Last year, I noted an article about the Chairman of FINRA voicing the SRO's focus on ensuring that broker/dealers conducted adequate due diligence on investment products sod by their registered reps. Now, Investment News is reporting on a talk by an SEC official whose job is broker/dealer examination. His message: "We're looking at due diligence."
The due diligence obligation has many facets. A broker/dealer must make an inquiry into the material aspects of an investment in order to satisfy itself of the reasonableness of profitability. The inquiry must include validation of the significant information disclosed in offering and collateral documentation. The inquiry must be sufficiently detailed as to reasonably uncover any undisclosed facts that a reasonable investor would consider material. The broker/dealer must be able to demonstrated that the person who conducted the investigation on its behalf has the education and experience to perform the analysis in a way that is likely to achieve these goals. Finally, the broker/dealer has to be able to communicate the findings to its registered reps in such a way that the rep is knowledgeable about the product, but is also communicating only the approved information to a prospective investor.
A broker/dealer can outsource a lot of the work involved. However, it remains responsible for ensuring the thoroughness of the inquiry, understanding of the product by management, and proper sales practices by the field force. As FINRA has said repeatedly over the past few years, the B/D can not outsource its responsibilities.
(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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