Thursday, January 7, 2016


Generally speaking, if an investment is a security it either needs to be registered or exempt from registration. And yet it is far too commonplace to read headlines about enforcement actions related to the sale of unregistered securities, or about defrauded investors lured in to the glittery promises of unvetted, unregistered, high-risk products. In some instances the issuers did know, or should have known, that the investment instruments were indeed securities. Or the issuer misunderstood the scope or technicalities of a registration exemption. And finally, I have, on some occasions, dealt with regulators that did not or could not accept the fact that a financial instrument was a non-security beyond their jurisdiction. But I digress.

In 2010, FINRA filed a Notice seeking a Temporary Cease and Desist Order against Pinnacle Partners Financial Corporation (“Pinnacle”) of San Antonio, Texas. FINRA alleged that, among other things, Pinnacle was selling private placements in unregistered security interests in oil and gas ventures. Pinnacle issued a statement denying that its sales suffered from fraudulent material omissions, but it is unclear if they denied that their oil and gas investments qualified as a security or if they were securities that met a registration exemption. Again, many in the industry, as well as consumers, fail to appreciate the distinction between a security, a security that is exempt from registration, and a security transaction that is exempt from registration. And, of course, even exempt transactions, such as those pursuant to Reg. D, Rule 506 require a filing with the SEC and state regulators.

Pinnacle and its president consented to a temporary cease and desist order at the beginning of 2011. But they were suspended a year later, and expelled a year after that

So what's all the fuss about? If a Broker-Dealer cannot distinguish a security from a non-security, there may be other basics for which they lack competence. Sure registration is not a panacea. Many investors get snookered on registered investments. But the fact that a security is illegally unregistered, or misidentified as a non-security, is frequently the tip of the ice berg. Indeed, Broker-Dealers such as Pinnacle take on substantial due diligence, record keeping and compliance obligations pursuant to FINRA Rule 3040 when their sales force is pushing securities sponsored by third-parties. And, of course, FINRA has issued substantial guidance regarding the heightened risks and ancillary Broker-Dealer obligations of non-conventional investments.

So: Buyer and Broker beware. If you are a buyer, and it looks, walks and quacks like a security—it probably is one. Same holds true for the Broker-Dealer and it's FA's. Once one realizes it is a security, both the customer and the salesperson should expect to receive an open and thorough PPM as well as back-up due diligence upon request. If it is not available, you cannot do your due diligence, which is a good sign that you shouldn’t be buying or selling it.  

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