Commerce Division of Securities  
 

BOGUS "IRA APPROVED" INVESTMENT SCHEMES

The retirement nest eggs of Americans are in danger of being scrambled by investment schemes falsely promoted as "IRA Approved" or otherwise endorsed by the Internal Revenue Service (IRS). Estate investment watchdog agencies estimate that tens of thousands of unwary Americans have in the past invested hundreds of millions of dollars of their savings for old age through individual retirement accounts (IRAs) and other tax deferred retirement savings vehicles that will end up being largely or entirely worthless.

Promising sky-high returns of 200-800 percent that will supposedly put investors on "Easy Street" with a bonanza of retirement income, the "IRA Approved" investment schemes range from the latest in high-tech (including wireless cable television and specialized mobile radio) to exotic livestock (such as ostrich farming) to real estate investment "pools."

Some "IRA Approved" schemes have been promoted through slick television "infomercials" and radio ads that turn the tables on investment victims by getting them to place the first call to the illicit promoters, rather than the other way around. The promoters cloak themselves in the legitimacy of the IRS and also seek to evade the consumer protection requirements of state and federal securities laws by claiming to be unregulated "general partnerships" and "limited liability companies."

"While it is vitally important for Americans to be thinking ahead and saving for their old age, they must be careful to steer clear of the unscrupulous individuals now preying on retirement nest eggs," says Colorado Securities Commissioner Philip A. Feigin, who is also a past-president of the North American Securities Administrators Association (NASAA). "The truth is there is no such thing as an 'IRA Approved' or 'sanctioned' investment. The IRS does not give its blessing to specific investments. These schemes attempt to fly below the radar of state and federal securities laws designed to protect investors and, in doing so, fail to indicate the extremely high likelihood that investors will lose 100 percent of the principal."

THE SCOPE OF THE PROBLEM

In 1995, a national survey by NASAA, that in the U.S. is the organization of the 50 state securities agencies, uncovered more than 150 enforcement actions or investigations underway in 20 states. Additionally, more than a dozen injunctive actions were taken by federal agencies, including the Securities and Exchange Commission and the Federal Trade Commission. Here are highlights from the files of state securities agencies:

NASAA and the National White Collar Crime Center (NWCCC) sent detailed questionnaires in mid-1994 to 7,000 investors in 141 high-tech investment schemes using the same IRA custodian firm in Pasadena, CA. Responses from the survey indicated that the vast majority of the victims were unsophisticated investors, many of whom responded to TV "infomercials" and radio ads. Victims in these schemes were identified in all 50 states. The IRA custodian has told authorities it was unaware of any problems and is cooperating with the state efforts.

A broader NASAA/NWCCC analysis of high-tech investment schemes found that the suspect firms that were under investigation at the state level were the subject of more than 100 state and federal enforcement actions. Additionally, at least 110 principals and salespeople under state investigation were the subject of enforcement actions.

The Indiana Securities Division took action in February 1994 against a firm purporting to be raising money for the construction of a wireless cable television facility in southern Florida. Claiming to already have been involved in 30-40 successful wireless cable television projects, the promoters promised 500 percent in short-term profits for those who invested through IRAs. Investors were told that there were few risks, and little or no chance of failure outside of an "act of God" or "Invasion by Cuba." Investors also were told that one of the principals in the scheme was a member of the National Society of Certified Fraud Examiners (NSCFE). According to Indiana, one salesperson described the principal as follows: "He's a licensed fiduciary who prevents, you know, the company from ripping off funds." The promoters said the offering was a "general partnership" and, as such, not required to register under federal and state securities laws. Indiana found that the firm was selling securities, held no FCC licenses for wireless cable in south Florida and had no track record of success. Additionally, the principal touted as a "fraud examiner" had dropped out of NSCFE membership and yet another promoter was the subject of a FTC injunction involving more than $100,000 in restitution and penalties for deceptive activities in conjunction with an earlier wireless cable television lottery application mill.

A securities division in a southern state investigating a specialized mobile radio (SMR) scheme found that salespeople were using a pitch script reading as follows: "I've been encouraged to call you by the IRS because you have some form of self-contributory, self-directed retirement program like an IRA ... The problem is that you may be like the millions of Americans who are merely (sic) using their retirement fund as an income shelter only and not as an equity growth vehicle directed for comfortable retirement living ... The IRS feels that's not saving for retirement. Does this sound familiar?"

In another case from a Midwest state, an undercover securities investigator posing as a potential investor in a high-tech scheme was reassured by a salesperson in the following terms: "Another very important fact is that this is IRA-sanctioned. You can remove money from an IRA account and put it into this IRA without any penalties or taxation whatsoever involved at all, so certainly that lets you know that it must be, um, very solid because the government would not allow anything like that to happen if it was not something very solid for you to get into..." (tape transcript)

As part of a massive dragnet involving more than 50 high-tech investment schemes and promoters, the California Department of Corporations made a criminal referral in a video phone case where the promoter of an interactive video distribution service (IVDS) deal continued to solicit investors from a telephone in a detention center. A total of $12 million in investor funds were collected in this scheme. California also took actions in schemes in which undisclosed commissions of 50 percent were paid out of the proceeds of investor retirement funds. In another case, California determined that just 1/2 of 1 percent of proceeds were actually going to construction of the wireless cable television project touted to IRA savers.

One ostrich farm investment scheme that has been the subject of regulatory action by several state securities divisions advertises that IRA savers can get profits of 200-300 percent almost immediately. Investors were told that ostriches comprise the "agricultural industry of the century ... (a) fully insured investment that has been called the cash crop of the 1990's." Investors were solicited to be "general partners" in the raising of $80,000 to maintain two breeder birds. No mention was made of the extremely risky nature of the ostrich farming business, including breeding difficulties, disease problems, and an uncertain commercial market.

HOW "IRA APPROVED" SCHEMES WORK

Faced with the need to save for old age, millions of Americans make decisions each year about what to do with their tax-sheltered retirement funds, including individual retirement accounts (IRAs), Keogh plans, Simplified Employee Pension (SEP)-IRAs for the self-employed, and 403B tax-sheltered annuities for employees of non-profit concerns and educational organizations. IRAs and the other retirement savings vehicles are intended to provide the ability to make deductible, and non-deductible contributions that grow and compound without taxation until they are withdrawn in retirement years. Complex rules govern the tax deductibility, transfers, rollovers and withdrawals of IRAs and the other retirement vehicles. For independent sources of information on how retirement savings accounts work, see the final section of this "Bulletin.")
v Even though most financial advisors urge individuals to build an IRA (or IRAs) with a diversified balance of investments (such as certificates of deposit, mutual funds, individual stocks, and bonds), it is legal to put almost any investment in a retirement savings plan. Under federal law, only a few categories of investments are prohibited for IRA dollars, including art objects, antiques, stamps, and other collectibles (including some coins). However, this does not mean that all other investments are good ideas for retirement savings accounts. For example, it makes little sense to put tax-free municipal bonds in an IRA that is already exempt from taxation. Similarly, investors are discouraged from over-reliance in IRAs on risky, thinly-traded, high-commission investments, such as real estate limited partnerships.

IRA funds must be handled by a custodian, such as a bank, trust department or mutual fund. However, the custodian of IRA funds is not obligated to review or approve of the investments selected for a self-directed IRA. For its part, the IRS neither approves of specific investments nor does it directly or indirectly advise retirement savers on what to do with their IRAs.

The major shift in recent years away from employer controlled pensions in favor of self-directed retirement savings has created a major opening for unscrupulous promoters of illicit investment schemes. These individuals realize that billions of dollars in investment capital is now in the hands of individuals who are extremely ill-equipped to make decisions about how to save wisely for their retirement years. As a result, a growing number of investment schemes include with all solicitation materials the paperwork needed to establish an IRA (or transfer) existing retirement savings. In addition, individuals leaving one job and forced to make a decision about where to rollover their retirement savings within 60 days without penalty are also prime targets for investment schemers.

HOW DO THE SCHEMERS FIND POTENTIAL INVESTORS?

Not so long ago, almost all illicit investment schemes were promoted through high-pressure telemarketing "cold calls" that zeroed in on likely victims (or "mooches," to use the unflattering terminology of the industry). However, new "IRA Approved" investment schemes have been promoted through slick television "infomercials" (long-form advertisements that run 20-30 minutes) and radio ads. Those who respond by calling a toll-free "800" or "888" number get a package of materials, followed by high pressure telephone sales pitches. Fraud investigators speculate that getting victims to call first makes the work of the schemer much easier, since the potential investor has already "bought into" the scheme by taking the first step.

Typical of the resulting "IRA Approved" sales pitch is this text from a follow-up letter sent out by the promoters of an illicit wireless cable television scheme described as a "Qualified Retirement Plan":

"That means you can replace any of your low-yield IRAs with a more profitable but still relatively safe wireless cable investment. Many of our current customers took substantial positions with us after comparing their actual IRA return of 3 to 5 percent of our 400 percent projected return. They simply did their homework, looked at all the facts and decided that the investment was as safe as any around. It just happens to have a higher return!"

TYPES OF "IRA APPROVED" INVESTMENT SCHEMES

In recent years, the reallocation of the telecommunications airwaves by the Federal Communications Commission (FCC) has resulted in a number of major federal lotteries and auctions for new and largely untested technologies. Given the media enhanced allure of the "information superhighway," promoters of investment schemes were quick to realize that these "sexy" new high-tech opportunities could be peddled to novice investors who are unaware of the enormous risks and uncertainties involved.

It is important to recognize that these technologies are not the problem; the concern is about the schemers who exploit the technologies in order to victimize investors. Among the major technologies that have been latched on to by promoters of "IRA Approved" schemes are:

• Wireless cable (or "super high frequency") television. There is a legitimate and growing wireless cable television industry in the United States. In fact, wireless cable TV stocks were among some of the strongest performing investments during 1993. Unfortunately, it is just such headline-grabbing success that investment schemers seize on when they look for ways to separate investment victims from their retirement savings. Wireless cable involves the use of microwave technology to relay cable television programs to small satellite dishes at the homes of subscribers. The FCC's original lotteries awarding wireless cable TV licenses triggered an avalanche of "application mill" fraud and abuse in the late 1980's and early 1990's. In the spring of 1992, NASAA issued an urgent national warning with the Council of Better Business Bureaus about swindlers falsely promising to be able to secure wireless cable TV licenses for unwary investors. The emphasis in wireless cable TV schemes shifted to "IRA Approved" investment schemes in "general partnerships" and "limited liability companies." ( In reality, the "IRA Approved" schemes are still investment contracts subject to state and federal securities law.) Claiming to be raising funds to "build out" wireless cable operations in specific markets, the promoters grossly overstate the potential for profit, exaggerate the numbers of channels at their disposal, may not be in possession of the FCC licenses involved, and gloss over substantial risks, including unpredictable consumer demand and emerging new technologies, including direct broadcast satellite DBS).
• Specialized mobile radio (SMR). Most American cities have long had taxis, delivery services and other dispatch operations using dedicated radio networks. Under emerging SMR technology, it is expected that more networks will be available in the same cities and that major new services (such as digital paging) will be available. However, the new generation of SMR is still largely a dream. Nonetheless, promoters of "IRA Approved" SMR deals make it sound as though the new SMR technology is already in wide use and delivering stellar returns for savvy "ground floor" investors.
• Personal communications services (PCS). It is expected that many American will move away from traditional cellular phones in favor of personal communications services (PCS) that weigh less, offer cheaper calling costs, have longer battery life, and work in locations (including inside offices) where cellular phones often fail. Promoters of "IRA deals" in PCS misrepresent the technology as a sure-fire success that is already on track to be used widely in the United States.
• In addition to the high-tech schemes, there also has been a surge in illicit investment schemes involving exotic livestock (such as ostriches and emus) and real estate deals (such as mortgage pools). The ostrich deals are usually packaged as partnerships in which investors pay several thousand dollars or more for shares in "breeder pairs" of the animals, which are then raised on ranches, usually in the Southwest U.S. The ostriches are touted as being the next non fat, low-calorie fad food item headed for the dinner table of every American household. In fact, the existing market for the exotic livestock is so far extremely limited and uncertain. In addition, a number of the touted ostrich and emu ranches have been found to be either imaginary or vastly overblown in terms of size.

Protecting Yourself Against "IRA Approved" Schemes

State securities agencies urge you to study the following steps in order to avoid falling victim to an "IRA Approved" investment scheme:

• Exercise extra caution during the tax season when it comes to making IRA investments. Just because the pressure may be on to make a decision about your IRA or other retirement plan contribution, don't make the mistake of going along with the first sales pitch you hear. Take the time to evaluate the investment opportunity and, if necessary, consult with a competent tax advisor.
• Avoid any investment touted as "IRA Approved" or otherwise endorsed by the IRS. This is a clear sign of trouble. Those who promote legitimate investment opportunities do not pretend to have the blessing of the IRS. The IRS does not endorse specific tax deals.
• Don't buy an investment on the basis of a television "informercial" or radio advertisement. Too many people mistakenly believe that just because a slick ad has been produced that there must be something to the product that is being sold. Just because an ad for an investment airs on television or radio does not mean that it has been "cleared" or otherwise reviewed by some federal or state agency. And don't assume that a radio or television station has done anything to check out the claims made by the advertisers; most broadcasters take no responsibility for the accuracy of the ads they air. The same is true for many investment-related radio talk show hosts, many of whom do not check out advertisers and may receive a payment for their personal endorsement.
• Beware of promises of no-risk, sky-high returns on exotic investments for your retirement account. It is true that the promised returns of some high-tech investment deals far outstrip those that are projected for stocks, bonds, and other more mainstream investments. But it is a basic rule of investing that a higher return means higher risk. If someone tells you that you can make 200 or 300 percent on your money in a few years and that the chance of loss is low or nonexistent ... you have found a deal that is too good to be true! Remember that someone who has no intention of delivering on promises may be willing to say anything in order to make a sale!
• Never transfer or roll-over your IRA or other retirement funds directly to an investment promoter. Your fund has to go to a pension fund administrator, such as a bank, trust department or mutual fund. If your money is sent directly to the promoter, it is not going into a recognized IRA and, even worse, may be gone for good. In one case in Texas, two ostrich farm promoters allegedly took $150,000 from a woman and promised to put it into an IRA. Instead, it is claimed that they misappropriated $35,000 of the funds for their own purpose.
• Proceed with caution when you are encouraged to invest in a "general partnership" or "limited liability company." Many of the current crop of high-tech, real estate and exotic livestock deals are packaged as "general partnership" or "limited liability companies" in an attempt to evade the consumer protection requirements of state and federal securities laws. These laws are designed to require promoters to disclose all pertinent facts about themselves and the investment. In attempting to skirt these laws, the promoters may conceal personal bankruptcies, previous securities law violations, risks (including lack of expertise), actual marketing costs (some of the high-tech deals involve 40-60 percent commissions for sales people, leaving little or nothing for the actual project), and competing technologies. Just because a promoter claims that what he or she is offering is something other than a "security," does not make it so!
• Don't be swayed by the fact that a bank or trust department is serving as an IRA custodian. IRA custodians have to follow many IRA rules in handling retirement funds, but are not obligated to check out the investments to which savers direct funds. The custodian is not "on the hook" if you IRA investment turns out to be a worthless scheme. In one case in Washington state, a promoter put members of an investment club into notes, the proceeds of which the promoter then turned around and "loaned" to himself. When the club members contacted the New England bank serving as custodian for the IRA accounts they were told that the bank was not responsible for the investment. The bank indicated that it would continue to collect custodian fees on the investment club members' worthless IRA accounts.
• Keep in mind that a "hot" industry does not necessarily translate into a "hot" company. Just because a lot of headlines are being generated about the prospects for a new or emerging high-tech industry does not mean that a specific company is going to be part of the overall success story. Promoters of illicit schemes often attempt to make themselves seem more legitimate by providing copies of glowing news articles from The Wall Street Journal, Business Week, Forbes and other business publications. Take the time to look at these stories carefully. If they do not mention the company that has approached you, they are irrelevant to your investment decision.
• Always check out an investment and promoter before you turn over your money. The Ohio Division of Securities is a watchdog agency that works to protect Ohio investors against investment fraud and abuse. Before investing, always check with the securities agency in your state to determine that the salesperson and the investment opportunity are in full compliance with the securities laws and rules. Even if the promoter of a high-tech, exotic livestock or real estate investment claims that an investment is not a "security," you should still contact the Ohio Division of Securities at 1-800-788-1194.
• Another good reason for calling: you can check out the disciplinary background of the firm and salesperson soliciting your money. Hundreds of enforcement actions have been taken in relation to "IRA Approved" investment schemes and related offerings. A serious problem is a "red flag" indicating that you may want to avoid a firm or salesperson with a checkered past. For information contact the Ohio Division of Securities at 1-800-788-1194.
• Educate yourself about IRA's and retirement planning. The IRS offers "Individual Retirement Arrangements" at no cost to those who call 1-800-TAX-FORM (829-3676).
• Another good reference is "Planning for Your Retirement," an introductory brochure from the American Association of Retired Persons (AARP) Worker Equity Program. Write: "Planning for Your Retirement," AARP, 601 E Street NW, Washington DC 20048.
• Price Waterhouse, Ernst & Young, and J.K. Lasser are among the organizations and individuals publishing annual tax guides that are available at your library and through local bookstores.