Private Placements are considered alternative investments and are issued under Regulation D under the Securities Act of 1933. Regulation D contains rules for issuing securities that provide exemptions from the more rigorous Securities and Exchange Commission (SEC) registration requirements and allows companies to issue securities without normal disclosures.
Investors who are recommended private placements must meet the “accredited investor” standard under Rule 501. Rule 501 defines “accredited investor” as any person who has a net worth in excess of $1,000,000, excluding residence, or annual income in excess of $200,000, $300,000 if filing jointly with a spouse, in the two most recent years.
According to a 2008 estimate, companies issued approximately $609 billion of securities through Regulation D offerings. While the private placement market allows many small companies to raise capital, regulators have raised a number of issues with due diligence procedures and brokerage firm sales efforts when selling private placements to investors. The North American Securities Administrators Association says private placements are one of the most common cause of regulatory action by state regulators. States brought more than 200 enforcement actions involving private placements in 2011, more than doubled the number of action in2007.
FINRA recently published its 2014 Business Conduct Priorities stating that the regulator “remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles…may be challenging for investors to understand.” FINRA stated that its “concerns are magnified when there is a strong incentive for the firm or registered representative to recommend the product because of its fee or compensation structure.” Private placement usually provide greater financial benefit to the broker than other types of investments.
The agency also stated that it “has long been concerned about abuses in the sale and marketing of private placement securities and we regularly have identified this issue as an examination priority.” FINRA also noted that changes to Regulation D under the Jumpstart our Business Startups (JOBS) Act now allow general solicitation and advertising when offering private placements. FINRA commented that the JOBS act loosing of regulations “provides new challenges for firms to ensure advertisements and other marketing materials are based on principles of fair dealing and good faith, are fair and balanced, and provide a sound basis to evaluate the facts about securities acquired in a private placement.”
FINRA reiterated that it would continue to “examine firms’ private placement activity to ascertain whether firms are taking reasonable steps to validate that investors meet accredited investor standards.” FINRA also commented that the JOBS act in no way diminishes a firm’s responsibility to conduct adequate due diligence on its offerings to ensure any recommendations to purchase securities in a private placement are suitable for the investor
There are steps that investors can take to try to protect themselves from investing in private placements that are inappropriate for them or may be bad investments.
1) If a broker can’t answer your questions about the private placement company, its business model, or executives’ backgrounds, approach with caution.
2) Limit your exposure in alternative investments. Some sources advise that as little as 5 percent of the portfolio should be invested in these instruments.
3) Find out how long the private placement has been sold to investors. Many alternative investments haven’t suffered through a market downturn so it’s uncertain how it would perform under stress.
4) Get all representations about the investment in writing from the broker. Check these statements against the private placement memorandum to make sure that the broker’s verbal representations don’t contradict the terms of the investment.
5) Find out how much the financial adviser is getting paid for recommending the investment.
6) Don’t complete a subscription agreement or accredited-investor questionnaire if you are asked to falsify your financial information in order to qualify.
The attorneys at Gana Weinstein LLP are experienced in handling claims involving the inappropriate recommendation of private placement securities. Our attorneys can help you detect and uncover suspicious activity in your accounts. Our consultations are free of charge and the firm is only compensated if you recover.