Aug 29 Schemes involving shady offerings of
privately-issued securities are a perpetual problem on Wall
Street, even during the sleepy end of summer.
The Financial Industry Regulatory Authority has been
juggling a slew of disciplinary cases this month involving
improper sales of "private placements" - securities that are
privately issued (typically by small and start-up companies) and
sold privately to selected investors without being publicly
traded or registered with regulators.
Sales of these often illiquid securities are perfectly legal
if they comply with industry rules, but some have left investors
In August alone, eight cases involving private placements
have surfaced in the disciplinary database run by FINRA, the
industry-funded Wall Street watchdog. Some have ended with
brokers being thrown out of the business and firms being
reprimanded for not supervising brokers involved in the deals.
More cases could be coming at a quicker pace - fast enough
to save some investors from losing money.
Recent changes to industry rules require brokerages to hand
over private offering documents to FINRA within 15 days of the
first sale. That makes it easier for the regulator to sniff out
possible wrongdoing, said J. Bradley Bennett, FINRA's
enforcement head, in an interview on Tuesday.
The regulator has received 1,900 offerings since December,
2012, when the rule took effect, Bennett said, who added that
FINRA's staff has referred numerous concerns to its enforcement
unit for review because of the new trove of information.
Some red flags that can trigger a closer look by FINRA's
enforcement team include offerings tied to fields that are the
subject of a lot of hype, such as natural gas extraction, said
Bennett. Routine FINRA examinations sometimes yield other signs
of possible trouble, such as a surge in business or a brokerage
set up specifically to push one company's private offering.
One notable case pending against a New York broker shows the
potential for harm. FINRA alleges that he made fraudulent
misrepresentations while selling about $5 million in notes in
two private offerings between 2009 and 2012. He allegedly did
not tell investors about the issuers' financial problems,
including $3-million in tax liens, according to an Aug. 9
The notes defaulted and the investors lost their principal,
FINRA alleges. The broker, who has denied the allegations, also
allegedly diverted some investors' money to a personal bank
account. The case will proceed before a FINRA hearing officer.
While the events that spurred recent cases pre-date the new
FINRA rule, they highlight behavior that regulators expect to
see continue as investors seek lucrative alternatives to the low
yields available in savings accounts and many other conventional
"It's a ripe area where there's a potential for a lot of
harm," Bennett said.
Selling unregistered securities is allowed under a safe
harbor in industry rules known as "Regulation D" that exempts
issuers from having to register certain securities offerings
with regulators. The rules do require that issuers and brokers
selling private placements meet various conditions, such as
selling only to "accredited investors" who top certain income
and net worth thresholds.
Individuals, for example, must have a minimum annual income
of more than $200,000 or a net worth exceeding $1-million,
excluding their home, to qualify to invest in these offerings.
The U.S. Securities and Exchange Commission last month
lifted a ban on advertising private securities deals. Issuers
will still be required, however, to sell securities only to
individuals who meet the accredited investor standards. Another
rule change coming in September will bar private placement sales
by felons and those kicked out of the securities business.
Private placements can be especially attractive to small
brokerages, which can earn commissions of between 10 percent and
20 percent of the sale, say industry sources.
But that can create powerful incentives to sell dubious
Two former Arizona-based brokers, for example, allegedly
promised returns from 14 to 56 percent for investments in a
business that would buy cars at U.S. auctions and ship them to
Russia for resale. But the deal went bad in 2008, according to
an Aug. 8 FINRA order.
The brokers then allegedly used the investors' money for
personal expenses and other purposes, FINRA said. They were
fired in 2011, after allegedly pushing the securities without
their firms' knowledge, according to FINRA documents.
Such covert sales, a practice known as "selling away," is a
violation of securities industry rules and common in sales of
private placements, say compliance experts. Neither broker
responded to FINRA's allegations.
Some start-up company lawyers voice concerns that improper
sales practices in the brokerage industry are giving private
placements a bad name. Many start-up company founders avoid
brokers altogether by promoting investments in their businesses
directly to affluent individuals known as "angel investors" or
venture capital firms, said William Carleton, a Seattle-based
lawyer who advises start-ups.
The model eliminates financial incentives that could
motivate some brokers to promote dubious investments, Carleton
said. "You don't get into people flogging the deal to generate a
commission for the broker," said Carleton.