Articles Tagged with due diligence

shutterstock_19864066The Securities and Exchange Commission (SEC) recently announced charges against Macquarie Capital (USA) Inc., (Macquarie) a wholly owned subsidiary of Macquarie Group Limited. The SEC alleged that the firm was responsible for underwriting a public in Puda Coal (Symbol: PUDA). However, during the firm’s due diligence, the SEC alleged that Macquarie obtained a report indicating that the China-based company’s offering materials contained false information.

Macquarie agreed to settle the SEC’s charges by paying $15 million and covering the costs of a fair fund to compensate investors who suffered losses after purchasing shares in the public offering. In its press release, the SEC recognized that underwriters are gatekeepers who are supposed to be relied upon by investors to ferret out the essential facts and address inaccuracies before marketing a stock to the public.

The SEC found that Macquarie was the lead underwriter on a secondary public stock offering in 2010 by Puda Coal. At that time Puda Coal purported to own a coal company in China and falsely told investors that it held a 90 percent ownership stake in the Chinese coal company. Macquarie then was accused of repeating those statements in its marketing materials for the offering despite obtaining a report showing that Puda Coal did not own any part of the coal company. The SEC found that Macquarie had access to filings in China during its due diligence review that showed that Puda Coal’s chairman had transferred ownership of the coal company to himself and then sold nearly half of his interest.

shutterstock_94066819The Financial Industry Regulatory Authority (FINRA) sanctioned brokerage firm EDI Financial, Inc. (EDI Financial) alleging that the firm’s business involved the sales of private placement offerings. From approximately January 2008 through November 2014, FINRA alleged that a substantial portion of EDI Financial’s revenue came from sales of private placements. But despite the importance of private placement sales to EDI Financial’s bottom line FINRA alleged that the firm failed to have adequate policies and procedures to supervise the sales of its private placement activities.

EDI Financial has been a registered broker-dealer since 1986. The firm conducts a general securities business which includes the sales of private placements and mutual funds. The firm has 70 brokers that operate out of its 22 branch offices, with headquarters in Irving, Texas.

FINRA found that EDI Financial failed to adopt and implement a supervisory systems reasonably designed to achieve compliance with the firm’s suitability obligations for the solicitation and sale of private placements. For example, FINRA determined that the firm lacked adequate written procedures concerning the what concentration of a customer’s assets could be allocated to private placements. Additionally, FINRA alleged that the firm did not effectively monitor customers’ exposure to private placements.

shutterstock_168326705The law offices of Gana Weinstein LLP have been investigating the sales of Servergy, Inc. (Servergy) stock through a private placement by WFG Investments, Inc (WFG) to its clients. The Securities and Exchange Commission (SEC) recently filed an action in the Northern District of Texas against Servergy concerning possible violations of the anti-fraud provisions of federal and state securities laws. Between August 2009 and February 2013, Servergy raised approximately $26 million by selling shares of its common stock to private investors

Servergy is a Nevada company headquartered in Texas formed in August 2009. The company’s main product is the developing and manufacturing the Cleantech 1000 Server (CTS-1000), technology that can be used in network function virtualization, distributed storage, and cloud computing. The SEC’s Servergy lawsuit concerns misstatements made by Servergy’s CEO, William Mapp III, to investment advisors and investors regarding Servergy’s prospects. Specifically, it was alleged that the company made statements indicating that Freescale Semiconductor had previously ordered CTS-1000 servers, that Amazon.com, Inc. had pre-ordered the server, and that the CTS-1000 consumes 80% less power, cooling, and space than its competitors.

However, according to the SEC, there was no evidence to back up that Mapp’s statements that Freescale’s ever placed such orders of the CTS-1000. The SEC also alleged that the claims concerning pre-orders from Amazon for the CTS-1000 did not exist. Finally, the SEC alleged that there were errors in a chart titled “Comparing Servergy to the Blade Server Competition” that was included in one of the Company’s private placement memoranda.

shutterstock_114128113Our firm has written numerous times about investor losses in programs such as various equipment leasing programs like LEAF Equipment Leasing Income Funds I-IV and ICON Leasing Funds Eleven and Twelve. These direct participation programs, like their non-traded REIT and oil and gas cousins, all suffer from the same crippling flaw that dooms these investments to a high likelihood of failure from the get go. The costs and fees associated with all of these investments cause the security to be so costly that only unprecedented market boom conditions can lead to profitability. Market stagnation or decline makes any significant return a virtual impossibility.

Yet, investors are in no way compensated for these additional risks. These investments tout high yield like returns for risks far in excess of traditional high yield investments. In fact, the only reason brokers sell these products is because of the high sales commissions coupled with the lack of price transparency that allows these products to be displayed at inflated values for years on investor account statements.

In an equipment leasing program a sponsor sells limited partnership units then takes out substantial offering costs and fees and invests the remainder in a pool of equipment leases that are leveraged up with additional borrowing. Brokers market these products as a predictable income stream but in fact, and what nearly all brokers fail to mention, is that a substantial portion of investor distributions are actually a return of their original investment and not actually income generated from operations.

shutterstock_178801067This article continues the examination of the findings by The Financial Industry Regulatory Authority (FINRA), in an acceptance, waiver, and consent action (AWC), concerning LaSalle St. Securities, LLC (LaSalle) private placement deficiencies.  FINRA also found that LaSalle served as the placement agent for a 2009 private placement offering by Revitalight Operators, LLC. The private placement memorandum (PPM) stated investors would be entitled to a 9% “preferred return” on their outstanding investments prior but that this preferred return was not guaranteed and might never be paid. FINRA found that LaSalle was responsible for the PPM’s contents. The PPM contained a summary of financial projections which FINRA found contained assumptions that the total net return over six years would be $2.050 million and that investors’ capital contributions would be returned in the fiftieth month. The PPM stated that investors could receive a 27.13% annual return on investment. However, FINRA determined that the projected annual return were calculated using a flawed methodology.

Finally, FINRA alleged that member firms that using consolidated reports are communications with the public and must be clear, accurate, and not misleading. Firms should have systems in place to ensure that valuations provided regarding customer assets held at the firm are consistent with the firm’s official account statement distributed to the customer. The firm should also take reasonable steps to accurately reflect information regarding outside accounts and assets. If a firm is unable to adequately supervise the use of the reports then the firm must prohibit dissemination of the reports.

FINRA found that LaSalle had procedures in place governing consolidated reports. The procedures provided that the CCO or specifically designated principals, will review the consolidated reports to ensure adherence to all applicable rules. Despite the procedures, FINRA found that LaSalle had an inadequate system in place because the firm did not ensure that all representatives actually followed the proscribed procedures. FINRA determined that LaSalle’s training was limited to blast emails to brokers advising them that consolidated statements needed to be submitted to the home office for review as correspondence.

shutterstock_187532306The Financial Industry Regulatory Authority (FINRA), in an acceptance, waiver, and consent action (AWC), sanctioned brokerage firm LaSalle St. Securities, LLC (LaSalle) over allegations that staff found certain deficiencies with respect to: 1) a private placement offering involving Seat Exchange Corporation where LaSalle failed to exercise adequate due diligence before allowing a broker to recommend the offering to four investors; 2) a private offering by Revitalight Operators, LLC, LaSalle distributed a private placement memorandum to potential investors that did not include material facts and used a flawed methodology for projecting return on investment; 3) an offering of Platinum Wealth Partners, Inc. (PWP) by one of its brokers the firm failed to supervise; and 4) the fact that LaSalle allowed its representatives to send consolidated reports to its customers but failed to adequately supervise those reports.

LaSalle has been registered with FINRA as a broker-dealer since 1976, has 232 registered representatives, 107 branch offices, and its principal place of business is in Chicago, Illinois. LaSalle has various business lines.

FINRA alleged that in April 2010, a broker with the initials “PL” sought the firm’s approval to recommend the purchase of shares in Seat Exchange Corporation, a Regulation D private placement to four customers. Seat Exchange had only one director, who also owned 21.5% of the company and the placement agent for offering was Chicago Investment Group (CIG). CIG was also an affiliated with Seat Exchange. According to FINRA, LaSalle had supervisory procedures requiring that all appropriate due diligence efforts on behalf of any private placement offering are undertaken and documented or that we obtain sufficient documentation from a third party that they have undertaken sufficient due diligence.

shutterstock_102242143According to the Financial Industry Regulatory Authority’s BrokerCheck system, there have been four customer complaints filed against former Sigma Financial Corporation (Sigma) and current Charles Schwab broker, Mark Johanson (Johanson) stemming from unsuitable Tenants-in-Common (TIC) investments.

Sales of TICs exploded during the early 2000s from approximately $150 million in 2001 to approximately $2 billion by 2004. TICs are private placements that have no secondary trading market and are therefore illiquid investments. These products were promoted as appropriate section 1031 exchanges in which an investor obtains an undivided fractional interest in real property. In a typical TIC, the profits are generated mostly through the efforts of the sponsor and the management company that manages and leases the property. The sponsor typically structures the TIC investment with up-front fees and expenses charged to the TIC and negotiates the sale price and loan for the acquired property.

TIC investments entail significant risks. A TIC investor runs the risk of holding the property for a significant amount of time and that subsequent sales of the property may occur at a discount to the value of the real property interest. FINRA has also warned that the fees and expenses associated with TICs, including sponsor costs, can outweigh the any potential tax benefits associated with a Section 1031 Exchange. That is, the TIC product itself may be a defective product because its costs outweigh any potential investment value for a customer. FINRA also instructed members that they have an obligation to comply with all applicable conduct rules when selling TICs by ensuring that promotional materials used are fair, accurate, and balanced.

shutterstock_154554782The Financial Industry Regulatory Authority (FINRA) sanctioned broker Financial America Securities, Inc. (Financial America) and John Rukenbrod (Rukenbrod) concerning allegations that between August 2009, and May 2011, the firm, acting through Rukenbrod, failed to adequately supervise the business being conducted out of one of the firm’s branch offices. FINRA found that the firm: 1) failed to conduct any inspection of the branch office; 2) failed to review any incoming or outgoing e-mails of the three registered representatives operating out of the branch; 3) failed to adequately supervise private securities transactions engaged in by two of the registered representatives; 4) failed to ensure that all electronic communications were captured and retained; 5) failed to create and maintain a written report of inspections of the branch as required; and 6) failed to ensure that the firm’s securities business was supervised by a licensed securities principal.

Financial America has been a FINRA firm since 1970, employs 31 registered representatives, has two branches, and engages in a general securities business. Rukenbrod entered the securities industry in 1966 and cofounded Financial America in 1970.

FINRA alleged that two of Financial America’s representatives initialed “PC” and “CM” engaged in a securities business primarily in the sale of private placement offerings and Rukenbrod was the firm’s designated supervisor. In April 2010, FINRA found that Rukenbrod attended an investor presentation at PC and CM’s branch for a private placement offering. Rukenbrod turned down the offering and stated that the firm would not participate in the offering until certain due diligence procedures were agreed upon.

shutterstock_95416924This post picks up on our first article on The Financial Industry Regulatory Authority (FINRA) sanctioning brokerage firm B. C. Ziegler and Company (B. C. Ziegler) and ordering the brokerage firm to pay $150,000 on allegations that the firm failed to implement a supervisory system reasonably designed to ensure that material economic information regarding Church Bonds was disclosed to the firm’s brokers, trading desk, and customers.

FINRA found that while the firm maintained a Credit Watch List to check for delinquent and missed Church Bond payments, this list was only produced periodically and not every time a Church Bond issuer fell five weeks behind on its sinking fund payments. Accordingly, FINRA found that B. C. Ziegler violated NASD Rule 3010 by failing to establish and maintain a supervisory system reasonably designed to ensure that material economic information, such as delinquent sinking fund payments, was disclosed to the firm’s brokers and customers who were sold Church Bonds in secondary market transactions.

FINRA found that prior to September 2010, B. C. Ziegler did not inform its brokers, trading desk, or customers when an issuer was more than 30 days behind on its sinking fund payments, an indicator of financial distress. Further, it was alleged that from September 2010, through at least May 2012, B. C. Ziegler’s registered representatives and trading desk were informed only periodically when a Church Bond issuer fell five weeks behind on its sinking fund payments through the Credit Watch List causing B.C. Ziegler’s supervisory system to not be reasonably designed to consider material economic information in the pricing of Church Bonds in secondary market transactions. The result, FINRA found, was that the firm had similar pricing for secondary market trades in Church Bonds that were current and delinquent with sinking fund payments.

shutterstock_77335852The Financial Industry Regulatory Authority (FINRA) sanctioned brokerage firm 79 Capital Securities, LLC (79 Capital) and broker Michael Ward (Ward) concerning allegations around June and July 2012, 79 Capital and Ward posted on the website of a business networking organization sales material regarding GWG Renewable Secured Debentures (GWG Debentures), an illiquid and high-risk alternative private placement investment that omitted material information concerning the debentures. Additionally, FINRA alleged that the firm and Ward failed to record basic suitability information and create new account forms for customers involved in two transactions for the purchase of debentures. Finally, FINRA found that respondents also permitted an employee whose FINRA registration had not been approved, to sell the GWG Debentures and in doing so failed to enforce the firm’s written procedures requiring the creation of new account forms and prohibiting unregistered persons from effecting securities transactions.

According to our investigation, 79 Capital is the third brokerage firm or broker to be sanctioned by FINRA in the past year concerning the improper sale of GWG Debentures. See Broker Sanctioned Over Unsuitable Sales of Private Placement Securities (FINRA sanctioned Karen Geiger); FINRA Sanctions Michael Wurdinger and Anil Vazirani Over GWG Debenture Sales (FINRA sanctioned brokers associated with Center Street Securities, Inc.).

As a background, GWG Holdings, Inc. purchases life insurance policies on the secondary market at a discount to the face value of the policies. Once purchased, GWG pays the policy premiums until the insured dies and then GWG collects the face value of the insurance hoping to earn returns by collecting more upon the maturity of the policies than it has paid to purchase the policy and service the premiums. FINRA found that the company has a limited operating history and has yet to be profitable.