Finra warns on private-placement investments

Wall Street’s industry-funded regulator issued a new investor alert in the lead up to Monday’s lifting of the general-solicitation ban on private-placement investments.
The alert, ( “Private Placements — Evaluate the Risks Before Placing Them in Your Portfolio,” ) cautions that investing in private placements, or an offering of a company’s securities that is not registered with the Securities and Exchange Commission, is “risky and can tie up your money for a long time.”
The general-solicitation ban for private placements, eradicated by a statute in the Jumpstart Our Business Startups Act, was part of a regime that kept unregistered equity offerings out of reach of the inexperienced investor, with only “accredited investors” allowed to invest unless a company was granted an exemption.
“For companies to be eligible for that exemption, they had to limit the type of investors they were soliciting,” said Gerri Walsh, senior vice president for investor education for the Financial Industry Regulatory Authority Inc., which wrote the latest in a series of cautionary investor alerts. “Our concern now is that regular investors will be seeing these solicitations.”
A positive aspect of the general-solicitation ban, beyond protecting overzealous investors, was that general solicitation was often a red flag for companies engaged in fraud, according to Ms. Walsh.
While the broader consequences of lifting the ban are hard to predict, the average investor should remain on guard.
“We wanted to make sure investors know that any private offering of securities may have liquidity risks,” Ms. Walsh said. “If the company never goes public, you may not be able to get back what you put in. Depending on the structure of your portfolio, you may be exposed to some sort of concentration risk.”
Though the average investor will be more easily accessible to companies offering private placements, broker-dealers are still bound by SEC rules on the matter.
“With broker-dealers, there are rules related to suitability of recommendations,” Ms. Walsh said. “There are also rules related to due diligence for broker-dealers before recommending private-placement investments.”
Unlike traditional stocks, private placements are exempt from many public reporting requirements. Important financial information about private-placement companies that could affect the performance of their shares may not be available, according to Finra.
Longstanding federal law restricts how companies solicit investors in private placements, but billions of dollars flow into the securities each year, to the benefit of a number of small and startup companies, according to Finra. They are less liquid, or harder to sell, than traditional stocks because of regulatory restrictions.
Finra has sanctioned firms and individuals for fraud and false advertising in hawking private placements.
Finra recommends that investors get a second opinion on a private placement from a licensed broker, research the offering company extensively and plan for the security’s liquidation. Investors also should learn whether the private placement has any attached conditions or contingencies, which affect how the issuer spends the money it raises.
Information on the companies will be made available in their offering document and Form D, which is filed with the SEC, and possibly also from state securities regulators. Finra also has special guidance for private placements dealing with oil, gas and real estate investments.