We have published a number of articles to help investors understand how to purchase pre-IPO shares and the potential risks and rewards of doing so.
Our first foray into the area was an article written by Robert Rapp, “A New Private Trading Platform for Restricted Securities: Liquidity for Accredited Investors at What Price,” which discussed the then-newly announced joint venture between SharesPost, Inc. and NASAQ OMX Group to launch a secondary market trading platform for the purchase and sale of private company securities. This article was published in 2013. Also published in 2013 was our “A Very Basic Primer on Pre-IPO Markets” by our Financial Poise editors. This also is worth a read for anyone interested in preliminary information on investing in pre-IPO shares.
In 2015, we warned of the high valuations of many pre-IPO companies in “Pre-IPO Shares: Red Hot But Risky”. This article warned investors then that “[w]hile funds like this may seem attractive, the ordinary investor should proceed with caution. It is true that the performance of such shares as of late – especially in booming tech companies with significant pre-IPO valuations- are attractive. But will that always be the case?”
The Wall Street Journal piece entitled “Regulators Probe Marketing of Hot Private Tech Shares,” tells the tale of a Jonathan Sands, who ran what was apparently a hedge fund called Artist Capital Inc.,and his sales pitch for an investment fund with $100 million of stock in Uber which the fund didn’t actually own. According to the article, middlemen like Sands were “designing derivatives that deliver payments to employees based on a stock’s perceived value.” But, as the article points out, “[p]rices used in transactions can be based on little more than a guess, since private companies keep almost all their financial information secret.”
Today’s market is vastly different. With the introduction and continued prevalence of the internet’s role in selling and buying securities (whether that be through crowdfunding, social media or the like,) the ability to offer unregistered, private securities is advancing at an alarming rate. Unfortunately, more and more of these unregistered, private securities are being sold to unsuspecting and unassuming older investors, making them not only unprofitable for the investor, but dangerous and fraudulent, as well.
In InvestmentNews’ article “Sales of unregistered securities are a growing problem that’s harming investors-and the industry,” author Bruce Kelly states: “By all indications, the marketplace for all types of private, unregistered securities, including private placements sold to wealthy investors and institutions, is thriving. But what’s growing alongside this legitimate, if risky, market is a seedy side of the financial advice industry. Investment funds promising above-market returns that employ networks of brokers, former brokers, insurance agents or others lurking on the fringes of the industry to sell their investments (pre-IPO shares) are taking advantage of unsuspecting investors.”
The sales of new private stock offerings have rapidly escalated, while the sale of public stock offerings have remained steady. The most popular of the private stock offerings, known as Regulation D offerings, “have more than doubled, from 18,295 in 2009 to 37,785 in 2017. Those deals, along with other types of private offerings, raised a total of $3 trillion in 2017.”
Unless the investor client is very wealthy (in which case, brokers and advisors have no deterrent to sell to those individuals with a net worth of $1 million or more,) the average investor has no business investing in the alternative investments some brokers tout. And the average investor is being targeted. Even more unfortunate is the fact that these investments are not transparent because they don’t need to be and are oftentimes heavily marketed because of the availability of online platforms.
According to the Financial Industry Regulatory Authority (FINRA), a not-for-profit organization protecting investors by making sure the broker-dealer industry operates fairly and honestly, investing in unregistered securities carries a great amount of risk. But, if you do decide to invest, here are some helpful red flags to look out for. Any, or a combination of these may signal fraud:
Do your research. Make sure to check FINRA’s BrokerCheck report to determine whether your investment professional and/or brokerage firm is registered within the industry. Another resource to employ is the Securities and Exchange Commission (SEC’s) EDGAR site. EDGAR included corporate information, registration statements, as well as confirmation as to whether a company is using registration exemptions under Regulation D.
[Editor’s Note: On a related topic, in our webinar, “Impact of the JOBS Act on the IPO Market,” we discuss the regulatory burdens associated with “going public” and thereafter “being public” as major hurdles facing smaller issuers considering the prospect of an IPO. This is an updated version of an article that was originally published on May 27, 2015.]
Financial advisor, author.
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