Richard Ketchum, chairman and chief executive of the Financial Industry Regulatory Authority (FINRA) admonished broker-dealers that sell risky private placements under the Regulation D exemption to conduct more vigorous due diligence, following up on red flags and “pushing and pulling” for information about the products, according to Bruce Kelly’s InvestmentNews article entitled “Finra’s Ketchum: B-Ds must ‘push and pull’ for Reg D details.”
While levels of due diligence needed may vary from deal to deal, broker-dealers must actively scrutinize Reg D offerings: “In those situations where you’re providing advice or actively selling a private placement, it’s not good enough to just read the document. If that document raises red flags or doesn’t answer questions, it’s not good enough to go to a canned information session,” Ketchum was quoted as saying, adding: “You need to push and pull.”
The failure of broker-dealers to conduct adequate due diligence when selling private placements has become evident since the fraudulent Medical Capital Holdings Inc. and Provident Royalties LLC offerings, which were ponzi schemes that collapsed in 2009.
Dozens of broker-dealers sold about $2.7 billion of those two offerings combined without performing any independent verification of their bona fides or following up on red flags, despite receiving a fee of 1% of the sale, known as a “due-diligence fee.” Instead, firms commonly relied on the outside analyst’s report, which was often paid for by the product sponsor, according to the article.
“Whether you’re getting that information from people who have somewhat of an underwriting relationship, or whether you’re getting that from the issuer, you need to be confident, with the questions around it, that the investment is not going to go up in smoke,” Ketchum was quoted as saying, adding that there are “instances when it’s a good idea to visit some of the key production areas of a partnership.”
Firms need to “push the envelope” about due diligence. “We want to recognize where there’s limited disclosure and appears to be a speculative investment, you need to push to try to get more information,” Ketchum warned.
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