Private Placement – the offer and sale of any security by a brokerage firm not involving a public offering. Private offerings are not the subject of a registration statement filed with the SEC under the 1933 Act. Private placements are done in reliance upon §3(b) or §4(2) of the 1933 Act as construed or under Regulation D as promulgated by the SEC, or both. Regulation D, promulgated in 1982, sets forth certain guidelines for compliance with the Private Offering Exemption. Any representatives who are involved in the private placement process are expected to have a working familiarity with Regulation D.

While a company and its management may think they are conducting a Private Placement in the proper manner, the Financial Industry Regulatory Authority (FINRA) has recently noted significant market abuses in the sale of private placements. These abuses include:

  1. Fraud and sales practices directly related to the marketing of Regulation D offerings,
  2. The delivery of private placement memoranda, and
  3. Sales materials to investors that contained inaccurate statements or omitted information necessary to make informed investment decisions.

When recommending a security, the management of the issuing company:

  1. Is under a duty to conduct a reasonable investigation concerning that security and the company’s representations about it.
  2. Should have conducted a reasonable investigation and its recommendation is based upon the conclusions resulting from such investigation. Must comply with this duty. Failure is a violation of the antifraud provisions of the federal securities laws.
  3. Must adhere to just and equitable principles of trade.
  4. Must prohibit manipulative and fraudulent devices.

The issuer is responsible for:

  1. Having only true statements, based in part on due diligence documentation.
  2. Adequate and through due diligence initiatives.
  3. Not having any due diligence oversight, as this can lead to a violation of the antifraud provisions of the federal securities laws.
  4. Due diligence efforts; this will be judged after the fact.

The Justice Department, the SEC and the courts are the correct venues for enforcing § 10(b) and Rule 10b-5 liability, not FINRA.

 What to consider:

  1.  Exemption. A Private Placement offering, even if exempt, is never exempt from the fraud provisions of the Act and requires careful compliance with the relied upon exemption. If an issuing company fails to qualify for the Private Placement exemptions relied upon, it can face severe penalties and possible criminal repercussions. Procedural violations may include a company:
    • Relying on a 4(2) exemption but offering certain securities to a non-sophisticated investor [which is a § 4(2) requirement].
    • Failing to make, or untimely make, a securities filing.
    • Failing to disclose material information (e.g., financial data, relevant risk factors) or making misleading statements in a private placement offering documents.
    • Having a general solicitation or advertising.
    • Not limiting the number of non-accredited investors.
    • Omitting specific required disclosures to participating investors.
    • Not adequately verifying that the investors solicited and accepted are qualified to participate, and meet suitability standards.
  1. Financial Statements should set forth the complete financial condition of the company, and include balance sheets, income statements, and cash flows. They should be audited, or at the very least ready for audit, with complete footnote disclosure.
  1. Complete due diligence file:
    • Conduct a reasonable investigation. Failure to conduct due diligence on a private placement exists if management only reviewed the offering documents and sales materials provided by the company before approving the product for sale, without independently verifying the company’s representations in the offering documents.
    • Identify and understand the inherent risks of the offerings. The company’s management must have reasonable grounds to allow the continuing selling efforts of the offerings (i.e., no flags, such as liquidity concerns, missed interest payments and defaults regarding the private placement, etc.).
  1. Fairness of transactions between entities. A Fairness Opinion is an independent qualified third-party financial expert’s statement as to the “fairness”, from a financial point of view of a specified financial transaction, based on professional judgment supported by collected data. The “fairness” is from the standpoint of a certain designated party or parties, usually in relation to minority shareholders.
  1. Salespeople
    • Representations as to financial targets as to when investors would receive the return of their principal investment, and the yield on their investment, must be documented and reasonable. There must be a reasonable basis for yields, return of return, projections, etc., supported by prior performance of targets having been met, and reflected in the projections.
    • The registration provisions of the Securities Exchange Act of 1934 provide that it is illegal for a company to pay commissions to an individual or entity unless the individual or entity is a licensed securities broker or bona fide employee of the issuing company. In addition, state securities laws must be examined to ensure compliance. (Some states, such as Arizona, specifically prohibit commission payment to non-FINRA Registered Representatives – even if employees of the Issuer.)
  1. Supervisory system for the selling effort should be established, maintained and enforced to achieve compliance with applicable federal and state securities laws and regulations.
  1. Mail Campaigns. Periodically sending letters to private placement investors updating them on the progress of their investment should be realistic and provide required risk disclosures.  Letters must disclose the complete financial condition of the company.
  1. Failure to comply with material elements of this memo could result in the investor having the lifetime right of rescission, with repayment from the company, its officers and directors, and the salesperson.
  1. Integration rules. The SEC may group a series of Private Placements (offers as well as sales) and classify it as one transaction.
  1. Prospect of Future Public Offering. Many companies make the mistake of thinking they may be setting themselves up for a future public offering, or even worse, telling investors that an IPO is imminent, when they may not be able to obtain a legal opinion that the Private Placement securities were issued legally.