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Private placement or “Regulation D” offerings have become an important source of capital for American enterprises.

Since 2008, companies have issued over half a billion dollars a year in securities through the private placement market.

Although the private placement market remains a viable source for small business growth, the Financial Industry Regulatory Authority (FINRA) has discovered significant issues in several of their investigations.

Some of these alarming issues include fraud, illiquidity, valuation figures, sales practice abuses, and marketing materials issued with inaccurate statements or omitted information pertinent to making a sound investment decision.

Such problems pose a legitimate concern for more than most investors who are attracted to the private placement market.

However, there are important steps broker-dealers can take in order to limit the possibility of significant losses by clients in the private placement market.


There are federal and state laws that prohibit the sale of securities that are not registered with the Securities and Exchange Commission (SEC) and state securities agencies unless the securities or the particular securities transaction is exempt from registration.

There are three rules under Regulation D (504, 505 and 506) that provide exemptions from the registration provisions under section 3(b) of the Securities Act.

Rule 504 applies to limited offerings for which the total offering price of securities within a one year period does not exceed $1 million.

Under Rule 505, limited offerings of securities that do not exceed $5 million within a one year period are exempt and can be sold to an unlimited number of “accredited investors” and up to 35 non-accredited investors.

Rule 506 provides a legal safe harbor for an exemption from registration under Section 4(2) of the Act for the sale of securities to an unlimited number of accredited investors and up to 35 non-accredited investors providing that non-accredited investors possess a certain degree of financial sophistication.

According to Regulation D, an accredited investor is defined as “any person who meets, or who the issuer reasonably believes meets, certain requirements, including natural persons with a net worth in excess of $1 million or annual income in excess of $200,000 (or $300,000 jointly with a spouse).”


The following are some of the primary risks associated with investing in private placements:

Inadequate disclosure – private placement marketing materials are oftentimes issued with inaccurate statements or omitted information, which are necessary to make an informed investment decision. In fact, Rule 505 and 506 do not require issuers to provide any specific written information concerning the offering to accredited investors.

Lack of liquidity – Private placements are illiquid investments. Redemptions are usually restricted, which means that money can be locked up for months or even years. They are not publicly traded, and there is no ready secondary market where securities can be sold. If investors have immediate cash needs, they may not be able to sell the private placement securities without violating the law, and if they are able to sell them, they might find themselves struggling to sell them at a just price.

Imprecise valuation – Since no ready market for private placements exists, valuation is left up to mathematical models that may use unreliable factors. Oftentimes, valuations are left up to personal estimates.

Insufficient broker due diligence – broker-dealers that sell risky private placements should carry out rigorous due diligence procedures prior to offering them to their clients. However, too many broker-dealers are ignoring red flags and Financial Industry Regulatory Authority (FINRA) suggestions that could prevent clients from suffering investment losses. This may be due to concerns by broker-dealers that private placement sales may slow if clients are aware of the significant risks they pose.


If a broker-dealer lacks important information about a private placement issuer or its securities it is recommending, the broker-dealer must disclose this fact along with the risks that arise from a lack of information.

However, a broker-dealer is not permitted to rely blindly upon an issuer for information about a company, nor may it rely on information given by the issuer or its counsel in the place of conducting its own reasonable investigation.

Broker-dealers are required to exercise a high degree of care in investigating and verifying an issuer’s representations and claims.

Even if a broker-dealer’s customers are sophisticated and well-educated investors, it does not obviate their duty to conduct a reasonable investigation.

It is recommended that broker-dealers provide the same information to accredited investors as they are required to provide to non-accredited investors to help avoid liability for fraud.

The following are some of the other responsibilities that broker-dealers are required to fulfill when recommending private placement investments to customers:

Suitability obligations – broker-dealers must conduct a reasonable basis suitability analysis when recommending securities to both accredited and non-accredited investors. This analysis should take into account the investor’s knowledge and experience and not just the investors net worth or income. In addition, broker-dealers must perform a customer specific suitability analysis that considers the individual customer’s other holdings, financial situation and needs, tax status, and investment objectives. Customer should also fully understand and be able handle the risks involved in private placement investing.

Conduct reasonable investigations – broker-dealers should, at a minimum, conduct a reasonable investigation concerning the private placement issuer and its management, the business prospects of the issuer, the assets held by or to be acquired by the issuer, the claims being made, and the intended use of proceeds of the offering. Even if a subsequent offering may be for the same issuer, a broker-dealer must conduct a reasonable investigation in connection with each individual offering. Broker-dealers should also retain records documenting bot the process and results of its investigation.

Resolve conflicts of interest – If a broker-dealer is an affiliate of an issuer in a Regulation D offering, it must ensure that its affiliation does not compromise its independence as it performs its investigation. Thus, broker-dealers must resolve any conflict of interest that could hinder its ability to conduct a detailed and independent investigation.

Investigate private placement memorandum – a broker-dealer that prepares private placement memorandum has a duty to investigate securities offered under Regulation D and any representations made by the issuer in the private placement memorandum or other offering document. Sales literature concerning a private placement that a broker-dealer distributes is considered a communication with the public, and if such materials are not fair and balanced or it misleading, the broker-dealer may be deemed to have violated securities laws, rules or regulations.

Identify red flags – while conducting a reasonable investigation, broker-dealers must note any information that it encounters that could be considered a “red flag” that would alert a prudent person to conduct any further inquiry. A broker-dealer’s reasonable investigation responsibilities would obligate it to follow up on any red flags that it encounters during its inquiry as well as to investigate any substantial adverse information about the issuer. One example of a red flag is an issuers refusal to provide a broker-dealer with information that is necessary for the broker-dealer to meet its duty to investigate the offering.

Investigate experts before reliance – broker-dealers may retain counsel or other experts to assist the firm in undertaking and fulfilling its reasonable investigation responsibilities. However, a broker-dealer must diligently review the qualifications and competence of counsel or experts retained to perform an investigation on its behalf. The use of counsel or experts does not complete the broker-dealer’s investigation responsibilities, insofar as a review of the counsel’s or expert’s report may identify issues or concerns that a broker-dealer must further investigate.

Establish supervision procedures – broker-dealers that engage in private placement offerings must have supervisory procedures that are reasonably designed to ensure that the firm’s personnel and registered representatives: 1) engage in an inquiry that is sufficiently rigorous to comply with their legal and regulatory requirements; 2) perform the analysis required FINRA rules; 3) qualify there customers as eligible to purchase private placement offerings; and 4) do not violate the antifraud provisions of the federal securities laws or FINRA rules in connection with their preparation or distribution of offering documents or sales literature. These procedures must be reasonably designed to ensure that each private placement offering is properly supervised before they are marketed and sold to customers.

Broker-dealers who fail to carry out their responsibilities can be liable to investors for damages stemming from a private placement investment.

The Securities and Exchange Commission (SEC) holds broker-dealers responsible for recommending private placements and imposes the aforementioned duties concerning a security and its issuer’s representations.

This duty stems from the special relationship broker-dealers share with their clients.

Failure to carry out this duty could result in a violation of FINRA antifraud provisions and federal securities laws, particularly the Securities Act and Section 10(b) of the Securities Exchange Act.

It can also constitute a violation of FINRA rules requiring just and equitable principals of fair trade.

In addition, investors who have suffered damages in a private placement offering can bring forth claims against their broker-dealers to recover monetary losses.

The most important of investors’ rights is the right to be informed!

This article on private placements is by the Law Offices of Robert Wayne Pearce, P.A. , located in Boca Raton, Florida.

For over 40 years, Attorney Pearce has tried, arbitrated, and mediated hundreds of disputes involving complex securities, commodities and investment law issues.

The lawyers at our law firm are devoted to protecting investors’ rights throughout the United States and internationally!

Please visit our blog, post a comment, call 800-732-2889, or email Mr. Pearce at pearce@rwpearce.com for answers to any of your questions about losses you may have suffered in private placements and/or any related matter.

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Robert Wayne Pearce

Robert Wayne Pearce of The Law Offices of Robert Wayne Pearce, P.A. has been a trial attorney for more than 40 years and has helped recover over $170 million dollars for his clients. During that time, he developed a well-respected and highly accomplished legal career representing investors and brokers in disputes with one another and the government and industry regulators. To speak with Attorney Pearce, call (800) 732-2889 or Contact Us online for a FREE INITIAL CONSULTATION with Attorney Pearce about your case.

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