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Regulatory Sanctions

Undisclosed Private Securities Transactions Run Aground with Failed Sales Materials

September 15, 2017
This post started out as a cautionary tale about undisclosed private securities transactions and outside business activities, and ended with a discussion on sales materials that fail to comply with FINRA's content standards for communications with the public. This 'sidebar' commentary addresses a WAKE-UP CALL to brokers who think nothing twice about pursuing undisclosed activities outside the scope of their member firms' business. 


Christopher Hawn agreed to a $10K fine and a 6-month suspension to settle FINRA charges that he participated in 2 private securities transactions and engaged in an outside business activity, all without providing prior written notice to his respective member firms. He also was cited for distributing sales materials prepared by the private securities issuer that failed to comply with FINRA's content standards for communications with the public.


BACKGROUND.   Hawn has 10 years of securities industry experience with 4 firms. He obtained his Investment Company Products / Variable Contracts Representative license in 2005, and obtained his General Securities Representative license in 2011. Between September 2012 and April 2013, Hawn was associated with SC Distributors (''SCD"); between May 2013 and August 2015, he was associated with ALPS Distributors; ALPS terminated him because of “an undisclosed investment-related outside business activity.” Hawn currently is not associated with a FINRA member firm. He had no prior relevant disciplinary history.


FINRA FINDINGS.    Over a one-month period – from September 1 to October 4, 2012 – while associated with SCD, Hawn participated in 2 undisclosed private securities transactions. During this time, Hawn also distributed sales materials prepared by the issuer that failed to comply with FINRA's content standards for communications with the public. Between July 2013 and August 2015, while associated with ALPS, Hawn engaged in an undisclosed outside business activity. Hawn compounded his violative actions by falsely attesting on SCD and ALPS Monthly and/or Annual Compliance Questionnaires that he had not engaged in any private securities transactions or outside business activities.


Now for the details.


Undisclosed Private Securities Transactions.    Hawn introduced a friend and an uncle to an investment opportunity in a private placement offering of a security (the "PPO"). Each invested nearly $99,000 in the offering. Hawn's participation included: 

  • Providing both with an overview of the PPO;
  • Introducing both to the promoters;
  • Providing both with the subscription documents, marketing materials, and an information memorandum;
  • Providing his uncle with advice about the PPO and inviting his uncle to participate in a WebEx discussion hosted by the promoters of the PPO.


Private Placement Marketing Material.   NASD Rule 2210 and FINRA Rule 2010, among other things, states that: (i) all member communications must be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service; and, (ii) no member may omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communications to be misleading.


The private placement marketing materials and an information memorandum that Hawn distributed to his friend and his uncle did not include the risks of investing in the PPO or provide a sound basis for evaluating the financial information contained in the PPO. And, while the information memorandum contained forecasts of financial information, it did not include clear language that described the assumptions used for the financial information or factors that might inhibit achievement of the issuer's projected financial results.


Undisclosed Outside Business Activities.    On 11/21/13, Hawn signed on as a consultant for LCM, a privately owned registered investment advisor. The agreement provided that he be paid a fee of $100 per hour for his consulting activities, though he never was compensated by LCM. As a consultant for LCM, Hawn referred investors to LCM and served as a member of the LCM Investment Committee.


False Annual Compliance Questionnaires.    Hawn falsely responded on all SCD and ALPS ACQ’s that he never had any involvement with private securities transactions or outside business activities. ALPS went further by requiring monthly certifications – and of course Hawn made false attestations here, as well.


FINANCIALISH TAKE AWAYS.    FINRA comes down hard on brokers who engage in unauthorized private securities transactions and outside business activities, and comes down harder on those brokers who compound the violations by lying on Annual Compliance Questionnaires (ACQ’s). It’s another thing – perhaps infrequent – when FINRA factors into its sanctions apparent violations that involve communications with the public - i.e., those prepared by a PPO issuer.


But that was the case here, and Hawn was fined $10K and suspended 6 months.


I applaud FINRA for disclosing the sales material violations even though they appear to have been essentially outside the scope of its member firm’s everyday business activities. But that really isn’t the case because SCD would have been responsible for monitoring such private securities transactions had the firm given Hawn its approval to proceed. SCD would have to record on its books any sales compensation that Hawn received, and the firm would been had to supervise the transactions - extending its oversight to monitoring for fair, balanced and accurate communications with the public – all in compliance with NASD Rule 2210 and FINRA Rule 2010.


I view this as a WAKE-UP CALL to “wayward” brokers, who should understand that it’s their firms, and not they themselves, who are best equipped to evaluate private securities transaction compliance. It should not come as a surprise that brokers will focus largely, if not exclusively, on transactional compensation. But, as we learn from this case and others, there are risks and hazards with all investments. Bottom line: It's better to have 2 sets of eyes on the ball rather than one.


A SUGGESTED ‘SWEEP’ FOR FINRA.    In what may be a first for Financialish, I recommend that FINRA conduct an sweep examination of documentation supporting approved private securities transactions (“PST’s”) that are on the books of its member firms. FINRA would experience first hand how prevalent approved private securities transactions are among its member firms – a statistic that FINRA might share with the industry – while learning how well firms conduct due diligence on these transactions. FINRA's #1 priority is to protect individual investors, and there's no doubt they have significant exposure to PSTs, which are all-too-often out of the sightlines of securities regulators and registered financial services entities.


This case was reported in FINRA Disciplinary Actions for August 2017.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case # #2015046760801.