Thanks to government oversight, equity investments that trade on major stock exchanges are highly regulated. Furthermore, many publicly held corporations are familiar names to most investors.
But one category of investments is riskier and less regulated. Keep in mind the advice “buyer beware” when evaluating a private placement investment.
What is a private placement?
According to the Securities Exchange Commission (SEC), “ . . . a private placement is a securities offering exempt from registration and is sometimes referred to as a private placement or an unregistered offering. Under the federal securities laws, a company may not offer or sell securities unless the offering has been registered with the SEC or an exemption from registration is available.”
The SEC has warned investors that, because these investments are unregistered and not subject to the same disclosure rules as other investments, there is a greater chance of fraud. Of course, not all private placement investments are fraudulent, but prior to investing any money, due diligence beforehand is critical.
Private placement red flags
An excellent starting point when evaluating a private placement offering is the SEC’s list of potential red flags:
- Claims of high returns with little or no risk
- Unregistered investment professionals
- Aggressive sales tactics
- Problems with sales documents
- No net worth or income requirements
- No one else seems to be involved except for the salesperson
- Sham or virtual offices
- Not in good standing in the state where it was formed
- Unsolicited investment offers from a stranger or someone you know
- Suspicious or unverifiable biographies of managers or promoters
Due diligence tips
One of the simplest ways to protect yourself is to make sure you are buying the offering from a registered broker. You can find information on registered brokers on BrokerCheck, a free service offered by the Financial Industry Regulatory Authority (FINRA).
The broker’s history will show any disclosures, an industry term indicating the broker may have a blemish on his or her record. If the offering isn’t being sold by a registered broker, that means the offering may not be subject to regulatory oversight.
Registered brokers and brokerage firms are required to perform a “reasonable investigation” of any product they are offering to their clients, according to SEC regulations. However, that investigation can vary and does not guarantee the risk or viability of a private placement.
Another way to guard against fraud is to conduct research on all the parties involved with the investment. The recidivism rate for financial crimes is very high; people and companies who’ve been caught defrauding investors in the past are likely to do so again. If anyone involved in an investment you’re considering has a criminal background, that’s clearly someone you want to shy away from.
For example, take the case of Howard Appel. Mr. Appel had previously committed securities violations, yet after being released from prison, he went right back to work. Ultimately, he was convicted of securities fraud three separate times.
A background check would have revealed his past and provided the extra caution investors need. Mr. Appel was involved in low-priced securities (LPS) manipulation, but he acquired large blocks of shares through private placements to execute his scheme.
One more red flag
Perhaps the largest red flag, and certainly the one that grabs the attention of many prospective investors, is when something seems too good to be true, and not just financially. Plenty of fly-by-night companies have promised cures for cancer, 100% bullet-proof vests, 10,000% returns, and many other incredible promises. No doubt, someone will claim to have invented time travel in a limited-time offering to investors.
If it sounds a little far-fetched, it probably is. In the end, it’s your money you’re investing. Make sure you know where it’s going.
We hope you found this article useful. For assistance researching a potential investment, contact Integras Intelligence at 212.871.1274.
