In case someone has not heard it sometime over the past two years, the Chairman and CEO of FINRA, Richard Ketchum, pointed out that broker-dealers need to engage in a vigorous due diligence process. Investment News has a story about a news conference that Mr. Ketchum delivered at FINRA's annual meeting in Washington.
Mr. Keetchum is referring specifically to Reg D offerings, private offerings not required to register with the SEC or the states. These offerings especially come under scrutiny because there is no regulatory review of the disclosures made in connection with the offerings. His remarks apply to other investment products that advisors recommend to their clients.
The bottom line is that broker dealers and advisors have an obligation to conduct an investigation into an offering that is sufficient to uncover the material facts which will have an impact on the riskiness and profitability of an offering. Reading an offering document and third party reports is a part of the process but not sufficient. The broker-dealer and advisor must also satisfy himself that the characteristics that promote profitability exist, verify any risk mitigation, and reconcile any discrepancies uncovered. Occasionally this can be accomplished in a single desktop session. Usually, it requires multiple management interviews and extensive telephone follow up. It especially requires that the work be conducted on behalf of and under the direction of the broker-dealer or advisor. The firms that provide third party due diligence reports are consummate professionals with extensive knowledge and experience and and are of great value in the process. Broker-dealers can consider their work product only as another input into its own due diligence process.
(Disclosure: Clarity Finance, the sponsor of this blog, provides due diligence services on a consulting basis to broker-dealers and financial advisors)
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