BD Failed to Conduct Adequate Private Placement Due Diligence
FINRA censured and fined a broker-dealer $175,000 for failing to conduct adequate due diligence before recommending a private placement offering to accredited investors. FINRA alleges that an affiliate of the firm reviewed the private offering memorandum and highlighted shortcomings including a failure to describe the company’s business, a weak corporate governance structure, a lack of financial statements, and disclosure inconsistencies. Regardless, the firm approved the offering even though it provided investors an “Acknowledgement of Additional Risks” that described the offering document’s shortcomings. FINRA Rule 2111 requires a firm “to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.” The Rule requires the firm to have “an understanding of the potential risks and rewards associated with the recommended security or strategy.”
OUR TAKE: The firm tried to disclaim responsibility and put the onus on investors by specifically telling them that the offering document had deficiencies. However, Rule 2111 does not allow this “caveat emptor” approach. Instead, a broker-dealer must actually perform the necessary due diligence to understand the risks before recommending the security.