Articles Tagged with Regulation D

shutterstock_132704474The investment lawyers of Gana Weinstein LLP are investigating customer complaints against broker Dennis Riordan (Riordan). According to Riordan’s BrokerCheck records there are at least 3 customer complaints against Riordan, 1 judgment or lien, and 2 criminal matters. The customer complaints against Riordan allege a number of securities law violations including that the broker made unsuitable investments, excessive trading, and failure to follow instructions among other claims.

The most recent disclosure filed in February 2015 concerns a tax lien for $33,287. Tax liens and judgements are often a sign that the broker cannot manage their own personal finances and may be tempted to recommend high commission products or strategies to clients in order to satisfy debts. The most recent complaint against Riordan was filed in December 2013 and alleges an unsuitable recommendation in a private placement security.

Brokers have a responsibility treat investors fairly which includes obligations such as making only suitable investments for the client. In order to make a suitable recommendation the broker must meet certain requirements. First, there must be reasonable basis for the recommendation the product or security based upon the broker’s investigation and due diligence into the investment’s properties including its benefits, risks, tax consequences, and other relevant factors. Second, the broker then must match the investment as being appropriate for the customer’s specific investment needs and objectives such as the client’s retirement status, long or short term goals, age, disability, income needs, or any other relevant factor.

shutterstock_187532306The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm Carolina Financial Securities, LLC (Carolina Financial) concerning allegations that the firm failed to conduct proper due diligence on private placements sold by the firm.

Carolina Financial has been FINRA member since 1997 and operates out of Brevard, North Carolina. The firm has 12 registered representatives and derives generates revenues through the sale of private placements. The firm has two other prior disciplinary actions including a FINRA action in July 2010, concerning allegations that Carolina Financial failed to ensure that an escrow account was established for a contingent offering.

NASD Rule 3010 requires brokerage firms to establish, maintain, and enforce a supervisory system reasonably designed to comply with the securities laws and the FINRA rules. As part of a brokerage firm’s responsibility includes conducting due diligence on its securities products in order for the firm to understand the risks of these products and to have a reasonable basis to believe these products are suitable for at least some customers. FINRA stated in its complaint that due diligence is especially important for alternative investments such as private placement offerings under Regulation D where there is no registration of the securities with the SEC.

shutterstock_168478292We now have the answer to what they will think up next. According to a New York Times article, one of Wall Street’s most exclusive investment products, sold to the wealthy, is moving toward the mainstream investor. Private equity funds. These vast pools of capital that buy and sell companies will become accessible to smaller investors if supports have their way under a plan being contemplated by the Nasdaq stock exchange.

The plan calls for a market where investors in private equity funds can sell their interests to individuals whose net worth falls short of the usual requirements for such investments. Today, private equity funds are limited by the Investment Company Act of 1940 limits their investors to “qualified purchasers,” or individuals with at least $5 million in investments.

Other rules that stand in the way of the sale of alternative investments to the masses include Regulations D. Under Regulation D, private placements can only be sold to “accredited investors.” Under Rule 501 an “accredited investor” is any person who has a net worth in excess of $1,000,000 — excluding residence — or has an annual income in excess of $200,000 in two most recent years.

The Financial Industry Regulatory Authority (FINRA) sanctioned and fined Hantz Financial Services, Inc. (Hantz Financial) $75,000 concerning allegations that between April 2004, until April 2011, Hantz Financial violated FINRA rules by failing to properly enforce its written supervisory procedures for conducting due diligence with respect to a non-exchange traded real estate investment trust (REIT) and by failing to establish and maintain a supervisory system reasonably designed for conducting ongoing due diligence of REITs.

Hantz Financial has been a member of FINRA since 1999 and is headquartered in Southfield, Michigan. The firm employees 276 registered representatives and conducts a general securities business.

A REIT is a corporation or trust that owns income-producing real estate.  REITs pool the capital of numerous investors to purchase a portfolio of properties that may include office building, shopping centers, hotels, and apartment buildings that the average investor would not otherwise be able to purchase individually.  Shares of non-traded REITs do not trade on a national securities exchange and are generally illiquid for periods of eight years or more.  The risks of non-traded REITs are significant and FINRA has issued an Investor Alert warning investors of some of the potential risks.

Private Placements are considered alternative investments and are issued under Regulation D under the Securities Act of 1933.  Regulation D contains rules for issuing securities that provide exemptions from the more rigorous Securities and Exchange Commission (SEC) registration requirements and allows companies to issue securities without normal disclosures.

Investors who are recommended private placements must meet the “accredited investor” standard under Rule 501.  Rule 501 defines “accredited investor” as any person who has a net worth in excess of $1,000,000, excluding residence, or annual income in excess of $200,000, $300,000 if filing jointly with a spouse, in the two most recent years.

According to a 2008 estimate, companies issued approximately $609 billion of securities through Regulation D offerings. While the private placement market allows many small companies to raise capital, regulators have raised a number of issues with due diligence procedures and brokerage firm sales efforts when selling private placements to investors.  The North American Securities Administrators Association says private placements are one of the most common cause of regulatory action by state regulators.  States brought more than 200 enforcement actions involving private placements in 2011, more than doubled the number of action in2007.

The Financial Industry Regulatory Authority (FINRA) recently sanctioned broker Michael A. Barina (Barina) over allegations that Barina failed to conduct reasonable due diligence into the offering a private placement security.  In addition, FINRA alleged that the broker commingled certain funds.

Barina first became registered with FINRA in 1999.  Barina was registered from November 13, 2009, through November 14, 2011, with Coker & Palmer, Inc. (Coker & Palmer).  In November 2011, Barina became registered with Aegis Capital Corp. until May 2013.  Thereafter, Barina was registered with Merrimac Corporate Securities, Inc. until October 2013.

Brokerage firms and brokers are responsible for conducting due diligence on all securities recommended by a broker.  The due diligence requirement is heightened where the investment recommendation is a private placement offering or other type of non-public offering where there is no public information available and brokerage firm is acting as the underwriter of the securities.

FINRA has barred broker Daniel P. Deighan (Deighan) for seven months and fined him $27,500 over allegations that he recommended private placements to customers that were not suitable given the customers’ net worth, annual income, and the concentration of the private placements in their accounts.

Private placements are securities that do not trade on stock exchanges and are exempt from the regular filing requirements.  Private placements are issued under Regulation D under the Securities Act of 1933.  Regulation D contains three rules (Rules 504, 505, and 506) that provide the rules required to be followed in order to qualify for the exemptions from the more rigorous Securities and Exchange Commission (SEC) registration requirements.

The three rules primarily govern the size of the offering and the number of participants that can invest in the private placement.  However, under all three rules, with certain limited exceptions, investors must meet the “accredited investor” standard under Rule 501. Rule 501 defines “accredited investor” as any person who has a net worth in excess of $1,000,000, (excluding residence) or annual income in excess of $200,000 (or $300,000 jointly with a spouse) in the two most recent years.  While the size of the private placement market is unknown, according to 2008 estimates, companies issued approximately $609 billion of securities through Regulation D offerings.

Private securities offerings of oil and gas ventures pose a substantial danger for investor fraud. According to the Securities and Exchange Commission (SEC), there has been an increase in the number of civil fraud cases related to oil and gas private placements.  Investing in private placement offerings carries unique risks and private oil and gas offerings have additional risks for investors to be aware of and to consider.

The SEC’s Investor Alert listed common red flag sales pitches that fraudulent oil and gas investments often make to investors including:

  •  Sales pitches referring to high oil and gas prices;

The Financial Industry Regulatory Authority (FINRA) has filed a complaint against Success Trade Securities, Inc (STS) and its CEO and President Fuad Ahmed (Ahmed) accusing them of improperly selling $18 million worth promissory notes.  The promissory notes were issued by STS’ parent company Success Trade, Inc. (STI) to 58 investors.   The notes were sold primarily to sports athletes in the NFL or NBA.

The FINRA complaint alleges that the STI notes were part of ponzi scheme to simply raise capital and fund STS’ operations while purportedly offering investors 12-26% returns.  The investors were not aware of the risks of investing in the STI notes.  For example, STS was at all times financially insolvent and could only meet its ongoing expenses by selling more STI notes and by continuing the scheme.  Crucial risks such as the viability of the company are material risks that need to be disclosed to investors.  The complaint also alleges that STS and Ahmed failed to register the STI notes as a private placement offering as required under Regulation D.

Problems with the notes began to emerge once the STI notes became due in 2012 through 2013.  At that time, STS and Ahmed solicited noteholders to roll over or extend the terms of the STI notes at higher interest rates or offered customers an equity interest in STS.  The complaint also alleges that in connection with the rollover and extended note sales the firm failed to disclose to some investors that the firm is financially unable to repay the notes that have become due.

Investors continue to suffer substantial losses from recommended investments in the Behringer Harvard REIT Funds.  The Behringer Harvard REIT Funds including the Behringer Harvard Mid-Term Value Enhancement I, Behringer Harvard Short-Term Opportunity Fund I, and the Behringer Harvard REIT I  and II (Behringer REITs) have sometimes been sold to investors as safe, stable, income producing real estate investment trusts.  While the Behringer REITs were initially sold to investors for $10 per share, currently some of these REITs trade as low as approximately $2.00 on the secondary market.  Worse still, some of the funds no longer pay a dividend or investors receive only a fraction of what their advisor initially told their clients they could expect the investment to yield.

The Behringer REITs are speculative securities, non-traded, and offered only through a Regulation D private placement.  Unlike traditional registered mutual funds or publicly traded REITs that have a published daily Net Asset Value (NAV) and trade on a national stock exchange, the Behringer REITs raised money through private placement offerings and are illiquid securities.  In recent years, increased volatility in stocks has led to an increasing number of advisor recommendations to invest in non-traded REITs as a way to invest in a stable income producing investment.  Some non-traded REITs have even claimed to offer stable returns while the real estate market has undergone extreme volatility.  Brokers are often motivated to sell non-traded REITs to clients due to the large commissions that can be earned in the selling the Behringer REITs.

Investors are now bringing claims against the brokerage firms that sold them the Behringer REITs alleging that their advisor failed to disclose important risks of the REITs.  Some common risks that customers have alleged were not disclosed include failing to explain that Behringer REITs may not be liquidated for up to 8 to 12 years or more, that the redemption policy can be eliminated at any time, and that investor returns may not come from funds generated through operations but can include a return of investor capital.