Evidently, some broker-dealers and compliance officers did not get the message that FINRA is serious about firms’ obligations to conduct a reasonable investigation of issuers and the securities they recommend in private placements. FINRA has been rather busy the first half of 2011 bringing enforcement actions against broker-dealers and compliance officers that failed to conduct reasonable investigations into private placements. This should not be surprising given that FINRA identified private placements as one of its examination priorities in both its 2010 and 2011 Annual Regulatory and Examination Priorities Letters. FINRA also issued Regulatory Notice NTM 10-22 in April 2010, describing broker-dealers’ obligations to conduct reasonable investigations in private placements.
Since January 2011, FINRA has brought actions against at least five broker-dealers and ten individuals for either failing to conduct adequate due diligence into private placements or failing to implement adequate supervisory systems and procedures for private offerings. These actions consistently involve the following shortcomings:
- Reviewing solely the issuer’s unverified and uncorroborated statements in the offering document;
- Failing to obtain or review the issuer’s financial statements;
- Failing to visit the issuer’s facilities or meet with its key personnel;
- Failing to research the background information on the offering’s officers;
- Failing to use the services of third-party due diligence providers; and
- Failing to identify in supervisory procedures the specific due diligence steps to be taken and firm personnel responsible for such steps.
FINRA requires that firms have written procedures outlining the steps it will undertake in conducting due diligence on its securities products. These due diligence procedures should be designed to help firms understand the inherent risks of these products and to determine whether these products are suitable for its customers. FINRA stated in a recent Letter of Acceptance, Waiver and Consent that “[d]etailed and robust written procedures are particularly important for private offerings, because there is no registration of the securities with the SEC and public information regarding the offering may be limited.”
Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, recently said the agency will continue its focus on sales of private placements to determine whether the selling firms fulfilled their responsibility to customers. Broker-dealers should note FINRA’s fixation in this area. If your firm engages in private placements, it would behoove you to assess whether your internal controls, supervisory systems and risk management practices properly address your due diligence obligations.