With private-placement sales facing intense scrutiny, industry experts are reminding regulators that sophisticated investors who should have been aware of the risks involved in such investments sometimes look for scapegoats when the deals sour.
Most notably, one due-diligence attorney fired off a potent missive to the Financial Industry Regulatory Authority Inc. about clients' responsibilities when buying the high-risk investments.
In a letter sent last month to James Shorris, Finra's executive director of enforcement, Bryan Mick, president of Mick & Associates PC LLO, said that he applauded Finra's recent efforts to “lower the boom on shady private placements.”
However, Mr. Mick, whose firm has been scrutinizing private offerings for eight years, strongly reminded Mr. Shorris that investors share the risks when buying into such deals.
“While customer suitability must remain a primary focus, we perceive that many of these highly sophisticated clients, who are willing to make a higher-risk investment for the potential of high investment returns, are suffering from selective amnesia, and the regulatory agencies are all too eager to be the diagnosing physician,” Mr. Mick wrote in his letter.
Another consultant wholeheartedly agrees with Mr. Mick.
“There are two sides to every story, if not multiple sides,” said Janice Sackley, principal of Fiduciary Foresight LLC.
“One of the greatest risks financial professionals face is the inconvenient memories of customers,” she said. “Customers, in looking back, can have convenient memories — convenient for them, inconvenient for the financial professional.”
Brokers and financial advisers must document client meetings and phone calls carefully to help keep track of clients' wishes and goals, Ms. Sackley said.
She stressed, however, that the responsibility for providing invest-ors with information about private placements is clearly the broker-dealer's or adviser's.
“There are many in the industry who are selective about disclosure” when it comes to investments such as private placements, and that is clearly to the detriment of investors, Ms. Sackley said.
And the industry has a serious problem with disclosure that is unclear and opaque, said Richard Nummi, executive consultant at Accounting and Compliance International. What's more, disclosures for private placements and other investments that are “written for lawyers by lawyers” draw the ire of arbitration panels, he said.
“Arbitration panels are bringing that home” in disputes with clients, Mr. Nummi said. “They're saying, "If we can't understand [broker-dealers' disclosure], take out your checkbook.'”
Investor losses in private placements have been highlighted by the implosion last summer of deals for Medical Capital Holdings Inc. and Provident Royalties LLC. Both companies were subsequently socked with fraud charges by the Securities and Exchange Commission.
State securities regulators have also joined the fray.
A complaint filed last month by the Massachusetts Securities Division alleges that independent broker-dealer Securities America Inc. failed to reveal pertinent information to investors about high-risk notes issued by Medical Capital.
In December, Mr. Shorris told
InvestmentNews that the industry regulator has “a number of investigations under way involving allegations of wrongdoing arising from the sales of these "Reg D' private placements.” He added that this year Finra expects to bring enforcement cases on private placements.
“Reg D” refers to the securities regulations that govern the sale of private-placement investments, which generally don't have to be registered with regulators. Typically, Reg D offerings are conducted by smaller companies.
Over the past six months, many brokerage executives have said they are afraid of giving brokers and advisers access to any new private deals in the wake of the Medical Capital and Provident incidents.
In his letter to Mr. Shorris, Mr. Mick compared investors who lose money in private placements to those who lose money in the stock market.
“If an investor bought Citigroup at $26 and it is now worth $3, the typical reaction is, "The bank loaded up on [collaterialized debt obligations],' "Our broker can't pick bank stocks,' or, "Management is clueless,' and the investor takes his lumps,” Mr. Mick wrote. “On the other hand, if the investor loses 80% to 90% — or even a fraction of capital — in a private placement, the patented approach is, "Somebody committed fraud, and I am going to sue them.'”
Mr. Mick pointed out that the overall economy has taken a bite out of private deals, too.
“While we encourage regulatory enforcement against truly fraudulent sponsors, we hope that this enforcement is tempered by recognition of economic conditions that have been identified by many macroeconomists as close to those experienced in the Great Depression.”
Mr. Mick noted that in the midst of the economic meltdown, “investors, plaintiff's counsel and regulators are quick to label "frauds' and "Ponzi schemes' without fully analyzing the definitional element of such labels.”
Finra spokesman Herb Perone declined to comment on the letter, because it relates to Reg D offerings, “the sales of which are the subject of multiple investigations by Finra.”
E-mail Bruce Kelly at [email protected].
