PLI Panelist Points to FINRA Enforcement Cases as the “What Not to Do” Manual


The Financial Industry Regulatory Authority (FINRA) has an active enforcement program, bringing more than 1,400 disciplinary actions last year, and imposing more than $176 million in fines. Within that program, FINRA has paid increased attention recently to broker-dealers engaged in private placements. FINRA’s enforcement activity in the private placement space has been spurred in part by the adoption of Rule 5123. This rule generally requires each FINRA-member firm that sells a security in a private placement to file a copy of the offering document with FINRA within 15 calendar days of the date of the first sale. Before this rule, adopted in 2012, FINRA would often only learn of problematic conduct by member firms in private placements during regular periodic examinations conducted long after harm to investors had happened.

At the Practising Law Institute’s recent Private Placements and Hybrid Securities Offerings conference, panelist Suzanne Rothwell, formerly of FINRA and now the managing member of Rothwell Consulting LLC, stressed that FINRA will continue to take a critical look at the conduct of member firms in private deals. She specifically highlighted FINRA’s enforcement actions involving First American Securities, an Ohio-based brokerage firm. Ms. Rothwell suggested that broker-dealers involved in private placements could take a healthy step toward FINRA compliance by reading the First American cases and doing exactly the opposite of what happened in those actions. The settlements date from last year, but they do tell a remarkable story.

Thomas J. Brenner, Jr., the CEO and president of First American, engaged in two separate private placements that were, in FINRA's words, "rife with supervisory and substantive violations." The laundry list of violations alleged by FINRA included:

  • negligent misrepresentations;
  • misleading, exaggerated and unwarranted statements;
  • material omissions in investor documents;
  • failure to have a reasonable basis to recommend the investment to customers; and
  • failure to conduct adequate due diligence.

The first violations involved a private placement by a corporation called PGC, founded and owned by two individuals, one of whom was an indirect owner of First American by virtue of owning 50 percent of First American's parent company. The offering materials contained several statements that claimed or implied that the investments were secured, or were otherwise safe. In fact, the investments were not secured and were highly risky und speculative, but the offering materials disclosed no risk factors.

The offering materials also failed to disclose a "going concern" note in a recent Form 10-Q. The documents also touted the CEO's business acumen generally, and in the real estate industry specifically, but failed to disclose that he had previously filed for Chapter 7 bankruptcy. The offering documents also failed to note that the company included in a 2013 Form 10-Q a note indicating that there was substantial doubt about the company's ability to continue as a going concern.

In another offering, in the securities of UR LLC, a limited liability company, the issuer did not distribute a private placement memorandum during the active solicitation period, and the firm failed to engage in any realistic due diligence. The limited information given to shareholders understated the commission to be paid to First American, and falsely claimed or implied that the investors had a security interest in medical receivables or other form of capital protection when no such protections existed.

As in the PGC offering, the materials distributed to investors failed to include any discussion of any risks associated with what again was a highly speculative investment. The firm did prepare a placement memorandum stating that "the Notes are speculative securities that involve a high degree of risk," and that "No Person guarantees that an Investor will realize a significant return on (or even the return of) his or her investment," but investors did not have access to the PPM. The materials given to investors also failed to disclose that UR LLC’s CEO had been subjected to an industry bar by FINRA for rules violations.

In a final and rather dramatic charge, FINRA claimed that the firm misled investors about the basic fact of whether the issuer’s planned business operations were legal. UR LLC was established to provide a funding vehicle to physicians and other health care providers to finance practice-owned laboratories that conducted certain toxicology tests. Once the practice loans with UR LLC were fully repaid, the practices were to receive a portion of the profit associated with the lab testing. The 50-percent owner of First American's parent owned the company that built the laboratory space for the practices, leased the testing equipment, and provided the personnel for the testing, billing and other related services. FINRA noted, however, that this business model may have been unlawful under both federal and state anti-kickback laws.

Brenner settled the FINRA charges by agreeing to a deferred fine of $30,000, disgorgement of $189,000 in commissions and a 16-month suspension from associating with any FINRA-registered firm in any capacity. FINRA also charged First American and other associated persons in connection with these transactions. In addition to the supervisory and transactional violations described above, FINRA charged the firm with engaging in the securities business while being net capital deficient and filing inaccurate FOCUS reports. The firm withdrew from FINRA registration, and agreed to a fine of $150,000, disgorgement of $190,000 in commissions and a censure.

FINRA-registered broker-dealer firms should pay careful attention to the conduct and consequences of First American’s private placement transactions. Admittedly, these cases are particularly egregious, but as Ms. Rothwell pointed out, they do highlight the transactional matters that FINRA will closely scrutinize, and they do provide a vivid picture of conduct to avoid.

Financial Industry Regulatory Authority Letter of Acceptance, Waiver and Consent No. 2015046056405 (First American Securities); Letter of Acceptance, Waiver and Consent No. 2015046056403 (Thomas J. Brenner, Jr.).