Monthly Archives: September 2013

FINRA Investor Alert – Private Placements: Evaluate the Risks before Placing Them in Your Portfolio

Each year, companies raise billions of dollars selling securities in non-public offerings 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. But investing in them is risky and can tie up your money for a long time

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. The offering document, sometimes called a private placement memorandum or term sheet, likely will contain limited information on the company’s business (and may not be provided at all, if the offering is sold only to accredited investors). 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.
But private placements are not exclusively offered to accredited investors. If you receive information about a private placement and don’t meet the net worth or income criteria, you may still be asked to invest as a non-accredited investor. Ask yourself if you can absorb a loss or potentially have your money tied up for a long time. Keep in mind that private placement securities are considered “restricted” securities and cannot be resold without registration or an exemption from registration – features that make them difficult to sell (illiquid) and may negatively impact the price at which you are able to sell them. In addition, the issuer typically does not have an obligation to provide liquidity to investors by buying the securities back when the investor wants to sell.
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, including the industry in which it operates to make an informed decision. Also ask yourself whether you are comfortable getting limited information for the duration of the investment. Most importantly, understand if, 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. Expect your broker to be knowledgeable about any risk factors associated with the company’s business, such as other competitors in the company’s space, or economic risks specific to the company’s business. Risk factors might also include risks associated with the issuing company itself, such as a weak balance sheet, use of leverage or a limited operating history. In addition, your broker should also be familiar with the risks and features of the private placement.
  • Ask your broker how this investment fits in with the mix of other investments you hold. How does it align with your risk profile? 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.
  • If you are provided with a private placement memorandum or other offering document, carefully review it. Make sure that statements by your broker or in other sale materials are consistent with it. The offering document—and any sales materials associated with the private placement—should be detailed and balanced. If you don’t understand them, don’t invest. Ask for a copy of the offering document, if one has not been provided to you.
  • Read the issuing company’s Form D, if available on the SEC’s EDGAR database. While it contains only limited financial information, it identifies the company’s executives and describes other matters that can be valuable. Also contact your state securities regulator for information.
  • For real estate private placements, ask about the schedule and source of investor distributions. Specifically, find out if the company’s income is able to cover those distributions, or if distributions may be made from proceeds from sales of additional shares or borrowings.
  • For oil and gas private placements, ask what you can expect to receive in return for your investment, and the circumstances that would result in a loss of some or all of your investment. Ask if the issuer has entered into any operational or services agreements with affiliates, since this can add additional costs that may dilute your return. Also ask about the issuer’s past performance in prior offerings, and review the map of the proposed well locations for drilling activity, whether successful or not, in the vicinity. Lastly, ask how—and when—you will be informed of the status of the drilling efforts and whether or not audited financials of the issuer or the specific offering will be provided.
  • Ask whether the private placement is being sold on a conditional or contingency basis. These types of private placements are designed to be concluded only when certain conditions are met, such as a specific dollar amount invested by a given date. If so, there should be specific information regarding whether the proceeds from sales of securities received prior to the contingency being satisfied may be accessed by the issuer. If any specified conditions or contingencies are not met, the offering document should clearly state that investors will be refunded their investment amount. If there are no contingencies, be wary. An offering that may proceed without a minimum level of investments or other conditions could be a red flag, as the issuer can use the proceeds immediately, regardless of the amount raised from other investors.
  • Be extremely wary of private placements you hear about through spam emails or cold calling. They are very often fraudulent. A legitimate investment salesperson must be properly licensed, and his or her firm must be registered with FINRA, the SEC and a state securities regulator—depending on the type of business the firm conducts. To check the background of a broker or investment adviser, use FINRA’s BrokerCheck. If you suspect fraud or believe you are being treated unfairly by a securities professional or firm, File a Complaint with FINRA.
  • 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.

Five Tax DON’Ts Before 2014

As we approach 2014, it is time to review the last several months and think about what can be done in an effort to lower your taxes for 2013. Here are five tax tips to consider before year-end.

  1. DON’T forget to maximize your retirement saving contributions
  2. DON’T forget to review where you are with capital gains and losses
  3. DON’T forget to get your charitable donations done by year-end
  4. DON’T forget to consider doing a Roth IRA conversion by December 31, 2013
  5. DON’T forget to bring your tax return if you are planning to meet with your advisor before year-end
For a copy of the entire article prepared by SEI click here