In the wake of recent problems with
private placement deals, the
Financial Industry Regulatory Authority (FINRA) has weighed in to remind broker-dealers of their due diligence
obligations with respect to private placements. Private placement deals
gone wrong, for example those with Medical Capital and Provident Royalties,
have resulted in a large number of FINRA securities arbitration claims
(as well as class action lawsuits) in the past several months. Such offerings
face continued scrutiny from securities regulators around the country.
Regulatory Notice 10-22, issued on April 20, 2010, FINRA spells out the obligations of broker-dealers
when offering private placements. The Notice “reinforces and details
a broker-dealer’s obligation to conduct a reasonable investigation
of an issuer.” It is interesting to note that this Notice is not
setting out new regulatory guidance – it is a reminder to firms
of there already existing obligations to their clients.
The Notice specifically states that broker-dealers are required to conduct
a suitability analysis; NASD Rule 2310 (Suitability) requires a broker-dealer
to have reasonable grounds to believe an investment recommendation is
suitable for the customer.
Additionally, the Notice states that broker-dealers have an obligation
to conduct a reasonable investigation of the issuer and the securities
they recommend in private placement offerings. Broker-dealers must conduct
a reasonable investigation of the security and the issuer’s representations
about the security.
Failure to conduct such an investigation can constitute a violation of
the securities laws and FINRA rules. A broker-dealer may not rely blindly
on the representations of the issuer. Essentially the broker-dealer must
exercise a “high degree of care” and conduct its own independent
investigation of the issuer and the security, especially if there are
any “red flags” with regard to the issuer or offering.
Broker-dealers must also comply with the advertising, supervisory, and
record-keeping rules of FINRA and the SEC.