Lifting the Advertising Ban Will Expose Investors to Greater Risk of Fraud
WASHINGTON, D.C. – In advance of a federal rule to allow advertising of high-risk and potentially fraudulent private placement offerings, the North American Securities Administrators Association (NASAA) today issued an advisory cautioning investors about the risks these offerings carry.
Private placement offerings allow companies to raise money by selling stocks, bonds and other instruments. These offerings may be exempt from federal securities registration requirements. As a result, this exemption allows a company to raise business capital without having to comply with the registration requirements of a public securities offering.
Currently, Rule 506 of Regulation D of the Securities Act of 1933 does not permit general solicitation or advertising of private placement offerings. The JOBS Act directed the Securities and Exchange Commission (SEC) to lift this ban as long as the sales are limited to “accredited” investors – people who have sufficient wealth or access to information that would presumably allow them to make completely informed investment decisions. The SEC is finalizing its proposed rule lifting the ban.
“State securities regulators are concerned that Main Street investors will be lured into high-risk or fraudulent investments when the ban on general solicitation of private placement offerings is lifted,” said North Dakota Securities Commissioner, Karen Tyler.
Once implemented, this rule will allow companies and promoters to offer securities through direct mail, cold calls, free lunch seminars and television or radio commercials. “As a result, unscrupulous companies and promoters may take advantage of the new rules to offer potentially fraudulent investments,” NASAA’s advisory says.
Because private placement offerings made in reliance on Rule 506 of Regulation D are not reviewed by regulators, they have become a haven for fraud. According to NASAA’s most recent enforcement statistics, private placement offerings are the most frequent source of enforcement cases conducted by state securities regulators.
The NASAA advisory includes information on the risks associated with private placement offerings and tips on how to protect yourself when considering such an offering.
“Rule 506 has been used by legitimate small businesses as an important source of capital, and state securities regulators want those businesses to be able to thrive and create jobs without unnecessary regulatory impediments,” Tyler said. ”However, a healthy private placement marketplace requires investors who feel adequately protected.”
For more information about the risks associated with private placement offerings, contact your state or provincial securities regulator. Contact information is available on the NASAA website at www.nasaa.org.
NASAA is the oldest international organization devoted to investor protection. Its membership consists of the securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada and Mexico.
NASAA Informed Investor Advisory
Are you an informed investor? Private Placement Offerings
In 2012, Congress passed the JOBS Act, which directs the Securities and Exchange Commission (SEC) to implement rules that, among other things, allow general solicitation and advertising of private placement offerings that are made in reliance on Regulation D, Rule 506. Once implemented, those rules will allow companies and promoters to offer securities through means such as direct mail, cold calls, free lunch seminars and media advertisements. As a result, unscrupulous companies and promoters may take advantage of the new rules to offer potentially fraudulent investments.
What is a Private Placement Offering?
Private placement offerings allow companies to raise money by selling stocks, bonds and other instruments. Such offerings may be exempt from federal securities registration requirements. This exemption allows a company to raise business capital without having to comply with the registration requirements of a public securities offering.
Federal law allows companies to make a private placement offering to people who have sufficient wealth or access to information that would presumably allow them to make completely informed investment decisions. Those investors are known as “accredited” or “sophisticated” investors.
Currently, Rule 506 of Regulation D of the Securities Act of 1933 does not permit general solicitation or advertising of private placement offerings. The JOBS Act directs the SEC to lift this ban on general solicitation or advertising as long as the sales are limited to “accredited” investors.
Who is an Accredited Investor?
To qualify as an accredited investor, you must:
- Have a net worth, not including your primary residence, of a least $1 million; or
- Have an income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
Private Placements and the Risk of Fraud
Entities raising capital through private placements often have a limited operating history and typically have more modest revenue streams than larger companies. Because private placement offerings made in reliance on Rule 506 of Regulation D are not reviewed by regulators, they have become a haven for fraud. According to the most recent enforcement statistics from the North American Securities Administrators Association, private placement offerings are the most frequent source of enforcement cases conducted by state securities regulators.
Risks Associated with Private Placement Offerings
- Because private placement offerings are exempt from registration requirements at both the state and federal level, no regulator has reviewed the offerings to make sure the risks associated with the investment and all material facts about the entity raising money are adequately disclosed.
- There may not be regulatory background checks of the sellers or managers and officers of the company issuing the investment.
- Private placement offerings often project higher rates of return, but this is only because the risk of the underlying investment is also significantly higher.
- Securities offered through private placements are generally illiquid, meaning there are limited opportunities to resell the security. Therefore, investors may be forced to hold the investment indefinitely.
- Investors in a private placement offering are usually provided with less disclosure information than they would receive in a public securities offering. Consequently, investors know much less about the investment and the people behind it.
- Historically, private placement offerings have been sold through familiar sources such as the recommendation of a friend, a broker-dealer, or members of a church or other social organizations. These sales rely upon directed communication and trusted relationships. Once the general solicitation provision of the JOBS Act is implemented, private placement offerings may be sold through unknown sources by such means as cold calls or free lunch seminars that may use high pressure sales tactics and impose artificial time limits in an effort to hurry the investment decision.
How to Protect Yourself When Considering a Private Placement Offering
- Do not complete a Subscription Agreement or Accredited Investor Questionnaire unless you understand it and agree with the entire document.
- If you are asked to falsify your financial information to qualify as an accredited investor, walk away.
- If the seller cannot satisfactorily answer your questions about the company, its business model, or its executives’ backgrounds, walk away.
- Ask for information. Even though federal and state securities laws do not mandate companies to disclose information in a private placement offering, an investor should still ask questions and request information. Take control and withhold your investment dollars if you do not get the information you request.
The Bottom Line
If you have any questions about private placement offerings, contact the North Dakota Securities Department at 1-800-297-5124.