Private Placement Investments and Brokers’ Due Diligence Requirements

What is a Private Placement Investment?

A private placement is an offering of unregistered securities to a limited pool of investors. In a private placement investment, a company sells shares of stock in the company or other interest in the company, such as warrants or bonds, in exchange for cash. But for some investors, exclusivity can be a trap.

Unlike public offerings, private placement investments receive little SEC oversight. Unfortunately, these investments can be structured to benefit the issuer at the expense of investors, charging upfront fees as well as exorbitant commissions for brokers. The income/dividends from these investments are not guaranteed and may end up being sporadic or non-existent.  What’s more, it can be exceedingly difficult to cut your losses.  Often, these investments cannot be resold – the terms of the investment may prohibit you from selling your interest. Or you may be able to unload your share only on a secondary market through a specialized broker, who may offer you pennies on the dollar.

Clearly, these private placements don’t make sense for many investors. However, the brokers who sell them can be highly motivated to convince you to purchase these risky investments, due to their uniformly high rate of sales commissions (often 8% or more).  Unscrupulous brokers, eager for a high sales commission, may fail to complete their due diligence (which is a laborious task due to the complex nature of these investments), and may mislead investors as to the true nature of the risks.

What are the FINRA Requirements for Broker Due Diligence for Private Placement Investments?

FINRA’s rules on a broker’s due diligence requirement for marketing a private placement investment are as follows. Broker-Dealers must conduct “a reasonable investigation” of a private placement investment before selling it for the issuer. At a minimum, FINRA requires that for each new placement, the broker’s investigation entail a review of the issuer and its management; its business prospects; assets it holds or plans to acquire; the intended use of proceeds from the offering; and claims made in any offering documents.

Some brokers lack the resources to cover all of that, so they rely on reports supplied by third-party due diligence firms. The reports are often paid for by the issuer of the private placement, and may not be fully objective. Brokers are meant to use the reports to help them decide whether to market the placements. They don’t typically show the reports to clients.

FINRA Arbitration Attorneys for Private Placement Investments

If you purchased a private placement investment through an investment advisor or stockbroker, and have suffered heavy losses, you may be able to recover your losses through a process called FINRA arbitration.

FINRA Arbitration is a unique, narrow area of the law. The attorneys at Epperson & Greenidge have extensive experience working within FINRA and we specialize in bringing these arbitration claims on behalf of investors. We accept all cases on a contingency basis: We only get paid if and when you collect money. Time to file your claim may be limited, so call 877-445-9261 now to speak to a private placement investment fraud attorney at Epperson & Greenidge for free.