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FINRA Regulatory Notice Regarding Regulation D Offerings

Insight June 07, 2010

The Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 10-22 on April 20, 2010. The notice, which came in light of recent abuses in Regulation D offerings, was intended to be a reminder to broker-dealers of their obligation to conduct a reasonable investigation of the issuer and the securities they recommend in offerings made under the Security and Exchange Commission's Regulation D under the Securities Act of 1933 (also known as private placements).

This obligation arises from the broker-dealer's "special relationship" to the customer and the representation, in recommending the security, that the broker-dealer has conducted a reasonable investigation and is basing the recommendation on conclusions drawn from the investigation.

If such a reasonable investigation is lacking, the broker-dealer must make that fact and the risks that arise from the lack of information known when making a recommendation.

Additionally, broker-dealers recommending securities offered under Regulation D must meet its suitability requirement under NASD Rule 2310, and must comply with the advertising and supervisory rules of FINRA and the SEC. That is, a broker-dealer must conduct a suitability analysis when recommending securities to both accredited and non-accredited investors that will take into account the investor's knowledge and experience.

While the notice admits that no list of reasonable investigation practices would suffice since each investigation must be tailored to the specific facts of the Regulation D offering in question, it does provide a list of sample investigative practices. A few of those include:

  • Examining the issuer's governing documents, noting particularly the amount of its authorized stock and any restriction on its activities.
  • Looking for any trends indicated by the financial statements.
  • Inquiring about internal audit controls of the issuer.
  • Contacting customers and suppliers regarding their dealing with the issuer.

The full notice is available at FINRA.org.