October 21, 2015
It's an LP or a note and those are not really securities . . . or so you think; then again, you're not totally sure, particularly about the LP but, hmmm, you sort of recall hearing something, like that. Maybe? Maybe not? Oh well, it's all so confusing and you don't see any reason to notify your brokerage firm about your efforts to solicit investments for the note or LP. Alas, this notice stuff has been troubling folks for a long time. Unfortunately, more often than not, what you think you don't have to do, you do. Consider this recent FINRA settlement.
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Michael Anthony Duch submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Michael Anthony Duch, Respondent (AWC 2010023826302, October 15, 2015).
Duch was first registered in 1992; and by 2005 he was associated with FINRA member firm Cambridge Investment Research, Inc., While associated with Cambridge, Duch operated a branch office and an office of supervisory jurisdiction from which he and another registered representative did business as SFG. The AWC asserts that he was Permitted to Resign by Cambridge in July 2010. The AWC asserts that Duch had no prior relevant disciplinary history.
The AWC alleges that in May 2010, Duch contacted a married couple, who were both Cambridge customers and via email discussed an investment opportunity in a limited partnership formed in 2009: Running Springs Oil and Gas, L.P., which was purportedly created to generate oil and gas investments in the Bakken Region of North Dakota. Emails from Duch to the couple regarding Running Springs included this disclosure:
"Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer Member FINRA/SIPC."
Although the couple invested in the LP, the AWC does not disclose the amount of the investment, which is characterized as "unknown." The AWC concedes that although Duch facilitated the investment, he did not receive compensation from Running Springs.
In June 2010, the husband emailed Duch to inquire as to why the Running Springs investment was not on the SFG statement. Duch replied that the investment had been made directly with Running Springs and could only be "manually added" to Cambridge statements.
In 2009, the Obele Energy. L.P. was formed for the purpose of investing in Bakken region oil and gas investments. In May 2010, Duch purportedly contacted both a Cambridge customer and two non-Cambridge customers via email regarding investment opportunities in this LP. Emails from Duch to the couple regarding Obele Energy included a disclosure that the investment opportunity was not something:
"offer[ed] through our firm or for which we receive any compensation or other consideration."
In furtherance of his communications with the customer and non-customer, Duch asserted that he was "personally invested with the company." Although Duch reiterated the disclosure noted above that the securities were not offered through Cambridge, each email contained this notice:
"Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer Member FINRA/SIPC."
Duch emailed the three individuals copies of the Obele Energy Agreement and Subscription Agreement, and provided the potential investors' contact information to Obele Energy's sole director and President. Although Duch introduced and facilitated the three investors and their investments, the AWC concedes that he was not compensated by Obele . The AWC does not disclose the amount of the investment, which is characterized as "unknown."
Montana Victory Insurance Services
In the fall of 2009 and spring of 2010, Duch allegedly participated in the offering of unregistered promissory notes offered by Montana Victory Insurance Services, a Montana property and casualty insurance company. In November 2009, the subject notes paid 10% per annum, and Duch is reported as having invested in the notes. The AWC alleges that Duch provided information about the notes to several Cambridge customers and non-customers, and that two customers invested.
The AWC asserts that in late November 2009, Duch facilitated the investments by providing the two investors with copies of the Note and Financial Call Notice. Duch asked the investors to sign goth the Note and Notice, and he returned the executed documents with copies of the investors' drivers license and a $75,000 check. Thereafter, in December 2009, Duch also submitted paperwork and a $25,0000 check for a further personal investment for one of the two customers.
A Matter of Notice
For whatever reasons, Duch failed to give Cambridge prior notice of the Running Springs, Obele, and Montana Victory transactions. The AWC asserts that from November 2009 through May 2010, Cambridge's written supervisory procedures generally prohibited its registered reps from engaging in private securities transactions, whether or not compensation was paid for effecting the transactions. Consistent with the provisions of NASD Rule 3040, Cambridge required registered representatives to submit written requests for permission to engage in private securities transactions.
Accordingly, FINRA deemed Duch above conduct to constitute violations of NASD Rule 3040 and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Duc a $15,000 fine and a 20-business-day suspension.
Bill Singer's Comment
FINRA seems troubled by the somewhat contradictory circumstances in which Duch purportedly informed some of the above investors that, on the one hand, their investments were not being made through Cambridge but were made directly with the issuer, but, on the other hand, SFG account statements were asserting that securities were being offered through his member firm. According to NASD Rule 3040. Private Securities Transactions of an Associated Person:
(c) Transactions for Compensation
(2) If the member approves a person's participation in a transaction pursuant to
paragraph (c)(1), the transaction shall be recorded on the books and records of the
member and the member shall supervise the person's participation in the transaction as
if the transaction were executed on behalf of the member.
(d) Transactions Not for Compensation
In the case of a transaction or a series of related transactions in which an associated
person has not and will not receive any selling compensation, a member which has
received notice pursuant to paragraph (b) shall provide the associated person prompt
written acknowledgment of said notice and may, at its discretion, require the person to
adhere to specified conditions in connection with his participation in the transaction.
According to Rule 3040(c), transactions for compensation that are approved by the member firm as private securities transactions must be "recorded on the books and records of the member." On the other hand, approved private securities transactions that do not result in the associated person's receipt of compensation, do not require such a disclosure (although the firm is free to impose "specified conditions." Given that the AWC concedes that Duch was not compensated in the subject investments, it does not appear that the transactions had to be recorded on Cambridge's books and records.
Why then does the AWC seem to highlight the fact that 1) Duch asserted to investors that the investments were made directly with the issuer, but 2) SFG account statements asserted that all securities are offered through Cambridge? If the point was to suggest that the cited private securities transactions should have been disclosed on SFG statements, I'm not sure that's correct. More likely -- and with stronger support -- the AWC was underscoring the confusion made evident by the June 2010 email from the husband-investor in Running Springs who asked why his investment did not appear on his SFG statement. The implication is that the husband may have thought the investment was brokered through SFG/Cambridge and that Duch had not properly clarified that before facilitating the investment. Although the facts in the Obele investments are less compelling on this point, it still remains that Duch said one thing but the Cambridge account statements may have muddied the waters.
Finally, as to the continued confusion surrounding the status of notes in "selling away" matters, consider the now 14-year-old NASD Notice to Members 01-79: Selling Away And Outside Business Activities / NASD Reminds Members Of Their Responsibilities Regarding Private Securities Transactions Involving Notes And Other Securities And Outside Business Activities (December 2001), which advised that:
Page 687 of NTM 01-79
Recently, NASD Regulation has seen an increase in selling away involving independent insurance agents registered solely as Series 6 Investment Company and Variable Contracts Products representatives. These Series 6 representatives are increasingly being targeted by issuers, promoters, and marketing agents to sell short-term promissory notes to their customers. Although in many instances these notes are securities, promoters of these products are marketing them to registered persons as nonsecurities products that do not have to be sold through a broker/dealer by a registered person. In a significant number of cases, associated persons have sold these notes to their customers away from their firms and without firm approval as required by Rule 3040.
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