Private Placements

Regulatory Obligations

Private placements are unregistered, non-public securities offerings that rely on an available exemption from registration with the SEC under either Section 3 or 4 of the Securities Act.

In Regulatory Notice 23-08 (FINRA Reminds Members of Their Obligations When Selling Private Placements), FINRA noted the obligations of firms that recommend private placements to conduct a reasonable investigation of those securities under Reg BI for recommendations to retail customers and FINRA Rule 2111 (Suitability) for recommendations to non-retail customers, as well as other obligations that could apply even in the absence of a recommendation, including FINRA Rules 2210 (Communications with the Public), 3110 (Supervision), 3280 (Private Securities Transactions of an Associated Person), 5122 (Private Placements of Securities Issued by Members) and 5123 (Private Placements of Securities).

Regulatory Notice 23-08 updated and supplemented guidance published under Regulatory Notice 10-22 (Obligations of Broker-Dealers to Conduct Reasonable Investigations in Regulation D Offerings) and reminded firms that the reasonable investigation of a recommended privately offered security, at a minimum, should include an evaluation of “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; and the intended use of proceeds of the offering.” 

Additionally, FINRA Rules 5122 and 5123 require firms to timely file with FINRA offering documents and information for the private placements they offer or sell, including retail communications used by the broker-dealer to promote or recommend an offering, unless a filing exemption is available.

Findings

• Inadequate Filings Procedures: Not maintaining policies and procedures, processes and supervisory programs to comply with filing requirements; resulting in a failure to file or untimely filings (with, in some cases, delays as long as six to 12 months); and relying on a filing exemption under FINRA Rule 5123(b) that is not applicable to the offering (e.g., the exemption for sales to certain institutional accredited investors, which is generally not applicable for sales to individual accredited investors).
• Failing to Conduct Reasonable Investigation: Failing to fulfill reasonable-basis obligations prior to recommending private placements to retail investors, by:
  • failing to conduct an appropriate level of research on the issuer’s business, particularly when there is a lack of operating history;
  • relying solely on the firm’s past experience and knowledge with an issuer based on previously completed offerings;
  • failing to inquire into, analyze and resolve red flags identified during the reasonable investigation process or in third-party due diligence reports; and
  • failing to conduct a reasonable investigation of the issuer, the individuals involved in its management or other “covered persons” under Reg D.
• Failure to Evidence Due Diligence: Failing to maintain records of, or otherwise evidence or reasonably explain, due diligence efforts into issuers’ financial condition, operations, representations of past performance and involvement in litigation or any evaluation of “red flags” or problematic claims and representations identified during due diligence.
• Improper Discharge of Reg BI Obligations: Incorrectly purporting to not make recommendations of private placements, or claiming that the issuer is making the recommendations, despite evidence that representatives communicated a “call to action” to customers concerning the particular security that is individually tailored to the customer (and as a result, the firm or its representatives did not exercise reasonable diligence, care and skill in making such recommendations); or not adequately identifying, disclosing and, where appropriate, mitigating conflicts of interest associated with recommendations of private placements.¹
• Failure to Comply With SEC Rules Regarding Contingency Offerings: Participating in a contingency offering without meeting the requirements of SEA Rules 10b-9 and 15c2-4, in particular when the contingency terms are amended during the offering (e.g., reducing the minimum contingency amount). 

Effective Practices 

• Private Placement Checklist: Amending due diligence checklists to account for specific types of private placements with unique risk factors or conditions that may impact whether they are in the best interest of retail customers.
• “Bad Actor” Questionnaires: Reviewing “Bad Actor” forms or similar questionnaires at both the issuer level (e.g., Directors’ and Officers’ Questionnaires) and placement agent level (e.g., registered representative questionnaires) to support compliance with Rules 506(d) and 506(e) of Regulation D.
• Independent Review: Conducting and documenting reviews of material aspects of the offering by, for example;
  • verifying representations and claims made by the issuer that are crucial to the performance of the offering (e.g., costs projected to execute the business plan, projected timing, overall rate of return for investors);
  • identifying any red flags with the offering or the issuer, such as questionable business plans or unlikely projections or results; and
  • identifying concerns that would be deemed material to a potential investor, such as liquidity restrictions.
• Review of Offering Terms: Reviewing offering terms to determine if they are reasonably structured for compliance with applicable rules (e.g., the escrow arrangements and termination provisions in contingency offerings) and evaluating whether projected returns stated in offering documents are consistent with the overall financial structure and fundamentals of the offering and issuer.
• Ongoing Use of Proceeds Assessment: Maintaining a reasonable understanding of material changes to the offering—or the issuer’s business during the offering—and evaluating factors that may alter the issuer’s intended use of proceeds. 

Additional Resources

• FINRA
  • Private Placements Key Topics Page
  • SEC Regulation Best Interest Key Topics Page
  • Report Center—Corporate Financing Report Cards
  • Regulatory Notice 23-08 (FINRA Reminds Members of Their Obligations When Selling Private Placements)
• SEC
  • Regulation Best Interest, Form CRS and Related Interpretations
  • Disqualification of Felons and Other "Bad Actors" from Rule 506 Offerings and Related Disclosure Requirements (Sept. 19, 2013)

1 See the Report’s Annuities Securities Products topic for additional findings concerning failure to comply with Reg BI’s Conflicts of Interest Obligation.