Private Placements (Regulation D)

Private Placements are issued under Regulation D (17 CFR § 230.501 et seq.) under the Securities Act of 1933. Regulation D contains three rules (Rules 504, 505, and 506) providing exemptions from the more rigorous Securities and Exchange Commission (SEC) registration requirements and allows companies to offer and sell securities without extensive disclosures.

The three rules primarily govern the size of the offering and number of participants that can invest. However, under all three rules, with certain limited exceptions, investors must meet the “accredited investor” standard under Rule 501. Rule 501 defines “accredited investor” as any person who has a net worth in excess of $1,000,000, (excluding residence) or annual income in excess of $200,000 (or $300,000 jointly with a spouse) in the two most recent years.

While the size of the private placement market is unknown, according to 2008 estimates, companies issued approximately $609 billion of securities through Regulation D offerings. While the private placement market allows many small companies to efficiently raise capital, regulators have found significant problems in the due diligence and sales efforts of some brokerage firms when selling private placements to investors. These problems include fraud, misrepresentations and omissions in sales materials and offering documents, conflicts of interest, and suitability abuses.

The Securities Exchange Commission, federal courts, and FINRA have all found that brokerage firms have a duty to conduct a reasonable investigation concerning the private placements issuer’s representations concerning the security. A brokerage’s firm’s due diligence obligation also stems from Rule 2310 suitability obligations requiring the broker to have reasonable grounds to believe that a recommendation to purchase, sell or exchange a security is suitable for the customer. In order to meet the due diligence obligation, the brokerage firm and/or broker must make reasonable efforts to gather and analyze information about the private placement, the issuer and its management, the business prospects of the issuer, the assets held by or to be acquired by the issuer, the claims being made by the issuer in the offering materials, and the intended use of proceeds of the offering.

Unfortunately, many investors have suffered dramatic investment losses because brokerage firms ignored red flags or conducted only a cursory review of the product before recommending it to clients. In other circumstances, brokers have recommended large concentrations and holdings in private placements to customers subjecting the client’s accounts to substantial risks of loss. If you have suffered losses as a result of investments in private placements, please contact Gana Weinstein LLP.