COMPLIANCE WATCH: Finra Suspends Exec In Private Placement Case
A DOW JONES NEWSWIRES COLUMN
NEW YORK (Dow Jones) Private Placement–A brokerage company’s former chief executive has been suspended for improper marketing of private placements, the first settlement in a crackdown by the Financial Industry Regulatory Authority on sales practices involving the unregulated securities.
Finra announced the settlement Monday in which Pacific Cornerstone Capital, Inc. of Irvine, Calif., was fined $700,000 and its former CEO, Terry Roussel, was fined $50,000. Roussel also was suspended from the industry for 20 days and from acting as a principal for three months.
The agency found that Pacific Cornerstone failed to provide full and accurate information in offering documents and marketing material for private placements it sold to investors. The company and Roussel neither admitted nor denied the charges, but consented to the entry of Finra’s findings.
Charging a brokerage chief executive in an enforcement case is “extremely unusual,” according to James Shorris, Finra’s executive vice president and head of enforcement. He said Roussel was found to have participated in drafting sales literature.
Offering materials and letters to investors promised returns of more than 18% and returns of principal within two to four years, among other things, according to the settlement agreement. The investments failed to meet those targets “year after year.” Finra said the expected returns were “unreasonable given past performance,” according to the settlement.
The case is the first to arise from a broad Finra investigation of brokerages’ sales of private placements, or Reg D offerings. Investor complaints about private placements tripled during 2009 compared to 2008, according to Shorris. The complaints are increasing as a growing number of Reg D offerings are going sour, he said.
More enforcement cases will follow in 2010, Shorris told Dow Jones Newswires. He predicted “serious consequences” for those involved, he said.
Investigations are also focusing on the suitability of private placements for certain investors and the concentration of those investments, which are illiquid, in portfolios. Reg D offerings can only be sold to accredited investors, which includes individuals whose net worth exceeds $1 million, or who earn $200,000 in individual income or $300,000 in joint income. But certain Reg D offerings may not be suitable for all investors who meet that standard, he said. Finra is also concerned about whether brokerages are conducting adequate due diligence on the offerings, he said.
Many private placements don’t involve brokerages, but their involvement is becoming more prevalent as small companies look for alternative means of raising capital. Broker dealers that sell private placements are typically small and independent because the offerings often aren’t large enough for major Wall Street firms to justify their underwriting costs. The offerings can be an important source of revenue for those brokerages. Sales commissions often range from between 7% and 10% of the transaction.
Finra’s case against Pacific Cornerstone focuses on more than $50 million in total sales of private placements between January 2004 and May 2009 in two affiliated companies that use investor funds to acquire and own real estate. The brokerage also raised funds for other affiliated companies by selling REIT shares, which those companies were to use for real estate purchases, but fell far below the amounts it promised to investors in offering documents, according to the settlement.
Pacific Cornerstone, as part of the settlement, will have to send its advertising and sales literature to Finra for a review for a year before it can send it to customers.
Roussel, the suspended executive, told Dow Jones Newswires that he and the company settled the matter, in part, so they could move forward with their business. He noted that Finra never alleged any securities law violation and the firm itself hasn’t been suspended or limited in any of its activities.