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Regulator Calls For Tougher Diligence By B-Ds, Private Placements

Failed deals involving private placements in Medical Capital Holdings and Provident Royalties are yielding calls from regulators for a more stringent due diligence process by broker/dealers touting the products to investors.

At a meeting in Washington on May 24, the chairman and CEO of the Financial Industry Regulatory Authority (FINRA) called on broker/dealers to be more vigilant about garnering information on private placements and how they then use that information to market and sell the products to investors.

“In those situations where you’re providing advice or actively selling a private placement, it’s not good enough to just read the document. If that document raises red flags or doesn’t answer questions, it’s not good enough to go to a canned information session,” said FINRA’s Richard Ketchum. “You need to push and pull.”

The issue of broker/dealers conducting adequate due diligence when selling private placements has been front and center this past year – in large part because of Medical Capital Holdings and Provident Royalties LLC. Both entities were charged with fraud by the Securities and Exchange Commission (SEC) in July 2009. Since then, hundreds of investors have filed arbitration claims and lawsuits against various broker/dealers that sold the products.

Despite the fact that the broker/dealers behind sales in Medical Capital and Provident conducted no due diligence about the investments and instead relied on an outside analyst’s report, they still received a fee of 1% of the sale.

“Whether you’re getting that information from people who have somewhat of an underwriting relationship, or whether you’re getting that from the issuer, you need to be confident, with the questions around it, that the investment is not going to go up in smoke,” FINRA’s Ketchum said earlier this week.

“Firms need to push the envelope about due diligence,” he added.

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