Wednesday, August 26, 2009

NASAA's List of Investor Traps

The North American Securities Administrators Association (NASAA) has issued an alert to investors advising them of ten "investment traps" identified by NASAA's Enforcement Trends Project Group. Each of these ten investment schemes promises very high returns, but furnishes very little or no disclosure of the risks, high commissions, and other fees related to these investments. Of the ten traps listed, NASAA "identified real estate investment schemes, leveraged ETFs, private placement offerings and natural resources investments, and Ponzi schemes as the greatest potential threats to investors this year."

Each of the investment traps identified by NASAA are listed below, with a link to an example, advisory, or additional explanation:

1. Entertainment Investments. These unregistered investments, encompassing a variety of products including movies, infomercials, internet gambling and pornography sites, promise high returns while offering little disclosure of risk.

2. Gold Bullion and Currency Scams. With the high price of gold, investors should beware of gold bullion scams in which the seller offers to retain “purchased” gold in a “secure vault” and promises to sell the gold for the investor as it gains in value. In many instances the gold does not exist. Similar are the many forms of foreign exchange (forex) trading schemes. Trading in foreign currencies requires resources far beyond the capacity of most individual investors. Promoters profit by charging high commissions or selling investment strategies assuming that trades are actually made. In many instances there are no trades; the money is simply stolen.

3. Leveraged Exchange-Traded Funds (ETFs). As we mentioned in our August 24 post, "Regulators Warn Investors About Leveraged and Inverse ETFs," this relatively new financial product has been offered to individual investors who may not be aware of the risks these funds carry. The funds, which trade throughout the day like a stock, use exotic financial instruments, including options and other derivatives, and promise the potential to provide greater than market returns as the value of the underlying assets rise or fall. Given their volatility, these funds typically are not suitable for most retail investors.

4. Life Settlements. State securities regulators long have been concerned about life settlements, or viaticals, and the rising popularity of these products among investors has prompted a recent congressional investigation. While life settlement transactions have helped some people obtain funds needed for medical expenses and other purposes, those benefits come at a high price for investors, particularly senior citizens. Wide-ranging fraudulent practices in the life settlement market include Ponzi schemes; fraudulent life expectancy evaluations; inadequate premium reserves that increase investor costs; and false promises of large profits with minimal risk.

5. Natural Resource Investments. NASAA expects to continue to see a rise in energy and precious metals scams promising quick, high returns. Investors anxious to recover losses quickly likely will be hooked by oil and gas schemes, as well as fraudulent offerings of investments tied to natural gas, wind and solar energy, and the development of new energy-efficient technologies.

6. Ponzi Schemes. Despite the heightened awareness of Ponzi schemes following Bernard Madoff’s multi-billion dollar fraud and 150-year prison sentence, these scams continue to trap investors. The Ponzi scheme is a house-of-cards swindle in which high returns are paid to initial investors out of the funds of later investors, who end up losing all or most of their money to the promoter.

7. Private Placement Offerings. Private placements offer businesses the opportunity to raise capital by selling securities to a relatively small number of investors as opposed to a public offering made through national securities markets. State securities regulators have observed a steady and significant rise in the number of private placement offerings that are later discovered to be fraudulent, especially those made under a federal registration exemption (Regulation D, Rule 506). Companies using this exemption can raise an unlimited amount of money without registering the offering with the SEC as long as they meet certain standards. Although properly used by many legitimate issuers, the exemption has become an attractive option for con artists, as well as individuals barred from the securities industry and others bent on stealing money from investors through false and misleading representations.

8. Real Estate Investment Schemes. NASAA members have noted a rise in scams disguised as offers to help homeowners caught up in the turbulent housing market “save” their homes or “fix” their mortgages, usually in exchange for a fee paid in advance. “Most of these advance-fee offers only generate a quick profit for the con-artist and provide no benefit to the consumer,” Joseph said. Some homeowners, particularly seniors, may be attracted to reverse mortgages, which are a legitimate lending option. However, the resulting lump sum home equity payment makes them an attractive target for unscrupulous salesmen, who may attempt to direct these funds toward worthless or unsuitable investment products.

9. Short-term Commercial Promissory Notes. Many seniors have lost their life savings by investing in short-term commercial promissory notes that are nine months or less in duration. These notes may be touted as being “insured” or “guaranteed,” but the insurance companies generally are located outside of the United States, are not licensed to do business in the United States, and lack the resources necessary to deliver on the promised guarantees. Unlike publicly advertised promissory notes, promoters of these notes usually attempt to use commercial paper exemptions as a basis for selling the products without registration. The commercial paper exemptions apply only to high-grade commercial paper traded by major corporations – not to these risky notes pushed to the public by a sales force paid with extremely high commissions.

10. Speculative Inventions and New Products. New products are for venture capitalists who know how to assess the risks. They are not good investments for your retirement money even though they may promise high returns.

The full text of NASAA's advisory on investment traps is available at:

SEC and CFTC Announce Meetings on Harmonizing Regulations

The SEC and CFTC announced last week that the two agencies will hold joint meetings to seek input from the public on harmonization of the regulation of similar types of over the counter (OTC) financial instruments. The first meeting will be held at the CFTC on Sept. 2, 2009. The second meeting, on Sept. 3, 2009, will be held at the SEC. These meetings are being held in response to the Obama Administration's White Paper on Financial Regulatory Reform which called on the SEC and CFTC to “make recommendations to Congress for changes to statutes and regulations that would harmonize regulation of futures and securities.” The White Paper also recommended that the two agencies submit a report to Congress by September 30, 2009 identifying the conflicts that currently exist in statutes and regulations governing OTC instruments, and either justifying or making recommendations to eliminate these differences.

The SEC announcement of the joint meetings is available at:

The CFTC announcement of the joint meetings is available at:

Monday, August 24, 2009

Regulators Warn Investors About Leveraged and Inverse ETFs

The SEC and FINRA issued a joint release warning individual investors of the dangers of leveraged and inverse exchange traded funds (ETFs). According to the alert, these specialized and complex products, designed to achieve their stated performance on a daily basis, pose extra risk for individual investors, who tend to buy-and-hold. The thrust of the alert is that "investors should be aware that performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives."

The release describes leveraged ETFs as:
Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs (also called “short” funds) seek to deliver the opposite of the performance of the index or benchmark they track. Like traditional ETFs, some leveraged and inverse ETFs track broad indices, some are sector-specific, and others are linked to commodities, currencies, or some other benchmark. Inverse ETFs often are marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets.
Leveraged inverse ETFs are described as:
Leveraged inverse ETFs (also known as “ultra short” funds) seek to achieve a return that is a multiple of the inverse performance of the underlying index. An inverse ETF that tracks a particular index, for example, seeks to deliver the inverse of the performance of that index, while a 2x (two times) leveraged inverse ETF seeks to deliver double the opposite of that index’s performance. To accomplish their objectives, leveraged and inverse ETFs pursue a range of investment strategies through the use of swaps, futures contracts, and other derivative instruments.
The primary risk the alert warns of is that leveraged and inverse ETFs "are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time -- over weeks or months or years -- can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets." The release also includes some "real-life" examples of the magnified negative effects these kinds of ETFs can have for investors who make the mistake of holding them for longer periods.

As with all investments, the alert warns that the best way for investors to protect themselves is to understand thoroughly the instruments or vehicles before investing. This includes reading the prospectus, seeking the advice of a qualified investment professional who understands these products, and also understands the investor's individual risk tolerance and investment goals. With respect to leveraged or inverse ETFs, the release advises investors to ask:
  • How does the ETF achieve its stated objectives? And what are the risks?

  • What happens if I hold longer than one trading day?

  • Is there a risk that an ETF will not meet its stated daily objective?

  • What are the costs?

  • What are the tax consequences?
The full text of the SEC and FINRA investor alert is available at:

Thursday, August 20, 2009

SEC Seeks Comments on New Short-Selling Price Test

As we reported in April in our post, "SEC Proposes Short-Selling Restrictions," the Commission proposed amendments to Regulation SHO to restrict short sales. In that rule proposal, the Commission sought comment on two alternative short sale price tests, one based on the national best bid and the second based on the last sale price:
  • Proposed Modified Uptick Rule: A market-wide short sale price test based on the national best bid (a proposed modified uptick rule).

  • Proposed Uptick Rule: A market-wide short sale price test based on the last sale price or tick (a proposed uptick rule).
Yesterday, the SEC announced that it would seek "public comment on an alternative approach to short selling price test restrictions that may be more effective and easier to implement than previously proposed price test restrictions currently under consideration." According to the SEC, this alternative approach, the "alternative uptick rule," unlike the proposals in April, "would not require monitoring of the sequence of bids (that is, whether the current national best bid is above or below the previous national best bid), and as a result the alternative uptick rule would be easier to monitor. It also may be possible to implement this approach more quickly and with less cost than the prior proposals." The comment period on the original April proposal closed June 19, and the comment period for the new release will close thirty days from the publication in the Federal Register of the "alternative uptick rule" release. In other words, the period will likely close in late September.

The full details of the alternative uptick rule are available in a new release:

The original proposals are available at:

Related article:

Wednesday, August 19, 2009

Fed and Treasury Extend TALF

Yesterday, the Federal Reserve Board and the Treasury Department announced that they will extend the the Term Asset-Backed Securities Loan Facility (TALF) through March 31, 2010 for newly issued asset-backed securities (ABS) and legacy commercial mortgage-backed securities (CMBS), and newly issued CMBS through June 30, 2010. Previously, loans through the TALF had been set to expire on December 31, 2009.

As we reported in our March 17, 2009 post, "Details of the Term Asset-Backed Securities Loan Facility,"

The TALF is not part of the Troubled Asset Relief Program, but a joint public-private investment program dramatically expanded under Treasury's recently announced Financial Stability Plan. The TALF was expanded by Treasury and the Federal Reserve Bank to create incentives for market participants such as hedge funds and other investment companies to return to the securitization market, thereby unfreezing that market and allowing banks to resume functioning within it. The Financial Stability Plan calls for the expansion of the TALF facility up to $1 trillion for permitted investments, and TALF may be further expanded to include commercial mortgage-backed securities, private-label residential mortgage-backed securities, and other asset-backed securities

Though financial market conditions have improved in the past few months, according to the Fed and Treasury, "the markets for asset-backed securities (ABS) backed by consumer and business loans and for commercial mortgage-backed securities (CMBS) are still impaired and seem likely to remain so for some time." Consequently, the Fed and Treasury are extending TALF loans; however at the present time, they will not be making any further additions to the types of collateral that are eligible for the facility:
After having conducted a thorough analysis of a number of potential candidates, the Federal Reserve and Treasury announced on Monday that they are holding in abeyance any further expansion in the types of collateral eligible for the TALF. The securities already eligible for collateralizing TALF loans include the major types of newly issued, triple-A-rated ABS backed by loans to consumers and businesses, and newly issued and legacy triple-A-rated CMBS. The Federal Reserve and Treasury are prepared to reconsider their decision if financial or economic developments indicate that providing TALF financing for investors' acquisitions of additional types of securities is warranted.
The text of the Fed and Treasury announcement of the TALF extension is available at:

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