Private Placements—Evaluate the Risks before Placing Them in Your Portfolio

Financial Industry Regulatory Authority (FINRA)
Private Placements—Evaluate the Risks before Placing Them in Your Portfolio
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Who is an accredited investor? ©FINRA

Each year, companies raise billions of dollars selling securities in non-public offerings of securities that are exempt from registration under the federal securities laws. These offerings, known as private placements, can be a key source of capital for American businesses, especially small or start-up companies. But investing in private placements is risky and can tie up your money for a long time. As with other investments, you can also lose some or all of your money.

Fraud and Sales Abuses

FINRA uncovered fraud and sales practice abuses related to private placements that resulted in sanctions of firms and individuals for providing private placement memoranda and sales materials to investors that contained inaccurate statements. In addition, some materials omitted information necessary to make informed investment decisions, and some firms failed to conduct an adequate investigation of the issuer to determine if the private placements were suitable for their customers.

What Is a Private Placement?

Simply stated, a private placement is an offering of a company's securities that is not registered with the Securities and Exchange Commission (SEC) and is not offered to the public at large.

Many private placements are offered pursuant to Regulation D of the Securities Act of 1933, which specifies the amount of money that can be raised and the type of investor that can be solicited to participate in the offering.

If you are offered an investment in a private placement, you should know that there may be limited information about the issuer and management, and limited financial reporting. And since many private placement securities are issued by companies that are not required to file financial reports, you may have problems finding out how the company is doing, and gauging how your private placement is likely to perform over time.

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.

General Solicitation Landscape Changing

Historically, companies that claimed an exemption under Regulation D were prohibited from engaging in general solicitation or using advertising to market securities. 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 Regulation D Rule 506 private security offerings. While the target audience will be accredited investors, the reality is that all investors—whether accredited or not—will likely be exposed to private placement sales pitches and advertising, for instance by Regulation D crowdfunding platforms, as never before.

Private Placement Tips

Follow these tips to determine if a private placement investment is right for you.

• Find out as much as you can about the company’s business and understand how and when you might liquidate your private placement securities.

• Ask your broker what information he or she was able to review about the issuing company and this private placement.

• Be extremely wary if you receive paperwork to sign about a private placement without having a personalized discussion with your broker about why such an investment is right for you.

• Be extremely wary of private placements you hear about through spam emails or cold calling. They are very often fraudulent.

Ask and check. Ask if the investment professional selling the private placement is registered with FINRA or the SEC. Then check to see if this is in fact the case.

For more tips about private placements, go to the FINRA website.

Gerri Walsh is Senior Vice President of Investor Education at the Financial Industry Regulatory Authority (FINRA).

FINRA is the largest independent regulator for all securities firms doing business in the United States. Our chief role is to protect investors by maintaining the fairness of the U.S. capital markets. FINRA does not endorse, sponsor, or guarantee, nor is it sponsored by, any advertisers on this site, and any dealings with those advertisers are solely between you and the advertisers.

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