Private Placements

Private placements are private securities offerings exempt from registration with the Securities and Exchange Commission (SEC). Typically, these securities are sold under Regulation D of the Securities Act of 1933, which allows a company – also known as an issuer – to sell securities that have not been registered with the SEC. Though there are various securities exemptions, issuers selling unregistered securities often rely on exemptions available under Rules 504, 506(b), and 506(c) of Reg D. Each rule contains specific requirements that issuers must meet.

Companies offering private placements can be either privately held or publicly traded. Private placement offerings may involve a wide range of securities, including notes, warrants, bonds, common or preferred stock, and interests in limited liability companies and limited partnerships.

Private placements may be sold directly to investors by issuers or FINRA-regulated broker-dealers. FINRA imposes obligations on broker-dealers to conduct reasonable due diligence on private placements it offers and sells to investors and meet supervisory requirements. Any information provided to investors in private placement offering documents must be true and must not omit material facts necessary to prevent misleading statements about the securities. Material misstatements or omissions in private placement offering documents are subject to federal securities laws’ antifraud provisions.

Investors acquiring securities in private placements often receive restricted securities – restricted from transfer or sale for a specific period of time – which may only be sold if they are registered with the SEC or meet an applicable exemption. Even after this restricted period ends, investors may not be able to sell securities if there is no market.

There are significant risks associated with investments in private placements, particularly their lack of liquidity and speculative nature. Additionally, unregistered securities offered and sold under the exemptions are not subject to the same disclosure requirements applying to registered offerings. The retail private placement market is scarcely regulated, with most retail investors buying unregistered securities directly from issuers availing themselves of an exemption.

Private Placements Sold Pursuant to Reg D

Issuers selling securities exempt from registration under Reg D must meet the specific requirements set forth in the rules.

• Rule 504: Under Rule 504, issuers can sell up to $5 million in unregistered securities in a 12-month period. Issuers may not use general solicitation or general advertising; however, they are permitted to do so if the issuer is registered in a state that requires the use of a substantive disclosure document or if the securities are sold under a state exemption permitting general solicitation and advertising to accredited investors. The rule does not limit the number of non-accredited investors the issuer can sell to and does not impose a disclosure requirement for non-accredited investors.
• Rule 506(b): Under Rule 506(b), issuers can sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors who must be sophisticated. The rule requires that non-accredited investors receive disclosure documents generally including information provided in registered offerings, financial statements, and that issuers make themselves available to answer questions. The rule does not allow for general solicitation or general advertising. The rule does not impose a limit on the amount an issuer can raise.
• Rule 506(c): Under Rule 506(c), issuers are allowed to conduct general solicitation and advertise an offering as long as all purchasers are accredited investors. Issuers must take reasonable steps to verify that the investors are accredited. The rule does not impose a limit on the amount an issuer can raise.

FINRA Rules on Private Placements

Broker-dealers engaged in private placement sales have additional obligations under FINRA rules.

FINRA Rule 5122

Requires broker-dealers that sell their own securities or the securities of a control entity to file a private placement memorandum (PPM), term sheet, or other offering documents at or before the first time the documents are provided to any prospective investor.

FINRA Rule 5123

Requires broker-dealers that participate in private placements of securities to file, within 15 days of the first sale, a private placement memorandum (PPM), term sheet, or other offering documents, or indicate that such offering documents were not used. The rule provides exemptions to the filing requirement for securities sold to highly sophisticated purchasers such as institutional accounts, qualified purchasers, qualified institutional buyers, and accredited investors.

Private Placement Retail Communications

FINRA Rule 2210 defines “retail communication” as any written communication (including electronic communications) distributed to 25 or more retail investors within any 30-day period. Private placement advertising, marketing, and sales materials must comply with the rule irrespective of whether the communications were prepared by the broker-dealer itself, the issuer, or a third party. The documents may not predict future investment performance or forecast returns such as dividends, income, yields, and capital appreciation.

FINRA requires that retail communications include a balanced discussion of the private placement investment’s benefits and risks and avoid false, misleading, or promissory statements or claims. A broker-dealer presenting a PPM that predicts returns, makes false claims, or in any way misleads an investor, also violates Regulation Best Interest.

FINRA has proposed expanding Rules 5122 and 5123 to add “any retail communication” to the documents that must be filed in connection with private placement sales.

Investors interested in private placement investments should consider whether they have the financial experience and sophistication necessary to assess the investment and its risks. Common broker misconduct involving private placements includes promises of high returns, misstatements, and misrepresentation.

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