Victim of Financial Fraud? Call Now
Securities Lawyer Jonathan Kurta
By: Jonathan Kurta Author

How Do Direct Participation Programs Work?

A direct participation program (DPP) is an investment vehicle that allows retail investors to buy shares of private companies. Direct participation program investments are referred to as “non-correlated assets” because changes in their value do not correlate to shifts in the market. While this affords DPP investors the potential to earn significant returns, investing comes with considerable risk.

Direct Participation Program Investor Risks

Direct participation programs are a type of private placement. Private placements are always high-risk investments because the issuers do not have to provide information about their financials to the public. They are also illiquid and extremely difficult to sell. Investors typically cannot withdraw their funds for a set period, usually five to ten years, without paying fees.

While some direct participation programs are only available to wealthy accredited investors, others are readily available to ordinary investors. As a result, investment advisors may recommend direct participation programs to a broad range of clients, many of whom will not have the appropriate risk tolerance for a private placement. Unfortunately, while brokers should carefully disclose the risks of DPPs to their clients, many fail to do so.

While some direct participation program investors will have to accept their losses, many will be able to pursue claims for recovery in securities litigation or FINRA arbitration. Brokers who recommend DPP to investors with conservative investment goals may have violated FINRA Rule 2111 and recommended an unsuitable investment. This rule requires that investors consider their customer’s risk tolerance before recommending an investment.

How Do Direct Participation Programs Work?

In a direct participation program, investors’ funds are collectively invested in privately held companies. While DPPs may invest in a broad range of industries, approximately two-thirds of DPP investments involve real estate investment trusts (REITs).

What Are the Benefits of a Direct PPP?

Direct participation programs offer the following benefits to retail investors: 

  1. The ability to generate returns even in a down market.
  2. Reduction of federal income tax liability. Instead of paying corporate taxes, DPP investors only pay taxes on their personal income. Investors also get to take the DPP’s tax deductions.
  3. Regular dividend payment. A successful direct participation program may generate returns as high as 5% to 7% percent. DPPs that generate revenue from rent or mortgage payments can offer a stable source of income.

Fraud and Misconduct 

Because direct participation programs do not have to make their company’s financials public, FINRA requires that broker-dealers conduct their own investigation into the private placement before recommending it to customers. FINRA rules state that a broker-dealer “may not rely blindly upon the issuer for information concerning a company.” 

Broker-dealers may appoint certain brokers to work as Direct Participation Program Representatives. Investors should be able to trust their DPP Representative understands the investment products and will not hide any of the relevant facts regarding the fees associated with the investment. 

FINRA Rule 2310 stipulates that certain DPP costs come with strict limits: 

  • Offering expenses are not to exceed 15% of the gross expense of the offering.
  • The total amount of all compensation, including broker-dealer compensation paid from offering proceeds and “trail commissions,” are not to exceed 10% of the gross proceeds of the offering (excluding securities purchased using reinvested dividends). 

Firms must supervise their brokers to ensure they provide accurate information regarding the price of their DPP shares. In 2020, one firm had to pay FINRA a $300,000 fine following the discovery that the firm had not used an approved methodology to determine the price of certain direct participation program shares.

What are the Red Flags for DPP Fraud?

Retail investors who invest their money in DPPs should be aware of several red flags for securities fraud. This includes fraud on the part of direct participation program managers and promoters, as well as fraud stemming from investment advisor and broker recommendations. Signs that an investor may have a claim for a direct participation program attorney to review include:

  • DPPs that were promoted at “free lunch” seminars
  • Inadequate access to information about the DPP or the fees charged to investors
  • Excessive fees charged for participation and early withdrawal
  • Sudden and unexplained losses, inconsistencies in account statements, and other general red flags for investment fraud

Discuss Your Legal Options with a Direct Participation Program Fraud Attorney

Have you suffered losses investing in a direct participation program? If so, we encourage you to contact us for more information. To discuss your legal options with a direct participation program fraud attorney in confidence, call 877-600-0098 or request a free consultation online now.

Securities Lawyer Jonathan Kurta
Written by: Jonathan Kurta

Jonathan Kurta is an accomplished securities attorney and a founding partner at Kurta Law.