Beware of Pre-IPO Scams: Protect Your Investments

The lure of getting in on the ground floor of the next big tech giant or revolutionary startup can be enticing. Get in early and reap the rewards when the company goes public. 

But investing in pre-IPO (Initial Public Offering) comes with risks. The company may not survive those early stages and even worse, it might not be legitimate. The Securities and Exhange Commission (SEC) warns investors to be aware that these apparent golden opportunities are not always what they seem to be.

Here’s what you need to know to safeguard your investments and stay clear of scams.

What Are Pre-IPO Investments?

Pre-IPO investing involves buying shares in a company before it officially goes public. Promoters often promise high returns, leveraging the excitement of getting in early on a startup poised for success. However, these investments come with substantial risks:

• High Risk of Failure: Many startups never succeed, and the share price may never appreciate.
• Lack of Liquidity: If the company doesn’t go public, a market for the shares may never develop, leaving investors unable to sell their shares.
• Unregistered Securities: Most pre-IPO offerings are not registered with the SEC, making them illegal unless they qualify for specific exemptions.
• Buyout Rights: A buyout that pays investors back but doesn’t pay them for their risk or allow investors to participate in the upside.

The Dark Side: Pre-IPO Investment Scams

Fraudsters exploit the allure of pre-IPO investments to deceive unsuspecting investors. The SEC’s Office of Investor Education and Advocacy (OIEA) continues to receive complaints about such scams. Here are common tactics used by scammers:

Unregistered Investment Professionals: Most investment frauds in the U.S. are committed by unlicensed and unregistered individuals. Always verify the registration status of the seller on Investor.gov. and broker on FINRA.org.

Aggressive Sales Practices: Scammers often set up “boiler rooms” with unregistered sales agents who use high-pressure tactics to solicit investments. These agents might contact investors through cold calls, often using scripts designed to counter any objections.

Social Media Solicitations: Social media platforms have become popular tools for fraudsters to solicit victims. Never base investment decisions solely on information from social media.

Trending Topics: Scammers frequently pitch companies in trendy yet obscure sectors like crypto assets or artificial intelligence, capitalizing on the hype to attract investors.

Red Flags of Pre-IPO Scams

Fraudulent pre-IPO offerings often come with false or misleading claims. Be wary of:

• Impressive Websites and Spam Emails: Fraudsters create professional-looking websites and bombard potential investors with enticing emails.
• Unfounded Comparisons: Promoters may compare their company to successful enterprises to lure you in.
• Claims of Imminent IPOs: Promises that the IPO is “imminent” or will occur “this year” are often false that is the oldest trick (high-pressure sales tactics) in the book.
• No Upfront Fees: Claims of no upfront fees may hide exorbitant undisclosed markups.
• Limited Shares: Promoters might falsely claim they have a limited number of shares at a lower price or a higher return potential.

Real-World Example: SEC Combats Pre-IPO Fraud

In a notable case, the SEC charged three individuals with fraud for selling over $184 million of unregistered membership interests in LLCs that claimed to invest in pre-IPO shares. The individuals, operating through StraightPath Venture Partners LLC and later Legend Venture Partners LLC, used boiler rooms and high-pressure sales tactics, misleading investors about the true value of shares and pocketing over $45 million in fees.

The SEC’s action resulted in both StraightPath and Legend being placed under court-ordered receiverships. The SEC’s complaint sought permanent injunctive relief, return of ill-gotten gains, and civil penalties. Sheldon L. Pollock, Associate Director of the SEC’s New York Regional Office, likened the fraud to a Hollywood movie, highlighting the elaborate and deceptive nature of the scam.

Protect Your Investments

Before investing in pre-IPO shares, conduct thorough research:

• Verify Registration: Use the SEC’s tools to check if the seller and/or broker is registered.
• Evaluate Claims: Scrutinize claims about the company and the IPO timeline.
• Consult Professionals: Seek advice from licensed financial advisors.

By staying informed and vigilant, you can protect your hard-earned money from pre-IPO scams and make safer investment decisions.