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Investor Alert

Pre-IPO Offerings—These Scammers Are Not Your Friends

It's no secret that when a promising company emerges or an industry sector becomes "hot," investors typically flock to get a piece of the action. But what happens when the company is privately held and investors can't readily buy shares because the company has not conducted an initial public offering of its stock? Investor demand for shares of the private stock of high-profile social media companies—such as Facebook, Groupon, Twitter and Zynga—had surged before their IPOs. These companies had millions of subscribers and had dramatically changed the way people interact. But social media had also become the latest hook on which con artists could hang a scam. In this case, fraudsters dangled the promise of wealth from the sale of "pre-IPO" shares.

For instance, in late December 2010, shortly after the Securities and Exchange Commission settled a civil action, federal prosecutors brought criminal charges against a self-employed securities trader who allegedly bilked more than 50 U.S. and foreign investors out of more than $9.6 million in a series of pre-IPO scams spanning an eight-year period. We were also aware of other potentially fraudulent schemes that solicited potential victims by purporting to sell shares of Facebook.

FINRA issued this alert to warn investors about pre-IPO scams purporting to offer access to shares of popular, well known private companies.

Pre-IPO Speculation Always Risky, Can Be Illegal

In general, offerings of securities must either be registered with the SEC or meet an exemption under the federal securities laws—otherwise the offering is not legal. "Pre-IPO" speculation involves buying unregistered shares in a private company before the initial public offering of securities—and it can range from risky deals to outright frauds.

On the legitimate end of the spectrum, a company can sell its unregistered shares in private transactions (often called "private placements"), and such sales to investors are an essential source of capital for American business, particularly small firms. But these Investments can be fraught with risk—including the fact that you can't be certain the company being touted will actually complete an IPO. This means you cannot be sure whether you will ever be able to sell the shares you purchased. Separately, the fair market value of your shares may be based solely on speculation. And privately purchased shares typically come with restrictions, such as lock-up periods that prevent you from selling your shares for up to a year even if the company goes public in the interim. In addition, even though you might see advertisements or public solicitations to participate in a private placement, these deals are typically open only to "accredited investors," which includes individuals who have net worth of more than $1 million (excluding the value of their primary residence) or income of more than $200,000 in the current year and each of the preceding two years ($300,000 for couples).

On the other end of the spectrum, the unregistered shares offered to you could be part of a fraud. The company might not exist—or, if it does, the promoter might be offering shares he doesn't have or that he acquired in a questionable transaction. The fraud could also involve misrepresentations about the company and its prospects, including the likelihood, timing and pricing of any potential IPO. In the criminal case mentioned above, the defendant falsely claimed that he had worked at Goldman Sachs, was a preferred client of the firm and had access to discounted, pre-IPO shares of such well-known companies as AOL, Google, Facebook and Rosetta Stone.

The bottom line is that many pre-IPO scams involve unlicensed individuals selling unregistered securities—that's why it's critical to check out both the promoter and the investment. And pre-IPO offerings that target the general public—especially those that are publicized through "spam" emails—often violate the federal securities laws.

Protect Yourself

Fraudsters would have investors believe that virtually anyone can get in on pre-IPO deals of small, little-known start-ups as well as those of large, popular companies. One sure-fire way to avoid being taken in by an unsolicited offer is to ignore it—regardless of how you heard about it. Someone claiming to have shares of Facebook or some other social networking company may very well be a paid promoter or, more likely, a con artist trying to take your hard-earned money.

Never rely solely on information contained in an unsolicited fax, email, text message, tweet or other format for social network communications—or in a blog post or online thread. To steer clear of potential scams, follow these tips.

  • Consider the source. If you received an unsolicited offer to invest in a pre-IPO opportunity—by any means—don't take the bait. It's easy for promoters to make unsubstantiated claims about owning stock or being able to offer you shares of stock they have somehow been able to accumulate. The stories a con artist might spin are myriad but share one trait—they are all built on lies and deception.
  • Always ask: "Why me?" An unsolicited offer to buy pre-IPO shares raises the obvious question: Why would a total stranger tell you about a really great investment opportunity? The likely answer is that there is no such opportunity.
  • Be alert to persuasion. Virtually all pre-IPO scams dangle the prospect of exclusive access to eye-popping returns (an example of the "phantom riches" tactic) at a discount (the "reciprocity" tactic) if you act quickly ("scarcity"). Many scams also exploit "source credibility," trying to build your trust by claiming falsely to be with a reputable firm. And others, such as those purporting to involve well-known companies, use "social consensus" to suggest that everyone wants in so the deal must be good. To learn more about persuasion, read FINRA's Fighting Fraud 101.
  • Verify whether the person touting the stock or investment is licensed. A legitimate investment salesperson must be properly licensed, and his or her firm must be registered with the Financial Industry Regulatory Authority (FINRA), the SEC or a state securities regulator—depending on the type of business the firm conducts. To check the background of a broker or investment adviser, use FINRA BrokerCheck. Also, be sure to call your state securities regulator. You can find that number in the government section of your local phone book or by contacting the North American Securities Administrators Association (NASAA).
  • Determine if you're being conned by a convicted criminal. Check the Federal Bureau of Prisons Inmate Locator to determine if a solicitation is coming from someone who has served time in a federal prison. A surprising number of investors are conned each year by career criminals plying the only thing they know how to do. Many states also have similar prisoner locator systems.
  • Be a search engine sleuth. Use search engines to learn as much as you can about a solicitation and those behind it. For instance, if the individual promoting the investment has a history of fraud or criminal activity, you might find news reports and court documents with details. And, if an investment firm is mentioned, research its address using Internet search engines (even after you to look up the firm in BrokerCheck). It's possible the fraudsters are using a false or non-existent address or that the address—even a posh-sounding one—leads to a mail stop or a cubbyhole that might be only a desk and a phone. It's even possible that the fraudster has hijacked the name of a legitimate firm—but the address or phone number provided don't match with the entity in BrokerCheck.
  • Never send money to an individual or firm that you are hearing from based on an unsolicited communication. Even if you have met or spoken directly with someone selling an investment, never write a check out to the individual. Your money is apt to end up in a personal bank account, never to be seen by the investor.
  • Get an unbiased second opinion. The only way to verify whether a particular pre-IPO opportunity is legitimate is to conduct in-depth due diligence. To fully understand the terms of the deal and any restrictions that apply, you will likely need to enlist the aid of professionals who are in no way connected to the deal, including an attorney who is skilled in both securities law and contract law or a licensed investment professional.

If a Problem Occurs

If you believe you have been defrauded—or treated unfairly by a securities professional or firm—please send us a written complaint. And if you suspect that someone you know has been taken in by a scam, be sure to give us that tip. Here's how:


File a Complaint (for you)
Send a Tip (for others)

Mail or Fax:

FINRA Complaints and Tips
9509 Key West Avenue
Rockville, MD 20850
Fax: (866) 397-3290

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