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.
