Broker Due Diligence

Broker Due Diligence: Are your Investments Appropriate for you?

Broker due diligence is a process undertaken by brokerage firms to ensure that they are recommending and selling investment products that are appropriate for their clients. The purpose of this process is to protect the interests of the brokerage firm and its clients by ensuring that the investments being offered are suitable for the client’s investment objectives, risk tolerance, and financial situation.  

By carefully reviewing investment products and assessing their suitability for clients, brokerage firms can help ensure that their clients make informed investment decisions that align with their investment objectives and risk tolerance.  

Broker Due Diligence includes the following process: 

1. The brokerage firm will identify the investment product that they are considering recommending or selling to their clients. 
2. The firm will then conduct a thorough review of the investment product to determine its features, risks, and suitability for their clients.
3. If the investment product is a security, the brokerage firm will also assess the issuer of the security to ensure that it is a reputable company with a sound financial standing.
4. Conducting additional research on the investment product and the issuer to gather more information and ensure that they have a complete understanding of the investment opportunity.
5. Assessing the risks associated with the investment product and determine whether it is appropriate for their client’s risk tolerance.
6. To make sure they have a clear record, the brokerage firm will document the entire due diligence process, including their findings and analysis, of their recommendations and the factors that were considered. 

Broker Due Diligence with Alternative Investments 

“Alternative investments” generally refer to all non-traditional investments – like stocks, bonds, and mutual funds.  Examples include oil and gas limited partnerships, non-traded REITs, business development companies, tenant-in-commons, and equipment leasing funds, and DSTs.  The commonality is that alternative investments are high-risk, generally illiquid, and pay a high commission to the advisor that recommends them. 

Due to these increased risks, investment regulators like FINRA impose high due diligence requirements on broker-dealers and advisors in an attempt to ensure that alternative investments are not being sold improperly. 

In fact, brokerage firms and financial advisors have a fiduciary duty to their clients to perform adequate due diligence on any investment prior to offering it for sale to its clients. 

FINRA (Financial Industry Regulatory Authority) and the SEC (Securities and Exchange Commission) are regulatory bodies that oversee the securities industry in the United States. Both organizations have rules and regulations regarding due diligence by individuals or firms in the securities industry. 

FINRA has observed instances where some firms that have suitability obligations under FINRA Rule 2111 (Suitability) failed to conduct reasonable diligence on private placements and failed to meet their supervisory requirements under FINRA Rule 3110 (Supervision).  

FINRA has issued guidance to broker-dealers through FINRA Regulatory Notice 10-22 reminding them of their due diligence obligations specifically as they relate to Regulation D filings for alternative investments. 

NTM 10-22 includes the following statements: 

• FINRA has found significant problems in several examinations and investigations.  These problems include fraud and sales practice abuses in Regulation D offerings.  Recently, for example, broker-dealers were sanctioned for providing private placement memoranda and sales materials to investors that contained inaccurate statements or omitted information necessary to make informed investment decisions. 
• The [SEC] and federal courts have long held that a broker-dealer that recommends a security is under a duty to conduct a reasonable investigation concerning that security and the issuer’s representations about it.  This duty emanates from the broker-dealer’s “special relationship” to the customer, and from the fact that in recommending the security, the broker-dealer represents to the customer “that a reasonable investigation has been made and that [its]recommendation rests on the conclusions based on such investigation.” 
• …the SEC and courts recognize that a more thorough investigation is required for “securities issued by smaller companies of recent origin,” which could include many Regulation D issuers. 
• … a broker-dealer “may not rely blindly upon the issuer for information concerning a company” … 
• … nor may it rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation. 
• … firms are required to exercise a “high degree of care” in investigating and independently verifying an issuer’s representations and claims. 
• Indeed, when an issuer seeks to finance a new speculative venture, broker-dealers “must be particularly careful in verifying the issuer’s obviously self-serving statements.” 
• To demonstrate that it has performed a reasonable investigation, a broker-dealer should retain records documenting both the process and results of its investigation.  Such records may include descriptions of the meetings that were conducted during the investigation, including meetings with the issuer or other parties, the tasks performed, the documents and other information reviewed, the results of such reviews, the date such events occurred, and the individuals who attended the meetings or conducted the reviews. 

These requirements are important to protect investors. Unfortunately, these requirements are often overlooked by brokerage firms and advisors that are more interested in the high commissions they can earn selling such investments than they are in protecting the interests of their clients. 

Recovery of Investment Losses

The White Law Group has represented hundreds of investors that have lost money in alternative investments (investments like Griffin Realty Trust, FS Energy & Power Fund, GWG L Bonds, GPB Capital offerings, KBS REITs, American Finance Trust, Healthcare Trust, Inc. and Atlas offerings, just to name a few).

These claims generally argue that the brokerage firm is negligent and violated its fiduciary duty by recommending the alternative investment(s) to someone who lacked the sophistication or experience to understand the risks and that the brokerage firm failed to perform adequate due diligence to ensure that the investment had a reasonably likelihood of success. 

If you believe that your broker failed to do due diligence on your investment, and you suffered losses as a result, you may be able to file a FINRA claim. FINRA is the Financial Industry Regulatory Authority, which is a self-regulatory organization that oversees the securities industry in the United States. 

Free Consultation with National Securities Attorneys

If you suffered losses in an alternative investment and would like a free consultation with a securities attorney, please call The White Law Group at 888-637-5510. The firm works on a contingency fee basis to help you in your time of need.     

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Seattle, Washington.  For more information on The White Law Group visit http://whitesecuritieslaw.com.