This is an archived article that was published on sltrib.com in 2008, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.
Every week I get calls from Utah residents who have lost money by investing money with friends, family or neighbors they trusted -- but who were not licensed to sell securities.
Many of these people have given someone a short-term, high-interest loan with a promissory note that has not been repaid. Others have invested money with someone who claimed to be achieving spectacular returns from trading in commodities or foreign currencies. Still others have lent money to a new company that has a great idea but needs a short-term loan until it gets financing.
Nearly always there is a guarantee of unusually high returns with no risk, and of course they have never missed a payment. By the time they call me the money is gone, their calls are being ignored and they want legal advice on what to do next.
A quick search usually uncovers bankruptcies or judgments that were not disclosed by the person who took the money. I explain that in many cases the courts will consider people who are obtaining these loans to be issuing securities, which are highly regulated by state and federal authorities. If important information such as bankruptcies, judgments, or financial problems is not disclosed (intentionally or not) to lenders before the money is handed over, the borrower may have committed securities fraud and can be prosecuted.
In the worst cases, people have borrowed money against their homes or liquidated their retirement in order to fund these risky loans or investments in anticipation of higher returns. Unfortunately by the time they call me, the money is long gone and so is the person who took the money -- very little can be done.
Recent news stories about Bernie Madoff's $50 billion Ponzi scheme described how he took advantage of friends he knew through church and country club memberships. Unfortunately, this is all too familiar.
Our state has a long history of financial fraud perpetrated by, against and among members of the LDS church, as well as other groups. I will leave it to sociologists to explain why this occurs, but my advice is this: If someone casually mentions that they used to be the elders quorum president (or some other position) in the context of an investment presentation, don't walk, run for the exit! Church affiliation is not relevant in investment decisions.
Investing with people you know may be comforting, but it has no bearing on whether an investment is sound. You need to carefully investigate each investment opportunity and set aside your friendship. In fact, I would recommend investing with people you do not know; it takes the emotion and friendship out of the equation and helps you to focus on the merits of the opportunity. And if things go bad you will not hesitate to aggressively protect your interests.
Most people do not like to sue their family and friends -- it makes family reunions and church functions too uncomfortable.
As with any investment opportunity, it is crucial to do your homework before investing with or lending to people you know. If it involves a company, ask for a private placement memorandum and company financials. If it involves an individual, ask for his or her financial record. In every case ask about their legal problems and then independently search state, federal and bankruptcy court records to determine if there are lawsuits or judgments against them.
If loans are secured, verify the collateral and your position by obtaining title information on the property. Hire an attorney and accountant to review documents and to draft agreements. And most important, get it in writing . I am constantly amazed how many people will loan hundreds of thousands of dollars to their neighbor without getting anything on paper.
Stick with licensed stock brokers or registered investment advisers. If you are thinking about putting money into a hedge fund or other type of unregistered, unregulated investment fund, watch out for red flags. If the promised returns are unusually high, you should be more careful, not less.
Beware of guarantees, aggressive sales pitches, requests for secrecy and people who need the money urgently. Ask the hard questions before you hand over your money, not after. And although referrals are good, just because others have made money with this investment fund does not mean you will too. Just ask the folks who invested with Val Southwick or Bernie Madoff.
Mark Pugsley is a Salt Lake attorney who specializes in securities disputes and fraud litigation. He is partner and chair of the securities litigation group at the law firm of Ray Quinney & Nebeker.