SECURITIES 101: FOR LAW ENFORCEMENT OFFICIALS

1. SECURITIES 101: FORLAW ENFORCEMENT OFFICIALS Securities Products, Schemes and Scams NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION “Because Every Investor Deserves Protection” Prepared by the NASAA Investor Education Coordination Project Group

2. Introduction Have you ever been presented with a potential securities fraud case and thought: “what’s the best way to proceed with this?”

3. Introduction • Financial fraud prosecutions are not the typical cases you probably handle on a routine basis. • If investigated correctly, cases can result in: • Felony convictions • Lengthy prison sentences • Opportunities for victims to recover some lost money through: • Restitution orders • Asset freezes • Forfeitures

4. Purpose of this Presentation • To make you aware of some of the elements of securities products and financial crimes; • Provide you with information on resources available to you with these cases; and • Strengthen your investigative techniques in regard to financial fraud cases.

5. In the United States, BILLIONSof dollars are lost each year to investment fraud and scams. These scams affect both the rich and poor; the sophisticated and the unsophisticated; the timid, the greedy, and the elderly. Investment fraud affects everyone!

6. VICTIM IGNORANCE: The best friend of financial criminals Frauds succeed because people hear and believe the promises of the promoter, and don’t investigate either the promoters or investments being sold to them.

7. Registration of Securities • With few exceptions, every offer or sale of a security must, before it is offered or sold in a state, be registered or exempt from registration under the securities laws of the state or province in which the security is offered and sold. • Some securities sales that are exempt are self-executing and require no securities filings with a state or provincial regulator. • Other exemptions are available depending on the manner in which the securities are sold, and include various factors.

8. Background Information:Who needs to be licensed to sell securities? 1. Brokerage Firms: • Also known as broker-dealers. • Investors maintain their securities accounts with these firms, which need to have licenses to do such business. 2. Securities Salespersons: • Commonly referred to as stockbrokers; work for the broker-dealer firms. • Individuals with whom investors deal directly when effecting transactions in their accounts. • They typically receive commissions when investors purchase or sell securities.

9. Background Information:Who needs to be licensed to sell securities? 3.Investment Advisers: • A person who, for compensation, is engaged in the business of providing advice, making recommendations, issuing reports or furnishing analyses regarding securities. • Either a natural person or a business entity can be an investment adviser. 4. Investment Adviser Representatives: • A natural person who gives advice on behalf of an investment adviser to a certain minimum number of natural person clients through regular meetings or communications.

10. Central Registration Depository (CRD) • A computerized database for securities regulators that holds qualification, employment, and disclosure histories of registered/licensed securities individuals and firms. • Also contains information on enforcement actions taken against unregistered/unlicensed individuals and entities. • Contact your state securities regulator for information contained within the CRD.

11. Concept of “Full Disclosure” • Investors are entitled to complete, accurate and detailed information about the offering. • Salespersons and issuers have an affirmative obligation to provide complete disclosure.

12. Securities Products • Products commonly referred to as securities: • Stocks, Bonds, Notes, Options, Debentures, Convertible Certificates • Products not commonly referred to as securities, but still subject to the laws governing securities: • Fractional undivided interest in mineral / oil rights • Certificate of interest in profit-sharing agreement • Transferable share, voting trust certificate • Investment contracts consisting of precious metals and fine arts

13. Stock Certificates • Shares of stock represent a fraction of ownership in a corporation. • A stock certificate of a corporation provides written evidence that the named person on the certificate is the owner of a designated number of shares of that corporation’s stock.

14. Stock Certificate (Front)

15. Stock Certificate (Back)

16. A holder of a bond has loaned his money to a company or governmental unit (the “borrower” or “issuer”). In return, the company or governmental unit promises to repay the amount borrowed plus a specified amount of interest at a future date. Bonds

17. Bond (Front)

18. Bond (Back)

19. Convertible Certificates • A bond, debenture, or preferred share which may be exchanged by the owner for common stock or another security, usually of the same company, in accordance with the terms of the offering.

20. Convertible Certificate (Page 1)

21. Convertible Certificate (Page 2) Page 2 Page 3

22. Warrants and Options • Warrants are certificates that are usually issued along with a bond or preferred stock entitling the holder to buy a specified amount of the security at a specific price. • Stock options are similar to warrants, however they would not be issued along with a bond or preferred stock certificate. Call options give the holder the right to buy and put options give the holder the right to sell a specific number of shares at a stated price.

23. Warrant

24. Promissory Notes • A written promise to pay or repay a specified sum of money, either at a stated date or on the demand of the holder. • Most promissory notes sold to the general public must either be registered or exempt with the State’s Securities Regulator, and also with the federal Securities and Exchange Commission (SEC).

25. Promissory Note

26. Investment Contracts • To be considered a security and be subject to securities laws, an “investment contract” must have these four elements: 1. An investment of money 2. In a common enterprise 3. An expectation of profits 4. Profits are derived from the efforts of others • This can entail mutual fund interests or other securities products such as coin deals and artwork.

27. Investment Contract (Page 1) Page 1 Page 2

28. Investment Contract (Page 2) Page 4 Page 3

29. Investment Contract (Page 3) Page 6 Page 5

30. Viatical Settlement Contract • An investor purchases the right to receive a portion of the death benefit of a life insurance policy or pool of policies. • This type of investment is referred to as a “viatical settlement” when the insured suffers from a terminal illness. • It is referred to as a “life settlement” when the insured is a healthy senior citizen.

31. Viatical Settlement Contract

32. FractionalInterest in Oil and Gas Wells • A “fractional interest” is a portion of the payment of a lease for land on which one or more wells are or will be located. • Investors share proportionally in the profits of the well.

33. Fractional Interest in Oil and Gas Well

34. Limited Partnership Agreement • Contract which creates a partnership between the manager or operator, called the “general partner,” and those who finance the business, called the limited partners. • “Limited partners” receive a return (profit) based on the ratio of their investment to the total amount of all the investments in the business.

35. Limited Partnership Agreement

36. Interest in a Limited Liability Company (LLC) • Structured similarly to a limited partnership. • Advantage of a LLC over a limited partnership applies only to the managing member, who under this form of business structure cannot incur any personal liability beyond the amount of his or her investment.

37. Interest in a LLC

38. Mutual Funds • Mutual funds pool investors’ money to purchase the securities of other companies, resulting in a portfolio of many different companies. • Individual investors own shares of the portfolio and are paid dividends based on the funds’ earnings after expenses. • A fund manager buys and sells securities for the funds’ shareholders.

39. Mutual Fund Prospectus

40. Ponzi Schemes Pyramid Schemes Offer and Sale of Securities by Unlicensed/Unregistered Individuals Offer and Sale of Unregistered Investment Products Affinity Fraud Nigerian Letters Prime Bank Instruments Churning Lack of Suitability Theft in Brokerage Accounts Common Scams and Schemes

41. Internet Investment Fraud Promissory Notes Bogus Investments Boiler Rooms Equipment Leasing Viatical Settlement Fraud Coins and Precious Metals Oil and Gas Schemes Misrepresentations Omissions of Material Fact Common Scams and Schemes

42. Traits of a Typical Perpetrator • Very friendly, appears to take a personal interest in victim. • Professional persuader, takes control of conversation, builds relationships. • Plays on victims confusion about the variety and complexity of financial products. • Brings out one of our worst traits – greed. • Attempts to make the victim feel inadequate if they question him or her.

43. Ponzi Schemes • Scheme in which a person makes payments to investors from money obtained from later investors. • “Rob Peter to Pay Paul” is the principle of the scam. • The scam is kept rolling by constantly recruiting newcomers. • High interest is paid to the earliest investors who recruit others, often by word of mouth.

44. Ponzi Scheme Chart 1 Ponzi Company Ponzi Company uses a portion of Investor A’s investment as the return on investment Investor A invests Other investors start investing after Investor A gets a return on investment.

45. Ponzi Scheme Chart 2 Ponzi Company Ponzi Company returns part of Investor B’s investment from either Investor A’s or Investor B’s investments of money. Ponzi Company pays Investor A’s next return from Investor B’s investment of money. Investor A invests Investor B invests Additional investors invest based on the returns that prior investors receive which demonstrates that it’s a safe and profitable investment.

46. Ponzi Scheme Chart 3 Ponzi Company Ponzi Company returns part of Investor A’s or B’s or C’s investment from any other investors money that is available. Ponzi Company pays Investor A’s next return from Investor A’s or B’s or C’s investment of money. A invests B invests C invests And the beat goes on and on until all the money is depleted and there are no new investors willing to invest.

47. Pyramid Schemes • A “pyramid scheme” is an illegal form of multi-level marketing where the product (if a product exists) is only of secondary importance. • Investor pays some type of initial fee which gives them the right to recruit others.

48. PyramidSchemes • For each person recruited into the pyramid scheme, the recruiter receives money or other bonuses. • In turn, the new participants must make their initial fee payments, which are larger than the earlier participants’ payments, in order to get the right to recruit.

49. Pyramid Scheme (Page 1)

50. Pyramid Scheme (Page 2)