Expert Contends that Brokerage Firms are Failing to Satisfy their Due Diligence Obligations.


Broker-dealers that sold billions of dollars in fraudulent private placements, such as Medical Capital and Provident Royalties notes, “failed massively in their due diligence responsibilities to investors” according to Gordon Yale, a CPA and expert witness in securities fraud cases. (See “Private-placement due diligence ‘sloppy,'” Investment News). They grossly misrepresented investigations into the investments and issuers they claimed to have performed, and, in fact, merely relied on self-serving representations made by management that were false and fraudulent.

Mr. Yale has served as an expert witness in more than 50 cases, including those involving private placements issued by Medical Capital Financial Corp. and Shale (Provident) Royalties. Many of the broker-dealers that sold these private placements have since shut their doors, unable to continue under the burden of their liabilities and legal costs.

In 2009, the Securities and Exchange Commission found that Medical Capital Financial and Provident Royalties committed fraud. The Financial Industry Regulatory Authority (FINRA) found that leading sellers of Medical Capital and Provident Royalties failed to conduct adequate due diligence on these securities.

“It was basically the same recklessness with which major investment banks conducted their mortgage-backed-securities business, but it was done by middle- or lower-tier firms and [with] a different set of products. You need to understand the underlying business and management’s representations about the performance of that business, and then begin performing due-diligence procedures that are either going to corroborate those representations or not,” Mr. Yale was quoted as saying.

Securities America claimed in sales materials provided to investors that it had performed “industry-leading” due diligence on Medical Capital and other private placements it sold. In fact, said Mr. Yale, they did not, and merely relied on representations made by Medical Capital management and by third-party due diligence vendors that merely relied on management representations.

“One of the problems is that many of the firms relied on third-party due-diligence vendors ‘ [when] the issuer paid those third-party due-diligence providers,” Mr. Yale said, adding: “They viewed those reports as the end of the process, rather than the beginning. There’s a notice to [Finra] members, 05-48, that basically says you can outsource any function, but you can’t outsource your responsibility for compliance with federal securities laws or regulations.”

True due diligence requires the expertise of CPAs and other experts digging into the offering documents, according to Mr. Yale. “Neither Securities America nor any other firm whose documents I’ve seen ever did that,” said Mr. Yale.

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