fsi private place 4 2010

FALLOUT FROM THE RECENT PRIVATE PLACEMENT SCANDALS : 

FALLOUT FROM THE RECENT PRIVATE PLACEMENT SCANDALS Michael Schwartzberg, Partner (New York City) Brandon Reif, Partner (Los Angeles, CA) WINGET, SPADAFORA & SCHWARTZBERG, LLP

OVERVIEW : 

Broker-Dealer’s regulatory requirements in a Regulation D private placement offering Summarize what is required by Broker-Dealers, Registered Representatives and Supervisory personnel Identify Best Practices Describe the current regulatory and litigation/arbitration landscape How to conduct yourself in Reg D offerings given recent guidelines issued by FINRA How to deal with litigation and/or regulatory investigations OVERVIEW 2

Slide 3: 

Regulation D: Provides exemptions from the registration requirements of the 1933 Act; otherwise known as “Private Placements” Huge source of capital markets for small companies: raised $609 Billion in Reg D offerings in 2008 Accredited Investors v. Non-Accredited Investors Section 5 of the Act sets forth exemptions to both limited and unlimited non-accredited investors 3

BROKER-DEALER’S OBLIGATIONS IN REG D OFFERING : 

Duty to conduct reasonable investigation concerning the proposed investment and the issuer Duty to ensure that recommendation is suitable for customer (regardless of whether investor is accredited or non-accredited) BROKER-DEALER’S OBLIGATIONS IN REG D OFFERING 4

RECENT REG D SCANDALS : 

Provident Shale Royalties Medical Capital Holdings RECENT REG D SCANDALS 5

REGULATORY RESPONSE TO REG D SCANDALS : 

Taking aim at the issuers and the broker-dealers selling Reg D private placements Securities and Exchange Commission Asset Freeze over Provident Royalties, LLC Asset Freeze over Medical Capital Holdings Subpoenas On-the-Record Testimony REGULATORY RESPONSE TO REG D SCANDALS 6

Slide 7: 

FINRA Regulation 8210 Requests On the Record Testimony (“OTR’s”) “Wells” Notices Provident Asset Management, LLC -- disbarred 7

Slide 8: 

State Actions Commonwealth of Massachusetts v. Securities America, Inc. Colorado: revocation of securities licenses Department of Justice Criminal investigation into the top executives of Medical Capital Holdings, Inc. 8

Slide 9: 

Broker-Dealers Have Duty to Conduct Reasonable Investigation Concerning the Security and the Issuer’s Representations About It 9

REASONABLE INVESTIGATION PRACTICES : 

In order to fulfill its regulatory requirements, a broker-dealer must conduct a reasonable investigation concerning: The issuer and its management The business practices of the issuer The assets being held or to be acquired The representations being made The intended use of the offering REASONABLE INVESTIGATION PRACTICES 10

BROKER-DEALER DUE DILIGENCE : 

Review of Documents Offering Materials Promotional Materials – are they fair, accurate and balanced Financial Records Other Documents BROKER-DEALER DUE DILIGENCE 11

Slide 12: 

Third-Party Due Diligence v. Issuer’s Own (paid-for) Due Diligence Site Visits and Principal Interviews Background Check Verification and Comfort with Product and Sponsor 12

DOCUMENTATION OF REASONABLE INVESTIGATION : 

In order to demonstrate that it has performed a reasonable investigation, a broker-dealer should retain records documenting both the process and the results of its investigation. Such records include: Descriptions of meetings conducted (with issuer or other parties) Descriptions of documents and other information reviewed The results of such reviews The dates the events occurred and the individuals who attended or conducted the reviews A single checklist of practices will not suffice for every offering mechanical reliance on a single checklist may result in a finding of an inadequate investigation. DOCUMENTATION OF REASONABLE INVESTIGATION 13

MULTIPLE OFFERINGS : 

Broker-Dealers must conduct a reasonable investigation for each offering, notwithstanding that subsequent offerings may be by the same issuer Investigate performance of prior offerings to detect any potential red flags MULTIPLE OFFERINGS 14

THE EXISTENCE OF RED FLAGS : 

Broker-Dealers must note any information that it may uncover in the course of an investigation that it considers a “Red Flag” Obligates broker-dealer to follow-up on any red flags it encounters during inquiry and investigate any adverse information about the issuer Broker-Dealer must do more than simply rely upon representations by issuer, the disclosures in offering documents or even a due diligence report of issuer’s counsel THE EXISTENCE OF RED FLAGS 15

Slide 16: 

Broker-Dealers have Duty to Ensure that the Investment Recommendation is Suitable for the Customer [FINRA Rule 2310] 16

REGISTERED REPRESENTATIVE SALES PRACTICES : 

Know the Product – Due Diligence by Registered Representative Understand Mechanics of Product Understand Risks Understand Role in Portfolio   Know Your Customer – Suitability Accredited and Non-Accredited Investors PPM with Subscription Agreement and Disclosures REGISTERED REPRESENTATIVE SALES PRACTICES 17

SUPERVISION OF REG D OFFERINGS : 

Broker-Dealers must have supervisory procedures in place that are reasonably designed to ensure that its registered representatives: Perform the analysis required by FINRA Rule 2310 Qualify their customers as eligible to purchase securities pursuant to Regulation D SUPERVISION OF REG D OFFERINGS 18

Slide 19: 

Verify Accredited Investor Status Ensure There are No Discrepancies Between the Subscription Documents and the Firm’s New Account Documents  Supplemental Disclosure Form of Material Risks  Paper the File – Contemporaneous Notes  Do Investments Appear on Brokerage Statements  Does Firm Send a Confirmation 19

FINRA Regulatory Notice 10-22 : 

Newly issued guidance by FINRA setting forth standards and guidelines for broker-dealers to conduct reasonable investigation in Reg D offerings Issued April 2010 FINRA Regulatory Notice 10-22 20

DEFENDING AGAINST A PRIVATE PLACEMENT CLAIM : 

Investigate the Customer Analyze the Relevant Files (e.g. Due Diligence files; Sales Practice files; Supervision files) Consolidation/Severance of Multiple Claims Mitigation of Damages Coordinate Defense with Regulatory Inquiries DEFENDING AGAINST A PRIVATE PLACEMENT CLAIM 21