Tracy Nye, 50, says he was forced out of early retirement last year after losing $1.5 million on privately placed investments—largely unregulated equity and debt securities not listed on an exchange. The Boise (Idaho) resident says he put $1.1 million into debt securities issued by Medical Capital Holdings, a financial firm, and $400,000 into Shale Royalties, an affiliate of energy company Provident Royalties. In July 2009, the U.S. Securities and Exchange Commission sued the firms for fraud, and most of the investments were wiped out.
Most private placements are offered to individuals under the SEC's Rule 506, which allows sales to "accredited investors"—those with net worth of $1 million or $200,000 in annual income—as well as institutions. The rule assumes that they have the sophistication to evaluate the investments. The problem is that the SEC established the requirements in 1982 and hasn't adjusted them for inflation. As a result, says Jennifer Johnson, a law professor at Lewis & Clark Law School in Portland, Ore., some investors, especially retirees who qualify, may not understand the risks. The financial overhaul bill enacted in July directs the SEC to exclude primary residences from the net worth calculation and to study the accredited investor standards.
Private placements allow companies to raise money without going through the extensive financial disclosure required by a public offering. Neither the SEC nor state regulators routinely review them. Most offerings aren't fraudulent and can be lucrative for appropriate investors, says Jay Turo, chief executive officer of Growthink Securities, which helps private companies raise capital.
Still, the lack of information can put investors at a disadvantage, says Manning Warren, a law professor at the University of Louisville's Brandeis School of Law. "At best they don't get enough disclosure to understand the risks involved, and at worst, these investments turn out to be totally bogus," he says. The Financial Industry Regulatory Authority, which oversees brokers and their firms, says complaints about private placements have jumped 35 percent so far this year on top of a more than 50 percent increase in 2009.
Investors lost more than $1 billion by purchasing private placement securities issued by Medical Capital, which offered financing to health-care providers awaiting payment of bills, and about $485 million from Provident Royalties, an oil and gas investment firm, according to the SEC's estimates. The SEC said the firms made misrepresentations and misappropriated money. Both companies are in receivership and the cases are pending.
Nye, the Idaho investor, says that brokers at Jackson McClenny Investments, the firm that sold him Medical Capital and Shale Royalties, were clear about the illiquidity of the investments without emphasizing the risks involved. Formerly in the construction business, he's now operating a restaurant that sells smoothies and sandwiches instead of enjoying his early retirement. The phone number listed for Jackson McClenny in Boise has been disconnected, and the firm doesn't appear in Finra's BrokerCheck, an online database.
The bottom line: Some retirees who qualify as accredited investors based on their assets may lack the expertise to evaluate private placements.