FINRA Cautions Investors on the Risks of Investing in Private Placements

FINRA recently issued an Investor Alert, “Private Placements — Evaluate the Risks Before Placing Them in Your Portfolio,” warning investors about investing in private placements. 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, and prospective investors generally must be “accredited” to invest in a private placement, meaning that the investor has certain minimum net worth or annual income. Examples of private placements include hedge funds, oil and gas partnerships, private real estate investment trusts (“REITS”), tenants in common (“TIC”) investments, and other risky, speculative investments.

In the alert, FINRA cautions that private placements are “risky and can tie up your money for a long time.” FINRA also warned investors that it has “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.” FINRA further stated that “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.”

“Investors should understand that many private placement securities are issued by companies that are not required to file financial reports, and investors may have problems finding out how the company is doing. Given the risks and liquidity issues, investors should carefully assess how private placements fit in with other investments they hold before investing,” said Gerri Walsh, FINRA’s Senior Vice President for Investor Education.

FINRA advises investors to take care when considering a private placement investment, and offers several tips, including:

• 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.

Unfortunately, FINRA’s Investor Alert comes too late for many investors who invested in TICs, nontraded REITs, promissory notes, and oil and gas partnerships in 2007 and 2008. For example, in many cases conservative, risk averse investors purchased shares of nontraded REITS for $10, and received distributions consisting of borrowed funds or return of principal without realizing the source of their distributions. Thereafter, many nontraded REITs halted all distributions, and investors saw share values plummet. In some cases, investors have lost not only their income stream, but also principal invested in the nontraded REIT.

Sonn Law Group specializes in representing investors (not brokerage firms) in securities arbitration and investor fraud cases throughout the country. Sonn Law Group has represented numerous investors in FINRA arbitration claims against the brokerage firms who sold illiquid, high-commissioned, non-traded investments, including TICs, REITS, promissory notes, and more, who have filed claims against NFP Securities, Inc., and Investors Capital Corp., among others. Sonn Law Group continues to investigate investment claims against other firms and financial advisors regarding illiquid private placement investments.

To learn more, including whether you may have a claim for your private placement investment or other investment losses, please call us at 844-689-5754 or complete our “contact form.”