There are several ways you can invest via brokerages. There's the way most of us are familiar with -- invest in stocks and mutual funds through an account at a brokerage. (Learn how to find a new or better brokerage for yourself in our Broker Center.) Then there's a lesser-known way: investing in the brokerage itself. This is often best avoided.
The nice folks at the NASD, which oversees some 5,200 brokerages, recently issued a warning for consumers about "broker-dealer self-offerings" (BDOs). They say, "To raise capital, brokerage firms sometimes sell their own or an affiliate's securities. Such broker-dealer self-offerings can take the form of registered public offerings or private placements. While private BDOs can be legitimate investments, recent NASD and U.S. Securities and Exchange Commission (SEC) enforcement actions highlight the potential for abuse in private BDOs."
Private BDOs are risky because if the company isn't publicly traded, you may have a lot of trouble trying to sell your investment. Since private companies are not required to make regular financial disclosures to the SEC and the public, there is often relatively little information you'll be able to find on them. There's also a major conflict of interest at play, as the firm selling you the BDO stands to benefit from getting the money you invest in it.
If you're thinking of investing in a BDO, find out why the company is raising this money. For example, is it to fuel growth or to defend against sinking earnings? From the NASD, here are some red flags related to BDOs:
- Cold-calling or spam mail. Investing based on phone calls you've received from strangers or mass emails is rarely smart. It's better if you take the initiative to find investments -- perhaps via your own research or with the help of investing newsletters.
- Hard sells. If you're being pressured to buy right away, walk away.
- Extreme claims. If you're given promises of great performance, don't believe it. Few investments offer any kind of guaranteed performance. (If that's what you're after, look at bonds and CDs.) If you're told about an imminent IPO, look it up online. In fact, look up the company online regardless, and see what you can find. If you're told that the investment is "risk-free," laugh out loud.
- Refusal to provide supporting documents, such as financial statements and perhaps SEC registrations, is an obvious warning signal.
Learn more at the NASD website, or perhaps just avoid BDOs entirely. You have other options. You can invest in larger brokerages that are public simply by buying their stock -- for example, Ameritrade
Here are some recent Fool articles on brokerages and their investment potential:
- E*Trade's Rising Bid?, by Steven Mallas
- A New Day at Schwab, by Nathan Slaughter
- Ameritrade's Q3 Shines, by Roger Nusbaum
- No Bull at Merrill, by Alyce Lomax
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.