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Gold Scams Attract Investors & Fraudulent Activity

Samuels Yoelin Kantor LLP

As we’ve said before, where there is money, there is greed. It seems that 2011 is the year of commodities and companies prepared to capitalize on investor anxiety. Be careful when investing in gold and if you suspect any suspicious investment strategies, contact us immediately. It costs you nothing, and could save you from investment fraud.

The Financial Industry Regulator Authority (FINRA) released an investor alert recently because gold is glittering in the news. Con-artists are as interested as investors and financial fraud experts expect trouble.

We want to make investors aware of the warning signs related to gold stock scams, and we encourage you to alert us if you discover them. Investors can help regulate the industry by cooperating and sharing information about potential scams. FINRA’s investor alert can be found on their website and we have included the helpful information below:

Spotting “Gold” Stock Scams

Many gold-related investment scams involve the stocks of gold mining and/or exploration companies. The stock value is often based on gold reserves that are difficult to estimate, much less verify. While stock promoters regularly cite the potential value of a gold reserve, some statements can be deliberately misleading. For example, in 2010, the Securities and Exchange Commission (SEC) took legal action against a mining company based in Florida for false press releases and other misleading statements associated, in part, with a mining project in Ecuador. The releases claimed the gold reserves were worth more than $1 billion. The SEC noted that the exact value of those reserves could not be known “without further detailed exploration.”

Warning signs related to gold stocks include:

• Price targets or predictions of swift and exponential growth. These predictions often are based on gold reserves, the actual existence and true size of which are next to impossible to verify. A company recently claimed that its mine in Nevada contained “approximately 2.14 million ounces of gold equivalent resources,” with an estimated market value of over $2 billion. Based on these reserves, the company touted in one of its promotions that an investment “Could turn $10,000 into $384,600.”

• References to being a “buyout target” for other mining companies. One company claiming gold reserves valued at more than $112 billion declared in an Internet promotion that it was a “PRIME BUYOUT TARGET” at a buyout price that was 15 to 35 times its current value, which was around a dollar.

• Claims that tie stock performance to the general rise in gold prices. Stock prices tend to rise or fall for a host of reasons, such as overall market conditions, sector performance and an individual company’s earnings. A rise in gold prices does not guarantee a rise in the price of a gold company’s stock—there might be little or no correlation between these two things.

• Scare tactics such as the threat of inflation or an economic meltdown. While some investors might hold gold as a hedge against inflation or economic uncertainty, owning a gold stock does not automatically serve that same function. Scare tactics are often used to push an investor to make a quick decision.

• Speculative claims based on a new reserve’s proximity to an existing reserve. A company recently stated in one of its promotional materials that its mining property could be worth “billions in unrecovered gold” based “on the success of its neighbors.” Without more information, such an assertion amounts to little more than idle speculation.

• A change in the company’s name or trading symbol to align it more closely with gold. One company that currently purports to engage in gold mining and exploration was originally incorporated with a business strategy to provide golfing opportunities on private courses to nonmembers. Another original focus was to establish health spas in urban areas. Yet another cited its original business plan was to develop, manufacture and sell commercial feed to nurture the Chinese mitten-handed crab. Name changes are reported through SEC Form 8-K, which you can find by using the SEC’s EDGAR database.

Fool’s Gold for Lunch

Be wary of “free lunch” programs that purport to provide educational information about gold investing. In June 2010, the SEC charged six individuals with running a Ponzi scheme that bilked more than 3,000 investors out of $300 million. The fraudsters, none of whom were registered to sell securities, claimed to represent an independent financial education firm that had discovered a way to earn up to 36 percent annual returns by investing in mining investments that were “fully collateralized by gold.” Rather than invest the money, the firm’s salesmen used the assets on lavish home renovations, mortgage payments for members of their extended family and the purchase of a luxury fishing resort in South America.

In addition, be mindful of warning signs common to many stock scams:

• Claims that making profits in gold are “easy.”

• The use of headlines from respected financial news sources regarding gold, which can easily be taken out of context.

• Mention of the names of major investors or investment institutions that provide an air of credibility.

• Statements about how much easier it is for lower-priced stocks to skyrocket in value in comparison to higher-priced stocks.

• Pressure to invest immediately.

Smart Tips To Avoid Potential Gold Stock Scams:

• Investigate before you invest. Never rely solely on information you receive in an unsolicited fax or email. It’s easy for companies or their promoters to make exaggerated claims about new products, lucrative contracts, or the company’s revenue, profits, or future stock price. Be wary of claims about significant mineral reserves or mining operations in countries far removed from the U.S. that make it difficult to verify such claims through independent research.

• Always ask: “Why me?” Why would a total stranger tell you about a really great investment opportunity? The answer is that there is no such opportunity. In many email, fax and online scams, those who tout the stock are corporate insiders, paid promoters or substantial shareholders who stand to profit handsomely if the company’s stock price goes up.

• Read a company’s SEC filings, if available. Most public companies file reports with the SEC. Check the SEC’s EDGAR database to find out whether the company files with the SEC. Read the reports and verify any information you have heard about the company. But remember that just because a company has registered its securities or has filed reports with the SEC, it doesn’t mean that it will be a good investment.

Alternatives to Gold Stocks

While you may be tempted to invest in a single stock, it is very risky to put all your “golden eggs” in one basket. Investing through a mutual fund or exchange traded fund (ETF) that focuses on gold companies or gold itself can help spread out and potentially lower your risk. Take the time to research fees and other expenses. Review the underlying securities that make up a given fund. You can do so by going to the issuer’s website, reviewing the latest quarterly report showing the fund’s major holdings or, in the case of an ETF, the exchange on which the ETF trades. Research the fund’s manager or management team and read the prospectus carefully, and consider enlisting the help of an investment professional before you invest.

If you are considering a mutual fund that focuses on gold, be aware that most gold mutual funds primarily hold mining stocks, many of which are international, but some hold physical gold, as well. Mutual funds do not allow investors to take possession of physical gold.

If you are considering investing in an ETF that focuses on gold, understand its structure, including whether it uses futures strategies—and whether or not it holds the physical gold, invests in gold futures contracts or tracks a gold-related index. Be aware that ETFs that are backed by physical gold are not the same thing as a direct investment in gold. While some ETFs that are backed by physical gold allow individual investors to redeem shares for bullion, the ones that do may only allow physical redemptions under certain limited circumstances. So while they may be effective at offering exposure to gold prices, most are not an efficient way to obtain an ownership interest in physical gold. Therefore, if you are investing in a physical gold ETF, make sure you understand your redemption rights. Depending on its legal structure, a gold commodity ETF can be subject to varying tax treatments. Be sure to check with your tax advisor about the consequences of investing in a gold commodity ETF.

If you are thinking about investing directly in bullion or gold coins, similarly research your options. For a basic how-to overview, questions to ask and additional resources, read the Federal Trade Commission’s Investing in Bullion and Bullion Coins. Investors should be aware that while some gold promoters and dealers deliver what they promise, others don’t. Also, verify that a ready market exists to liquidate personal holdings of bullion and coins at current market prices and the related transaction costs.

Finally, be advised that while legitimate gold and ETF investments may be an acceptable diversification strategy, these investments can be quite volatile. A heavy concentration of gold investments can leave you overly exposed and at risk of losing a substantial percentage of your money.

Touts and outright scams come in many forms and involve many types of investments. Right now, you would do well to avoid unsolicited promotions of low-cost “gold” stocks. They are likely to mine a hole in your pocketbook.

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