FINRA Reminds Brokerage Firms of Their Obligations When Selling Regulation D Offerings & Private Placements

On April 20, 2010, the Financial Industry Regulatory Authority ("FINRA") issued a notice to its member brokers firms reminding them, and providing guidance on, what their obligations are when they sell Regulation D offerings to investors. In its notice, FINRA reiterates that brokerage firms are obligated to conduct a reasonable investigation of the issuer and the securities before they recommend and sell securities under the Securities and Exchange Commission's Regulation D under the Securities Act of 1933. These securities also are known as private placements.

(See NTM 10-22 at this link http://www.finra.org/Industry/Regulation/Notices/2010/P121299.)

The timing of FINRA's notice to brokerage firms is not surprising. Over the past several years, a number of brokerage firms sold billions of dollars in various private placements that turned out to be fraudulent investments and Ponzi schemes. Investors have suffered billions of dollars of investment losses as a result. These investments include Medical Capital, Provident, Shale Royalties, DBSI, and Striker.

Thousands of investors throughout the United States have filed FINRA arbitration claims and class action lawsuits against brokerage firms for the firms' roles in recommending and selling the fraudulent Regulation D securities. In those arbitration claims and lawsuits, investors have alleged, among other things, that the brokerage firms failed to conduct reasonable investigations of the private placement offerings, i.e., failed to conduct proper due diligence. Investors have alleged that there were numerous red flags that brokerage firms either failed to find or ignored, and that if the red flags had been recognized or heeded, the brokerage firms properly would have refused to recommend and sell the securities. Cases of this nature have been filed against brokerage firms such as: Securities America, NEXT Financial Group, Wedbush Morgan, QA3 Financial, Capital Financial Services, Milkie Ferguson, J.P. Turner, National Securities, and First Allied Securities.

Regulation D provides exemptions from the registration requirements of Section 5 under the Act. Sales of Regulation D securities, however, are not exempt from the anti-fraud provisions of the federal securities laws. As such brokerage firms have a duty to conduct a reasonable investigation of securities that they recommends. Moreover, as part of their obligations, brokerage firms are required to meet FINRA's suitability requirement, the first part of which requires brokerage firms to investigate a security to determine whether that security should be sold to any investor.

In its notice to brokerage firms, FINRA reminds brokerage firms that when conducting their investigations of securities, they "'may not rely blindly upon the issuer for information . . .'" and that they may not "rely on the information provided by the issuer and its counsel in lieu of conducting [their] own reasonable investigation." FINRA further instructs its members that "a more thorough investigation is required for 'securities issued by smaller companies of recent origin," and that the presence of "red flags" requires further investigation by the brokerage firm. In addition, FINRA tells brokerage firms that if they lack essential information about an issuer or its securities they must disclose this fact to investors, as well as the risks that arise from this lack of information.

Dimond Kaplan & Rothstein, P.A. has filed FINRA arbitration claims on behalf of hundreds of Medical Capital, Provident, Shale Royalties, DBSI, and Striker investors and continues to pursue such claims on behalf of investors in an effort to recover the investment losses.

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