By Michelle Singletary
Thursday, March 9, 2006
When the North American Securities Administrators Association announced its top investor traps to watch out for in 2006, there were the usual suspects.
On the list again this year were "prime bank schemes." These are sophisticated scams in which con artists promise high-yield, tax-free returns that are said to result from "off-shore trades of bank debentures." Investors are told that they are lucky to be privy to such information since only the rich know about such practically risk-free investments.
Need I say there are no such prime bank investments offering high-yield rates. This is a straight-up con.
The NASAA warns investors to watch out for schemes in which promoters offer great returns if you buy pay phones or ATMs. In order to make the deal more attractive, investors are told that after a given period, the equipment can be sold back to the seller at the investor's original purchase price.
Also on the list is a product that could easily confuse investors. Ever hear of an equity-indexed certificate of deposit?
The NASAA is particularly concerned that many seniors will confuse equity-indexed CDs with their older, completely federally insured cousin, the traditional certificate of deposit. They're not.
These hybrid securities products offer a return that is based on a certain stock market index, usually the S&P 500-stock index. Although your principal is FDIC-insured, your return is not. Instead, your return is dependent on the performance of the specific index. In fact, you could get no return at all on your investment.
The NASAA advises that this is not suitable for seniors who may need a guaranteed return for retirement expenses.
"The pace of innovation in financial services is ever increasing," said Patricia D. Struck, NASAA president and Wisconsin securities administrator. "There is a new hook weekly."
Investors may now choose among variable rate CDs, jumbo CDs, callable CDs and CDs with other special features. These CDs pose greater risks to investors.
Struck said she's concerned that with equity-indexed CDs, people will just hear "certificate of deposit" and not understand exactly what they are getting. "The risk isn't the product, but the way it's marketed," she said.
The warning about equity-indexed CDs should be heeded for other types of hybrid CDs as well, Struck said.
For example, NASAA says seniors should be careful about buying callable CDs. Many elderly investors have been complaining they've been misled into buying these certificates with up to 30-year maturities, according to state securities regulators.
Callable CDs often have higher yields than traditional bank-issued CDs because they require a 10-, 20- or even 30-year investment commitment. You can withdraw your money from this type of CD, but you pay a high penalty for doing so. Redeeming the CD early may result in large losses -- as much 30 percent of the original investment in some cases, according to the NASAA.
In one Iowa case, a retiree in her seventies invested over $100,000 of her 97-year-old mother's money in three callable CDs with 20-year maturities. Her intention, she told her broker, was to use the money to pay her mother's nursing home bills. Regulators say sellers of callable CDs often don't adequately disclose the risks and restrictions.
Investors also often don't realize that with callable CDs, only the issuer can "call," or redeem, the CD. A bank might decide to call its high-yield CDs if interest rates fall. But if you've invested in a long-term CD and interest rates subsequently rise, you'll be locked in at the lower rate.
Before purchasing a callable CD, you should go through a 13-question checklist prepared by NASAA. Use the following Web address to get the checklist: http://www.nasaa.org/content/Files/CallableCD.pdf .
For instance, one question asks you to confirm when your CD matures. A lot of consumers -- when they need their money -- realize too late they've got a CD with a longer maturity date than they thought.
Another question you are urged to find out is how the CD is held. It used to be you just bought a CD from a bank or savings institution. But now many brokerage firms and independent salespeople offer CDs.
However, unlike traditional bank CDs, brokered CDs are sometimes held by a group of investors. Instead of owning the entire CD, each investor owns a piece. In this case, you need to confirm how your CD is held, and be sure to ask for a copy of the exact title of the CD. If several investors own the CD, the broker may not list each person's name in the title. But you should make sure that the account records reflect that the broker is merely acting as an agent for you and the other owners.
You want to do this so you can be sure that your portion of the CD qualifies for up to $100,000 of FDIC coverage, according to the Securities and Exchange Commission.
The NASAA called its investor warning list this year the "Unlucky 13." Really, you don't need luck to avoid being duped into investing your money in an inappropriate product. Just inform yourself.
· On the air: Michelle Singletary discusses personal finance Tuesdays on NPR's "Day to Day" program and online athttp://www.npr.org.
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