Private placements are investments not offered to the general public. The SEC says that certain financial products can only be offered to so-called “sophisticated” or “accredited” investors. That’s because the risks of these investments can be quite high. Examples of opportunities restricted to sophisticated investors include pre-offering securities and some hedge fund investments. Within the industry these investments are commonly called “private placements.”
Private placement fraud can occur in different ways. It can happen when the company offering the investment lies about the investment. According to the SEC, those schemes are relatively rare. It also happens when a stockbroker sells unsuitable private placements or sells them to investors that don’t qualify. That is the topic of this post.
To understand how this happens, one must first understand the terms used by the SEC in determining whether someone is qualified to purchase a private placement. The SEC says that these investments can be offered only to accredited investors or sophisticated investors.
In simple terms, a sophisticated investor is someone with sufficient capital, net worth and experience. An “accredited investor” is someone that has a net worth of at least $1 million (excluding one’s home) and income of at least $200,000 for the prior two years ($300,000 if joint income) and an expectation to keep making the same amount.
SEC Rule 506 of Regulation D
According to the SEC, a company wishing to raise money but does not want to go through a formal public offering can do so if it follows some basic rules:
First, it cannot use general advertising or solicitation.
Second, it can sell its securities to an unlimited number of accredited investors.
Third, it can sell securities to up to 35 non-accredited investors if they are sophisticated. According to the SEC, that means “they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.”
Companies like the safe harbor provisions of Regulation D because they can quickly raise money without a lot of red tape. Stockbrokers love these offerings because they pay higher commissions. Sometimes brokers will entice customers by telling them they are getting an opportunity to get in on the ground floor, something that the general public can’t buy.
There are also other times when investments are only offered to sophisticated or accredited investors.
Private Placement Fraud – Nonqualified Investors
Over $1 trillion in capital is raised each year through private placements. Although not at all the investments are sound, fraud is relatively low. Because there is less vetting of private placement deals and far less disclosures, theoretically the people buying into these deals have the experience and knowledge to evaluate the offering and good income and net worth in case the investment fails.
Private placements don’t register with the SEC meaning they operate outside of SEC regulations. That is why the SEC wants to insure that investors know what they are doing and can financially survive if the investments fails.
Because the commissions are generally much higher, some rogue brokerage firms and brokers push these investments on unsuitable clients.
We have also seen many cases where brokers provide inaccurate financial information. Remember, the offering memorandum and materials presented to investors have never been filled or reviewed by the SEC.
Avoiding Private Placement Fraud – Tips for Investors
The Financial Industry Regulatory Authority (FINRA) published an investment alert for potential private placement investors. The alert contains several important tips for investors:
- “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.” [Editor’s note: Private placement securities are typically “restricted” meaning they can’t be readily sold. Even if there are no such restrictions, there is no secondary market for these securities meaning they can’t easily be sold. That is why they are not a good fit for anyone who needs access to their money or who is nearing retirement. Brokers have an obligation to explain these restrictions to prospective investors.]
- “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.” [Editor’s note: Brokers are not relieved of their due diligence obligations simply because the investment is a private placement or because you qualify as a sophisticated investor.]
- “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.” [Brokers have an obligation to only make investment recommendations that are suitable to your needs. That means stockbrokers also have an obligation to understand your financial goals and risk tolerance.]
- “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.” [Simply because your broker has a due diligence obligation doesn’t mean you shouldn’t do some checking yourself.]
- “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.” [If the offering is a nontraded REIT, make sure you fully understand how long you must hold on to the investment. Many REITs have no secondary market. That means you may not be able to sell if you need emergency access to your money.]
- “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.”
- “Be extremely wary of private placements you hear about through spam emails or cold calling. They are very often fraudulent. A legitimate broker 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. Officers, directors and other persons associated with an issuer may sell securities of that issuer without being licensed, so long as they are not compensated for the transaction and meet other conditions.” [If you suspect fraud or believe you are being treated unfairly by a securities professional or firm, contact us immediately.]
- “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.” [See the BrokerCheck link above. Even if the private placement isn’t registered, you want to make sure the investment advisor selling you the investment is properly along with their employer. Registered brokerage firms are regulated, have minimum capital requirements and often have insurance.]
Scottsdale Broker Faces Private Placement Fraud Charges
In January 2020, a Glendale, Arizona filed a claim against Newbridge Securities and his former broker, Larry Labine. The customer says Labine was recommending investments that were both highly risky and non-liquid. While that might be okay if properly explained, the customer further alleged that he was not properly informed.
While anyone can have a dispute with his or her broker, the average broker has zero reportable events on his record. Larry Labine? Thirty-nine which puts him the bottom 99.9 percentile of brokers.
While everyone is presumed innocent until proven guilty, Labine has been guilty many times over.
His Arizona state securities license was revoked in 2017.
In 2015, FINRA said that while associated with Newbridge, Labine was selling senior corporate debentures to customers. Despite knowing of the company’s failing financial commission, Labine withheld that information from investors. He also didn’t disclose his cozy financial arrangements with the company including a promised seat on the board of directors if he met certain sales goals. In other words, Labine had more of incentive to operate for his own best interest instead of his clients.
FINRA barred him from the industry.
The SEC barred him for the same conduct in April 2016.
In 2004 he was suspended from the securities industry for a full year. He was accused of recommending investments that were unsuitable based on the “customer’s investment objectives, financial situation and needs.”
He has 28 customer disputes.
Broker Suspended for Inflating Investor’s New Worth
Last week, a former LPL broker was fined and suspended from the industry for 6 months. FINRA says Donald Woods inflated the net worth figures of retirees so they could qualify for non-traded REIT investments.
Like Larry Labine, Woods has a horrible record. 11 customer complaints and one regulatory action. He is currently suspended.
FINRA says, “Woods Without admitting or denying the findings, Woods consented to the sanctions and to the entry of findings that he submitted applications to purchase real estate investment trusts (REITs) that overstated the customers’ liquid net worth in order to circumvent his member firm’s restrictions. The findings stated that Woods did not have a reasonable basis for recommending that the customers purchase the REITs, which were inconsistent with the customers’ investment profiles. Woods received $5,600.70 in commissions in connection with these recommendations.”
Although he is suspended, Woods still has 4 pending customer complaints.
New York Broker Barred for Improper Private Placement Solicitation
When this post was first written in 2014, we discussed charges against New York broker Bruce Meyers. The lessons from that case are still relevant today.
FINRA claimed Meyers and the brokerage firm tht employed him engaged in the improper public offering of securities. They say, “Meyer and his firm marked a private placement offering to more than 1000 recipients of boiler-plate emails, without first establishing a substantive relationship with each recipient.” The firm and Meyers also made “exaggerated and unbalanced predictions of price performance.” If that wasn’t enough neither Meyers or his employer disclosed their ownership interest in the company’s whose securities were being offered.
Not only was Bruce Meyers banned from the industry, in 2018 his company was expelled from the financial industry.
How Do I Sue my Broker for Private Placement Fraud?
As noted above, simply because an investment or security is exempt from registration doesn’t mean that brokers aren’t responsible for your losses.
Investment advisors and their employers have many duties when making investment recommendations, particularly with private placements. Some of those duties include:
- Ensuring the investors qualifies as a sophisticated or accredited investor
- Ensuring the investor fully understands the investment including its risks and the lack of liquidity
- Understanding the customer’s needs and only recommending investments that are suitable.
- Performing due diligence on the investments being offered
- Making full disclosures of how the broker is compensated
We also warn investors about the prohibitions on solicitation and advertising of private placements. While we are skeptical of most boiler room operations that cold call investors, private placements have severe limits on how they can be marketed. Our advice is that if you receive an unsolicited email or phone calling offering you a special opportunity to get on the ground floor of the next great thing, hang up!
If you believe you’re a victim of a private placement fraud, contact us. This includes an abrupt loss in value or the inability to sell or liquidate your investment. With more decades of experience, we know how to recognize securities fraud and can help you get back your hard earned money.
To learn more, contact us online, by email or by phone . We accept cases in all 50 states. Cases are handled on a contingency or “success” fee basis meaning you never pay unless we first collect an award on your behalf. We also invite you to check out our cornerstone content on a variety of specific alternative investments.
All inquiries are protected by the attorney – client privilege and kept confidential. Never a charge for initial consultations.