PRIVATELY PLACED SECURITIES

Privately placed securities are those that are sold directly to institutional investors instead of being offered for sale to the general public. Privately placed securities are usually bond issues, including corporate bonds; they also include other debt instruments as well as equity securities. Privately placed securities are issued primarily by smaller companies, although even Fortune 500 companies occasionally make use of the private placement market. The major purchasers of privately placed securities are life insurance companies, with other institutional investors such as mutual funds, pension funds, banks, savings and loan associations, and limited partnerships also participating in buying private placements.

Certain securities offerings, including privately placed securities, are exempt from the registration requirements of the Securities and Exchange Commission (SEC). These include securities that are purchased for investment rather than for distribution. Exempt securities must be offered through direct communication with the purchaser without general advertising. Such investors are assumed to have access to significant financial information concerning the issuer and the issue and thus do not require the guarantee of full disclosure afforded by SEC registration. Accordingly, exemption from SEC registration applies to the sale of securities involving a limited number of financially sophisticated purchasers.

While companies may not need to register their private placements with the SEC, they must comply with the SEC's Regulation D, which governs the private placement of securities. Instead of registering a prospectus with the SEC, companies prepare a private placement memorandum (PPM) for prospective investors. The PPM typically includes a description of the business, with a scenario covering anticipated business conditions and financial projections.

Privately placed securities are generally considered less liquid than comparable public issues. That is, it is easier for a purchaser to resell publicly issued securities than privately placed securities. This is due to the conditions under which private placements are issued as well as the restrictions that exist on resales. As a result of this liquidity risk, privately placed securities generally pay higher rates of interest than comparable public issues.

In 1990 bonds represented 87 percent of all privately placed securities, with equity securities accounting for the remaining 13 percent. Approximately $87 billion of privately placed bonds were issued in 1990, representing 29 percent of the $299 billion of new bonds issued in the United States that year. The $87 billion in privately placed bonds represented a decline from the high of $128 billion issued in 1988. One factor accounting for the decline was the desire of life insurance companies, the primary purchaser of private placements, to find more liquid investments to better cope with changing financial conditions.

Private placements proved to be very popular in the 1990s, as low yields in the public market sent investors to private placements. According to Securities Data Co., the market volume of private placements rose to $201 billion in 1996, a 50 percent increase over 1995. During 1995 44 percent of all private placements were led by investment banks, with commercial banks leading in 33 percent of the transactions.

Private placement offers several advantages to both borrowers (issuers) and lenders (purchasers). Since private placement is based on direct negotiations, it is possible to tailor the loan terms to fit the needs of both parties. Direct negotiation also makes it easier to structure complex offerings that would not be easily understood by the public. For lesser-known firms and smaller companies, private placements may represent their only source of long-term capital. For larger firms, private placements offer less expensive borrowing than with registered public offerings. Private placement also provides the issuer with some confidentiality regarding its financial records. In the case of public offerings and SEC registration, sensitive financial data must be disclosed.

Restrictive covenants are commonly used in private placements to protect the lender and ensure that the borrower conducts its business in a manner that will protect the value of the privately placed securities. While covenants are also written into loan agreements affecting public issues, they are generally more detailed in private placements. Among the areas covered by covenants are provisions for collateral to the security, delivery of financial data to the lender, and restrictions regarding the amount of additional long-term debt the borrower may take on. In addition the loan agreement may contain provisions limiting the issuer's ability to call in the security during times of falling interest rates and other restrictions designed to protect the purchaser's investment.