On January 9, 2024, the Financial Industry Regulatory Authority, Inc. (“FINRA”) published its 2024 Annual Regulatory Oversight Report (the “Annual Report”), as we blogged about. With respect to private placements, FINRA cites to Regulatory Notice 23-08 (see our alert), for a discussion of member firms’ obligations when recommending private placements, including the obligation to conduct a reasonable investigation of the offered securities under Regulation BI and FINRA Rule 2111, and other applicable rules, some of which impose obligations on member firms even in the absence of a recommendation.
The Annual Report reminds member firms that a reasonable investigation of a private placement must include, at a minimum, an evaluation of the issuer and its management, the business prospects of the issuer, the assets held by or to be acquired by the issuer, the claims being made and the intended use of proceeds of the offering. The Annual Report notes a number of related considerations for member firms, including whether the firm’s promotional communications for its private placements balance the potential benefits of the investment with a disclosure of potential risks, such as the illiquid nature of the securities, the absence of a substantial operating history and the lack of independently audited financial statements.
The Annual Report also notes FINRA’s findings and identifies effective practices for conducting private placements. In particular, FINRA states, from its review of recent private placements, many firms have not adequately complied with their diligence obligations or have not adequately identified, disclosed and, where required, mitigated conflicts of interest associated with private placement recommendations. FINRA identifies effective practices in the Annual Report including the following:
- creating checklists with articulated processes and requirements for the reasonable investigation process;
- conducting and documenting independent research on material aspects of the offering;
- verifying representations and claims made by the issuer that are crucial to the performance of the offering;
- identifying any red flags associated with the offering or the issuer;
- addressing and resolving concerns that would be deemed material to a potential investor;
- identifying conflicts of interest and then addressing such conflicts;
- conducting targeted, in-depth training about the firms’ policies, process and filing requirements; and
- reviewing offering terms to determine if they are reasonably structured for compliance with applicable rules.
A link to the Annual Report can be found here.