Finra warns investors on private placements

Finra issued a new investor alert in the lead-up to lifting the general-solicitation ban on private-placement investments.

The alert, “Private Placements — Evaluate the Risks Before Placing Them in Your Portfolio,” cautions that investing in nonregistered private placements is “risky and can tie up your money for a long time.”

The general-solicitation ban of private placements, reversed under the Jumpstart Our Business Startups Act, was part of a regime that tried to keep unregistered equity offerings out of reach of the inexperienced investor, with only “accredited investors” allowed to invest unless a company was granted an exemption.

LIMITING SOLICITATIONS

“For companies to be eligible for that exemption, they had to limit the type of investors they were soliciting,” said Gerri Walsh, senior vice president for investor education for the Financial Industry Regulatory Authority Inc., which wrote the latest in a series of cautionary investor alerts. “Our concern now is that regular investors will be seeing these solicitations.”

A positive aspect of the general-solicitation ban, beyond protecting overzealous investors, was that general solicitation was often a red flag for companies engaged in fraud, according to Ms. Walsh.

Although the broader consequences of lifting the ban are hard to predict, the average investor should remain on guard, she said.

“We wanted to make sure in-vestors know that any private offering of securities may have liquidity risks,” Ms. Walsh said.

“If the company never goes public, you may not be able to get back what you put in,” she said. “Depending on the structure of your portfolio, you may be exposed to some sort of concentration risk.”

Although average investors will be more easily accessible to companies offering private placements, broker-dealers are still bound by Securities and Exchange Commission rules, so only accredited investors will be allowed to invest in them.

“With broker-dealers, there are rules related to suitability of recommendations,” Ms. Walsh said. “There are also rules related to due diligence for broker-dealers before recommending private-placement investments.”

Long-standing federal law restricts how companies solicit investors in private placements, but billions of dollars flow into the securities each year, to the benefit of a number of small and startup companies, according to Finra.

Finra has issued sanctions for fraud and false advertising related to the investments.

Finra recommends that investors get a second opinion on a private placement from a licensed broker, research the offering company extensively and plan for the security’s liquidation. They also should learn whether the private placement has any attached conditions or contingencies that affect how the issuer spends the money it raises.