Beware Private Placements: Lessons From MedCap, Provident and DBSI

According to Brad Bennett, FINRA executive vice president and chief of enforcement, "Senior officials at these firms failed to fulfill their responsibilities to customers by not conducting reasonable investigations of these unrelated offerings, especially in light of multiple red flags suggesting liquidity concerns, missed interest payments and defaults.

FINRA will continue to look closely at sales of both affiliated and unaffiliated private placements to determine whether the selling firms fulfilled their responsibility to customers."

Sanctions on those involved in selling the failed product placements included fines of between $10,000 and $700,000. But sanctions didn’t just consist of monetary fines. Some individuals targeted by FINRA were also suspended from acting in any “principal capacity.” Some of the suspensions were indefinite, with others lasting only six months.

On top of the fines and suspensions, individuals and firms implicated in the scandal also face action by investors who lost money in the private placements—and those amounts dwarf the FINRA-imposed penalties.

Since June of last year, hundreds of arbitration claims have been filed, class action lawsuits commenced, and a stream of arbitration awards been issued against firms that sold interests in MedCap. One arbitration award, which was upheld in federal court last month, weighed in at a hefty $1.2 million.

Taken with the increased scrutiny faced by firms selling private placements, those kinds of awards will give many firms pause when they consider offering these investments to their clients—and rightfully so. A dozen firms that sold MedCap are now defunct as a result of their involvement with the private placement.

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See also The Law Professor's blog at AdvisorFYI.