Private Placement of Securities In addition to underwriting securities for distribution to the public,

Private Placement of Securities In addition to underwriting securities for distribution to the public,

securities may be placed with a limited number of financial institutions. Private placement, as this process is known, differs from the public offering of securities that we have described so far. Life insurance com- panies are the major investors in private placements.

Public and private offerings of securities differ in terms of the regu- latory requirements that the issuer must satisfy. The Securities Act of 1933 and the Securities Exchange Act of 1934 require that all securities offered to the general public must be registered with the SEC, unless there is a specific exemption. One exemption from registration under the 1933 act is for “transactions by an issuer not involving any public offering.” Regulation D, adopted by the SEC in 1982, sets forth the guidelines that determine if an issue is qualified for exemption from reg- istration. The guidelines require that, in general, the securities cannot be offered through any form of general advertising or general solicitation that would prevail for public offerings. Most importantly, the guidelines restrict the sale of securities to “sophisticated” investors. Such “accred- ited” investors are defined as those who (1) have the capability to evalu- ate (or who can afford to employ an advisor to evaluate) the risk and return characteristics of the securities, and (2) have the resources to bear the economic risks.

The exemption of an offering does not mean that the issuer need not disclose information to potential investors. In fact, the issuer must still furnish the same information deemed material by the SEC. The issuer supplies this information in a private placement memorandum, as opposed to a prospectus for a public offering. The distinction between the private placement memorandum and the prospectus is that the former does not include information deemed “nonmaterial” by the SEC, if such information is required in a prospectus. Moreover, unlike a prospectus, the private placement memorandum is not subject to SEC review.

Investment banking firms assist in the private placement of securi- ties in several ways. They work with the issuer and potential investors on the design and pricing of the security. Often it has been in the private placement market that investment bankers first design new security structures. The investment bankers may be involved with lining up the investors as well as designing the issue. Or, if the issuer has already identified the investors, the investment banker may serve only in an advisory capacity. An investment banker can also participate in the transaction on a best efforts underwriting arrangement.

In the United States, one restriction imposed on buyers of privately placed securities is that they may not be resold for two years after acquisi- tion. Thus, there is no liquidity in the market for that time period. Buyers

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of privately placed securities must be compensated for the lack of liquid- ity, which raises the cost to the issuer of the securities. In April 1990, however, SEC Rule 144A became effective. This rule eliminates the two- year holding period by permitting large financial institutions to trade securities acquired in a private placement among themselves without hav- ing to register these securities with the SEC. Private placements are now classified as Rule 144A offerings or non-Rule 144A offerings. The latter are more commonly referred to as traditional private placements. Rule 144A offerings are underwritten by investment bankers.