FOR PRIVATE PLACEMENT OFFERINGS
(EXEMPT FROM REGISTRATION)
Summaries of SEC interpretations & court
decisions dealing with Section 4(2). "Basic requirements for private
All of the offerees must have access to
meaningful current information concerning the issuer (i.e. the
partnership). The fact that an offeree has considerable financial resources
or is a lawyer, accountant or business person, & thus may be considered
sophisticated, does not obviate the need for appropriate information to be
Regulation D in no way relieves issuers
of their obligation to furnish investors whatever materiel information may
be needed to make any required disclosures not misleading. (SEC interpretation 1992)
SEC vs. Ralston Purina Co. 346 U.S. 119
(1953) "Private offering exemption for employees would exist only to
the extent that the employees had access to substantially the same
information concerning the issuer which registration would provide and who
are able to fend for themselves."
All offerees & purchasers must have
access to the same kind of information concerning the issuer which would appear
in an SEC registration statement; these persons must be able to comprehend
& evaluate such information. (It must be kept in mind that any offer to
an offeree who would not qualify, as well as any sale to a purchaser who
would not qualify, may destroy the private placement exemption and result
in a violation of Section 5 of the Securities Act.)
The issuer and any parties acting for the
issuer, including the Broker-Dealer, must take all reasonable steps to
insure that the information given to offerees & purchasers is COMPLETE
& ACCURATE. This is "due diligence". All information passed
on in the course of the private placement, either orally or by memorandum
(or offering circular) is subject to the anti-fraud provisions of the
Federal Securities laws.
The fact that an offering memorandum is
not reviewed by the SEC does not lower the standards for accuracy which
would be applicable to any registered offering.
What is readily apparent from the
foregoing is that current and accurate information about the offerees in a
private placement transaction is absolutely essential for the making of
judgments as to suitability, ability to evaluate an offering &
investment and investment intent!
ACCREDITATION IS NO SUBSTITUTE FOR DISCLOSURE.
In other words, just because an investor is accredited (sophisticated, rich
and smart), the requirement and need for full disclosure is still very
apparent! An offering to accredited investors is exempt from registration,
CLASS "B" MUTUAL FUNDS
The investment in mutual
funds recommended by brokerage firms is, of course, subject to the risks of
general stock market volatility, the risks of concentrating in a specific
sector(s), the risks entailed in the stocks of the individual companies
comprising the fund, the risks attendant to the increased volatility of
small capitalization companies and the additional volatility of exposure
attendant to any foreign stocks in the funds. These risks are rarely
disclosed to the client (Report of the Mutual Fund Task Force - April
Furthermore, neither the
brokerage firm or the broker typically explains the material difference
between Class A, Class B and Class C shares to the client. These
differences include first the front end load. Class A shares incur an
initial sales charge. However, this can be substantially reduced or
eliminated by breakpoint discounts. Class B and Class C shares have no
front end load. Second is the Contingent Deferred Sales Charge (CDSC).
Class A shares do not have one. With respect to Class B shares, the
CDSC declines over several years. With Class C shares, there is
usually a lower CDSC than Class B shares that is eliminated after one
year. Third is 12b-1 fees. Class B & C shares have this
ongoing servicing fee that is much higher than with Class A shares.
Fourth, is Conversion to Class A shares. For Class A shares this is
N/A. Class B shares convert to Class A shares after 8 - 10 years,
thereby reducing expenses. Class C shares do not and their annual
expenses remain at the same level.
In June 25, 2003, in an NASD
Investor alert: Class B Mutual Funds; Do They Make the Grade?, pointed
out that given the fact that senior citizens frequently require funds as a
result of declining health, placing funds in an investment that carries a
large load, whether up-front or deferred, is suspect.
While Class B shares do not
incur an up front sales charge, they do have a contingent deferred sales
charge (the commission paid to the brokerage firm) of typically 4-5%.
If the shares are held for a specified period (generally 6
years), With each year, the buyer continues to hold the
investment in the fund, the deferred sales charge decreases, e.g.,
assuming a 5% sales charge, the customer is charged 5% if sold during
the first year, 4% if sold during the second year, 3% if sold during the
third year, and so on. While Class A shares carry an up-front
commission, the customer is provided break-points for investing more than a
specified amount (generally $50,000) in a family of funds so that
investments of large size ($250,000 to $500,000) range from 1.5% to
2.5%(which is the lower commission paid to the brokerage firm). The
broker's commission is determined by the sales charge whether in the
form of upfront commissions for Class A shares or the deferred sales charge
of Class B shares. Therefore, the broker has a financial incentive not
to inform the customer of the lower commissions available through the
breakpoint pricing of Class A shares.
Furthermore, the fees
charged the fund by the manager (known as 12b-1 fees) are generally higher
(two to three times larger) for Class B shares so that the fund company can
recapture the commission paid the brokerage firm. The brokerage firm
may also be engaged with undisclosed revenue sharing (selling "shelf
space") to the mutual fund and/or paying its registered representatives
a cash incentive ("cash differential") to promote certain funds,
again without disclosure even though both may lead to the broker's decision
to recommend the fund's purchase.
While Class B shares
eventually convert to Class A shares. the conversion can take 8 to 10 years
so that even after the six year holding period, to avoid the deferred sales
charge, expires, the customer continues to pay the higher 12b-1 fees for a
period of years. Given the breakpoint pricing and the lower 12b-1 fees
available with the purchase of Class A shares, the justification for
recommending the purchase of Class B shares is inherently suspect and is
never the best answer for the investor ( Edward S. O'Neal, Mutual Fund
Share Classes and Broker Incentives, 9/1/99 Fin. Analysts J.76
Assuming the class A shares
have a 3% front-end break-point for purchases between $100.000 and $249,000,
the respective sales charge would be $5,000 for the Class B shares and
$2,000 for the Class A shares. Further, assuming a 0.80% management
fee for the fund and 12b-1 fees of 0.25% for the Class A shares and 1% for
the Class B shares, if the Customer intends to withdraw the income from the
account, Class B shares are never appropriate. For example, assuming
that the fund earns a 6% annual return, over 8 years the shares perform as
With Class A shares, the
amount invested each year would be $97,000. The 6% return each year
would be $5,820, the 12b-1 fees would be $257 annually, the management fee
would be $823 each year and the net earnings would be $4,740.
Over 8 years, that totals $37,923. With Class B shares we have the
full $100,000 invested for each of the 8 years, instead of $97,000.
The 6% return is $6,000 rather than $5,820 per year. However, the
12b-1 fee is a whopping $1,060 each year instead of $257! The
management fee increases from $823 per year to $949. The Net Earnings
decline from $4,740 per year down to $4,092. Over the 8 years, the net
earnings after all expenses are only $32,736 instead of $37,923 a decline
of $5,187 or nearly 14%. Even though "all" of the
invested funds go to work in the Class B shares, the Class A shares earn the
investor a 14% greater annual return. Since the 12b-1 fees for mutual
funds are generally 65% to 85% higher than the Class A 12b-1 fees, when
income is the objective, Class A shares outperform Class B shares because
the additional income generated by the "extra" 5% invested cannot
offset the additional 12b-1 fees charged on the entire investment.
In a down or breakeven
market, the Class A shares catch up to the Class B shares at the end of the
third year and outperform those shares thereafter. And, with the
declining deferred sales charge, liquidating the Class B shares is losing
proposition even in those first three years. Similarly, reinvesting
the dividends or interest, provides the same preference for Class A
shares. They catch up with the Class B shares after the fourth year
and outperform them thereafter while providing a distinct advantage if
liquidated during the first four years.
The only "winner"
involving the purchase of Class B shares is the brokerage firm. In our
example where the sales credit is only $2,000 greater for Class B shares
($5,000 as opposed to $$3,000) the firm would generate an additional $7,354
in 12b-1 fees until the shares converted. That, the 12b-1
differential, is the motivation, even for pushing Class B shares for even
relatively modest accounts.
Both the NASD and SEC hhave
initiated enforcement proceedings as a result of Class B sales abuses.
(See e.g. Joint SEC/NASD/NYSE Report of Examinations of Broker-Dealers
regarding Discounts on Front-End Sales Charges on Mutual Funds, (March
2003). Since the broker is compensated on the basis of the deferred
sales charge foe Class B shares (and. perhaps, trailing credits on a portion
of the 12b-1 fees), the broker has a vested interest in recommending the
seemingly "commission free" Class B share purchase so that
"all" the money can "work" for the investor and to never
disclose the true economic realities.
- Securities Expert Witness