Friday’s Fraud – Private Offerings: Investing, Fraud and the Value of Referees

By Benjamin Stubbs, Spring 2014 Student Intern

refMany of us learned in elementary school how important referees can be.  When close plays and mistakes happens, without a referee, no one has the final word and it’s difficult to correct mistakes and prevent cheating.  Though referees may be annoying and even enraging at times, it is important to have someone watching what happens to make sure rules are followed and games are played fairly.

The SEC as Referee

When it comes buying and selling securities—or stocks—in some ways the Securities Exchange Commission (SEC) is our referee of the securities market.  The SEC’s mission “is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital information.”  Essentially, the SEC watches stock sales and trades that people make to ensure they follow the rules and play fair.  In two acts passed in 1933 and 1934, Congress gave the SEC the authority to oversee, or to act as referee of, and to regulate the securities industry, and it has been doing so ever since—only without whistles and striped shirts.

A key component of the SEC’s oversight of securities is the general requirement that all companies, even small ones, offering or selling securities, must register the securities to be sold with SEC.  As with most rules, however, there are exceptions, and the SEC, through Regulation D (Reg. D), provides three exceptions to the general registration requirement.  For a fuller explanation of Reg. D and its exceptions, check out the SEC’s webpages on Rule 504, Rule 505 and Rule 506.  For our purposes here, it is sufficient to say that when a company’s sale of securities falls within one of these rules, the company does not have to register its securities with the SEC before it sells them.

What are Private Offerings and why are they risky?

These sales of unregistered securities are known as private (or non-public) placements or offerings, and as FINRA notes, every year companies raise billions of dollars selling them, which is good for them, and may be good for you too.  FINRA also notes, however, that “investing in private placements is risky and can tie up your money for a long time.”

One of the primary reasons private offerings are so risky is that there is often limited information about the company who is selling the stocks and often limited financial reports about the company because many of the companies who meet one of Reg. D’s exceptions are not required to file financial reports that other companies are.  In essence, trading in private placements is risky because the referee—the SEC—has less oversight and it is easier for companies to keep information about themselves hidden than it would be if they had to register their securities with the SEC before selling them.  Thus, selling and buying private offerings is something like playing a basketball game where, though three referees are normally required, only one or two are at your game.  As a result, more mistakes and foul play goes unnoticed.

For this reason, as NASAA’s article reports, “[f]raudulent private placement offerings continue to rank as the most common product or scheme . . . .”  In fact, in 2011 FINRA sanctioned several firms and individuals for providing inaccurate information about private placements to investors, and NASAA predicts that private offerings will continue to be one of the most fraud-prone practices in the coming years, particularly because certain advertising restrictions on them are being relaxed.

How can you protect yourself and your money?

rainyAs with any investments, it’s important that you do your homework to make sure you make informed decisions, and there are several organizations that want to help you.  Because private offerings are so risky and have been used often to defraud investors, FINRA offers several tips on what you should do to determine whether private offerings are right for you.  To summarize a few: find out as much as you can about the company offering the securities, and the company’s industry; ask your broker what information he or she used to investigate the company; ask your broker whether the investment fits with your other investments; review carefully any information you have been given on the private placement and make sure your information matches what your broker has on it; and “[b]e extremely wary of private placements you hear about through spam emails or cold calling” because “[t]hey are often fraudulent.”

FINRA also lists several steps that you should take if you’re considering investing in a specific type of company that is making a private offerings. Additionally, has a good article on the related topic of broker-dealer self-offerings that provides information and guidance on how to approach those.


The message here isn’t to avoid private offerings at all costs. The message is to be extra cautious about investing in private offerings, especially those you hear about through email or cold calls, because they may be a fraudulent offer, and even if they are legitimate they are risky.  Though investing in small companies can be very profitable if those companies succeed, private offerings are risky, can tie up your money for a long time so you can’t cash in on the investment and you could even lose all of your money.  So proceed cautiously and do your research before investing in a private offering, and if you think you may have been the victim of a fraudulent private offering, don’t be afraid to call our Clinic.

If you found this post helpful, or just interesting, check back in next Friday for the second edition of Friday’s Fraud Watch, helping you prepare for your future by learning from the past.