Opening a Private Placement Account

The account record and knowing the customer

FINRA Rule 4512 sets the baseline. For each account a member must maintain the customer's name and residence; whether the customer is of legal age; the names of the associated persons responsible for the account together with a record of the scope of their responsibilities; and the signature of the partner, officer or manager denoting that the account has been ACCEPTED. For an entity account, the names of any persons authorised to transact business on its behalf.

The rule also requires the member to make reasonable efforts to obtain the name and contact information of a TRUSTED CONTACT PERSON age 18 or older — someone the firm may contact about the account in specified circumstances. Note the standard: reasonable efforts. The absence of a trusted contact does not prevent the firm from opening or maintaining the account.

For institutional accounts the associated-person and trusted-contact requirements do not apply. An institutional account under Rule 4512(c) means the account of a bank, savings and loan, insurance company, registered investment company or registered investment adviser, or of any other person with total assets of at least fifty million dollars.

Account information that is subsequently updated must be preserved for at least six years after the update.

FINRA Rule 2090 states the underlying obligation in a single sentence: every member shall use reasonable diligence, in regard to the opening and maintenance of every account, to know and retain the essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer.

The supplementary material defines "essential" facts as those required to effectively service the account, to act in accordance with any special handling instructions, to understand the authority of each person acting on the customer's behalf, and to comply with applicable laws, regulations and rules.

Read that last clause in a private placement context. Complying with applicable law includes establishing that a purchaser is an accredited investor. Under Rule 2090, gathering the accreditation facts is not an extra step alongside knowing your customer — it is part of it.

Separately, the anti-money-laundering rules require a written Customer Identification Program. A broker-dealer must obtain specified identifying information before the account is opened — for an individual, name, date of birth, a street address and a taxpayer identification number — verify identity within a reasonable time using documentary or non-documentary methods, compare the customer against government lists of known or suspected terrorists, keep records of what it obtained, and give customers notice that the information is being requested to verify their identity. For legal entity customers, a separate rule requires procedures to identify and verify the BENEFICIAL OWNERS behind the entity, which matters constantly in private placements because so many investors subscribe through an LLC or a trust. The content outline pairs CIP and KYC as one knowledge area, and it is worth keeping them distinct: CIP establishes that the customer is who they say they are, KYC establishes what you need to know about them to serve them properly.

Authority, entities and third parties

Private placement investors are often not individuals buying in their own names. They are trusts, limited liability companies, self-directed retirement accounts and family entities, and the firm must understand who is entitled to act.

For a CORPORATION or LLC, a corporate resolution or equivalent authorisation identifies the officers or managers permitted to open the account and transact. The articles of incorporation or organisation evidence the entity's existence and, sometimes, its investment powers.

For a TRUST, the trust instrument or a certification of trust identifies the trustees and their powers. This matters more than usual in private placements: a trustee's authority to buy an illiquid unregistered security is not something to assume, and Rule 501(a)(7)'s accredited trust category itself requires that the purchase be directed by a sophisticated person.

For a PARTNERSHIP, the partnership agreement identifies the general partner and their authority.

For a THIRD PARTY acting on an individual's behalf, a POWER OF ATTORNEY is required, and the content outline asks you to distinguish FULL from LIMITED authorisation. A limited or trading power of attorney permits the third party to place orders. A full power of attorney additionally permits withdrawal of cash and securities. That distinction is one of the most reliably tested points in this part of the syllabus.

Where the account is a retirement plan, ERISA may apply. A plan fiduciary owes duties of loyalty and prudence under ERISA and must diversify plan investments unless it is clearly prudent not to. The practical consequence for a private placement representative is that an illiquid, concentrated, unregistered position in a plan account deserves more scrutiny than the same position in a taxable account, and that the plan's own governing documents may simply forbid it.

Rule 2090's obligation to know the authority of each person acting for a customer is what ties all of these documents together. Collecting them is the mechanism by which that obligation is met.

The private placement paperwork

Three documents appear in the content outline that a general securities representative would never see, and they are the ones that carry the exemption.

The SUBSCRIPTION AGREEMENT is the contract by which the investor offers to buy. It is an offer that the issuer accepts, which is why a subscription is not a completed purchase until countersigned. It contains the investment amount and terms, and — importantly — a set of investor REPRESENTATIONS: that the investor is purchasing for their own account and not with a view to distribution, that they can bear the economic risk and the loss of the entire investment, that they have had the opportunity to ask questions and receive answers, that they understand the securities are restricted and cannot be freely resold, and that they meet the applicable investor status.

Those representations are not boilerplate. The purchasing-for-own-account representation is how the issuer discharges the Rule 502(d) reasonable-care obligation to ensure purchasers are not underwriters. The opportunity-to-ask-questions representation maps onto Rule 502(b)(2)(v). The restriction acknowledgment maps onto 502(d)(2). Each clause is answering a rule.

The INVESTOR QUESTIONNAIRE establishes accredited investor status and, where relevant, sophistication. It collects income, net worth, professional credentials and investment experience. Under Rule 506(b) a completed questionnaire consistent with everything else the firm knows can support the issuer's reasonable belief. Under Rule 506(c) it cannot stand alone, because the rule requires reasonable steps to VERIFY — the questionnaire is where verification starts, not where it ends.

The QIB CERTIFICATION LETTER is the Rule 144A instrument. It is the certification by the purchaser's chief financial officer, a person performing an equivalent function, or another executive officer, specifying the amount of securities owned and invested on a discretionary basis as of a date on or since the close of the most recent fiscal year. It is one of the four non-exclusive methods Rule 144A gives a seller for establishing QIB status.

Where an offering is conducted electronically — and most now are — the content outline adds "documentation necessary for electronic private placement offerings." The substance does not change. Electronic signatures, identity verification, secure delivery of the offering documents and a reliable audit trail of what was delivered when are what an electronic process must produce, because the file has to prove the same facts either way.

One last document, and it is the investor's own: a CONFIDENTIALITY AGREEMENT, often signed before the PPM is released. Private issuers disclose commercially sensitive information to prospects, and a non-disclosure agreement is the ordinary condition of receiving it. It is also, incidentally, evidence that the offering was conducted privately.

Privacy, arbitration and supervisory approval

Three obligations complete the account opening.

PRIVACY. Regulation S-P requires a broker-dealer to provide an initial privacy notice to a customer no later than when the customer relationship is established, and an annual notice thereafter in the circumstances the rule specifies. Where the firm shares non-public personal information with non-affiliated third parties outside the permitted exceptions, the customer must be given notice and a reasonable opportunity to OPT OUT. The safeguards rule requires written policies and procedures reasonably designed to protect customer records and information. The exceptions matter in practice: disclosures made to process a transaction the customer requested, or with the customer's consent, do not trigger the opt-out — which is why sending a subscription agreement to the issuer's transfer agent is not a privacy problem.

PREDISPUTE ARBITRATION. Where the account agreement contains an arbitration clause, FINRA Rule 2268 requires a highlighted statement immediately preceding the signature line telling the customer the agreement contains a predispute arbitration clause and where in the agreement it appears, and requires seven specified disclosures immediately preceding the clause. They tell the customer that all parties are giving up the right to sue in court including the right to a jury trial; that awards are generally final and binding and a court's ability to reverse or modify one is very limited; that discovery is generally more limited than in court; that arbitrators need not explain the reasons for an award unless all parties jointly request an explained decision at least 20 days before the first scheduled hearing; that the panel may include a minority of arbitrators affiliated with the securities industry; that some forums impose time limits and an ineligible claim may sometimes be brought in court; and that the forum's rules are incorporated into the agreement.

The member must give the customer a copy of the agreement within 30 days of signing, and Rule 2268(f) prevents a member from enforcing an arbitration agreement against a member of a certified or putative class action until certification is denied, the class is decertified, or the customer is excluded.

SUPERVISORY APPROVAL. Rule 4512 requires the signature of a partner, officer or manager denoting acceptance of the account. Behind that signature sits FINRA Rule 3110, which requires a supervisory system reasonably designed to achieve compliance, written supervisory procedures, designated registered principals for each type of business, review of incoming and outgoing correspondence and internal communications, and internal inspections — annually for every office of supervisory jurisdiction and every branch office that supervises a non-branch location, at least every three years for other branch offices, and on a regular periodic schedule for non-branch locations. Rule 3110 also requires an annual compliance interview or meeting for each registered person. Rule 3120 requires the firm to test and verify its supervisory procedures and to report annually to senior management.

And a firm may decline. The content outline lists "circumstances for refusing or closing accounts," and the answer is that a member is not obliged to open an account for anyone. Where identity cannot be verified, where the source of funds is unclear, where the customer's objectives cannot be reconciled with what the firm sells, or where the customer will not provide the information the firm needs, declining is the correct outcome rather than a commercial failure.