Private Placements are Risky 

As an individual investor, you may be offered an opportunity to invest in an unregistered offering or private placement. You may be told that you are being given an exclusive opportunity. You may have seen an advertisement regarding the opportunity. The securities involved may be, among other things, common or preferred stock, a REIT, a limited partnership, a membership interest in a limited liability company, or an investment product such as a note or bond. Private securities offerings are generally limited by law to certain institutional and high net worth investors called “accredited investors”. This limitation exists because of the greater risks involved in private offerings as compared to, for example, investing in a publicly-traded stock. Keep in mind that private placements can be very risky and any investment may be difficult, if not virtually impossible to sell.    

A private placement is a securities offering that is exempt from registration with the SEC, and is also referred to as an “unregistered offering.” For the most part, private placements are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings. Private and public companies engage in private placements to raise funds from investors. Hedge funds and other private funds also engage in private placements. 

How do I know if I Bought a Private Placement or Unregistered Security?

Unregistered offerings often can be identified by capitalized legends placed on the offering documents and on the certificates or other instruments that represent the securities. The legends will state that the offering has not been registered with the SEC and the securities have restrictions on their transfer. You should read the offering documents carefully to understand the risks involved, and the broker must make fair and balanced communications to you when 

Earlier this month, the Financial Industry Regulatory Authority (“FINRA”) issued guidance to brokerage firms on communicating with retail customers about private placement offerings. It found that there were problems with the way firms communicated the risks of private placements to their retail customers making those communications misleading. 

Private Placement Retail Communications

Due to the fact that many brokers were not providing complete information on the risks of private placements when communicating with investors, FINRA provided guidance to brokers focused on disclosures regarding risk to the retail investor. The new guidance notes that in FINRA’s recent reviews of retail communications concerning private placement offerings found certain deficiencies including the failure of member firms to balance claims of potential investment benefits with the disclosure of risks

FINRA reminded the brokers that  Rule 2210(d)(1) requires the following:

1. That all member firm communications be fair, balanced, and not misleading.
2. Communications that promote the potential rewards of investment also must disclose the associated risks in a balanced manner.
3. Communications must be accurate and provide a sound basis to evaluate the facts with respect to the products or services discussed.
4. It prohibits false, misleading, or promissory statements or claims, as well as and the publication, circulation, or distribution of communication that a member firm knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading. 

FINRA noted that its recent reviews of retail communications concerning private placements have revealed deficiencies. It found that “most if not all investments in private placements are illiquid, and many such investments are speculative in nature. Some retail communications do not balance the claims of these investments’ benefits by disclosing these risks.” Other private placement communications “ have contained false, misleading, or promissory statements or claims such as assertions about the likelihood of a future public offering of the issuer, claims about the future success of the issuer’s new or untried business model, inaccurate or misleading assertions concerning the regulation or relative risk of the offering, or predictions or projections of investment performance prohibited by FINRA .”

A Broker Must Present a Balance of Risks and Investment Benefits

FINRA, therefore, reiterated FINRA’s Rule 2210(d)(1) requirement “that all member firm communications be fair, balanced and not misleading.” Due to these common deficiencies in communications with the public, FINRA  provided the following guidance to assist member firms in their creation, review, approval, distribution, or use of retail communications concerning private placement securities. For retail communications that are meant to highlight the potential benefits of a private placement investment, FINRA notes that its rules require retail communications that discuss the benefits of an investment to also include a discussion of its risks. Additionally, FINRA further notes that providing the risk disclosure in a separate document, such as a Private Placement Memorandum (“PPM”), or in a different section of a website, does not substitute for a disclosure contained in or integrated with retail communications governed by Rule 2210. 

This is important because a firm cannot simply rely on disclosure in a PPM if it makes misleading statements in communications with the public outside of the PPM.  

The Broker Cannot Predict Future Returns

Retail communications about private placements may not project or predict returns to investors such as yields, income, dividends, capital appreciation percentages, or any other future investment performance.

However, FINRA would allow forecasts of issuer operating metrics (such as forecasted sales, revenues, or customer acquisition numbers) that may convey important information regarding the issuer’s plans and financial position. Presentations of reasonable forecasts of issuer operating metrics should provide a sound basis for evaluating the facts as required by Rule 2210(d)(1)(A). For example, such presentations should include clear explanations of the key assumptions underlying the forecasted issuer operating metrics and the key risks that may impede the issuer’s achievement of the forecasted metrics.

Some issuers fund a portion of their distributions through the return of principal or loan proceeds. For example, a portion of a newer program’s distributions might include a return of principal until its assets are generating significant cash flows from operations. To ensure that communication is not false, exaggerated, unwarranted, promissory, or misleading, brokers must not misrepresent the amount or composition of such distributions. Nor may a broker state or imply that a distribution rate is a “yield” or “current yield” or that investment in the program is comparable to a fixed-income investment such as a bond or note. Presentations of distribution rates consistent with Rule 2210 would disclose:

1. that distribution payment is not guaranteed and may be modified at the program’s discretion;
2. if the distribution rate consists of a return of principal (including offering proceeds) or borrowings, a breakdown of the components of the distribution rate showing what portion of the quoted percentage represents cash flows from the program’s investments or operations, what portion represents return of principal, and what portion represents borrowings;
3. the time period during which the distributions have been funded from the return of principal (including offering proceeds), borrowings or any sources other than cash flows from investment or operations;
4. if the distributions include a return of principal, that by returning principal to investors, the program will have less money to invest, which may lower its overall return; and
5. if the distributions include borrowed funds, that since borrowed funds were used to pay distributions, the distribution rate may not be sustainable.15

FINRA believes that it is inconsistent with Rule 2210(d)(1) for retail communications to include an annualized distribution rate until the program has paid distributions that are, on an annualized basis, at a minimum equal to that rate for at least two consecutive full quarterly periods.

Investing in Private Placements is Risky 

These new rules are meant to tell your broker and brokerage firm that all communications it makes when selling you a Private Placement must be fair and balanced. Due to the complexities of such investments, often the sales materials or pitches given to prospective buyers are not fully and accurately disclosing the risks involved. Many people have lost money in Private Placement investments who did not understand that they were undertaking the risks that they were exposed to. If you or a loved one has suffered investment losses in a Private Placement or other unregistered security, we may be able to help you in your investment loss recovery.

You May be able to Recover your Investment Losses in a Private Placement  

If you or a loved one has suffered an investment loss as a result of a Private Placement or any other type of investment contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States. Contact us by filling out our online contact form, or calling 888-768-2499.