Earlier this month, FINRA issued Regulatory Notice 10-22 which reminds brokerage firms of their obligation to conduct a reasonable investigation of the issuer and the securities they recommend in offerings made under the Securities and Exchange Commission’s (“SEC”) Regulation D under the Securities Act of 1933 (“the Act”)—also known as private placements. A copy of Regulatory Notice 10-22 can be found by clicking on this link: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p121304.pdf
Regulation D provides exemptions from the registration requirements of Section 5 under the Act. Regulation D transactions, however, are not exempt from the antifraud provisions of the federal securities laws. A brokerage firm has a duty—enforceable under federal securities laws and FINRA rules—to conduct a reasonable investigation of securities that it recommends, including those sold in a Regulation D offering.
Regulatory Notice 10-22 also highlights private placement red flags and supervisory requirements, and suggests practices to help ensure that brokerage firms adequately investigate the private placements that they recommend. According to a recent estimate by the SEC, in 2008, companies intended to issue about $609 billion of securities in Regulation D offerings, making it a key 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 various brokerage 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 typically sold to “accredited” investors and a limited number of non-accredited investors. While accredited investors must meet certain income or asset tests, Regulatory Notice 10-22 emphasizes that a brokerage firm’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 brokerage firm 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.
FINRA has brought three enforcement actions in recent months involving private placement offering violations. They include a complaint charging McGinn, Smith & Co. and its president with securities fraud in the sales of tens of millions of dollars in unregistered securities, the expulsion of 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. 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.
KlaymanToskes is presently prosecuting numerous arbitration claims against various brokerage firms across the country to recover losses sustained in private placements. These include Medical Capital, Provident Royalties, and Shale Royalties investments.