The following post will provide the reader with some does and don’ts relative to the purchase of private placements.
Capital Financial Services, Inc. (CRD #8408, Minot, North Dakota) submitted a Letter of Acceptance, Waiver and Consent in which the firm was censured and ordered to pay $200,000 in restitution to investors. Without admitting or denying the findings, the firm consented to the described sanctions and to the entry of findings that it failed to have reasonable grounds to believe that private placements offered by two entities pursuant to Regulation D were suitable for any customer. The findings stated that the firm began selling the offerings for one entity after its representatives visited the issuer’s offices to review records and meet with the issuers’ executives; the firm also received numerous third-party due diligence reports for these offerings but never obtained financial information about the entity and its offerings from independent sources, such as audited financial statements. The findings also stated that despite the issuer’s assurances, the problems with its Regulation D offerings continued; the issuer repeatedly stated to the firm’s representatives that the interest and principal payments would occur within a few weeks, and the issuer made some interest payments but failed to pay substantial amounts of interest and principal owed to its investors, and these unfulfilled promises continued until the SEC filed its civil action and the issuer’s operations ceased. The findings also included that in addition to ongoing delays in making payments to its investors, the firm received other red flags relating to the entity’s problems but continued to allow its brokers to sell the offering to their customers; in total, the firm’s brokers sold $11,759,798.01 of the offering to customers. FINRA found that despite the fact that the firm received numerous third-party due diligence reports for the other entities’ offering, it never obtained financial information about the issuer and its offerings from independent sources, such as audited financial statements, and although it received a specific fee related to due diligence purportedly performed in connection with each offering, the firm performed little due diligence beyond reviewing the private placement memoranda (PPM) for the issuer’s offerings.
FINRA also found that the firm’s representatives did not travel to the entity’s headquarters to conduct any due diligence for these offerings in person and did not see or request any financial information for the entity other than that contained in the PPM. In addition, FINRA determined that the firm obtained a third-party due diligence report for one of the offerings after having sold these offerings for several months already; this report identified a number of red flags with respect to the offerings. Moreover, FINRA found that the firm should have been particularly careful to scrutinize each of the issuer’s offerings given the purported high rates of return but did not take the necessary steps, through obtaining financial information or otherwise, to ensure that these rates of return were legitimate, and not payable from the proceeds of later offerings, in the manner of a Ponzi scheme. Furthermore, FINRA found the firm also did not follow up on the red flags documented in the third-party due diligence report; even with notice of these red flags, the firm continued to sell the offerings without conducting any meaningful due diligence. The findings also stated that the firm failed to have reasonable grounds for approving the sale and allowing the continued sale of the offerings; even though the firm was aware of numerous red flags and negative information that should have alerted it to potential risks, the firm allowed its brokers to continue selling these private placements. The findings also included that the firm did not conduct meaningful due diligence for the offerings prior to approving them for sale to its customers; without adequate due diligence, the firm could not identify and understand the inherent risks of these offerings. FINRA found that the firm failed to enforce reasonable supervisory procedures to detect or address potential red flags and negative information as it related to these private placements; the firm therefore failed to maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations. (FINRA Case #2009019125903).