Home > Blog > Archive for the “Due diligence” Category

Archive for the ‘Due diligence’ Category

FINRA Elevates Focus on the Failure to Conduct Proper Due Diligence on Private Placements

On December 7, 2018, the Financial Industry Regulatory Authority (“FINRA”) issued a comprehensive report (“Report on FINRA Examination Findings”) which “focuses on selected observations from recent examinations that FINRA considers worth highlighting because of their potential significance, frequency, and impact on investors and the markets.”

Among the issues discussed in this report were significant concerns about some firms that failed to conduct reasonable diligence on private placements and failed to meet their supervisory requirements – especially in those circumstances when firms have an obligation to conduct a “reasonable investigation” through evaluation of the issuer and its management; the business prospects of the issuer; the assets held by or to be acquired by the issuer; the claims being made; and the intended use of proceeds of the offering.

In particular, FINRA has observed instances where some firms’ reasonable diligence was not sufficient in scope or depth to be considered a “reasonable investigation of the issuer and the securities.”

According to FINRA, these regulatory examinations revealed that “some firms failed to perform reasonable diligence on private placement offerings prior to recommending the offerings to retail investors” and that, “in some instances, firms performed no additional research about new offerings because they relied on their experience with the same issuer in previous offerings.”

In other instances, FINRA noted that “some firms reviewed the offering memorandum and other relevant offering documentation, but did not discuss the offering in greater detail with the issuer or independently verify, research or analyze material aspects of the offerings. FINRA also observed that some firms did not investigate red flags identified during the reasonable diligence process.”

Finally, FINRA stated that “where some firms obtained and reviewed due diligence reports provided by due diligence consultants, experts or other third-party vendors, they sometimes did not independently evaluate the third parties’ conclusions, respond to red flags or significant concerns noted in the reports, or address concerns regarding the issuer or the offering that were apparent outside the context of the report.” Of equal concern was the fact that “some firms used third-party due diligence reports that issuers paid for or provided in their due diligence analysis. While some of these reports provided valuable and relatively objective information, in some cases, firms did not consider the related conflicts of interest in their evaluation and assessment of the reports’ conclusions and recommendations.”

If you are an individual or institutional investor who has any concerns about your private placement investments with any brokerage firm, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

SEC issues alert on Investment Adviser due diligence of alternative investments

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) today issued a Risk Alert on the due diligence processes that investment advisers use when they recommend or place clients’ assets in alternative investments such as hedge funds, private equity funds, or funds of private funds.  

The alert describes current industry trends and practices in advisers’ due diligence. Compared to observations from prior periods, the staff noted that advisers are:

  • Seeking more information and data directly from the managers of alternative investments
  • Using third parties to supplement and validate information provided by managers of alternative investments 
  • Performing additional quantitative analysis and risk assessment of alternative investments and their managers.

 Additionally, staff observed certain deficiencies in several of the advisory firms examined, including:

  • Omitting alternative investment due diligence policies and procedures from their annual reviews, even though these investments comprised a large portion of certain advisers’ investments on behalf of clients
  • Providing potentially misleading information in marketing materials about the scope and depth of due diligence conducted
  • Having due diligence practices that differed from those described in the advisers’ disclosures to clients.

The alert can be found by clicking here.

Due Diligence on Medical Capital Notes at Issue in Massachusetts Case Against Securities America

In the Commonwealth of Massachusetts v. Securities America Inc, the United States is seeing the first instance of a state regulator bringing an enforcement case against a company over private placement deals.

The allegations contained in the initial complaint are partially based on the claim that Securities America failed to follow through with proper due diligence. A broker is required to perform due diligence on a product to ensure that it is a legitimate offering worthy of sale to clients. If there is evidence that the product, in this case Medical Capital private placement offerings, is fraudulent or otherwise unfit for would be investors, that product is abandoned.

The issue in the current case is that Securities America sold a private placement deal (Medical Capital Holdings Inc.) to hundreds of investors over multiple years despite incontrovertible evidence that the Medical Capital financial records were meritless.

Securities America clients were only one such group sold Medical Capital notes. Of the more than $1.7 billion worth of notes sold to investors, Securities America clients represent a capital investment of $697 million, or roughly 37% of the whole. It is worth noting that the enforcement case in Massachusetts is only applicable to residents of the Commonwealth who were sold Medical Capital notes through Securities America. However, given the damning evidence introduced by state regulators, the repercussions of this case will reach far beyond the 60 investors to which it applies.


FINRA – Private Placement Enforcement Cases to Come

James Shorris, executive director of enforcement at the Financial Industry Regulatory Authority (FINRA) has been quoted by Investment News as saying that enforcement cases on multiple private placement deals can be expected to begin by next year.

Private placement memorandum (PPM) deals, also known as Reg D offerings, have come under increased scrutiny after enjoying a period of great popularity. Issues that have been brought to the attention of FINRA include:

– Potential misrepresentations made by brokers regarding the sale of PPMs
– Due Diligence issues, including conflicts of interest over the authorship of due diligence reports
– Whether or not the PPM was suitable for many of the clients holding them

These and other issues are currently being examined by FINRA in connection with multiple PPM offerings.

Due Diligence Lacking in Private Placement Deals

Recent failures of private placement deals, including notes issued by Medical Capital Holdings, has brought to light the issue of due diligence performed by broker-dealers. The issue that has been raised is that there is little to no pre-screening of private placement investment products by a regulatory body. This lack of regulatory oversight has exposed investors to far more risk in private placement offerings than could likely be imagined.

Broker-dealers often leave the analysis of securities products to third-party due-diligence firms. Such firms normally consist of attorneys who are paid by the issuer to write a report evaluating the viability of the issuer’s deal. The potential for a conflict of interest is high as due diligence firms receive fees from the companies they must objectively vet. In addition to this, due-diligence firms often produce superficial reports that provide a perfunctory review of the issuers and their finances. This issue is compounded because many broker-dealers fail to read these reports.

Despite such concerns, both the market and investors’ appetites for such deals have increased exponentially. Last year over 26,000 private placement offerings were filed with the Securities and Exchange Commission, which requires little information about this type of investment. This has led to a precipitous climate for investors, leading to large scale exposure, and in some cases fraud.

In July of this year the SEC charged Medical Capital Holdings Inc. with fraud in the sale of $77 million of private securities in the form of notes. Since then, a court appointed receiver has said that $543 million worth, or about 87%, of all the accounts receivable Medical Capital controlled are “nonexistent.”

There’s no way to tally the potential cost to broker-dealers who sold clients Medical Capital deals. Investors have begun to file arbitration claims against the firms who sold the private placement products. Though broker-dealers worry of the damage done between them and their respective clients, the real damage has been to investors themselves.

The Importance of Selection of Counsel

The retention of an attorney is an important decision made with great care. Please review our web site and examine our experience and credentials.

Contact Us