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Regulatory Sanctions

Suppose FINRA Enforcement Dedicated an Exam Team to Private Placements

March 21, 2019

by Howard Haykin


Private placements of unregistered securities are some of the least regulated or monitored transactions in the brokerage industry. Yet, they frequently are the basis for FINRA disciplinary actions involving member firms and their associated persons.


Consider that the quality of any compliance or due diligence efforts related to private placements is wholly dependent on broker-dealers and their supervisory personnel. FINRA typically doesn't get involved until, and unless, its examiners conduct a review or onsite examination of a firm, and by then a bad deal is likely to have blown up in the faces of the broker-dealer and its customers.


Suppose FINRA were to establish a separate team of Enforcement examiners dedicated solely to private placements – one that could monitor the universe of private placement offerings on a ‘real time basis’. The team would maintain a (private) database or directory of private placements that member firms must report (into FINRA) prior to being offered to customers and potential investors. Examiners then would utilize this universe of deals to review for due diligence documentation of selected offerings, while monitor all others for indications of heightened risk among its member firms. 





In November 2018, a FINRA OHO panel sanctioned former FINRA member firm Spencer Edwards, Inc., on charges that it recommended and sold convertible, 2-year notes totaling more than $400,000 in a private placement to customers without having a reasonable basis to believe that the investments were suitable for any investor. The firm appealed the OHO decision to the NAC. However, because the firm terminated its broker-dealer registration on March 1, 2019, the status of this appeal is uncertain.


For the record, the OHO sanctions included ... a $495,000 fine, a 45-day suspension from association with FINRA, an order to offer rescission to customers, an order that the firm file all of its communications with customers prior to use for a 6-month period, and an order to retain an independent outside consultant to review and revise the firm’s supervisory procedures.   


Based in Centennial, CO, Spencer Edwards is said to have operated a full-service broker-dealer with some 36 associated persons during the relevant period (August 2013 to September 2014). In August 2013, the firm brought in an individual (“JL”) to develop and head an investment banking department.



WHAT WENT WRONG – ACCORDING TO FINRA ENFORCEMENT.   Between September 2013 and August 2014, the firm recommended and sold Digi Outdoor Media, Inc., two-year notes in a private placement to 13 customers. Spencer Edwards initiated discussions with Digi Outdoor Media about doing the offering around the time JL joined the firm in August 2013. [Note: FINRA charged JL with failing to conduct adequate due diligence for this offering, and those charges were settled. JL paid $23,000 in fines and disgorgement and he served 2 short-term suspensions.]


          DUE DILIGENCE EFFORTS.    Given that the ability to lease signage space in high traffic areas was central to the issuer's business model, the firm (through JL) failed to adequately address the reasonableness of the issuer’s projections or its claim that it had secured prime locations for its signs. For example, until requested by FINRA examiners, the firm made no effort to obtain signed leases.


The firm further failed to adequately address the issuer's financial condition or the background of its principals – even when issues were raised on multiple occasions by a lawyer retained by the firm to assist with its due diligence on the issuer. For example, JL failed to identify and investigate litigation that alleged securities fraud and the existence of liens related to the president and CFO of the issuer, as well as to predecessors of the issuer - all of which could impact DIgi Outdoor Media's assets and business.


          COMMUNICATIONS TO INVESTORS.    The firm distributed issuer-prepared materials to customers or potential customers that contained statements and claims which were misleading or omitted certain information that caused them to be misleading. The materials also failed to provide a fair and balanced presentation of information.



For further details on this case, click on ... FINRA Enforcement Complaint or FINRA OHO Decision.

The case was reported in FINRA Disciplinary Actions for February 2019 (AWC #2014041862701).