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Investor advocates and securities regulators have long warned of the risks of purchasing private placement offerings due to the lack of information about the offerings and the lack of liquidity in the investment. Now, according to a recent study conducted by the Wall Street Journal, there is an additional risk factor to contend with — that the brokers selling these private placement investments are among the most disciplined in the financial industry.

Private Placements — What are They?

Private placements can be stock, limited partnership interests or other kinds of securities issued by companies that are not publicly traded. By issuing these securities through certain exemptions from federal securities laws, the companies are not required to comply with public disclosure laws, such as filing quarterly and annual financial statements and providing ongoing disclosures to investors. In addition, private placement securities are not listed on securities exchanges, such as the New York Stock Exchange or NASDAQ. Therefore, investors cannot count on being able to sell these securities when they need money or believe the value has peaked. Sales of private placements have skyrocketed in recent years. In 2017 alone, more that 1,200 brokerage firms sold $710 billion in private placements, and statistics through May 2018 are on track to top 2017.

The Wall Street Journal Study

The Wall Street Journal built a database of more than 320,000 filings for private placements with the Securities and Exchange Commission from 2008 to May 2018, and then compiled a list of brokerage firms listed as selling the private placements. The Journal then compared the disciplinary records of stockbrokers currently working at those firms with those of brokers working at firms in the financial industry as a whole. The study’s findings were not surprising, but were disturbing nonetheless. Although only around four in ten brokerage firms sell private placements, those firms were 14 times more likely to have been expelled by FINRA than those that did not sell private placements. In addition, high-risk brokers (those brokers with three or more investor complaints, regulatory or criminal actions or other “red flags”) tend to associate with firms selling private placements, often because private placements pay higher commissions than other types of investments. The Wall Street Journal cited Newbridge Securities Corp. of Boca Raton, Florida, as an example. With more than 100 brokers, the study found that investors have a one in four chances of getting a broker there with at least three “red flags.” Regulators have sanctioned the firm 20 times over the past decade, with fines totaling $1.75 million.

What Can the Investor Do?

First, investors need to understand the risks inherent in private placement securities. Fair and robust securities markets depend on the disclosure of complete and accurate information upon which to make informed investment decisions. Companies that issue publicly traded securities that are listed on securities exchanges are required to provide publicly available information, such as financial statements, on a quarterly and annual basis. Companies that issue private placements do not have this requirement. Therefore, the information provided to investors may be incomplete or even inaccurate. Second, investors need to understand that the risks include a lack of liquidity. Investors who are used to being able to buy and sell exchange-listed securities by simply the click of a mouse or a quick call to their broker may be surprised to learn that selling a private placement security is not so easy. Investors need to be prepared to own their private placement securities indefinitely. Third, investors are urged to use the databases available to the public. If your broker or financial advisor recommends a private placement to you, check them out on FINRA’s BrokerCheck, as well as the firm itself and other financial advisors from the firm.

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