California Securities Fraud Lawyer Blog

Today, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2009. Now, brokers will have a much harder time justifying the sale of private placements to small investors. Effective as of July 21, 2010, an investor's primary residence will no longer be considered when attempting to qualify for the $1 million minimum net-worth requirement for accredited investors under Rule 501(a)(5) of Regulation D. Also, one year from the date of enactment, the SEC will undertake a review of the "accredited investor" definition to determine whether any other requirements should be implemented for the "protection of investors, in the public interest, and in light of the economy."

See Related Blog Postings:

• It's Time to Change the Accredited Investor Rule for Private Placements


• Even for Accredited Investors, Stockbroker Recommendations to Buy Private Placements Are Subject to the Suitability Rule

My California securities law firm has been inundated with inquiries from small investors who were sold unregistered private placements even though they were clearly not wealthy or financially sophisticated. Some of these private offerings--such as those issued by Medical Capital Holdings and Provident Asset Management--turned out to be outright frauds.

The private placements that are causing the most trouble were widely sold by stockbrokers who were only allowed to target wealthy individuals that have the financial capability to bear the risk of investing in unregistered and illiquid securities. These qualified investors are referred to as "accredited investors" under the federal securities laws. As discussed in a previous blog posting about accredited investors, an individual will be considered "accredited" if they have a net worth of $1 million (including equity in their home) or an annual income in excess of $200,000 (or $300,000 when combined with a spouse). The financial threshold for "accredited investors" was established under "Regulation D" which was adopted back in 1982. These requirements have not been updated since they were implemented 28 years ago. According to an analysis conducted by Businessweek, if adjusted for inflation, the accredited investor net worth requirement would increase from $1 million to $2.25 million and the income requirement would increase to $449,000 (single) and $674,000 (married). It is estimated that there were approximately 1.5 million "accredited investors" back in 1982. By 2008, the estimated number of households that were "accredited" swelled to as much as 7.2 million.

With such a low barrier to entry, many small investors were allowed to unwittingly put their retirement savings at risk--often lured by assurances from their stockbroker of high returns, safety and liquidity. An increase in the accredited investor qualification requirements is necessary to curtail the sale of private placements to individuals who can least afford to lose their investment.

See related blog posting:

Even for Accredited Investors, Stockbroker Recommendations to Buy Private Placements Are Subject to the Suitability Rule

In my California-based securities law practice, most of my clients that own a home qualify as "accredited investors" within the meaning of Regulation D which exempts private placements from federal securities registration requirements. Rule 501 of the Securities Act of 1933 defines an accredited investor as any person with a net worth (or joint net worth with a spouse) in excess of $1,000,000 at the time of purchase. According to an SEC Interpretive Release (See Question 255.13), when calculating an investor's net worth, their residence is included.

Financial advisors or stockbrokers who sell private placements are subject to the rules and standards promulgated by the Financial Industry Regulatory Authority (FINRA). According to FINRA, stockbrokers who act as selling agents for private placements are required to conduct a due diligence investigation of the offering so that they understand the nature of the investment and its risks. Also, before recommending a private placement to a particular customer, the stockbroker must perform a suitability analysis by examining the customer's overall financial situation and investment objectives. Because a home can represent an investor's largest asset, net worth alone should never be used to determine whether an investment is suitable. A customer's status as an accredited investor does not release a stockbroker from the suitability requirements.

Recently, there has been a surge in investor complaints involving private placements that were sold by broker-dealers who were acting as selling agents. Private placements that are creating a lot of investor complaints include: Medical Capital, IMH Secured Loan Fund, Provident Asset Management, Striker Petroleum and DBSI. Some of the broker dealers who actively sold one or more of these private placements are Securities America, QA3 Financial, National Securities, CapWest, Independent Financial Group, just to name a few. Please contact us if you have any questions about unsuitable private placements.