Marketing of Private Securities by Brokers Is A Persistent Problem Within the Brokerage Industry

Much of our economic growth is created by entrepreneurs starting a business in the family kitchen. In order to grow virtually all new starts need investment capital. Venture capital can come from a variety of sources including venture capitalists and private equity firms. The average investor is normally excluded from investing in such start-ups.

Sometimes, however, the average investor is presented an investment opportunity that appears too good to be true. Coincidentally, the opportunity comes from your trusted broker. At that point some red lights should be flashing. But what are private securities?
When a new business sells interests to investors they are generally known as private securities as opposed to public securities. Unlike public securities, private securities are not publically traded and are very difficult to monitor after the investment is made. Once you have made your investment it is almost impossible to liquidate your investment at a time of your own choosing.
Although the successes are widely publicized, we hear little of the many failures. Private securities sold as private placement securities are highly speculative and risky with a high rate of failure. Since they are private it is axiomatic that the public hears little of the failures- except the investors.
Sometimes private securities are sold by brokers. When that occurs your first question to the broker should concern the relationship between the broker and the private security. Brokers often claim that they are not receiving any commission. What they fail to mention is that they may have received equity as a managing partner in return for equity or other form of consideration. It is axiomatic that the broker’s motive is some form of payment. The practice of selling securities around the brokerage firm is known as “selling away”.
In any event, you should immediately notify the brokerage firm, ask if they have approved the investment, ask for the approval, and ask if your investment will be held within your account. With limited exceptions, securities rules require brokerage firms to approve any private security transaction sold by any of their brokers and must treat them as if they are being sold within the firm. Most firms will disapprove such activity by a broker if they know about it. They do not want the accompanying liability such as customer claims.
The marketing of private securities by brokers is a fraud and abuse of the investing public. Brokerage firms are required to play a critical role in preventing such abuses. FINRA alone cannot stop this fraud upon the investing public. Supervision after the fact does nothing to help a victim. Often firms fail to see the red flags. When that occurs your only remedy is securities arbitration against the brokerage firm.

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