Friday, September 7, 2018

How to spot a fake private offering?

I recently came across an SEC Investor Alert through another blog posting, which I decided to highlight on my blog as well because of its increased relevance and importance in today's investment environment. I am referring to the Investor Alert: 10 Red Flags That an Unregistered Offering May Be a Scam from August 4, 2014.

This guidance has become particularly important because of the adoption of Rule 506(c) that allows private placements to be conducted using general solicitation and advertisement.  Although all purchasers in such offerings must be "accredited investors," information about such offerings gets widely disseminated and reaches the eyes of the unsophisticated and nonaccredited investors through websites and social media.

Below is a list of some of the red flags discussed by the SEC:

1.  Claims of high returns with little or no risk.  Every private placement memorandum should have a section on risk factors relating to that particular offering.  If you don't find one, assume two things: (i) this PPM is incomplete, and (ii) the risks, even though unstated, still exist (and in abundance).

2.  Unregistered investment professionals.  Always check the bios of the management team, as well as the profiles of the people promoting the offering.  The promoters must always be registered as investment advisers and/or broker-dealers with the SEC.  You can check the promoters' records on the Investment Adviser Public Disclosure website or FINRA's BrokerCheck.  A missing registration is a red flag.  I have written extensively about using unregistered broker-dealers in the past.

3.  Problems with sales documents.  Definitely avoid handshake deals.  Avoid signing agreements that you do not understand.  Read the PPM in its entirely to spot any inconsistencies, mistakes, and typos.  All factual information should have references, and no promises should be made.  When you are thinking of investing, do an Internet search and a search of the company's home state Department of State website to determine whether such business actually exists.

4.  Beware of offerings that are extended to nonaccredited investors.  Most private placement offerings are only available to accredited investors.  Those that are not are probably done in circumvention of applicable federal and state securities laws.  There are, of course, exceptions.  Rule 506(b) private placement can include up to 35 nonaccredited but sophisticated investors, and Title III crowdfunding offerings conducted through registered portals can be extended to an unlimited number of nonaccredited investors.

5.  Where are the lawyers?  A private placement offering is typically done with the assistance of a law firm.  Check whether this is the case.  If not, - participation in such offering is not recommended.  If yes, - read the firm's profile.  Are the involved attorneys experts in the area of securities laws?

These (and other) red flags have become increasingly important in light of numerous initial coin offerings offered through the Internet to retail investors.  Recently, to set an example, the SEC launched a bogus offering of HoweyCoins to illustrate to the investors what a scam ICO could look like. 

However, regardless of the SEC guidances and illustrations, there are many investors who have recently become victims of online investment fraud scams.  Thus, it is important to continuously remind investors how to recognize scam offerings and to avoid them.

This article is not legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.  Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law.

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