FINRA issued an investor alert Tuesday regarding private placements and the risks inherent in such securities. The private placement alert warns of the dangers of investing in such non-public securities offerings without first seriously contemplating the risks of such investment activity.
Amongst the pitfalls FINRA cites are fraud and sales abuses in which brokers, firms and other financial professionals provide false, inaccurate or otherwise misleading private placement memoranda ("PPM") and sales materials to investors looking to make an informed decision about how to invest.
Though FINRA discussed the possibility of egregious fraudulent schemes, the alert also addresses a seemingly "simple" failure by a firm to conduct adequate investigation or due diligence; such a failure can lead to key omissions from sales materials that could obstruct a broker or advisor's ability to determine if a private placement offering is suitable for a given customer.
Because private placements are exempt from registration under federal securities laws, investors might receive limited information about the issuer, fund manager and financial history of the offering. With less information publicly available, FINRA reminds investors that private placements are associated with heightened risk.
Private placements are accordingly "restricted" securities, meaning they cannot be resold without registration and as such are fairly illiquid products whose issuer does not have an obligation to buy back when the investor wants to sell.
FINRA specifically asks investors to take the following steps to best prepare for a potential investment in a private placement offering:
>> Research everything about the private placement—the company's business, industry and comparable products. Read any and all private placement memoranda, issuer's Form D (available on the SEC's EDGAR database) and selling documents, if applicable.
>> Come up with a liquidation plan. Even though information may be limited for the duration of an investment, know upfront how and when liquidation of the private placement is possible.
>> Ask questions of your broker, advisor or firm. Brokers should be experienced or otherwise knowledgable about risk factors associated with the company's business or associated investment options. This person should also have knowledge of the risks and features of the specific private placement security being offered.
>> Consider how this private placement will complement your portfolio—does the offering signify a departure from your risk profile or is the portfolio healthy enough to absorb the private placement? Ask your broker.
>> Hope for the best, prepare for the worst. Know and understand the circumstances that could result in a loss of some or all of your investment—investigate the issuer's past performance in prior offerings if possible and, in the case of oil and gas private placements, research the map of the proposed well to gauge if nearby projects have been successful in the past.
>> Ask whether the security is conditional or being sold on a contingency basis. FINRA advises that conditional private placements may refund investors their investment amount in the event that certain conditions—such as a minimum dollar level of investment—are not met while offerings that proceed without conditions could be a red flag.
>> Verify registration with FINRA (BrokerCheck) or the SEC (Investment Adviser Public Disclosure). Ask if the investment professional selling the placement is registered with either organization. If not, the risk increases. If so, check to make sure.
>> Consider the source. Legitimate investment salespersons must be properly licensed and registered with FINRA or the SEC. Unsolicited advertisements—such as spam e-mails or cold calls—may not be associated with a registered person or firm and, as such, may be susceptible to a fraudulent scheme.
If you have invested in a private placement offering that was unsuitable for your because of a materially false, inaccurate or incomplete private placement memorandum or a product whose excessive level of risk was a missed red flag because of a broker or firm's lack of due diligence, and such an investment resulted in a financial loss, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.