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FINRA Elevates Focus on the Failure to Conduct Proper Due Diligence on Private Placements

On December 7, 2018, the Financial Industry Regulatory Authority (“FINRA”) issued a comprehensive report (“Report on FINRA Examination Findings”) which “focuses on selected observations from recent examinations that FINRA considers worth highlighting because of their potential significance, frequency, and impact on investors and the markets.”

Among the issues discussed in this report were significant concerns about some firms that failed to conduct reasonable diligence on private placements and failed to meet their supervisory requirements – especially in those circumstances when firms have an obligation to conduct a “reasonable investigation” through evaluation of the issuer and its management; the business prospects of the issuer; the assets held by or to be acquired by the issuer; the claims being made; and the intended use of proceeds of the offering.

In particular, FINRA has observed instances where some firms’ reasonable diligence was not sufficient in scope or depth to be considered a “reasonable investigation of the issuer and the securities.”

According to FINRA, these regulatory examinations revealed that “some firms failed to perform reasonable diligence on private placement offerings prior to recommending the offerings to retail investors” and that, “in some instances, firms performed no additional research about new offerings because they relied on their experience with the same issuer in previous offerings.”

In other instances, FINRA noted that “some firms reviewed the offering memorandum and other relevant offering documentation, but did not discuss the offering in greater detail with the issuer or independently verify, research or analyze material aspects of the offerings. FINRA also observed that some firms did not investigate red flags identified during the reasonable diligence process.”

Finally, FINRA stated that “where some firms obtained and reviewed due diligence reports provided by due diligence consultants, experts or other third-party vendors, they sometimes did not independently evaluate the third parties’ conclusions, respond to red flags or significant concerns noted in the reports, or address concerns regarding the issuer or the offering that were apparent outside the context of the report.” Of equal concern was the fact that “some firms used third-party due diligence reports that issuers paid for or provided in their due diligence analysis. While some of these reports provided valuable and relatively objective information, in some cases, firms did not consider the related conflicts of interest in their evaluation and assessment of the reports’ conclusions and recommendations.”

If you are an individual or institutional investor who has any concerns about your private placement investments with any brokerage firm, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).