Promissory Notes

Promissory note investments are an alternative investment that can be risky for investors. According to the Financial Industry Regulatory Authority (“FINRA”), scams involving promissory notes are flourishing; indeed, they are at the heart of many fraudulent investment schemes.

In general, a promissory note is an instrument that one party (the maker or issuer) gives to another (the payee) promising, in writing, to pay a sum of money under certain specific terms. It is one form of debt that companies use to raise money. Although the “note” may promise payment of a certain interest rate and the return of principal, the “promise” is only as good as the creditworthiness of the issuer. Over the last several years, billions of dollars in promissory notes, including notes issued by Medical Capital Holdings and Provident Royalties, LLC, have defaulted, leaving investors with pennies on the dollar or nothing at all. In many instances, promissory notes are used to facilitate Ponzi schemes.

Promissory notes are often issued by a type of “private placement” offering, also known as a Reg D offering in reference to the exemption from registration that is commonly used. These private offerings are typically high-risk, speculative, opaque (hard to identify the specific risks), expensive (in that they involve high commission payments and high fees) and rife with conflicts of interest that arise when the sponsors transact business with affiliated individuals or entities.

Promissory note investments are also usually illiquid (difficult to sell or value). They have no ready market because they are not publicly traded and there is little or no secondary market for them. In addition, early redemptions are often restricted and subject to significant discounts. In many cases, investors’ money is effectively locked up for years.

Promissory notes are on the list of Top Ten Investor Traps identified by the association of state securities regulators known as NASAA (the National Association of State Securities Administrators). All too often such “investments” are nothing more than fraudulent schemes with the money never being invested at all, but instead going into a bank account controlled by the sponsor and used for personal expenses.

Even when investors’ money is actually invested, serious concerns have developed about whether promissory notes are sold to investors solely because they generate high commissions, regardless of their unsuitability for the investor.

Lack of adequate investigation (due diligence) by sellers of promissory notes and failures to disclose the results of any such due diligence are also major problems in the sale of promissory notes. Richard Ketchum, chairman and chief executive of FINRA, warned broker-dealers that sell risky promissory notes and other private placements under the Regulation D exemption to conduct more vigorous due diligence, follow up on red flags and “push and pull” sponsors for information about the investment. Brokers that sell promissory notes have a history of ignoring such warnings and suggestions from FINRA. The reason may have to do with the fact that disclosure of negative information would undermine sales.

Even if not fraudulent, promissory note investments are often unsuitable for investors and should be avoided. At a minimum, investors should always carefully check out such investments and ask their state securities administrator for information about the offering and the sponsor before investing.

If you have investment losses or problems involving promissory notes, call the lawyers at Page Perry for experienced representation at (770) 673-0047 or (877) 673-0047 (toll free).