Investing in Due Diligence Can Uncover Shaky Firms.

A Midwestern insurance agent, who doesn't want his name used, claims he was scammed into selling questionable "promissory notes." You need to hear what he says, in case you're advised to make a similar investment, by someone you trust.

He had a client who wanted a safe, short-term investment, for around $1 million. (Don't let the big number put you off; these notes are sold to small investors, too.)

He says he called the marketing company from which he got annuities. The marketer had an idea: A nine-month promissory note from a Florida company called Lifeblood Biomedical.

Lifeblood, a new company, borrowed money from individual investors. The investor was supposed to earn 12 percent, at a time when one-year bank CDs were paying 4.5 percent. The agent wouldn't disclose his commission.

The company said it was working on a technology for storing and regenerating "cord blood" (blood from umbilical cords, after birth), which could be used to treat disease. "I thought, 'Oh boy, this is leading edge,"' the agent says.

He thinks he did "every shred of due diligence that could be done." He read the marketing materials, complete with doctors' endorsements. He flew to Florida to meet with company executives. He visited the lab in Atlanta and talked with the technician in charge. He says he was so excited that he even invested $100,000 of his own money.

To ensure repayment, the company provided a bond from Threshold Insurance Services in Panama. "That worried me a little bit, because it was out of the country," the agent says. "But we're trading mutual funds globally now, so the bond made sense."

That was last spring. In November, Florida shut down Lifeblood, and Threshold didn't cover the bond. Lifeblood's owners may face federal criminal charges for securities fraud, mail fraud and wire fraud, according to Laura Royal, the investigator for criminal enforcement in the state's Comptroller office in Tampa. Lifeblood's lawyers didn't return calls.

Investors put around $8 million into the notes. Florida has recovered some of the money, and hopes to repay around 30 cents on the dollar.

What did the agent do wrong?

* He checked only with the people who were running the firm.

* He didn't wonder why a risky start-up company could get an insurer to guarantee such a huge sum of money. Startups don't have the cash to repay in such a short period of time.

* He decided, based on no evidence, not to worry about the offshore insurance company. Had he called Florida's Insurance Department, he'd have learned that Threshold wasn't authorized to do business there.

* He didn't find it strange that a "guaranteed" investment would pay so much more than market interest rates. His client also had blinders on.

* He didn't check with his own state securities office to see if the notes were registered. Some states don't require certain short-term securities to be registered. But the agent should have found out what the exemptions were, and whether Lifeblood's notes qualified.

Royal is heading a 25-state task force to try to reduce the sales of worthless promissory notes. State regulators believe that some 1,000 insurance agents and other financial advisers are involved coast to coast. The agents generally work for (or own) small, independent agencies.

The states are investigating some 30 companies that have issued notes. They generally target older investors who want a higher return on their savings, at no risk. But younger investors are also entrapped. Some of the salespeople have apparently been misled themselves, or persuaded by the high commissions (up to 8 percent) to ignore common sense.

But other agents know exactly what they're doing. They advertise on the Internet, or in well-known newspapers, promising "10 percent to 15 percent interest, guaranteed principal, no fees, suitable for 401(k)s and IRAs." They persuade clients to cash in their life insurance or annuities.

Several states have brought charges.

The Securities and Exchange Commission is also bringing cases against fraudulent promissory notes.

There's a simple way of avoiding these losses. Give up the dream of earning high interest, risk free.

Class-Action Fallout

In the wake of the dishonest life-insurance selling of the '80s and early '90s, several insurers settled class-action lawsuits -- among them, New York Life, John Hancock, Transamerica Occidental Life and Prudential Life. A plan for Metropolitan Life is up for approval now.

The insurers are offering bilked consumers various forms of financial relief. But some people still think they're getting a raw deal.

A group of Prudential employees and exemployees in Plymouth, Mina., have stepped forward to say the unhappy policyholders may be right. In affidavits filed in the New Jersey federal district court (which is overseeing restitution), they allege that Prudential manipulated the process to limit what consumers get.

Pru rejects any blame. "We have reviewed the allegations and found no evidence to substantiate the charges," spokesman Robert DeFillippo says.

The mis-selling at Pru and other insurers depended on telling one of three big lies:

* "I'm selling you an investment, for college or retirement." (Fact: It's a life insurance policy. Part of your "investment" goes for insurance that you might not need.)

* "I can get you more insurance than you currently have, at little or no cost." (Fact: The insurer uses your older policy's dividends and cash value to purchase the additional coverage. When the older policy runs out of cash, you have to pay much higher premiums out of pocket or your coverage will lapse.)

* "You'll have to pay premiums only for a limited number of years." (Fact: If interest rates drop, you'll have to pay for many more years than the agent said.)

Some 640,000 Pru policyholders said they were victims of these whoppers. Pru reviewed their written claims and gave each one a score. High scorers were entitled to full restitution -- their money back or their policy restored. Lower scorers were offered partial restitution. Those who objected to their score could appeal their case. Pru supplied a lawyer for free.

Here's where the whistleblowers come in. They charge, among other things, that employees were pushed to give people lower scores, and instructed to leave out certain policies, when evaluating claims.

Again, Pru's DeFillippo objects. "Safeguards made it virtually impossible for the process to produce anything but fair and equitable reviews," he says.

Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.