Private Placements

Private placements involve the sale of securities that are not part of a public offering and are exempt from federal securities registration requirements. The types of securities frequently offered in a private placement include common or preferred stocks, promissory notes, limited liability companies (LLCs) and warrants. Most private placements are exempt from registration pursuant to Regulation D of the Securities Act of 1933 which limits the sale of securities to a select number of individuals or "accredited investors." An "accredited investor" is defined as any person with a net worth (or joint net worth with a spouse) at the time of purchase in excess of $1,000,000. Before a stockbroker or financial advisor may sell or recommend a private placement to their customer, they must ensure that the customer qualifies as an accredited investor. However, the fact that an investor qualifies as an "accredited investor," does not conclusively establish whether the private placement is appropriate for that particular customer.

Before recommending a private placement to a customer, stockbrokers must conduct a due diligence investigation of the private placement and perform a suitability analysis by reviewing the customer's overall financial situation and investment objectives. Net worth alone should never be the sole basis for determining suitability. There have been numerous instances where risky private placements offering a high rate of return were marketed and sold as a safe fixed-income investment to conservative investors, many of them elderly or retired. Some of the factors that could make a recommendation to invest in a private placement unsuitable include:

  • The customer did not qualify as an accredited investor
  • The broker misrepresented the financial condition of the company and the risks of investing
  • The customer had a low risk tolerance and a conservative investment objective
  • The investor's portfolio had a disproportionately large percentage of their assets in private placements or other risky and unsuitable investments
  • The customer could not financially bear the risk of loss