FINRA Hearing Panel Dismisses Private Offering Case

October 16, 2015

Based upon the number of lawsuits, there are a lot of disgruntled investors who invested in private offerings either just before or in the midst of the Great Recession. If the investment managed to survive that financial cataclysm, valuations may well have been hammered; however, for the lucky, staying the course may have yielded wonderful results. As those private placements make their way through courts and arbitration hearings, we have also witnessed many regulatory actions alleging fraud, non-disclosure, suitability, and the like. Consider a recent FINRA disciplinary proceeding against a member firm and its Chief Executive Officer/ Chief Compliance Officer:

Case In Point

In FINRA Department of Enforcement, Complainant, v. MSC-BD LLC and Paul J. McIntyre, Respondents (Complaint, FINRA, Disciplinary Proceeding No. 2011025679201, December 11, 2014), the "Summary" of the Complaint alleges that:

1. From September 2009 through March 2010, Respondents MSC - BD, LLC and Paul J. McIntyre ("MSC" and "McIntyre," respectively, or "Respondents'') misrepresented and omitted material facts in the offering documentation for the Hurricane Bay Marina private offering, which was sold to eleven investors through MSC and four other broker-dealers. During that time, McIntyre was the CEO and Chief Compliance Officer of  MSC. MSC and McIntyre created the offering to recoup losses by investors from a prior failed real estate offering. This information was not conveyed to new investors in the Hurricane Bay Marina private offering. By engaging in the foregoing conduct, MSC and McIntyre willfully violated Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), Rule 10b-5 thereunder, and FINRA Rules 2010 and 2020.

2. In addition, McIntyre, in his role as manager of the Hurricane Bay Marina offering, misused investor funds and violated the terms of the offering document by providing a full refund to one investor but not to others. McIntyre's conduct violated FINRA Rule 2010.

Page 1 of the NASD Complaint

As further noted in the Complaint, FINRA's Department of Enforcement asserted three causes of action that:
  • Respondents had not fully disclosed their marketing/sales involvement in what is referred to as the First Offering;
  • Respondent McIntyre was cited for not fully disclosing that he was receiving compensation as a Trustee of the Trust that was suing the guarantors of the First Offering notes; and
  • Respondents did not adequately disclose that the main purpose of what is referenced as the Second Offering was to raise funds to support the aforementioned litigation for the purpose of recouping investors' losses and anticipate litigation costs.
Bring It On

In the absence of a settlement, the Respondents opted to have their day in court and argued their case before a FINRA Office of Hearing Officers Hearing Panel. Following hearings, the OHO made the following findings FINRA Department of Enforcement, Complainant, v. MSC-BD LLC and Paul J. McIntyre, Respondents (OHO Decision, FINRA, Disciplinary Proceeding No. 2011025679201, October 2, 2015). As summarized in the OHO Decision:

(1) Enforcement failed to prove that, in light of the extensive disclosures in the PPM, as well as the structure of the Second Offering, a disclosure of Respondents' involvement in the  marketing and sale of the First Offering would have been material to reasonable Second Offering investors, or that the failure to make that disclosure caused the PPM to be misleading.

(2) In light of the PPM's disclosures regarding PJM's service as trustee and the PPM's disclosures of numerous other financial benefits to PJM from the Second Offering, Enforcement failed to prove that the fact that PJM would be compensated by the Company for his trustee services which were for the benefit of the Company, would have been material to reasonable Second Offering investors, or that the failure to make that disclosure caused the PPM to be misleading.

(3) The weight of the evidence indicated that the main purpose of the Second Offering was to raise funds to purchase the first mortgage and complete the construction of the marina, as stated in the PPM, and that the pursuit of litigation to enforce the guarantees, which were assets of the Company, was only a secondary goal. Further, because the First Offering investors received only subordinated interests in the Company, the Second Offering investors would have been the primary beneficiaries ofany recoveries in the litigation. Under these circumstances, Enforcement did not prove that Respondents failed to disclose the main purpose of the Second Offering, or that they misrepresented or omitted any material facts in that regard.

(4) The pro forma financial statements in the PPM disclosed anticipated legal costs to the Company of$300,000, and Enforcement did not allege or prove that this estimate was unreasonable. And while the PPM did not break out the anticipated costs of the litigation against the guarantors, Enforcement cited no authority requiring such a break-out, and it failed to demonstrate that such a break-out would have been material to reasonable investors in the Second Offering or that the failure to include such a break-out caused the PPM to be misleading.

(5) Insofar as any of the omissions alleged in the Complaint could be considered material, Enforcement failed to prove that Respondents acted with scienter or were negligent in not making the disclosures. The Panel notes that PJM circulated numerous drafts of the PPM for comments and proposed revisions to: (a) three attorneys, including GC, an experienced, independent securities attorney; (b) investors in the First Offering; (c) broker-dealers that PJM hoped would market the Second Offering; and (d) JL, who prepared an independent due diligence report on the Second Offering. PJM received numerous comments and suggested revisions to the PPM, particularly from GC, and adopted the material ones. Enforcement otTered no evidence that any of the reviewers suggested that PJM should add any of the disclosures that Enforcement contends were improperly omitted from the PPM. The Panel concludes that PJM acted in good faith in promulgating the PPM without the disclosures Enforcement cited and that, insofar as any material facts were omitted, the omissions were not attributable to intentional, reckless, or negligent conduct by Respondents.

(6) Finally, Enforcement failed to prove that PJM misused investor funds by returning one investor's entire investment in the Second Offering. PJM had authority under the PPM to reject proposed investments in the Second Offering on suitability grounds. Accordingly, his return of$20,000 of the investor's proposed investment on that basis was not improper. PJM testified credibly that he returned the remaining $5,000 balance in full in August 2010 rather than 45% of the balance because the administrative and accounting costs of retaining 55% of that amount ($2,750) were prohibitive. The Panel finds that he had authority to make such a determination under the terms of the PPM. Accordingly, all charges in the Complaint will be dismissed.

Page 4 - 6 of the OHO Decision

Bill Singer's Comment

As readers of the Blog know, I often lament that too many respondents in FINRA regulatory action run up the white flag far too early and tend to eschew lacing up the gloves and climbing into the ring against the self-regulatory organization.

Now, mind you, I understand why firms and individuals cry "Uncle" when faced with a FINRA regulatory Complaint; and among the most common explanation is that they cannot afford the cost of an attorney. Notwithstanding, if you are adamant in your innocence and you can't afford a lawyer, you may want to consider representing yourself. True, trying to out-lawyer FINRA when all you have is your own non-lawyer self is probably foolish, and you may well be able to negotiate a far better settlement than what may await you after fumbling through a hearing. Still -- if all that's on the settlement table is what you view as an excessive suspension or Bar, you might want to reconsider settlement and take a chance that you could land a lucky punch at a hearing.

I know that for many, there's the feeling that the fight is fixed and there is no point in going the distance with a FINRA disciplinary hearing if the outcome is rigged. If nothing else, though, the dismissal in MSC-BD LLC suggests that such a belief may not always be on a sound footing.

In MSC-BD LLC, the OHO Decision wagged a disapproving finger at Enforcement's basic theory behind its case; namely, that investors lacked adequate disclosure about material terms. The OHO Panel emphasized that notwithstanding what Respondents may or may not have divulged to investors, there was "extensive disclosures" in the Private Placement Memorandum.  Moreover, the PPM was deemed to have sufficiently disclosed Respondent McIntyre's Trusteeship and his receipt of financial benefits.

As to the "main purpose" of the Second Offering, the Panel rejected Enforcement's assertion that it was to fund the litigation against the guarantors of the First Offering notes. The Panel deemed that line of reasoning to present, at best, a secondary goal. The Panel found that the main purpose of the offering was to purchase a first mortgage and complete marina construction. Moreover, the Panel concluded that the primary beneficiaries of any litigation recovery were, in fact, the Second Offering investors (rather than those in the First Offering who held subordinated interests). Additionally, the Panel found that $300,000 in anticipated legal costs in the PPM seemed a reasonable estimation and not clearly misleading.

Even if the omissions alleged by Enforcement were, for argument's sake, material, the Panel saw no proof that Respondents had acted either with scienter, recklessness, or negligence in terms of such disputed disclosures. A laundry list of steps taken by Respondents in their apparent good-faith discharge of their obligations to ensure the accuracy of the PPM clearly persuaded the Panel against finding intent to deceive or intentionally mislead. Finally, the Panel declined to accept Enforcement's argument that the return of $20,000 to one Second Offering investor was improper and unauthorized by the PPM -- the Panel seems to chafe at the suggestion that such a refund (which appeared to have been made based on suitability considerations) was "improper."

Compliments to this OHO Panel for a thoughtful presentation of the facts and rationale in this case!

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