Private Placements

The company has fewer disclosure requirements than in a public offering, and the investment is typically hard to sell, so investors often have little information and no ready way out. Firms that sell private placements are expected to investigate an offering before recommending it. Losing money in a private placement is not, by itself, a claim. The key questions are whether the investment fit the investor and whether the professional who recommended it fulfilled their duties.

This May Not Be Your Fault

Private placements are often described as exclusive, which can make a loss feel like a personal misjudgment. It is not. These offerings come with less public information than a stock or bond, so investors depend heavily on the professional recommending one to look closely first.

A brokerage firm that recommends a private placement has a duty to carry out a reasonable investigation of the offering, and FINRA (the Financial Industry Regulatory Authority, which oversees brokerage firms) says it cannot rely only on what the company tells it. Under Regulation Best Interest, a broker recommending a private placement to an individual investor must also have a reasonable basis to believe it is in that investor’s best interest, and SEC staff guidance calls for heightened scrutiny of products like this one. When those duties are not met, responsibility may belong with the broker and the firm.

How Private Placements Work

Companies that raise money from investors generally must register the offering with the SEC or qualify for an exemption. Most private placements rely on an exemption known as Rule 506 of Regulation D. The offering is aimed mainly at “accredited investors,” a group the SEC defines largely by income or net worth, though one version of Rule 506 also allows a limited number of investors who do not meet that definition. The SEC’s investor bulletin on private placements points to several risks:

• Limited disclosure. Companies are not required to provide the disclosure that a registered offering requires.
• Little ability to sell. The SEC calls these investments “highly illiquid” and says investors should be prepared to hold them indefinitely.
• Higher business risk. The companies may be early stage and high risk, and investors should be able to afford a total loss.
• No SEC approval. Issuers file a notice called a Form D, but the SEC states that this does not represent SEC approval or registration of the offering.

These risks are why the brokerage firm’s own homework matters. In Regulatory Notice 10-22, FINRA reminded firms that they may not rely blindly on the issuer, and that a customer being sophisticated does not remove the duty to investigate.

Example: a retiree who needs income and access to savings may be a poor fit for an offering in a young company that pays nothing, cannot be sold, and shares little public information, even if the broker described it as an exclusive opportunity.

Common Examples of Private Placement Claims

• A broker recommended the offering without a reasonable investigation of the company, its management, or how the money would be used — see Regulation Best Interest
• The sales pitch or offering materials overstated returns, played down risks, or left out important facts — see Misrepresentation and Omission
• A high-risk, hard-to-sell offering was recommended to a retiree or a conservative investor — see Unsuitable Recommendations
• An investor with limited experience or modest savings was sold an offering without a clear explanation of how little the company had to disclose
• The broker sold the offering on the side, without the brokerage firm’s knowledge or approval — see Selling Away
• A large share of an account went into one private placement, or several tied to the same sponsor — see Overconcentration
• A firm failed to catch warning signs or to supervise a broker selling these offerings — see Failure to Supervise
• The company misused investor money, or paid early investors with funds from newer ones — see Fraud and Misappropriation

How Can You Protect Yourself From Private Placement Losses?

Private placements are not off limits, but they call for more questions than a stock or mutual fund does. A few steps that help:

• Ask what has been put in writing. The SEC suggests getting all the information you need, including whether the company’s financial statements are independently audited. If no one will give you offering documents, treat that as a warning.
• Ask how you would get your money out. Find out whether, when, and at what cost you could sell. Plan as if you could not.
• Ask whether you could afford to lose all of it. The SEC recommends asking this before investing in a company that could fail.
• Ask who approved the offering. Confirm the broker’s firm knows about and has approved the sale, and check both on FINRA BrokerCheck.
• Do not treat a filing as approval. A Form D on file with the SEC is a notice, not a review of whether the investment is sound.

Signs Your Private Placement May Have Been Unsuitable

• You were told the offering was exclusive or limited and felt pressed to decide quickly
• No one gave you offering documents, or walked you through them
• You were told about the possible return without a clear explanation that you could lose everything
• You learned you cannot sell the investment or get your money back
• A large part of your savings ended up in one offering, or in several from the same sponsor
• Your account paperwork describes conservative goals, but the offering is high risk
• You paid a company or an individual directly instead of through your brokerage account, or the investment does not appear on your account statements
• Payments, updates, or communication from the company stopped