FALLOUT FROM THE RECENT
PRIVATE PLACEMENT SCANDALS
Michael Schwartzberg, Partner (New York City)
Brandon Reif, Partner (Los Angeles, CA)
WINGET, SPADAFORA & SCHWARTZBERG, LLP
OVERVIEW
•
Broker-Dealer’s regulatory requirements in a Regulation D
private placement offering
Summarize what is required by Broker-Dealers, Registered
Representatives and Supervisory personnel
Identify Best Practices
•
Describe the current regulatory and litigation/arbitration landscape
How to conduct yourself in Reg D offerings given recent
guidelines issued by FINRA
How to deal with litigation and/or regulatory investigations
April 2010
2
Regulation D: Provides exemptions from the
registration requirements of the 1933 Act;
otherwise known as “Private Placements”
• Huge source of capital markets for small companies:
raised $609 Billion in Reg D offerings in 2008
• Accredited Investors v. Non-Accredited Investors
• Section 5 of the Act sets forth exemptions to both
limited and unlimited non-accredited investors
April 2010
3
BROKER-DEALER’S OBLIGATIONS IN REG D OFFERING
• Duty to conduct reasonable investigation
concerning the proposed investment and
the issuer
• Duty to ensure that recommendation is
suitable for customer (regardless of whether
investor is accredited or non-accredited)
April 2010
4
RECENT REG D SCANDALS
• Provident Shale Royalties
• Medical Capital Holdings
April 2010
5
REGULATORY RESPONSE TO REG D SCANDALS
Taking aim at the issuers and the brokerdealers selling Reg D private placements
Securities and Exchange Commission
i. Asset Freeze over Provident Royalties, LLC
ii. Asset Freeze over Medical Capital Holdings
iii. Subpoenas
iv. On-the-Record Testimony
April 2010
6
FINRA Regulation
i.
8210 Requests
ii. On the Record Testimony (“OTR’s”)
iii. “Wells” Notices
iv. Provident Asset Management, LLC -- disbarred
April 2010
7
State Actions
i.
Commonwealth of Massachusetts v. Securities
America, Inc.
ii.
Colorado: revocation of securities licenses
Department of Justice
i.
Criminal investigation into the top executives of
Medical Capital Holdings, Inc.
April 2010
8
Broker-Dealers Have Duty to Conduct
Reasonable Investigation Concerning the
Security and the Issuer’s Representations
About It
April 2010
9
REASONABLE INVESTIGATION PRACTICES
In order to fulfill its regulatory requirements,
a broker-dealer must conduct a reasonable
investigation concerning:
The issuer and its management
The business practices of the issuer
The assets being held or to be acquired
The representations being made
The intended use of the offering
April 2010
10
BROKER-DEALER DUE DILIGENCE
Review of Documents
i. Offering Materials
ii. Promotional Materials – are they fair,
accurate and balanced
iii. Financial Records
iv. Other Documents
April 2010
11
•
Third-Party Due Diligence v. Issuer’s Own (paid-for)
Due Diligence
•
Site Visits and Principal Interviews
•
Background Check
•
Verification and Comfort with Product and Sponsor
April 2010
12
DOCUMENTATION OF REASONABLE INVESTIGATION
In order to demonstrate that it has performed a reasonable
investigation, a broker-dealer should retain records documenting both
the process and the results of its investigation. Such records include:
Descriptions of meetings conducted (with issuer or other parties)
Descriptions of documents and other information reviewed
The results of such reviews
The dates the events occurred and the individuals who attended or
conducted the reviews
A single checklist of practices will not suffice for every offering
mechanical reliance on a single checklist may result in a finding of
an inadequate investigation.
April 2010
13
MULTIPLE OFFERINGS
Broker-Dealers must conduct a reasonable
investigation for each offering,
notwithstanding that subsequent offerings
may be by the same issuer
Investigate performance of prior offerings to
detect any potential red flags
April 2010
14
THE EXISTENCE OF RED FLAGS
Broker-Dealers must note any information that it may
uncover in the course of an investigation that it
considers a “Red Flag”
• Obligates broker-dealer to follow-up on any red flags it
encounters during inquiry and investigate any adverse
information about the issuer
• Broker-Dealer must do more than simply rely upon
representations by issuer, the disclosures in offering
documents or even a due diligence report of issuer’s counsel
April 2010
15
Broker-Dealers have Duty to Ensure that the
Investment Recommendation is Suitable for
the Customer [FINRA Rule 2310]
April 2010
16
REGISTERED REPRESENTATIVE SALES PRACTICES
• Know the Product – Due Diligence by Registered
Representative
Understand Mechanics of Product
Understand Risks
Understand Role in Portfolio
• Know Your Customer – Suitability
Accredited and Non-Accredited Investors
PPM with Subscription Agreement and Disclosures
April 2010
17
SUPERVISION OF REG D OFFERINGS
Broker-Dealers must have supervisory procedures
in place that are reasonably designed to ensure
that its registered representatives:
Perform the analysis required by FINRA Rule 2310
Qualify their customers as eligible to purchase securities
pursuant to Regulation D
April 2010
18
•
Verify Accredited Investor Status
•
Ensure There are No Discrepancies Between the Subscription
Documents and the Firm’s New Account Documents
•
Supplemental Disclosure Form of Material Risks
•
Paper the File – Contemporaneous Notes
•
Do Investments Appear on Brokerage Statements
•
Does Firm Send a Confirmation
April 2010
19
FINRA Regulatory Notice 10-22
Newly issued guidance by FINRA setting forth
standards and guidelines for broker-dealers
to conduct reasonable investigation in Reg D
offerings
Issued April 2010
April 2010
20
DEFENDING AGAINST A PRIVATE PLACEMENT CLAIM
• Investigate the Customer
• Analyze the Relevant Files (e.g. Due Diligence files;
Sales Practice files; Supervision files)
• Consolidation/Severance of Multiple Claims
• Mitigation of Damages
• Coordinate Defense with Regulatory Inquiries
April 2010
21