2. Due Diligence Under Current Regulatory Standards
Prepared by:
Brandon S. Reif
WINGET SPADAFORA & SCHWARTZBERG LLP
1900 Avenue Of The Stars, Suite 450
Los Angeles, CA 90067
Tel:

3. Reasonable Basis Suitability:
Obligations of Broker Dealers
Reasonable Basis Suitability:
Requires a reasonable basis to believe that the investment is suitable for some retail customer.
The broker dealer must understand the nature of the recommended security or the investment strategy and the potential risks and rewards.
See Notice to Member 10-22; 13-31; FINRA rule 2111.

4. Steps for Conducting a Due Diligence Investigation:
Reasonable Basis Suitability
Steps for Conducting a Due Diligence Investigation:
Examine the private placement memorandum (PPM);
Review current registration statements and financial reports;
Ascertain the personal history of sponsor’s managers and owners;
Verify any self serving statements by the sponsor or its managers; and
Follow up on any red flags.
See Notice to Member 10-22; 13-31; FINRA rule 2111.

5. Be Sensitive to Red Flags and Inquire Further:
Reasonable Basis Suitability
Be Sensitive to Red Flags and Inquire Further:
Financial statements and back-up;
Level of cooperation and thoroughness of disclosures;
Presence or lack of clear research and investment processes;
Undisclosed potential conflicts of interest; and
Background checks of managers, i.e. regulatory history, bankruptcy, or valuation concerns.
See SEC, Investment Advisor Due Diligence Processes for Selecting Alternative Investments and their Managers (Jan. 28, 2014).

6. Obligations of Broker Dealers
Customer specific suitability means the investment is suitable for the specific customer based on his/her:
Age;
Investment experience;
Liquidity needs and risk tolerance;
Other holdings;
Financial situation and needs;
Tax status;
Investment time horizon; and
Investment objectives.
See FINRA, Notice to Member13-31; FINRA rule 2111.

7. Customer Specific Suitability
Customer Specific Suitability Applies To Recommendations Made To Customers.
Customers are individuals who are not broker dealers and (1) open a brokerage account with a broker dealer OR (2) purchase a security for which the broker dealer will receive compensation.
Recommendations include (1) suggestions to purchase securities and (2) explicit advice to hold securities.
See FINRA, Notice to Member 12-55; 13-31; FINRA rule 2111.

8. Madhany v. Citigroup Global Markets
Recent FINRA Cases
Madhany v. Citigroup Global Markets
FINRA arbitrators found that the registered representatives recommended unapproved securities that were not adequately investigated.
FINRA panel awarded claimants $1,047, in compensatory damages and up to $10,031, to indemnify claimants for third party liability.
See FINRA Award, Madhany v. Citigroup Global Markets, Inc f/k/a Smith Barney Case No (Sept. 16, 2013).

9. Gruberman v. LaSalle Street Securities LLC
Recent FINRA Cases
Gruberman v. LaSalle Street Securities LLC
FINRA arbitrators found broker dealer liable for breaching their fiduciary duty based on:
Failure to complete due diligence before recommending securities and provide full disclosure relating to third party findings in due diligence report.
FINRA panel awarded claimants $135,
See FINRA Award, Gruberman v. LaSalle Street Securities LLC Case No (Jan. 30, 2014).

10. In Re Sunset Financial Services, Inc.
Recent FINRA Enforcement Action
In Re Sunset Financial Services, Inc.
Broker dealer failed to investigate the following red flags resulting in FINRA fines:
Sponsor’s financial difficulties;
Third party report detailing high default rate;
Same management of second offering where first failed;
Placement of securities on the approved list of offerings before due diligence was complete; and
Failure to supervise recommendations and due diligence procedures.
See FINRA Letter of Acceptance, Waiver and Consent No In Re Sunset Financial Services, Inc. (July 2, 2013).

11. 2014 SEC Regulatory Priorities Include:
Regulatory Priorities for 2014
2014 SEC Regulatory Priorities Include:
Assessment of alternative investments;
Leverage, liquidity, staffing, funding, and marketing to investors;
Representations and recommendations to investors;
Fraudulent sales practices and unsuitable recommendations; and
Firm supervision of private securities transactions.
See SEC, Examination Priorities for 2014 (Jan. 9, 2014).