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Promissory Notes: Promises, Problems

Many investors seek safe, fixed-rate investments, especially ones that can boost the interest they earn. You, too, may be looking for sound investments that pay better than average interest to generate income or meet the needs of your overall investing plan. But as you consider new investment products or services, always remember the correlation between risk and reward: every investment involves some degree of risk, and the greatest-yielding investments usually carry the highest levels of risk.

One interest-paying investment is the promissory note. These are an important means by which companies raise capital. Legitimate promissory notes are marketed almost exclusively to sophisticated or corporate investors that have the resources to research thoroughly the companies issuing the notes and to determine whether the issuers have the capacity to pay the promised interest and principal.

For sophisticated or corporate investors, promissory notes can be a good investment. These instruments provide a reasonable reward for those who are willing to accept the risk. However, promissory notes that are marketed broadly to the general public often turn out to be scams. And even legitimate notes carry some risk that the issuers may not be able to meet their obligations.

Unfortunately, there have been many instances of unscrupulous individuals pushing bogus promissory notes. They’re being sold as instruments that guarantee above-market, fixed interest rates, while safeguarding their principal. While fraudulent promissory notes appear to give investors the two things they desire most– higher returns and safety– they may not be worth the paper they’re printed on.

How Promissory Notes Work
Legitimate promissory notes are a form of debt that is similar to a loan or even an IOU. Companies issue these notes to finance any aspect of their business, from launching new products to repaying more expensive debt. In return for the loan, companies agree to pay investors a fixed return over a set period of time.

Even legitimate promissory notes are not risk-free. These notes are only as sound as the companies or projects they’re financing. Promising companies can stumble due to competition, bad management decisions, or unfavorable market conditions. If a company’s financial health weakens suddenly, it may not be able to pay interest and principal to investors.

How Promissory Notes Work

Telltale Signs of Promissory Note Fraud
What are the red flags you should look for when offered a promissory note investment?
Here’s a list:


“Insured” or “guaranteed” returns. To create a false sense of safety, the sellers of these notes may say they “insure” the payment of interest and principal, using either nonexistent insurers or those that reside offshore and may not be legitimate.
The promise of above-market returns. Returns that are higher than those of similar investments should raise questions.

“Risk-free” notes. Your risk with promissory notes is that the issuing company will be unable to make principal and interest payments. Since risk and reward are intrinsically related, it pays to remember that there is no such thing as a low-risk, high-reward investment.

A start-up’s notes are labeled “prime quality.” In the securities industry, prime quality investments require a company to have established a history of operations and earnings. So if the company issuing the so-called “prime” notes is a start-up or new company, steer clear.

Short-term notes. Notes with a nine-month term may be exempt from securities registration.

Notes from a stranger. A call or visit from a stranger hawking promissory notes is usually a good sign that the investment is fraudulent.

 

Your Investment Checklist


Research the Opportunity. Check with the Nevada Securities Division or the SEC to determine if a promissory note is properly registered or exempt from registration. If you suspect your investment is a fraud, be sure to alert the Nevada Securities Division at 1-800-758-6440.

Steer Clear of Nine-Month Promissory Notes. These short-term notes, which are sometimes exempt from securities registration, have been the source of most– but not all– of the fraudulent activity unearthed by securities regulators in the promissory note area. Since these notes are sometimes exempt from registration, you might not be entitled to some of the redress that the securities laws or regulators provide.

Buy Only Form Licensed Securities Brokers. Insurance agents, financial planners, and investment advisers cannot sell securities, including promissory notes, without a securities license. You should make sure the broker selling the note is licensed by contacting the Nevada Securities Division before you invest.

Ask Yourself: Does this Investment make sense for me? Before making any investment, determine what you are looking for and whether it fits into your portfolio. Investigate before you invest. And don’t forget to consider the risk-reward ratio the investment is offering. Then comparison shop. Look for similar or nearly as high returns with less risk whenever possible.


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This and other publications are available at no charge from the Nevada Secretary of State, Securities Division, by contacting:

555 E. Washington Avenue
Suite 5200
Las Vegas, NV 89101
702-486-2440

1755 E. Plumb Lane
Suite 231
Reno, NV 89502
775-688-1855


Toll Free: 800-758-6440

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Last updated: 2/19/2010 9:22:37 AM