Study guide
Before a single private placement can be sold, the representative must know exactly who the customer is, both in the regulatory sense of verified identity and in the practical sense of finances, objectives, and sophistication. This chapter covers building the customer investment profile, verifying accredited investor status, the identity and anti-money-laundering checks required at account opening, and the documentation and approvals that make an account compliant from day one.
Building the Customer Investment Profile
Account opening starts with FINRA Rule 2090, the know-your-customer rule, which requires a firm to use reasonable diligence to know the essential facts about every customer and about the authority of anyone acting for the customer. The working tool is the customer investment profile, the set of facts that later determines whether any recommendation is appropriate. The profile includes the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, time horizon, liquidity needs, and risk tolerance. For a private placement specialist, three of these deserve special weight. Liquidity needs matter because restricted securities typically cannot be sold for months or years, and often have no market even after the holding period runs; a customer who may need the money soon is a poor fit no matter how wealthy. Time horizon matters because private offerings frequently take years to produce any return or exit. Risk tolerance matters because the realistic range of outcomes includes total loss. Consider two prospective customers of Harborlight Securities. Daniel Okafor, forty-five, earns nine hundred thousand dollars a year, holds a diversified eight-figure portfolio, and can leave two hundred thousand dollars untouched for a decade. Rosa Camacho, seventy-one, technically clears the accredited net worth line only because of investment property, and depends on portfolio income for living expenses. Both may be accredited; only one has a profile consistent with an illiquid private offering. The profile is gathered at opening, documented in the account record, and updated when the representative learns of material changes such as retirement, divorce, or a business sale.
Verifying Accredited Status and Assessing Sophistication
How deeply a firm must probe an investor's accredited status depends on the exemption. In a Rule 506(b) offering, the issuer needs a reasonable belief that the investor is accredited, and a completed purchaser questionnaire covering income, net worth, and entity status ordinarily supports that belief unless red flags contradict it. In a Rule 506(c) offering, reasonable belief based on self-certification is not enough; the issuer must take reasonable steps to verify. The rule offers non-exclusive safe harbors: reviewing tax forms for the two most recent years plus a written expectation for the current year to verify income; reviewing recent bank and brokerage statements and a credit report, plus a representation that all liabilities were disclosed, to verify net worth; or obtaining written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or CPA that verification was performed within the prior three months. SEC staff guidance issued in March 2025 also recognized that a high minimum investment, at least two hundred thousand dollars for a natural person and one million dollars for an entity, coupled with written representations that the investor is accredited and is not financing the purchase through a third party, can constitute reasonable steps. Sophistication is a separate concept that belongs to 506(b): each non-accredited purchaser must have enough knowledge and experience in financial and business matters to evaluate the investment, either alone or with a purchaser representative. Under Rule 501, a purchaser representative must be sophisticated, must be acknowledged by the purchaser in writing, must disclose any compensation from the issuer, and generally may not be an affiliate, director, officer, or ten percent owner of the issuer unless closely related to the purchaser.
Customer Identification and Anti-Money-Laundering Duties
Federal anti-money-laundering law shapes every account opening. Under the Bank Secrecy Act as amended by the USA PATRIOT Act, every broker-dealer must maintain a customer identification program, or CIP. Before or shortly after opening an account, the firm must collect four pieces of information: name, date of birth for individuals, address, and an identification number, normally a Social Security or taxpayer identification number for U.S. persons or a passport or similar government number for foreign persons. The firm must then verify identity within a reasonable time through documents such as a driver's license, through non-documentary means such as database checks, or both; it must screen customers against government lists of known or suspected terrorists and comply with OFAC sanctions programs; and it must keep identification records for five years after the account closes. Customers must receive notice that identifying information is being requested. For legal entity customers, the customer due diligence rule adds beneficial ownership: the firm identifies each natural person owning twenty-five percent or more of the entity and at least one person with managerial control. The firm's broader AML program must be written, board-approved in effect through senior management, and built on designated compliance personnel, independent annual testing, ongoing training, and risk-based customer due diligence. When activity looks suspicious, a broker-dealer files a suspicious activity report for transactions of five thousand dollars or more that it knows or suspects involve illicit funds or serve no lawful purpose, generally within thirty days, and must never tip off the customer. Private placements carry distinctive red flags: funding from unrelated third parties, layered shell entities with no clear business purpose, or investors indifferent to the merits of the deal.
Documentation, Approvals, and Regulation Best Interest
FINRA Rule 4512 sets the minimum record for every account: the customer's name and residence, whether the customer is of legal age, the names of any associated persons responsible for the account, and the signature of the principal who approved the account opening. For non-institutional accounts, firms must also make reasonable efforts to obtain the name and contact information of a trusted contact person, someone the firm may reach if it suspects exploitation or cannot reach the customer; the customer may decline, and the account may still be opened. Where the account record includes investment-profile information used for recommendations, SEC books-and-records rules require the firm to furnish the record to the customer for verification within thirty days of opening and at least every thirty-six months thereafter, and to send updates when key facts change. On top of the documentation sits Regulation Best Interest. When a broker-dealer or its representative recommends any securities transaction or investment strategy to a retail customer, including the recommendation to open a particular account type or to roll assets into one, the firm must act in the customer's best interest without placing its own interest first. Reg BI is built from four obligations: disclosure of material facts about the relationship, including fees and conflicts, delivered in part through the Form CRS relationship summary; care in understanding and matching the recommendation to the customer; identification, disclosure, and in some cases elimination of conflicts of interest; and firm-level compliance policies. At account level, this means a representative at Harborlight Securities cannot steer Daniel into a costlier account arrangement, or into a private-placement-heavy strategy, unless a reasonable basis exists to believe it serves his interest better than the available alternatives.
Key terms
- Know your customer (FINRA Rule 2090)
- — The requirement to use reasonable diligence to know the essential facts about every customer and anyone authorized to act on the customer's behalf.
- Customer investment profile
- — The documented set of facts, including age, financial situation, objectives, experience, time horizon, liquidity needs, and risk tolerance, used to evaluate recommendations.
- Purchaser questionnaire
- — A form completed by a prospective investor attesting to income, net worth, and status, used to support a reasonable belief of accreditation, especially in 506(b) offerings.
- Verification safe harbors
- — Rule 506(c) methods for verifying accredited status, including tax-form review, asset and credit-report review, and third-party confirmation from a broker-dealer, adviser, attorney, or CPA.
- Purchaser representative
- — A sophisticated person, acknowledged in writing by a non-accredited purchaser, who helps evaluate a 506(b) investment and must disclose issuer compensation and conflicts.
- Customer identification program (CIP)
- — The required program for collecting and verifying name, date of birth, address, and identification number for each customer, with list screening and five-year recordkeeping.
- Beneficial ownership rule
- — Customer due diligence requirement to identify each 25 percent owner and a control person for legal entity customers at account opening.
- Suspicious activity report (SAR)
- — Confidential report a broker-dealer files, generally within 30 days, for suspicious transactions of $5,000 or more; disclosing the filing to the customer is prohibited.
- Trusted contact person
- — An individual the customer may designate whom the firm can contact about possible exploitation or inability to reach the customer; requesting one is required, providing one is not.
- Regulation Best Interest
- — SEC rule requiring broker-dealers making recommendations to retail customers to act in the customer's best interest through disclosure, care, conflict, and compliance obligations.
- Form CRS
- — The client relationship summary describing services, fees, conflicts, and disciplinary history, delivered to retail investors at or before a recommendation or account opening.
- Sophistication
- — The knowledge and experience in financial and business matters needed to evaluate an investment's merits and risks, required of non-accredited purchasers in 506(b) offerings.
Exam tips
- Memorize the four CIP elements: name, date of birth, address, and identification number. Verification can follow account opening within a reasonable time, but collection comes first.
- Keep the exemption mechanics separate: purchaser questionnaires and purchaser representatives belong to 506(b), while documentary verification safe harbors belong to 506(c).
- Accredited is not the same as suitable. An investor can clear every Rule 501 threshold and still be a poor match for an illiquid offering because of liquidity needs or time horizon.
- The firm must ask for a trusted contact person, but the customer may refuse and the account can still be opened; do not confuse the request duty with a customer obligation.
- SAR triggers are tested with numbers: $5,000 or more in suspicious activity, filing generally within 30 days, and absolute confidentiality toward the customer.