Private Placements

Private placements are unregistered securities that are issued and sold privately to investors without being registered with the Securities and Exchange Commission (SEC). The offer and sale of securities is regulated by the Securities Act of 1933 and issuers of unregistered securities usually rely on an exemption to the registration requirement under the Act to sell securities through private placements. The most common exemptions relied upon by issuers are found in Regulation D of the Act.

These securities offerings are exempt from registration under federal securities laws mainly because they are not being offered to the public at large. Brokerage firms that sell securities in non-public offerings, relying on an exemption from registration under Regulation D, must adhere to the requirements of FINRA Rule 5123 Private Placement of Securities or FINRA Rule 5122, entitled “Private Placement of Securities Issued by Members.”

Unregistered securities purchased through private placements are subject to additional risks from those found in registered securities. The two main risks associated with investing in private placements are: the potential for fraud; and the inability to easily and quickly resell the securities, also known as illiquidity.

First, since unregistered securities offered in private placements are not subject to many of the laws, regulations, and disclosure requirements that securities registered with the SEC are subject to, there is a greater opportunity for fraud. Investors should be wary when investing in these types of securities and should be on the lookout for several red flags.

Second, securities acquired through private placements will be “ restricted securities,” meaning that investors will not be able to easily resell them and/or there may not be any secondary market for them. This may subject investors to holding the shares for an indefinite period or be burdened with meeting the requirements under Rule 144 to remove the restriction on the securities in order to sell them in the secondary markets.

As regulated entities, brokerage firms are required under federal securities laws and FINRA rules to investigate the securities they recommend to investors. (FINRA Regulatory Notice 10-22). Private Placement Memorandums (PPMs) used by issuers to communicate the specifics of the securities offering must be reviewed and verified.

Brokerage firms’ obligation to conduct due diligence extends not just to the offering but to the representations being made by the issuer before promoting and recommending a private placement to investors. Because private placements are not scrutinized to extent of an initial public offering (IPO) for traded securities, investors do not have as much information available on the offering and are forced to rely upon brokerage firm representations when making their investment decisions.

Therefore a brokerage firm’s due diligence review must determine whether the information that it relies upon is credible and whether any further investigation is required. Any deficiencies in the review must be further investigated and any conflicts of interest or misrepresentation or omission of material facts must be clarified or corrected before brokerage firms can make any representations to investors about the private placement. Any failure to meet this obligation can lead to sales practice violations under FINRA rules.

Silver Law Group can help you determine whether an investment loss in a private placement is the result of securities fraud or FINRA sales practice violations. If an investor suffers losses from a private placement they may be able recover their losses in a FINRA arbitration claim.