[ by Howard Haykin ]

Once again, a Firm is disciplined for not doing what's called for in its WSPs.

A Schaumburg, IL-based firm agreed to settle FINRA charges it failed to conduct adequate due diligence on a private offering that was sold to its customers.  Prior to offering shares to customers, the firm took some investigative steps but relied too heavily on the representations made by the issuer within the private placement memorandum (PPM).

Firm Profile. Arete Wealth Management LLC is the successor to Keystone Securities, Inc., which was created in August 1998.  Keystone changed its name to Arete in February 2008.  Arete conducts a general securities business from its main office located in Illinois and has 17 branch offices.  The firm has 60 registered reps.  During all periods mentioned herein, Arete was a registered broker-dealer with the SEC and FINRA. The firm's registrations remain currently in effect.
 

FINRA Findings and Allegations. Between September 2007 and September 2008, Arete allegedly failed to enforce its WSPs regarding due diligence for private offerings, specifically by Arete failing to document its due diligence efforts for three offerings;  for 1 of these offerings, Arete failed to perform adequate due diligence.  Such deficiencies would violate NASD Conduct Rule 3010 and FINRA Rule 2010.

It is incumbent on a B/D to conduct due diligence on its securities products - to understand inherent risks of these products and to determine whether these products are suitable for its customers. Due diligence is especially important for alternative investments or private offerings - e.g., Regulation D offerings, where there is no registration of the securities with the SEC.

Arete's WSPs section on private placements mandated that the firm, "at a minimum," take the following steps prior to offering shares of private offerings to customers: 

• Obtain and review the offering material and all background documents;
• Research the issuer's industry segment, including historical growth, economic influences and competitive factors;
• Analyze the issuer's historical financial results and projected business activity;
• Review the issuer's management history; analyze its effectiveness and depth of experience;
• Use, where appropriate, the advice and guidance of an attorney, accountant, and/or other "due diligence" experts in the issuer's specific industry;
• Attend any "due diligence meetings" or other sessions providing an opportunity to meet the management and ask questions about the issuer and the offering; and
• Create a reasonably comprehensive "due diligence" file for the offering, containing copies of documents, records or meetings, telephone conversations,visits, etc.

Arete's Due Diligence Procedures Apparently Did Not Follow its WSPs.  Prior to offering shares of the Maize Fund LP to its customers, Arete took some investigative steps, allegedly as follows:

• Arete verified the money manager's credentials.
• Arete verified that customer funds were kept in a separate account maintained by a clearing firm.
• However, Arete relied too heavily on the representations in the issuer's PPM for Maize Fund.
  • Arete failed to contact the law firm that purportedly created the PPM to verify its involvement.
  • Arete failed to contact the accounting firm that purportedly was involved in preparing financial reports for Maize Fund to confirm its involvement.

When the Maize Fund could not immediately verify the value of customers’ investments, the firm conducted additional investigative steps that led to certain discoveries: 

• One individual involved with the fund had misrepresented his educational credentials.
• The law and accounting firms supposedly involved with the fund had not performed services for it.
• The SEC determined that the umbrella corporation that owned the fund was involved in fraudulent activity.
• The SEC seized the fund’s assets - even though the fund was not directly involved in the fraud.

Besides conducting inadequate due diligence, Arete allegedly failed to sufficiently document whatever due diligence steps it wook - which, according to FINRA, only consisted of a PPM, some back-and-forth email with the issuer, and a written timeline of meetings and phone calls. 

For the other 2 private offerings ...  FINRA found that Arete failed to document that adequate due diligence had been performed.  So, in each of the 3 offerings, the firm’s records lacked documentation evidencing a meaningful investigation or critical analysis of the offerings.

FINRA Sanctions. Arete agreed to the settlement which calls for a $25K fine.  This case was reported in FINRA's Disciplinary Actions for September 2012.

For further details, go to:  [FINRA AWC #2010021316801, September 2012].