatively young retirees, the period-certain option is probably not the best choice. Remember, the insurance company has to plan to pay for the rest of your longer-expected life, so that means you'll receive lower payments. In addition, because of the longer expected payout period, you magnify default and inflation risks since the insurance company has to remain solvent for a very long period of time and inflation will almost surely erode the yield over those longer periods. As an alternative to taking the inflation-indexed option, consider purchasing TIPs at the Treasury auctions and holding them to maturity, since TIPS both preserve capital and protect against inflation.

In another recent Bogleheads.org forum post, author and forum leader Taylor Larimore listed a number of valid reasons why he and his wife, Pat, purchased an SPIA. He stated that "The primary reason we bought our lifetime annuities was so that we could give our heirs their inheritance while we're living. The annuities assure us (and them) that we will not run out of money no matter how long we live." Taylor then went on to list a number of other reasons that he and Pat considered important in their decision to annuitize a portion of their savings:

"Our annuities give us a guaranteed income of approximately 10% of premium (using interest and principal). This is more than we could get from any other safe investment.
"Our annuities immediately reduced our estate for tax purposes and offered protection from lawsuits.
"It was very comforting to have a steady income and protection of principal during the recent bear market.
"Our annuity income is only partially taxable.
"It will be much easier for survivors to not worry about this part of our portfolio." Here are some situations where an SPIA may make sense:

For someone who is in good health and has a family history of longevity.
For folks who are afraid of running out of money before running out of breath.
For investors who don't know how to properly manage their assets or who don't care to do so.
For an investor who is concerned about a surviving spouse who has no knowledge of, or interest in, investing.
For people who have no heirs or who have no desire to leave the funds used to purchase the annuity as part of their estate.

There is no one rule that covers every situation or every investor. However, if one or more of the above situations apply to you, then there's a good possibility that an SPIA may be appropriate for you

Why Are CDs, Money Market Rates So Low? (NY Times)

December 26, 2009
At Tiny Rates, Saving Money Costs Investors
By STEPHANIE STROM
Millions of Americans are paying a high price for a safe place to put their money: extremely low interest rates on savings accounts and certificates of deposit.

The elderly and others on fixed incomes have been especially hard hit. Many have seen returns on savings, C.D.’s and government bonds drop to niggling amounts recently, often costing them money once inflation, fees and taxes are considered.

“Open a Savings Plus Account today and get a great rate,” read an advertisement in the Dec. 16 Newsday for Citibank, which was then offering 1.2 percent for an account. (As low as it was, the offer was good only for accounts of $25,000 and up.)

“They’re advertising it in the papers as if they’re actually proud of that,” said Steven Weisman, a title insurance consultant in New York. “It’s a joke.”

The advertised rate for the Savings Plus account has expired, according to the bank’s Web site; as of Friday, the account paid an interest rate of 0.5 percent. The bank’s highest-yield savings account, the Ultimate, was paying 1.01 percent.

The best deal Mr. Weisman has found is 2 percent on a one-year certificate of deposit offered by ING Direct, an online bank that has become a bit of a darling among the fixed-income crowd.

Interest on one- and two-year Treasury notes was just 0.40 percent and 0.89 percent, as of Monday. Bank of America offers 0.35 percent on a standard money market account with $10,000 to $25,000, and Wells Fargo will pay 0.05 percent on a basic savings account.

Indeed, after fees are subtracted, inflation is accounted for and taxes are paid, many investors in C.D.’s, government bonds and savings and money market accounts are losing money. In fact, Northern Trust waived some $8 million in fees on money market accounts because they would have wiped out all interest, and then some.

“The unemployment situation and the general downturn in the economy had an impact, but what’s going to happen now as C.D.’s mature is that retirees and the elderly are going to take anywhere from a half to three-quarters of a percent cut in their incomes,” said Joe Parks, a retired accountant in Houston on the advisory board of Better Investing, an organization that works to help people become savvier investors. “It’s a real problem.”

Experts say risk-averse investors are effectively financing a second bailout of financial institutions, many of which have also raised fees and interest rates on credit cards.
“What the average citizen doesn’t explicitly understand is that a significant part of the government’s plan to repair the financial system and the economy is to pay savers nothing and allow damaged financial institutions to earn a nice, guaranteed spread,” said William H. Gross, co-chief investment officer of the Pacific Investment Management Company, or Pimco. “It’s capitalism, I guess, but it’s not to be applauded.”
Mr. Gross said he read his monthly portfolio statement twice because he could not believe that the line “Yield on cash” was 0.01 percent. At that rate, he said, it would take him 6,932 years to double his money.

Many think the Federal Reserve is fueling a stock market bubble by keeping rates so low that investors decide to bet on stocks instead. Mr. Parks of Better Investing moved more money into the stock market early this year, when C.D.’s he held began maturing and he could not nearly recover the income they had generated by rolling them over.

He began investing some of the money in blue chip stocks with a dividend yield of at least 3 percent and even managed to find an oil-and-gas limited partnership that offered 8 percent.

Mr. Parks said, however, that he would not pursue that strategy as more of his C.D.’s matured. “What worked in the first quarter of this year isn’t as relevant, because the market has come up so much,” he said.

No one is advising a venture into higher-risk investments. Katie Nixon, chief investment officer for the northeast region at Northern Trust, said that, in general, “no one should be taking risks with their pillow money.”

“What people are paying for is safety and security,” she said, “and that’s probably just right.”

People who rely on income from such investments for support, however, are being forced to consider new options.

Eileen Lurie, 75, is taking out a reverse mortgage to help offset the decline in returns on her investments tied to interest rates. Reverse mortgages have a checkered reputation, but Ms. Lurie said her bank was going out of its way to explain the product to her.

“These banks don’t want to be held responsible for thousands of seniors standing in bread lines,” she said.

Such mortgages allow people who are 62 and older to convert equity in their homes into cash tax-free and without any impact on Social Security or Medicare payments. The loans are repaid after death.

“If your assets aren’t appreciating and aren’t producing any income, you’re getting eaten up in this interest rate environment,” said Peter Strauss, a lawyer who advises the elderly. “A reverse mortgage is one way of making a very large asset produce income.”

Eve Wilmore, 93, has watched returns on her C.D.’s drop to between 1 percent and 2 percent from about 5 percent a year or so ago. Yet the Social Security Administration recently raised her Medicare Part B premium based on those higher rates she had been earning. “I’m being hit from both sides,” Mrs. Wilmore said. “There’s some way I can apply for a reconsideration, and I’m going to fight it. I have to.”

She said she was reluctant to redeploy her money into higher-risk investments. “I don’t know what my medical bills will be from here on in, and so I want to keep the money where I can get to it easily if I need it,” she said.

Peter Gomori, who taught a course on money and investing for Dorot, a nonprofit that offers services for the elderly, did not advise his students on investment strategies but said that if he had, he would probably have told them to sit tight.

“I know interest rates are very low for Treasury securities and bank products, but that isn’t going to be forever,” he said.

But investment professionals doubt rates will rise any time soon — or to any level close to those before the crash.

“What the futures market is telling me,” Mr. Gross said, “is that in April 2011, these savers that are currently earning nothing will be earning 1.25 percent.”