Investment Disputes Relating To Regulation D And Private Placements

The SEC recently issued a press release warning investors about investing in private placements. As the name suggests, it’s an alternative form of fundraising by hedge funds as well as startups and companies who aren’t ready to or interested in issuing an IPO (initial public offering.)

These placements are generally offered only to select individual and institutional investors and have less regulatory requirements. They aren’t registered with the SEC because they aren’t traded publicly, so there isn’t as much information available for investors.

But by their very nature, private placements can also be indicative of a fraudulent scheme. Not all private placements are fraudulent, but investors should always be aware and on guard for highly touted and unusual investments. The SEC has specific rules regarding these types of placements.

While most investors do not understand Reg D or Private Placements, these are traditionally investments that do not trade on a public stock exchange.  In recent years, private placements have become popular amongst smaller broker-dealers who sell these complex investments to small investors claiming these investments offer greater security than the stock market.  However, in reality, these investments are illiquid and pay the broker a large commission.

What is a Regulation D

The government enacted The Securities Act of 1933 following the 1929 market crash to ensure that investors received disclosures and information when buying securities. As part of the Act, Regulation D detailed exceptions for registration that allowed for private placement.

These exemptions under Regulation D apply to the sale of unregistered securities and are commonly used for this purpose. They are:

• Rule 506(b), in which a seller can sell securities to as many accredited investors as they like, but to only 35 who are non-accredited.
• Rule 506(c), which allows a seller to solicit investors for private placements, including advertising, which can include direct mail, radio, TV, live seminars, and social media. However, only accredited investors are eligible, and the seller must verify their accredited investor status before selling.
• Rule 504 restricts some sellers to a maximum of $10 million of securities in a twelve-month period. The seller doesn’t have any disclosure requirements and can sell to as many and any type of investors.

Any offering documents related to the investment should have references to Regulation D. Documentation without any references should be considered a red flag.

The Risks Involved Investment in a Private Placement

Private placements are generally reserved for institutional and accredited investors for good reason. The higher returns are also a much higher risk, which may not be suitable for smaller investors’ risk tolerance and investment objectives.

Anyone investing in a private placement must be able to:

• Afford to lose their entire investment in the placement
• Recover from the possibility of a lost investment

Institutional investors have investments in a wide range of securities, so they are usually able to absorb smaller losses. But the “small” loss for an institution could bankrupt an individual investor.

You will likely not be able to sell the security should you decide you want out. Most are illiquid, and because they’re not traded on an exchange, you’ll have to hold them indefinitely. This doesn’t mean you’ll never receive a return. It just means that the return might be a long time coming, depending on the investment itself.

Additionally, private placements don’t come with the same protections as securities that are traded on an exchange.

Not all private placements are fraudulent, but due diligence is a must when considering one for your portfolio.

SEC Rules Relating To An Accredited Investor

These are investors who are not only sophisticated and experienced in investing, but they also meet one of the following criteria:

• They have earned income that exceeded $200,000 (or $300,000 together with a spouse or “spousal equivalent”) in each of the prior two years, and reasonably expects to earn the same amount in the current year
• They have a net worth over $1 million, either alone or with a spouse or “spousal equivalent.” This excludes the value of their primary residence and any loans secured by the residence up to the residence’s value
• They are a broker or other financial professional that hold certain certifications, designations, or credentials in good standing, such as and including a Series 7, 65, or 82 license.

A “spousal equivalent” describes someone in a relationship that, if married, would be the other’s spouse. Many states have “domestic partnerships” which may fit the description. In a few states like Texas, “common law marriage” may also apply. States like Florida that do not have common law marriage may recognize a common law marital relationship from another state as a legal marriage. If you’re not sure, check with a family law attorney to determine if you have a “spousal equivalent,” domestic partnership, or a legally qualified marriage in your state.

Did Your Broker Sell You an Unsuitable Private Placement?

You’re the only person who can make that decision, because, ultimately, it’s your money. As always, we strongly urge you to research and ask questions as much as you can prior to making any type of investment, whether it’s a private placement or something else. Even legitimate investments with the possibility of high returns come with a high risk of loss.

You can read the SEC’s press release on their website to learn more about Regulation D and private placements. The SEC also has additional information on exempt offerings and ten red flags that may indicate the fraudulent nature of unregistered offerings.

Did You Invest In Private Placements?

Silver Law Group represents investors in securities and investment fraud cases. Our lawyers are admitted to practice in New York and Florida and represent investors nationwide to help recover investment losses due to stockbroker misconduct. If you have any questions about how your account has been handled, call to speak with an experienced securities attorney. Most cases are handled on a contingent fee basis, meaning that you won’t owe us until we recover your money for you. Contact us today at (800) 975-4345 and let us know how we can help.