Promissory Notes

Unlike many investments today, promissory notes sound simple and safe, and appear to be an attractive alternative to volatile stocks and bonds. However, while promissory notes can be legitimate investments, some promissory notes sold widely to individual investors are not. Investors need to be informed and understand the investment they are considering.

A promissory note is a form of debt that companies sometimes use, like loans, to raise money. The company, through the notes, promises to return the buyer’s funds (principal), and to make fixed interest payments to the buyer in exchange for borrowing the money. Promissory notes have set terms, or repayment periods, ranging from a few months to several years.

Even legitimate promissory notes involve risks-the company issuing them may have problems, such as competition, bad management, or severe market conditions, that make it impossible for the company to carry out its promise to pay interest and principal to note buyers. Investors also need to know that bona fide notes are marketed almost exclusively to corporate and other sophisticated investors, who have the expertise and information to determine if the investment is a good one.

Problems with promissory notes fall into three main categories: deception of investors, unregistered securities, and unregistered sellers.The promissory note programs that are scams are often sold with the following deceptive statements: 1) investors would receive very high, double digit returns, 2) returns were guaranteed, and 3) the notes were backed by collateral to guarantee them. Frequently, a fraudulent promoter will persuade an independent life insurance agent, by offering very large commissions, to sell the notes to the agent’s trusting customers. Often, promissory note schemes target the elderly and their retirement savings.

Although those selling them may not know or admit it, these promissory notes are usually securities and must be registered with the Securities and Exchange Commission or the State they are sold in-or they must have a specific exemption from registration under the law. If the note is not registered, it will not be subject to review by regulators before it is sold, and investors have to do their own investigation to confirm that the company can pay its debt.

These promissory notes are usually securities, but those selling them often do not have the required securities sales license. If registered individual brokers are involved, they may be selling the notes without their firms’ approval.

Know that a financial adviser (or anyone else for that matter) cannot guarantee a particular return. Even if the note has a fixed interest return, the investment may not pay that amount-or return your principal-to you. Moreover, the seller may say the notes are insured, but not mention that the insurer may not be legitimate-and outside the US and beyond the reach of our laws.Recognize that these notes usually offer double-digit returns-those greater than 10%-while, at the current time, legitimate safe investments have a much lower return.  Moreover, many recent Ponzi schemes and other securities fraud cases involved the sale of promissory notes.

If you have purchased, or are considering the purchase of, a promissory note, please contact Wittenberg Law to discuss your legal rights and options.