FINRA Reminds Investors to Be Careful Investing in Private Placements

The Financial Industry Regulatory Authority (FINTRA) has issued an investor alert to remind investors of the risks of investing in private placements. Companies raise billions of dollars every year selling securities in non-public offerings that are exempt from registration under the federal securities laws. Small companies often raise capital through these "private placements." But FINRA reminds investors that investing in private placements is risky and can tie up your money for a long time. And, to state the obvious, you can also lose some or all of your money. In short, private placement investors often are subject to securities fraud and stockbroker misconduct.

Fraud and Sales Abuses

Due to the lack of regulatory oversight, private placements are more prone to fraud and sales abuses. The types of potential misconduct includes inaccurate statements in offering documents, material information that is omitted from offering documents, false or non-existent financial records, and outright fraud and theft, including Ponzi schemes.


Some Things You Should Know About Private Placements


You should know that there may be limited information about the issuer and management of the company issuing the private placement securities, and there may be limited or non-existent financial reporting. Financial reports may have received the vetting and approval of independent auditors. And since many private placement securities are issued by companies that are not required to file financial reports with the SEC, you may have problems finding out how the company is doing, and gauging how your private placement is performing. In addition, private placements generally are illiquid and can be difficult to sell when you own them, and the issuer typically does not have an obligation to buy the securities back when the investor wants to sell.


Who Can Invest?


You generally must be an "accredited investor" to invest in a private placement. This means, broadly speaking, that you must have a net worth (excluding your primary residence) of over $1 million - either alone or with a spouse. Or you must have income exceeding $200,000 over each of the last two years ($300,000 with a spouse), along with a reasonable expectation that you will earn the same amount during the current year. But even if you qualify as an accredited investor you must be willing to accept the significant risk of loss associated with private placements.

Historically, companies that sold private placements were prohibited from engaging in general solicitations or using advertising to market the securities. But the 2012 JOBS Act changed this. In accordance with SEC rules that take effect September 23, 2013, companies are allowed to conduct general solicitation and advertising for most private securities offerings. While the target audience will be accredited investors, the reality is that all investors - whether accredited or not - likely will be exposed to private placement sales pitches and advertising. We assume that the expected widespread marketing of private placements may have prompted FINRA's recent investor alert.


Tips for Investing in Private Placements


Make no mistake about it, notwithstanding many sales pitches that profess safety, private placements generally can be very risky investments. Before subjecting any of your money to such risk, it is important that you do your homework.

Find out as much as you can about the company's business, including the industry in which it operates. Also ask yourself whether you are comfortable receiving limited information from the company after you make the investment. Finally, you must be comfortable with the fact that you may not be able to sell the securities after you buy them.

Ask your broker what information he or she was able to review about the issuing company. Be careful if the only information the broker knows is information that the issuer of the securities provided. Ideally, the broker or the brokerage firm should have access to an independent evaluation of the company. Ask your broker how the investment fits in with the mix of other investments you hold.

If you are provided with a private placement memorandum or other offering document, carefully review it. Make sure that statements by your broker or in other sale materials are consistent with it. If you don't understand the offering document or any related sales material, then don't invest. Perform an internet search for information about the company's principals. Such a simple search can uncover a vast amount of information and can save you from future financial devastation. For example, you may learn that the company's executives previous have been accused of financial fraud.

Be extremely wary of private placements you hear about through spam e-mails or cold calling. They are very often fraudulent. A legitimate investment salesperson must be properly licensed, and his or her firm generally must be registered with FINRA, the SEC, and a state securities regulator. To check the background of a broker or investment adviser, use FINRA's BrokerCheck online system, which generally will reflect prior customer complaints.


Don't Make Payments to Individual Brokers


When you pay for the securities, don't make checks or other payments directly to your broker, adviser. In most cases, you should only send money directly to your brokerage firm, its clearing firm, or another financial institution. This will help you keep track of the funds and avoid the potential for fraud.

If you lost money in a private placement, contact a Dimond Kaplan & Rothstein, P.A. FINRA arbitration lawyer for a free consultation about your rights and your ability to recover your losses.

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