Are Private Placements a Tool for “Troubled Brokers”? That’s What a Wall Street Journal Study Suggests

If you want to find trouble on Wall Street, follow the money.  A “troubled broker” is a broker more concerned for his or her commissions than the quality of the investments he or she recommends.  Finding investors for private placements can be very lucrative for a broker, but very risky for a client.  As complaints about a broker mount on his CRD, so does the lifespan of a broker and as their career prospects dwindle, they become more desperate. While not all private placements are bad investments, they must be approached with extreme caution and are not appropriate for all investors.  If you get presented with a private placement, the very prospectus states: you should consult an attorney before signing.  It’s a mandatory disclosure that regulators believe you should get and you should not ignore it.  You should always consult a good New York securities lawyer before you give large amounts of your money to a non-public company in its infancy.  Understanding the investment, the company and doing due diligence is the only way to protect your interests.   If you don’t want to spend time or money to do that, don’t invest.  The “next big thing” your broker might be selling you on may be your “next big problem.”  There’s no free lunch.

These concerns about the multi-billion-dollar private capital markets are sound, based on a Wall Street Journal report finding that firms selling private placements have a much higher proportion of “troubled brokers”. The study compared the percentages of brokers with customer complaints, regulatory investigations and other disclosures at firms selling private placements with industry norms.  Among the worried securities industry members include former FINRA enforcement chief, Robert Bennet who allegedly proclaimed private placements as a “perennial concern for regulators.”. Private placement is the offer and sale of unregistered securities to a limited number of investors for a company’s capital generation. Our securities fraud attorneys always knew that a higher prominence of “troubled brokers” is at firms selling private placements, now our belief has been confirmed.

According to the WSJ study, of the firms selling private placements, half had at least one troubled broker out of every ten brokers.  Conversely, of the included firms that didn’t sell private placements, over 75% had less than that amount. Additionally, the analysis shows that half of the firms expelled by FINRA since 1993 sold private placements, despite comprising a lesser amount of the total industry. The private capital market has continued to rise with a reported $750 billion in sales. Given this, any insights about private placements should be known by investors, securities fraud attorneys, brokers and other affected financial industry members.

Unlike public offerings, private placements are exempt from registering private placements with the Securities and Exchange Commission under the Security Act’s Regulation D under the Securities Act of 1933. Private placements are only open to a select group of usually sophisticated investors including large banks and pension funds. Additionally, Section 4(a)(2) of the Securities Act, private placements are exempt if the securities purchasers are either “sophisticated investors” or wealthy enough to afford the risk. According to the SEC, a company offering private placements to individuals external to the exemption required demographics could be a securities law violation.

As opined earlier in this blog, private placements foster hype amongst the securities industry for the purported greater financial incentives. Companies issuing private placements will discover fewer formalities resulting in greater control, flexibility and time efficiencies. Private placements are exempt from administering a prospectus, disclosed financial information and other regulations. For sellers in the securities, including brokers, private placements produce higher commissions. While some investors also might benefit from the higher returns generated as a result, it’s a gamble – especially if you do not do your homework.  Conservative money should never go into a private placement; it’s a speculative venture.  If anyone tells you otherwise, he or she doesn’t know nor care for your best interests.  The risks are real, even in the seemingly best investments.

Private placements are not entirely unregulated, despite exemption from securities registration requirements. Private placements are still subject to antifraud provisions of the federal securities laws that prohibit material misstatement or omission, but that just means you can bring a lengthy and expensive lawsuit against a company that can dissolve and disappear or an arbitration against the broker and brokerage firm.

In Notice 10-22, FINRA notified brokers of their obligation to conduct reasonable investigations of Regulation D offerings. Brokers are ordered to investigate private placement issuers and securities thoroughly. While a prospectus is not required, the exemption is contingent on investors being able to have access to the usual information an investor needs to evaluate an investment. Rule 506 of Regulation D prohibits private placement issuers from marketing their securities out to the public with solicitation and advertising methods. At the very minimum, our investor fraud attorneys believe that the SEC and industry laws should work to keep private placements away from vulnerable groups.

Unfortunately, the modest regulation of private placements can still pose a potential threat to investor protection with the involvement of ill-intentioned securities members. Proceed with caution when considering private placements, securities exempt from registration. A broker’s failure to perform their due diligence on recommended private placements and/or failure to provide disclosure violates FINRA rules along with federal securities law. If you believe you have been taken advantage of by brokers selling a private placement or other risky investment, contact our securities fraud attorneys.


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