Due Diligence and Private Placements: FINRA's On a Rampage

August 9, 2011

In 2011, the Financial Industry Regulatory Authority ("FINRA") has been piling up the fines and suspensions for member firms and folks who are not taking their Due Diligence obligations seriously - and there's an emphasis on private placements.

From the Horse's . . .

In some cases, Respondents are getting slammed for simply reading an issuer's Private Placement Memorandum ("PPM") and relying upon the representations as the be-all-and-end-all of Due Diligence. FINRA takes a very different view.  It may be information coming from the horse's mouth to you but for a regulator, it's more likely coming from another orifice.

Surfin' USA

In other situations, FINRA was distressed when a member firm thought that it had prudently discharged its due diligence by checking out the facts about an issuer by visiting that company's website.  Ummm, oooooookay . . . you know, go ahead and do some fact checking through Google.  Sure, visit the issuer's website and poke around.  However, surfing online is just not adequate due diligence according to some recent FINRA regulatory cases.

Hide And Seek

Another trend that FINRA seems intent on curtailing occurs when one of its members is on notice of financial difficulties with an issuer, yet fails to fully raise those concerns with the buying clients.  In a challenging economy such as the one that we are now in, regulators are likely to investigate the adequacy of a brokerage firm's due diligence when an issuer has defaulted on various obligations (such as promissory notes) and such facts were not adequately disclosed in the PPM.  It's a fairly simple proposition: If you knew (or should have known) of an issuer's warning signs in terms of failures to timely pay principal or interest, you really better disclose that to the investors that you're soliciting.

So what if the issuer missed a few payments of principal or interest in the past year or so?  Well, sure, you might have some fair and sensible explanations to dismiss an investor's concerns, but, FINRA will likely want proof that you fully disclose those material facts to the folks to whom you  pitched the investment.  Fail to do so at your risk.

For more details on this emerging regulatory trend, READ