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FINRA’s focus for 2014

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FINRA, in a letter to members, communicated its 2014 regulatory and examination priorities, which include many concerns related to the Direct Investment Industry. Suitability, general solicitation, due diligence, and offerings through private placements have all made the list.

The concern with suitability includes complex investment products and specifically mentions Private Real Estate Investment Trusts (REITs). With lofty incentives, FINRA worries broker dealers and advisors may over look the suitability of such recommendations and not thoroughly disclose “the risks and potentially negative scenarios that might result in customer loss.” They point firms to Regulatory Notice 13-31 for suggestions on how to improve their suitability determinations.

FINRA describes non-traded REITs as “generally illiquid and fees associated with the sale of non-traded REITs can be high and erode total return.” They also highlight that distributions sometimes come from borrowed funds or a return of capital. Lastly, they warn that valuing non-traded REITs is complex, making it a challenge to understand actual performance.

With amendments to Regulation D Rule 506, effective as of September 23, 2013, permitting general solicitation and advertising of private placements, FINRA is even more concerned with sales and marketing abuses.

FINRA plans to examine firms’ private placement activity and determine whether reasonable steps are taken to ensure investors are in fact accredited. In the letter, FINRA states “Also, the recent Regulation D amendments do not diminish a firm’s responsibility to conduct adequate due diligence on its offerings to ensure any recommendation to purchase securities in a private placement are suitable.”

Lastly, FINRA will monitor member firms’ responsibilities as they relate to rule 5123 and 5122 which require filings within 15 days of the first sale of a private placement. They have found a significant number of instances where “broker dealers may not be performing their reasonable inquiry responsibilities as described in Regulatory Notice 10-22. Some examples of concerning items include contingency offerings with deficient escrow procedures, issuers in distressed financial conditions or in default, and raising money in serial offerings to repay previous investors.

In a statement, Richard G. Ketchum, FINRA’s Chairman and CEO, commented “by providing clear and detailed guidance to firms, we hope to not only support firms’ compliance efforts but also to alert firms to the issues we have identified as the most salient risks to investors and the integrity of our markets.”

To read the entire letter, click here.