In a promissory note scam, the individuals perpetrating the scam often stay behind the scenes. They persuade others to sell promissory notes by promising them large commissions. The individuals who sell the promissory notes to investors often rely on the information they have been given, and they may not know that the information is false or misleading. The individuals perpetrating the scam use a portion of the money they collect from investors to pay the sellers their commissions. The fraudsters typically abscond with the rest.
A promissory note is a form of debt. An investor generally agrees to loan money to a company in exchange for the company's promise that it will pay back the principal, plus interest, over a specific time period. Promissory notes are not usually sold to the general public. Fraudulent promissory notes are sometimes issued on behalf of fictitious companies. Sellers may tell investors the notes are a safe investment since they are guaranteed by insurance companies. The sellers also often promise a high rate of return. However, most of the companies that guarantee the notes are unlicensed. Fraudsters often target elderly investors who believe the notes won't expose them to the risks of the general securities market. Investors purchase the notes believing they are less risky and offer a higher-than-market rate of return. Sellers may encourage investors to cash-in their life insurance policies and buy promissory notes instead.
Legitimate corporate promissory notes are typically sold to sophisticated investors, and retail investors should be extremely skeptical of any salesperson offering to sell them a promissory note. To avoid promissory note scams, investors should investigate the person who is selling the promissory notes. Generally, these salespeople must be licensed in their state and with the Financial Industry Regulatory Authority. Investors should also research whether the company offering promissory notes is legitimate and healthy enough to pay its debts. Investors should be skeptical of notes that are supposedly insured or guaranteed or notes that promise to be risk-free, high yield investments.
For more information, see:
- Securities and Exchange Commission (SEC): http://www.sec.gov/investor/pubs/promise.htm
- The SEC provides a warning on Promissory Note Fraud.
- Financial Industry Regulatory Authority (FINRA): https://www.finra.org/investors/alerts/promissory-notes-can-be-less-promised
- FINRA explains how promissory notes can be less than promised.
[Last updated in June of 2023 by the Wex Definitions Team]
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