SEC: B-D gets F for Reg D due diligence

The Securities and Exchange Commission has alleged that an independent broker-dealer that was a leading seller of private placements that went bust failed to conduct reasonable investigations into the offerings — and pocketed fees for due diligence without adequately researching the instruments.
Capital Financial Services Inc., which has 332 affiliated representatives, sold preferred stock of Provident Royalties LLC entities from 2006 to 2009, according to an SEC cease-and-desist order, which is a preliminary step before a hearing with an administrative judge over the matter. Capital Financial brokers sold $63 million of the offerings by Provident, which the SEC charged with fraud in 2009.
The reps received an 8% commission — or $5 million — for selling the Provident deals. The firm collected a 1% due diligence fee, or $600,000.
Capital Financial also sold $100 million of private placements for Medical Capital Holdings Inc. The SEC has also charged Medical Capital with fraud.
Dozens of independent broker-dealers sold the two series of Regulation D offerings, and many have since folded due to the costs of fending off lawsuits from investors.
According to the SEC’s order, Capital Financial fell far short of adequate due diligence.
“Capital Financial never conducted independent verification of any of the offering materials provided by Provident,” the SEC stated in its order, which it issued April 6.
The broker-dealer “also never received audited or even unaudited financial statements for any of the Provident offerings,” the SEC said. “The only financial information Capital Financial received regarding Provident was an unaudited consolidated balance sheet review.”
Brian Boppre, the firm’s president until last July, also was named in the order. A public hearing is scheduled to take place by early June.
David Baugh, the firm’s attorney and a partner with Baugh Dalton Carlson & Ryan LLC, declined to comment.
The SEC’s order hits on one of the thorniest issues of independent broker-dealers’ selling private placements or non-traded real estate investment trusts.
Citing costs, firms often don’t perform their own due diligence, but rely on outside attorneys to assess the deals and investment programs. Those same firms, however, commonly receive a “due diligence” fee of 1% of the amount of the product sold by its brokers.
It was the fact that Capital Financial received the 1% fee that drew the scrutiny of the SEC.
“Capital Financial failed to disclose to customers that although it was collecting a due diligence fee, it was not conducting any due diligence,” the SEC order stated. In fact, the firm collected the $600,000 as a due diligence fee but incurred no expenses to match the fee, the SEC alleged. “At no time did Capital Financial hire independent counsel, an accounting firm, contact third parties regarding Provident’s business, or hire consultants to review the Provident offerings,” the SEC alleged.
Capital Financial has other legal problems stemming from its sale of private placements. It is working to settle a class action stemming from the sale of Provident shares by its brokers. That case is currently before a federal judge in Dallas.