Regulatory Notice 23-08

The Financial Industry Regulatory Authority (FINRA) has published a new Regulatory Notice (Regulatory Notice 23-08) addressed at member firms in connection with their obligations when selling or recommending private placements. Specifically, in view of recent developments in the private placement market, FINRA finds it necessary to again highlight its expectations particularly as regards the SEC’s Regulation Best Interest (REG BI) and FINRA Rule 2111 on suitability. In this context, FINRA also reminds of some other requirements relating to the sale or recommendation of private placements, including filing and communication obligations.
##### Regulation Best Interest and FINRA Rule 2111 obligations
FINRA and the SEC expect firms to always act in the best interest of customers, regardless of whether or not the client is a retail or institutional client. This implies that – when recommending or selling a private placement – firms have researched the product of interest (reasonable investigation) and have taken reasonable steps to understand the product and its inherent risks and potential rewards to determine whether or not the product is suitable for their clients. According to FINRA, such reasonable investigation must at least cover the following issues – as quoted:
– the issuer and its management;
– the business prospects of the issuer;
– the assets held by or to be acquired by the issuer;
– the claims being made; and
– the intended use of proceeds of the offering.
Additionally, member firms are recommended to look into a firm’s track record, any possible litigations, any recent material developments, and issues that may have arisen in the past between the issuer and affiliates or other third parties. When it comes to due diligence with respect to their customers, firms are required to ensure that they have a „reasonable basis to believe that the recommendation is in the best interest of a particular customer“. Such basis can be derived from examining a customer’s investment profile. If a member firm does not have sufficient information to determine whether or not an investment is suitable for the client, it should carefully evaluate whether or not it knows the client well enough to recommend a particular product. A product is deemed to be suitable, if the client „has an identified, investor-specific trading objective that is consistent with the product’s description in its prospectus or offering documents, and/or has the ability to withstand heightened risk of financial loss.” Private placements are typically treated as high-risk products which is why member firms must particularly ensure that they meet their due diligence and suitability obligations.
Furthermore and in same context, member firms are reminded of their obligation to provide customers with all information necessary to make an informed investment decision prior to the sale of the product, including information on any fees and other costs, its potential risks and benefits, and the member firm’s function in the sale (any potential conflicts of interest).
Finally, FINRA reminds firms of the fact that they need to have in place adequate policies and procedures to ensure compliance with the above noted obligations and that they need to document any due diligence assessments and „reasonable investigation“ outcomes so as to provide proof of the performed activities.
##### Other obligations pertaining to the sale or recommendation of private placements
– FINRA member firms must file with FINRA a copy of the offering documents „within 15 calendar days of the first sale. Additionally, they must file any retail communications used in the sale or recommendation of the product (prospectus).
– FINRA member firms must ensure that any „customer communication“ – e.g. sales material, prospectus, additional information – must be truthful, presenting the information fair and balanced, and is not misleading.
– FINRA member firms must ensure to adequately monitor their staff members engaged in the sale or recommendation of private placements. Each and every private placement offering must be supervised BEFORE it is marketed to clients.
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To conclude, FINRA also sets out some „Effective Practices“ as far as reasonable investigations are concerned.