Friday’s Fraud – Oil and Gas Drilling Scams: Don’t Drop Money Down Dry Wells

By Benjamin Stubbs, Spring 2014 Student Intern

oil gasFrom the Beverly Hillbillies to John D. Rockefeller, many people have struck it rich in the oil industry, and currently, many are hopeful that natural gas will prove to be just as rewarding. Before you invest in oil or gas, however, take a little advice from the Securities Exchange Commission (SEC): “If you think you’ve found the right oil or gas investment to ‘strike it rich,’ consider this: it may be a scam.”

Coming in sixth on NASAA’s list of most common investment frauds of 2013 is oil and gas drilling scams. NASAA explains that many who are frustrated with the volatility of the stock market turn to oil and gas but that “energy investments generally prove to be a poor substitute for traditional retirement planning.” Scammers often use high pressure tactics, combined with the glamour that many associate with oil drilling to steal investors’ money. I’ll give you a few tips below on how you can avoid falling prey.

What are drilling scams?

As NASAA explains, there are many ways to invest in oil and gas ventures, from partnerships to owning a fractional interests in leases. Drilling investments typically involve an investor paying money to a partnership in return for an interest in the partnership. The partnership will take upfront fees out of the investment and use the money to lease land and drill wells. After consultation with a tax expert, the investor might be able to take a tax write-off for the first year and then will share in any revenues generated by the wells.

telemarketAs the SEC explains, though many of these investments are legitimate, many are not. Though money can be made from the legitimate ones, the fraudulent schemes often involve a room of telemarketers who pressure you into giving them your money. After they have your money, they pay themselves. They may use all of their money to pay themselves, or they may invest whatever is left over in an oil or gas well, after they take what they want. Thankfully, there are some ways to tell the legitimate opportunities from the scams.

What can you do to protect yourself?

Generally, begin with the understanding that oil and gas investments—even legitimate ones—are risky. As NASAA explains, investments in drilling partnerships are very speculative, highly illiquid and may have a long holding period. This is so because no one knows for sure how much oil or gas a particular well may produce, and once you invest in the partnership, you may not be able to sell your interest, which means you may be stuck for a long time with an interest in a partnership that finds no oil. Further, oil and gas investments are riskier than they used to be. NASAA reports that “[d]rilling partnerships have always been a gamble, but recently, they have proven somewhat riskier than usual.”

red flagThe SEC provides some “Red Flag Warnings” you should look out for. The Red Flags include sales pitches that focus on current news headlines; “can’t miss” wells; unsolicited mail, faxes, emails and voice mail messages; limited or scarce opportunities; guarantees of high rates of return and tips or secrets that the seller tells you not to tell anyone else. If you encounter any, be wary.

The SEC also provides some advice on how you can protect yourself. Ask questions and verify the answers that you receive by conducting your own independent research. Try contacting the oil and gas regulatory agencies to get information on the company’s drilling history. This may confirm that the opportunity is legitimate, or that it is scam. Research the company on your own by going to the state’s secretary of state website and looking for financial information on the SEC’s website. Research the salesperson. Find out whether the person is licensed to sell securities in your state by running a BrokerCheck on him or her.

Verifying the company’s information on your own is especially important with oil and gas schemes because, as NASAA explains, many oil and gas scam artists work for a partnership in one state, have a physical operation in a second state and ask for money from people in a third state. This structure makes it more difficult to stop by their office or otherwise verify the information they give you. It also makes it more difficult for regulatory agencies to track down and prevent these schemes.

Conclusion

In the SEC’s words, “an educated investor is our best defense against fraud!” So, as we’ve said many times before, do your homework. If someone is asking you to hand over thousands of dollars in money you’ve earned, you have the right to ask them questions, and you should be comfortable with all of their answers before you invest. If you feel pressured or rushed, tell the salesperson you need some time to consider the investment, and during that time do your research.

As always, if you think you may have already fallen prey to a con artist, don’t be embarrassed or afraid to ask for help and contact our Clinic. For more tips on how you can avoid common frauds, check back in next week for the next edition of Friday’s Fraud.