Finance 500, Inc., headquartered in Irvine, California, was censured and fined $85,000 from Financial Industry Regulatory Authority (FINRA) after consenting to findings that the firm had failed to establish, maintain and enforce a supervisory system and written procedures to review and monitor private placements sales practices and materials. Letter of Acceptance, Waiver and Consent, No. 2013038091902 (Dec. 10, 2015).
According to the AWC, from June 2012 through June 2014, the firm’s supervisory system and written procedures concerning private placement due diligence was not adequate. Despite the firm conducting due diligence, the firm had inadequate supervisory measures concerning who should conduct the due diligence on private placements, the scope of responsibilities of individuals involved in such, or how the firm would identify, analyze, and address red flags concerning due diligence. The AWC further reported that the firm had failed to conduct reasonable due diligence on four issuer offerings. In the case of the first issuer (a thinly traded over-the-counter issuer trading on pink sheets that the firm worked with in the raising of $2,500,000 from customers via convertible notes and stock), the firm had identified red flags including the firm’s weak senior management, risky financial position, and failure to pay existing debt holders. Despite this, the firm reportedly failed to take adequate steps to address the red flags prior to selling the issuer’s offerings to customers. The AWC also reported that the firm had failed to identify red flags concerning the issuer’s chief executive officer who engaged in self-dealing by having the company pay for her luxury living accommodations.
The AWC also indicated that prior to the second issuer’s convertible note sale, the firm had taken no material steps with the second issuer offering to address red flags pertaining to employment agreements with the firm’s executives and the lack of audited financial statements.
The AWC additionally indicated that the firm’s supervisory system and written procedures concerning suitability in private placements was not reasonable. FINRA found that the firm did not have procedures in place regarding how it would consistently collect threshold suitability documents from each customer, resulting in the firm not retrieving information (or retrieving incomplete information) from customers. The AWC noted that the firm had failed to address how supervisory approval would be provided for particular customers. In certain cases, the supervisory system associated with such was evaded by permitting customers solicited by the firm’s representatives to make direct investments with the issuer.
The AWC indicated that the firm had failed to develop adequate protocol for when supervisory approval of an investment was to be given – and the firm had provided approval in certain cases after all subscription documents were already signed. FINRA found that the firm’s procedures were inadequate regarding how private placement suitability would be evaluated, such as what net worth would be deemed sufficient or how a customer’s concentration in private placements would factor into the firm’s suitability analysis.
The AWC further reported that the firm had failed to develop reasonable supervisory measures concerning marketing materials used in private placements. The firm had no reasonable system to determine whether the registered representatives were using materials that were approved. In fact, it was not until FINRA made a request to the firm to provide advertising materials that the firm learned that unapproved marketing materials were sent to customers and that presentations were made to customers during conference calls. FINRA found that the firm had violated NASD Rules 3010(a) and 3010(b) and FINRA Rule 2010 as a consequence of failing to have reasonable supervisory systems and written procedures to supervise private placements and failing to adequately supervise them.
The AWC finally indicated that from March 2013 – June 2014, the firm had used or permitted issuers to use PowerPoint presentations with customers or prospective customers which contained inadequate risk disclosure and failed to provide a balanced presentation of the risks/rewards of the investments. The firm reportedly failed to disclose several material harmful facts associated with the aforementioned issuers, and also failed to indicate negative financial performance and other risks related to the issuers. FINRA found that the firm had used or permitted issuers to use PowerPoint presentations with customers or prospective customers that contained misleading, unwarranted, or unsupported statements. For example, in one case, the presentations compared sales-to-investment ratio of the first issuer (a start-up company) to that of well-established companies, which FINRA considered unwarranted given the difference in sizes of the companies and given that the types of businesses were incongruent. FINRA found the firm’s conduct to be violative of Rules 2210(d)(1)(B) and 2010 in this regard. The firm was also cited for violating Rule 2210(d)(3) as a consequence of the presentations for three issuers not disclosing the firm’s name or relationship between the firms and issuer.
This is not the first time that Finance 500 had failed to abide by FINRA’s supervisory protocols. In August 2013, the firm was censured and fined $17,500 by FINRA after consenting to findings that the firm had violated Rules 2010 and 7330, and NASD Rules 3010 in connection with the firm’s failure to develop an adequate supervisory system and written supervisory procedures for trade reporting, sale transactions, clearly erroneous trade filing and best execution. Letter of Acceptance, Waiver and Consent, No. 2010021591601 (Aug. 2013). In December 2011, The firm was also censured and fined $50,000 after consenting to findings that the firm had violated Rule 2010, NASD Rules 2110 and 3010(a) and (b), in connection with the firm’s March 2008 – May 2009 sale of approximately $8,5000,000 in unregistered securities in violation of Section 5 of the Securities Act of 1933, considering the firm did not have any system designed to detect and prevent participation in unregistered distribution of securities and no procedures addressing acceptance of securities in certificate or electronic form and corresponding to the sale of the securities. Letter of Acceptance, Waiver and Consent, No. 2008013079801 (Dec. 2011).
Securities brokerage firms have a duty to supervise their brokers and the sales practices of their brokers, and to review customer statements for, among other things, evidence of suitability, unauthorized trading, or excessive activity. FINRA Conduct Rule 3010 specifically provides that each member shall establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with the Rules of this Association. Final responsibility for proper supervision shall rest with the member.
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