Due Diligence Concerns Permeate Private (Reg D) Offerings
The Real Estate Investment Securities Association (REISA) has drafted a proposed “best practices” guide for firms to use when they sell high-risk private placement securities, such as private notes, oil and gas deals, and real estate funds, which are also known as Reg D offerings, according to an October 19 article in InvestmentNews by Bruce Kelly (“Reg D guideline zeroes in on due diligence.” As the title says, the process of document review, checks and verifications called “due diligence” is at the heart of the proposed guideline.
The draft proposal, which was presented at REISA’s annual meeting, follows the collapse of two private placements and fraud charges by the Securities and Exchange Commission last year against Provident Royalties LLC and Medical Capital Holdings Inc. Independent brokerage firms such as Securities America sold close to $2.7 billion of Provident and Medical Capital Reg D offerings to investors. These firms are now facing a multitude of arbitration claims brought by investors, as well as regulatory actions, about the failure to disclose the true risks involved.
One problem with such private placements, recognized by REISA’s new guidelines, is the fact that, for various reasons, brokerage firms rely on the sponsors or reports by third parties who are paid by the sponsors instead of doing their own due diligence on Reg D offerings.
Due-diligence analysts who write the reports for the sponsors claim they are independent of the sponsor, and that, at times, they write negative reports. They did so on Medical Capital, but the reports containing red flags were withheld from investors by the brokerage firms.
Pratt H. Davis, a partner at Page Perry, LLC in Atlanta, observed “We have noticed some serious problems with certain Reg D (private) offerings. For example, based on the evidence developed by the Commonwealth of Massachusetts and other available documents, it appears that Securities America mislead investors and also intentionally made material misrepresentations to investors in order to get them to purchase these Medical Capital notes. Mr. Davis further noted, "it appears that Securities America not only turned a blind eye to the red flags and significant warnings in the due diligence reports, including the lack of audited financials, but also took specific actions to mislead the investors into believing such risks did not exist."
The Financial Industry Regulatory Authority Inc. has warned its member firms: “When presented with red flags, the broker-dealer must do more than simply rely upon representations by [an] issuer's management, the disclosure in an offering document, or even a due diligence report of [an] issuer's counsel.”
The REISA due-diligence best-practices guide reportedly will address those concerns. “Broker-dealers may not rely solely upon the accuracy of information supplied by the sponsor or its agents, but must engage in an independent due-diligence investigation that is customized for each offering. Most offerings may have certain unique features that require additional due diligence,” according to the draft of the due-diligence best-practices guide, which will now be considered by REISA's board.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing investors in private offering cases. For further information, please contact us.
