‘Boiler Room’ Con Artists Use Cracks in Law

Fraudulent telephone marketers, who bilk consumers out of billions of dollars a year, often escape prosecution because they tailor their crimes to fall through jurisdictional cracks in state and federal law, a top California regulator testified Thursday.

In addition, law enforcement agencies are so understaffed that they usually cannot track the extent to which telephone “boiler room” operators comply with laws already on the books, said G. W. McDonald, assistant commissioner for enforcement of the California Department of Corporations.

McDonald was among eight state and federal officials who testified on the second and final day of telemarketing fraud hearings conducted by the consumer affairs subcommittee of the House Committee on Government Operations.

The committee is studying ways that Congress can help state and federal agencies arrest and prosecute fraudulent boiler room operators, who use telephones to market everything from vitamins and office supplies to investments in coins and precious metals, and then either fail to deliver the goods, or deliver products worth a fraction of what the victim paid.

McDonald was particularly critical of what he said is the inability of the California Attorney General’s office, because of inadequate staffing, to keep tabs on the more than 300 boiler rooms in the state that are required to register under the state’s 1986 Telemarketing Registration Act.

“The California telemarketing statute has not worked because it has not been enforced,” he said.

“The sales material, the (telephone sales) script, and everything they (telemarketers) file with the A. G. is not what they’re actually using. So if you don’t follow up . . . having all the registration laws in the world doesn’t do anything,” McDonald said.

Equally troublesome, McDonald testified, are the number of fraudulent telemarketing pitches that fall between murky legal definitions that distinguish securities from commodities.

The most serious such scam involves the financing by legitimate banks of precious metals purchases made by investors who are brought into the market by independent “dealers” operating out of telephone boiler rooms. The dealers broker both the purchase of the metals and the bank financing. In that process the metal serves as collateral for the bank loan and the dealers gain an inflated commission.

The fraud involves the failure of the boiler room operators to disclose to the investor the dealer’s huge commissions. Authorities have calculated that in many cases the value of the metal would have to rise 30% during the life of the contract merely to allow the investor to earn back the money he has paid in commissions and fees.

“The banks deny any responsibility for the massive abuse at the dealer level,” McDonald said in written testimony presented to the subcommittee.

Under current law, the Department of Corporations cannot regulate California bank-financed precious metals programs because the department has concluded that the programs do not involve the sale of securities.

At the same time, the federal Commodities Futures Trading Commission, which regulates transactions in commodities futures, has determined that the bank programs amount to “cash and carry,” where the purchaser pays for the metal and immediately receives it, even though a portion is financed. Therefore, the commission has concluded that no futures contract is involved and it has no jurisdiction.

In another example of the limits placed on state enforcement authority, McDonald said that courts have held that his department has no authority to regulate so-called “dirt” schemes, in which boiler room operators market precious metals or minerals not yet mined. An investment in gold not yet mined is not a security transaction, according to a decision of the U.S. 9th Circuit Court of Appeal.

“Of course, as a result of these cases, the boiler rooms have moved to include mineral aggregate offerings and mining interest offerings in their portfolios,” McDonald testified.