Regulators Gets Tough on Stockbrokers Selling Private Placements

Lose Money in a Private Placement Offering? We May Be Able to Help

[Post updated through 2021] The Financial Industry Regulatory Authority (FINRA) is cracking down on stockbrokers and their broker dealers that sell private placements. For those not familiar with the term “private placement” this is a funding round of securities that are sold before a security goes public. They are not initially traded on an exchange and are often purchased by institutional investors and high net wealth individuals.

Recent frauds have caused FINRA to scrutinize the brokers selling these unregistered securities. Because they are not sold at public offering, the due diligence information available to purchasers is scarce. Unfortunately, many broker dealers rely on third party due diligence.

Companies seeking to raise money often hire lawyers to assist with their due diligence. The lawyers get paid by the company seeking to raise the money, which calls the lawyer’s independence into question. Much like the auditing firms that have been sued for not detecting fraud, brokers and their customers often have to rely on these gatekeepers for due diligence information.

The current round of sanctions by FINRA suggests that broker dealers have an independent duty to perform their own due diligence before recommending these investments. Private placements frequently carry high commissions and are therefore popular among stockbrokers.

FINRA this week fined Workman Securities $700,000 after its sold millions of dollars of notes issued by Medical Capital Holdings and preferred stock of Provident Royalties. Both issues were private placements. The SEC charged both issuers with fraud.

Investors purchasing private placements should be on high alert. While brokers have a duty to perform their own due diligence before recommending these products, those efforts have proven to be less than diligent.

Provident’s bankruptcy filings and other records reveal that over 50 broker dealers sold Provident Royalties stock. According to a July 2009 press release from the SEC, Provident was a $485 million offering fraud and Ponzi scheme that defrauded 7,700 investors.

FINRA says the brokers dealers should have performed their own due diligence and that minimal due diligence would have uncovered serious red flags in the private placement offerings.

FINRA says it will be looking not just at private placements but also non-traded real estate investment trusts (REITs) and other exotic investments. Before you purchase any such product upon the recommendation of a stockbroker or other financial professional, find out how much independent due diligence was performed by the broker dealer. If they are simply relying on the promoter’s own lawyers, watch out.

*Shortly after writing this post, Workman Securities announced it was going under. InvestmentNews says it simply had to many pending customer complaints. We suspect all or most were related to private placements. In fact, many brokerage firms that sold Provident Royalties private placement securities were forced to close their doors when they could pay investor claims.

In 2018, FINRA did a comprehensive study on brokerage firms selling private placements. The agency said,

• No Reasonable Diligence – Some firms failed to perform reasonable diligence on private placement offerings prior to recommending the offerings to retail investors. In some instances, firms performed no additional research about new offerings because they relied on their experience with the same issuer in previous offerings. In other instances, some firms reviewed the offering memorandum and other relevant offering documentation, but did not discuss the offering in greater detail with the issuer or independently verify, research or analyze material aspects of the offerings. FINRA also observed that some firms did not investigate red flags identified during the reasonable diligence process. For example, in offerings involving conservation tax easements, some firms did not investigate red flags that included, but were not limited to, significant risk of the Internal Revenue Service (IRS) disallowing tax deductions, as well as concerns regarding land appraisals.
• Overreliance on Third Parties – Where some firms obtained and reviewed due diligence reports provided by due diligence consultants, experts or other third-party vendors, they sometimes did not independently evaluate the third parties’ conclusions, respond to red flags or significant concerns noted in the reports, or address concerns regarding the issuer or the offering that were apparent outside the context of the report.
• Potentially Conflicted Third-Party Due Diligence – Some firms used third-party due diligence reports that issuers paid for or provided in their due diligence analysis. While some of these reports provided valuable and relatively objective information, in some cases, firms did not consider the related conflicts of interest in their evaluation and assessment of the reports’ conclusions and recommendations.

In 2020 FINRA imposed additional rules on the industry designed to protect investors.

I Lost Money in a Private Placement, Now What?

There are significant risks associated with private placement investments. Despite recent regulatory attention, these investments remain largely unregulated. They are often illiquid and speculative too. That makes them unsuitable for most retail investors.

In many cases, brokerage firms haven’t performed the necessary due diligence on the private placement they are marketing or ignored obvious conflicts of interest.

If you lost money in a private placement and purchased through a broker dealer or investment advisor, we may be able to get back your money. To learn more, visit our stockbroker fraud information page. Ready to see if you have a case? Contact us online, by email or by phone 202-800-9791. We accept case nationwide (minimum loss $100,000).

LIST OF BROKER DEALERS PURPORTDLY OFFERING PROVIDENT ROYALTIES SECURITIES. If you lost money on a private placement sold by one of these brokers, you may have a claim: