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Sales of Phony Bonds Top State's Fraud List

Securities: Easing of U.S. rules for insurance agents blamed for flood of short-term notes.


Investors are facing a surge of securities fraud cases involving the sale of phony short-term bonds that fail to deliver on promises of high interest payments, state securities regulators said Tuesday.

The sale of such bonds, called promissory notes or commercial paper, topped the California Corporations Department's annual list of the 10 most common investment fraud schemes handled by regulators over the last year.

California regulators have issued 435 orders against sellers of the notes since July after receiving complaints from San Diego to the Central Valley, said the department's enforcement chief, Bill McDonald.

"This problem has just exploded," he said. A major reason for the increase, he said, was the lowering of federal restrictions on sales of securities products by insurance agents, many of whom have begun to sell notes and other instruments without understanding the risks involved.

Fraudulent Internet-related offerings continued to be the second-most popular method of cheating investors for the second year in a row, leading the department to issue nearly 100 enforcement orders since July, McDonald said. "The Internet is clearly the marketing vehicle of choice for con artists."

And sales of phony investments over the telephone and through seminars continue to be popular, ranking third and fourth on the list. Affinity group fraud, whose perpetrators target members of a particular ethnic, religious or social group, placed fifth, down from first place last year. The list is based on both the number of enforcement actions brought by the department and regulators' predictions about investment fraud trends.

In recent months, promissory note schemes have outpaced the others. The notes are often limited to nine-month periods to take advantage of exemptions of state and federal laws regulating short-term corporate debt, McDonald said. The notes often promise investors double-digit interest payments, with the assets of a start-up company as collateral.

Those assets, McDonald said, are frequently of little or no value, leaving investors unable to recover their principal when the nine months are up. "There's nothing backing up these promissory notes," he said.

Among the civil actions brought by regulators in state court was a February suit against Hapjack Marketing Inc., a Fresno company that allegedly sold millions of dollars in notes issued by three other companies to hundreds of elderly investors.

The notes were supposed to generate an annual return of up to 15% by investing in commercial cash machines and discount phone service, but did not deliver on the promises, and nearly $14 million remains unpaid, the department alleged. In court documents, Hapjack and other defendants denied many of the allegations and answered that the "note holders have suffered no damages."

Although state authorities focus on stopping fraudulent activity, they often arrive on the scene too late to recover investors' funds, because the money typically has already been spent, said Richard Sintek, a staff attorney for the Corporations Department in Sacramento.

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