FINRA Sets Regulatory Guidance for Investigating Private Placements
Firms Must Properly Investigate Regulation D Offerings Prior to Customer Sales
Washington, D.C. — The Financial Industry Regulatory Authority (FINRA) today announced the publication of guidance for FINRA-registered firms about their obligations regarding customer suitability, disclosures and other requirements for selling private placements to customers, an area where recent examinations and enforcement actions have revealed a significant lack of regulatory compliance.
FINRA Regulatory Notice 10-22 reinforces and details a broker-dealer's obligation to conduct a reasonable investigation of an issuer and its securities that it recommends in offerings made pursuant to Regulation D under the Securities Act of 1933, also known as "private placements." The Notice also highlights private placement red flags and supervisory requirements, and suggests practices to help ensure that firms adequately investigate the private placements that they recommend.
According to a recent estimate by the Securities and Exchange Commission (SEC), in 2008, companies intended to issue approximately $609 billion of securities in Regulation D offerings, making it an important source of capital for American business, particularly small businesses.
"An increase in investor complaints regarding private placements, as well as SEC actions halting sales of certain private placement offerings, led FINRA to launch a nationwide initiative that involves active examinations and investigations of broker-dealers engaged in retail sales of private placement interests," said FINRA Chairman and CEO Rick Ketchum. "That initiative has uncovered misconduct, including fraud and sales practice abuses. While several enforcement actions have been taken and additional investigations are underway, FINRA is taking this opportunity to remind firms of their substantial duties when engaging in the sale of private placement offerings."
Recent problems uncovered by FINRA in Regulation D offerings have resulted in firms being sanctioned for providing private placement memoranda and sales materials to investors that contained inaccurate statements or omitted information necessary to make informed investment decisions.
Private placements under Regulation D are usually sold to "accredited" investors and a limited number of non-accredited investors. While accredited investors must meet certain income or asset tests, the Notice emphasizes that a broker-dealer's suitability obligations require it to conduct a reasonable investigation whenever it makes a recommendation in a private placement under Regulation D.
In addition to conducting a reasonable investigation concerning the issuer and its securities, a broker-dealer must have reasonable grounds to believe that the investment is suitable for the particular customer to whom it's offered and ensure that the customer fully understands the risks involved in the investment.
Bona fide private placements are exempt from registration under the Securities Act of 1933, thereby streamlining the capital-raising process. While private placements are exempt from registration, they are governed by the antifraud provisions of the federal securities laws. In addition, broker-dealers offering securities in private placements must comply with FINRA rules, including the FINRA advertising, supervisory and record-keeping rules. Finally, broker-dealers offering securities in Regulation D private placements must adhere to FINRA Rule 2010, requiring just and equitable principles of trade, and FINRA Rule 2020, which prohibits manipulative and fraudulent devices.
FINRA has brought three enforcement actions in recent months involving private placement offering violations. They include a complaint charging McGinn, Smith & Co. of Albany and its president with securities fraud in the sales of tens of millions of dollars in unregistered securities; the expulsion of Dallas-based Provident Asset Management for marketing a series of fraudulent private placement offered by an affiliate in a massive Ponzi scheme; and, fines totaling $750,000 against Pacific Cornerstone Capital, Inc. of Irvine, CA, and its former CEO for failing to include complete information in private placement offering documents and marketing material, as well as for advertising violations and supervisory failures.
Investors can obtain more information about, and the disciplinary record of, any FINRA-registered broker or brokerage firm by using FINRA's BrokerCheck. FINRA makes BrokerCheck available at no charge. In 2009, members of the public used this service to conduct 18.5 million reviews of broker or firm records. Investors can access BrokerCheck at www.finra.org/brokercheck or by calling (800) 289-9999.
FINRA is the largest independent regulator for all securities firms doing business in the United States. FINRA is dedicated to investor protection and market integrity through comprehensive regulation. FINRA touches virtually every aspect of the securities business – from registering and educating all industry participants to examining securities firms, writing and enforcing rules and the federal securities laws, informing and educating the investing public, providing trade reporting and other industry utilities, and administering the largest dispute resolution forum for investors and firms.
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