Enforcement Actions
Financial Industry Regulatory Authority (FINRA)
CASES OF NOTE
2011
NOTE: Stipulations of Fact and Consent to Penalty (SFC); Offers of Settlement (OS); and Letters of Acceptance Waiver, and Consent (AWC) are entered into by Respondents without admitting or denying the allegations, but consent is given to the described sanctions & to the entry of findings. Additionally, for AWCs, if FINRA has reason to believe a violation has occurred and the member or associated person does not dispute the violation, FINRA may prepare and request that the member or associated person execute a letter accepting a finding of violation, consenting to the imposition of sanctions, and agreeing to waive such member's or associated person's right to a hearing before a hearing panel, and any right of appeal to the National Adjudicatory Council, the SEC, and the courts, or to otherwise challenge the validity of the letter, if the letter is accepted. The letter shall describe the act or practice engaged in or omitted, the rule, regulation, or statutory provision violated, and the sanction or sanctions to be imposed.
November 2011
Brian Wade Boppre (Principal)
AWC/2009019125904/November 2011

Boppre was a member of his firmís new product committee, which was responsible for conducting due diligence and approving new products at the firm. Boppre knew of an issuerís failure to make payments to its investors and was also aware of other indications of the issuerís problems but approved the offering as a product available for his firmís brokers to sell to their customers. Also,  Boppre suspended the offering sales and then reopened the sales after further discussions with issuer executives.

Boppre allowed his firmís brokers to continue selling the offering despite the issuerís ongoing failure to make principal and interest payments, and despite other red flags concerning the issuerís problems. Acting on his firmís behalf, Boppre failed to conduct adequate due diligence of the offering before allowing firm brokers to sell this security; without adequate due diligence, the firm could not identify and understand the inherent risks of the offering and therefore could not have a reasonable basis to sell it. By not conducting adequate due diligence, Boppre failed to reasonably supervise firm brokersí sales of the offering.

Brian Wade Boppre (Principal): Fined $10,000; Suspended 6 months in Principal capacity only
Tags:  Due Diligence     |    In: Cases of Note : FINRA
Bill Singer's Comment
An interesting fact pattern -- read it carefully and make sure not to make the same mistakes.
Brookstone Securities, Inc.,David William Locy (Principal),Mark Mather Mercier (Principal), and Antony Lee Turbeville (Principal)
OS/2009017275301/November 2011

While associated with the firm, registered representatives made misrepresentations or omissions of material fact to purchasers of unsecured bridge notes and warrants to purchase common stock of a successor company.

The registered representatives:

  • guaranteed customers that they would receive back their principal investment plus returns, failed to inform investors of any risks associated with the investments and did not discuss the risks outlined in the private placement memorandum (PPM) that could result in them losing their entire investment. The registered representatives had no reasonable basis for the guarantees given the description of the placement agentís limited role in the PPM; and
  • provided unwarranted price predictions to customers regarding the future price of common stock for which the warrants would be exchangeable and guaranteed the payment at maturity of promissory notes, which led customers to believe that funds raised by the sale of the anticipated private placement would be held in escrow for redemption of the promissory notes.

The Firm, acting through a registered representative, made misrepresentations and/or omissions of material fact to customers in connection with the sale of the private placement of firm units consisting of Class B common stock and warrants to purchase Class A common stock; the PPM stated that the investment was speculative, involving a high degree of risk and was only suitable for persons who could risk losing their entire investment. The representative represented to customers that he would invest their funds in another private placement and in direct contradiction, invested the funds in the firm private placement.

The Representative recommended and effected the sale of these securities without having a reasonable basis to believe that the transactions were suitable given the customersí financial circumstances and conditions, and their investment objectives. The representative recommended customers use margin in their accounts, which was unsuitable given their risk tolerance and investment objectives, and he exercised discretion without prior written authorization in customersí accounts.

Acting through Locy, its chief operating officer (COO) and president, the Firm failed to reasonably supervise the registered representative and failed to follow up on ďred flagsĒ that should have alerted him to the need to investigate the representativeís sales practices and determine whether trading restrictions, heightened supervision or discipline were warranted. Moreover, despite numerous red flags, the firm took no steps to contact customers or place the representative on heightened supervision, although it later placed limits only on the representativeís use of margin. The firm eventually suspended his trading authority after additional large margin calls, and Locy failed to ensure that the representative was making accurate representations and suitable recommendations.

Turbeville, the firmís chief executive officer (CEO), and Locy delegated responsibility to Mercier, the firmís chief compliance officer (CCO), to conduct due diligence on a company and were aware of red flags regarding its offering but did not take steps to investigate. 

Acting through Turbeville, Locy and Mercier, the Firm failed to establish, maintain and enforce supervisory procedures reasonably designed to prevent violations of NASD Rule 2310 regarding suitability; under the firmís written supervisory procedures (WSPs), Mercier was responsible for ensuring the offering complied with due diligence requirements but performed only a superficial review and failed to complete the steps required by the WSPs; Locy never evaluated the companyís financial situation and was unsure if a certified public accountant (CPA) audited the financials, and no one visited the companyís facility. Neither Turbeville nor Locy took any steps to ensure Mercier had completed the due diligence process. Turbeville and Locy created the firmís deficient supervisory system; the firmís procedures were inadequate to prevent and detect unsuitable recommendations resulting from excessive trading, excessive use of margin and over-concentration; principals did not review trades or correspondence; and the firmís new account application process was flawed because a reviewing principal was unable to obtain an accurate picture of customersí financial status, investment objectives and investment history when reviewing a transaction for suitability. The firmís procedures failed to identify specific reports that its compliance department was to review and did not provide guidance on the actions or analysis that should occur in response to the reports; Turbeville and Locy knew, or should have known, of the compliance departmentís limited reviews, but neither of them took steps to address the inadequate system.

Brookstone Securities, Inc.: Censured; Fine $200,000

David William Locy (Principal): Fined $10,000; Suspended from 3 months in Principal capacity only

Mark Mather Mercier (Principal): Fined $5,000; Suspended from 3 months in Principal capacity only

Antony Lee Turbeville (Principal): Fined $10,000; Suspended from 3 months in Principal capacity only

Tags:  Private Placement    Suitability    Supervision    Due Diligence     |    In: Cases of Note : FINRA
October 2011
Capital Financial Services, Inc.
AWC/2009019125903/October 2011

The Firm failed to have reasonable grounds to believe that private placements offered by two entities pursuant to Regulation D were suitable for any customer.

The Firm began selling the offerings for one entity after its representatives visited the issuerís offices to review records and meet with the issuersí executives; the firm also received numerous third-party due diligence reports for these offerings but never obtained financial information about the entity and its offerings from independent sources, such as audited financial statements.

Despite the issuerís assurances, the problems with its Regulation D offerings continued; the issuer repeatedly stated to the firmís representatives that the interest and principal payments would occur within a few weeks, and the issuer made some interest payments but failed to pay substantial amounts of interest and principal owed to its investors, and these unfulfilled promises continued until the SEC filed its civil action and the issuerís operations ceased.

In addition to ongoing delays in making payments to its investors, the firm received other red flags relating to the entityís problems but continued to allow its brokers to sell the offering to their customers; in total, the firmís brokers sold $11,759,798.01 of the offering to customers.

Despite the fact that the firm received numerous third-party due diligence reports for the other entitiesí offering, it never obtained financial information about the issuer and its offerings from independent sources, such as audited financial statements, and although it received a specific fee related to due diligence purportedly performed in connection with each offering, the firm performed little due diligence beyond reviewing the private placement memoranda (PPM) for the issuerís offerings. The firmís representatives did not travel to the entityís headquarters to conduct any due diligence for these offerings in person and did not see or request any financial information for the entity other than that contained in the PPM.

The Firm obtained a third-party due diligence report for one of the offerings after having sold these offerings for several months already; this report identified a number of red flags with respect to the offerings. Moreover, the firm should have been particularly careful to scrutinize each of the issuerís offerings given the purported high rates of return but did not take the necessary steps, through obtaining financial information or otherwise, to ensure that these rates of return were legitimate, and not payable from the proceeds of later offerings, in the manner of a Ponzi scheme. Furthermore, the firm also did not follow up on the red flags documented in the third-party due diligence report; even with notice of these red flags, the firm continued to sell the offerings without conducting any meaningful due diligence.

The Firm failed to have reasonable grounds for approving the sale and allowing the continued sale of the offerings; even though the firm was aware of numerous red flags and negative information that should have alerted it to potential risks, the firm allowed its brokers to continue selling these private placements.The firm did not conduct meaningful due diligence for the offerings prior to approving them for sale to its customers; without adequate due diligence, the firm could not identify and understand the inherent risks of these offerings.The Firm failed to enforce reasonable supervisory procedures to detect or address potential red flags and negative information as it related to these private placements; the firm therefore failed to maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations.

Capital Financial Services, Inc.: Censured; Ordered to pay $200,000 restitution to investors
Tags:  Private Placement    Suitability    Due Diligence     |    In: Cases of Note : FINRA
Bill Singer's Comment
Folks, if this case doesn't make it abundantly clear, if you're going to traffick in the sale of private placements, you gotta go to the car lot and kick the tires.  The days of pushing the paper and getting the non-refundable due dilly fee are over.
Patrick Francis Harte Jr. (Principal)
2006004666601/October 2011

Harte participated in the sale of unregistered securities, in violation of Section 5 of the Securities Act of 1933.

Harte and a registered representative at his member firm sold millions of shares of a thinly traded penny stock, resulting in proceeds exceeding $9.3 million for firm customers; the total commissions generated were $481,398.

Harte failed to conduct any due diligence prior to the stock sales; the circumstances surrounding the stock and the firmís customers presented numerous red flags of a possible unlawful stock distribution.

Harte did not determine if a registration statement was in effect with respect to the shares or if there was an applicable exemption; Harte relied on transfer agents and clearing firms to determine the tradability of the stock. Harte failed to undertake adequate efforts to ensure that the registered representative ascertained the information necessary to determine whether the customersí unregistered shares could be sold in compliance with Section 5 of the Securities Act of 1933.  Also, he did not consider the determination of the free-trading status of shares to be within his supervisory responsibilities.

Harte failed to follow up on red flags; he was on notice of the inconsistencies between customersí trading experience and activity in their firm accounts but took no action.

In addition, Harte received customer emails which evidenced a greater level of market sophistication than reflected in their account forms but failed to investigate these discrepancies.

Patrick Francis Harte Jr. (Principal): Barred
Tags:  Unregistered Securities    Due Diligence        Email     |    In: Cases of Note : FINRA
Bill Singer's Comment
The email comment is fascinating -- at what point are brokers supposed to initiate a spot quiz of their clients to determine who is pretending to be more sophisticated and who is pretending to be less sophisticated? 
August 2011
Leroy Henry Paris II (Principal)
AWC/2009019070102/August 2011

As his member firmís president, CEO and registered principal, Paris had overall supervisory responsibilities for the firm, including reviewing and performing due diligence for private placements and for reviewing and approving new products, including the assignment of a new product to a business unit.

Paris signed a sales agreement for a private placement offering and failed to perform due diligence beyond reviewing the private placement memorandum (PPM), and while he had received third-party due diligence reports regarding earlier private placements, he did not seek or obtain a report for the latest offering and did not conduct any continuing due diligence or follow-up because of the limited time between offerings, the similarity of the deals and representations from the issuer that no additional due diligence was necessary. Unlike earlier offerings, there were serious red flags that Paris could not identify without adequate due diligence.

In his firmís sale of several offerings by another issuer, Paris failed to perform due diligence even though his firm received a specific fee related to due diligence purportedly performed in connection with each offering. Paris did not travel to the issuerís headquarters to conduct due diligence and did not seek or request any financial information other than what was contained in the PPM. Once he had concluded that his firm could sell the offerings, Paris did not conduct any continuing due diligence or follow-up, and due to limited time between the offerings, the similarity of the deals and representations from the issuer that no material changes had occurred, he concluded that no additional due diligence was necessary. In addition, Paris did not believe it necessary to pay for due diligence reports for the new offerings because they would say the same thing as previous reports but they did identify numerous red flags. Moreover, Paris should have scrutinized each of the offerings given the high rates of return to ensure they were legitimate and not payable from proceeds of later offerings, as in a Ponzi scheme.

Acting on his firmís behalf, Paris failed to maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations with respect to the offerings.

Leroy Henry Paris II (Principal): Fined $10,000; Suspended 6 months in Principal capacity only
Tags:  Due Diligence    Private Placement     |    In: Cases of Note : FINRA
Timothy D. Camarillo
OS/2010023612301/August 2011

Camarillo entered into a contract with a company to sell its private placements, and sold approximately $370,000 of these private securities to his customers, receiving over $13,000 in commissions, without providing notice to, or receiving approval from, his member firm.

Camarilloís firmís written procedures, which he attested to reading and understanding, instructed employees to provide notice to the firmís compliance department and to seek the firmís written approval prior to engaging in any securities transactions not executed through the firm. The company provided Camarillo with sales literature, and without submitting the brochure to his firm for approval, he distributed the brochure to his customers; the brochure contained several unwarranted, exaggerated and misleading statements, omitted material facts and ignored risk while guaranteeing success.

Camarillo did not have a reasonable basis to recommend that his customers purchase the securities, had no experience selling these types of products and did not conduct proper due diligence. Camarillo did not sufficiently understand the products offered through the company or how the investments were managed; all of Camarilloís customers who invested in the products informed Camarillo that they were seeking preservation of capital and viewed the investments as a retirement investment. Camarillo did not investigate the claims made in the sales literature that the returns were guaranteed, he had no basis to recommend the investment to customers seeking preservation of capital, and his recommendations to invest in the company were unsuitable.

Camarilloís customers lost tens of thousands of dollars by relying on his recommendation, because even after partial reimbursement from the companyís court-ordered receivership, Camarilloís customers only recouped 69 percent of their investment. Moreover, the products, as marketed, were securities, the sale of which required Camarillo to possess a Series 7 license; at the time he sold the securities, Camarillo held only a Series 6 license.

Timothy D. Camarillo : Fined $10,000; Suspended 4 months; Ordered to pay $13,000 restitution to customer
Tags:  Private Placement    Due Diligence    Unregistered RRs     |    In: Cases of Note : FINRA
July 2011
Brookstone Securities, Inc. and David William Locy (Principal)
AWC/2009019837303/July 2011

Acting through Locy, Brookstone Securities did not have WSPs addressing due diligence requirements for third-party placements.

Acting through Locy, Brookstone failed to conduct an adequate due diligence of a third-party private placement offering before Locy approved the offering of shares to customers. Locyís due diligence efforts did not include any investigation into an equity fund, despite acknowledging that he knew very little about it or the third-party placement and could not get any solid information about the fund, including pending litigation or financial statements. Locy knew nothing about the fund that was not contained in a PPM the issuer prepared, but accepted that the firm representatives forming the offering had conducted due diligence and relied on their opinion of the fund. Locy acknowledged the representatives had limited, if any, experience forming a private placement.

The firm's representatives sold or participated in sales of shares to customers without notifying Locy or anyone else at the firm, which caused those sales to not be recorded on the firmís books and records.

Brookstone Securities, Inc. and David William Locy: Censured; Fined $25,000 jointly/severally

Tags:  Due Diligence    Private Placement     |    In: Cases of Note : FINRA
Bill Singer's Comment
FINRA sort of spells it out for you: You are not discharging you due dilly obligations if you merely rely upon the PPM and/or accept one of your registered rep's opinion about the deal (which was an offering that the subject RR put together).
Edward Philip Gelb (Principal)
AWC/2009019466601/July 2011

Gelb solicited individuals, including customers at his member firm, to invest in entities that were purportedly engaged in the export and import business with a manufacturer based in China.

Gelb raised approximately $1.8 million from investors and received approximately $79,500 from the entities as compensation derived from his solicitation of, and directing investors to, the entities.

Private Securities Transaction

Gelb was aware of his firmís policies and procedures, which specifically prohibited its registered representatives from participating in any manner in the solicitation of any securities transaction outside the regular scope of their employment without approval. Gelb signed annual certifications attesting to this knowledge and failed to notify his firm about his solicitation of investors for the entities because he did not expect the firmís approval of the product.

Due Diligence

Gelb failed to obtain adequate information about the investment and instead relied upon unfounded representations, including guarantees that the investorsí principal would be protected despite the fact that, at no time, had Gelb seen any financial documentation for the entities. The information available on the Internet about the entities was limited to the companiesí own website.

Risk Disclosures

FINRA determined that despite the highly risky nature of the investment, Gelb led the customers to believe that the investment he was recommending was a safe and secure investment and, in some cases, Gelb was aware that customers were taking out home equity lines of credit on their homes to fund their investments in the entities. Customers who invested in the entities Gelb recommended had low risk tolerances and had investment objectives of growth and/or income, and Gelb did not have a reasonable basis for recommending the entities to the customers.

Outside email

Gelb utilized an outside email account, without his firmís knowledge or consent, to conduct securities business.Although the firm was aware of the outside email account, Gelb had not been approved to utilize that email address to conduct securitiesrelated business and by operating an outside email account for securities-related business without the firmís knowledge and consent, Gelb prevented his firm from reviewing his emails pursuant to NASD Rule 3010(d).

Edward Philip Gelb (Principal): Barred
Tags:  Email    Annual Compliance Certification    Due Diligence     |    In: Cases of Note : FINRA
Garden State Securities, Inc. and Kevin John DeRosa (Principal)
AWC/2009018819201/July 2011

The Firm failed to ensure that it established, maintained and enforced a supervisory system and written supervisory procedures (WSPs) reasonably designed to achieve compliance with the rules and regulations concerning private offering solicitations.

The firmís procedures were deficient in that they failed to specify, among other things, who at the firm was responsible for performing due diligence, what activities by firm personnel were required to satisfy the due diligence requirement, how due diligence was to be documented, who at the firm was responsible for reviewing and approving the due diligence that was performed and authorizing the sale of the securities, and who was to perform ongoing supervision of the private offerings once customer solicitations commenced. As a result of the firmís deficient supervisory system and WSPs, the firm failed to conduct adequate due diligence on private placement offerings. The Firm's WSPs required due diligence to be conducted on every private placement it offered, and required that such review had to be documented; the firm failed to enforce those provisions with respect to an offering. Had the firm conducted adequate due diligence, it reasonably should have known that the company had defaulted on its earlier notes offerings and that there was a misrepresentation in the private placement memorandum (PPM) with respect to principal and interest payments to investors in the earlier offerings. The Firm failed to take reasonable steps to ensure that it timely learned of the missed payments on the earlier notes offerings and disclosed them to prospective investors in the notes. Due to the firmís lack of due diligence, DeRosa sold notes issued to customers, and in connection with those sales, the firm and DeRosa mischaracterized and/or negligently omitted certain material facts provided to investors. DeRosa sold $833,000 of the notes to customers and generated approximately $37,485 in gross commissions from the sales of the notes. Through DeRosa and another registered representative, the Firm solicited customers to invest in another companyís stock but failed to conduct adequate due diligence.

The owner of an investment banking firm represented that the customersí funds would be wired to a client trust account at a bank and then forwarded to an escrow account, which a third party would control, before being invested; the firm did not take any steps to verify this claim before wiring the customer funds to the account. No one at the firm verified the existence of the client trust and escrow accounts, and, after the funds were wired, no one requested or received a bank account statement to verify the receipt and location of the funds; the firm failed to question why the wire instructions failed to reference the client trust account in the bank account title section on the form, but instead referenced the investment banking firm. Instead of directing the customersí money into the escrow account, the owner of the investment banking firm kept the funds in bank accounts he controlled and used the funds for his own benefit.

In addition, in connection with his sales of the companyís stock, DeRosa disseminated to prospective investors a presentation he had received from the owner of the investment banking company, which summarized the offering. Moreover, the presentation constituted sales literature but did not comply with the content standards applicable to communications with the public and sales literature. Furthermore, the presentation failed to provide a fair and balanced treatment of risks and potential benefits, contained unwarranted or exaggerated claims, contained predictions of performance and failed to prominently disclose the firmís name, failed to reflect any relationship between the firm and the non-FINRA member entities involved in the offering, and failed to reflect which product or services the firm was offering.

Garden State Securities, Inc.: Censured; Ordered to pay jointly and severally with DeRosa, $300,000 in restitution to investors. FINRA did not impose a fine against the firm after it considered, among other things, the firmís revenues and financial resources

Kevin John DeRosa (Principal):  Fined $25,000; Ordered to pay jointly and severally with Garden State $300,000 in restitution to investors; Suspendedfrom association with any FINRA member in any capacity for 20 business days, and Suspended from association with any FINRA member in any Principal capacity only for 2 months.

Tags:  Escrow    Due Diligence    Private Placement     |    In: Cases of Note : FINRA
National Securities Corporation and Matthew G. Portes (Principal)
AWC/2009019068201/July 2011

National Securities failed to have reasonable grounds to believe that certain private placements offered pursuant to Regulation D were suitable for customers. Acting through Portes, as the firmís Director of Alternative Investments/Director of Syndications, National failed to adequately enforce its supervisory procedures to conduct adequate due diligence as it relates to an offering. Portes and the firm became aware of multiple red flags regarding an offering, including liquidity concerns, missed interest payments and defaults, that should have put them on notice of possible problems, but the firm continued to sell the offering to customers. Acting through Portes, the Firm failed to enforce its supervisory procedures to conduct adequate due diligence relating to other offerings.

Portes reviewed the PPMs for these offerings and diligence reports others prepared, but the review was cursory.The due diligence reports noted significant risks and specifically provided that its conclusions were conditioned upon recommendations regarding guidelines, changes in the PPMs and heightened financial disclosure of affiliated party advances, but the firm did not investigate, follow up on or discuss any of these potential conflicts or risks with either the issuer or any third party. In addition, acting through Portes, the Firm failed to enforce reasonable supervisory procedures to detect or address potential ďred flagsĒ as related to these offerings; and the firm, acting through Portes, failed to maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations.

National Securities Corporation: Censured; Odered to pay a total of $175,000 in restitution to investors.

Matthew G. Portes  (Principal): Fned $10,000; Suspended from association with any FINRA member in any principal capacity only for 6 months.

Tags:  Due Diligence    Suitability        Private Placement     |    In: Cases of Note : FINRA
Bill Singer's Comment
FINRA is starting to make a point about Due Diligence of private placements -- you need to inquire and if you're on notice of problems (potential or otherwise), you better start to inquire.  There's no more wiggle room when it comes to these red-flag situations.
Ryan Jeffrey Kirkpatrick
2006004666601/July 2011

Kirkpatrick sold millions of unregistered shares of stock for accounts opened at his member firm on his customersí behalf, realizing approximately $9.3 million in proceeds for the customers without taking the necessary steps to determine whether his customersí unregistered shares could be sold in compliance with Section 5 of the Securities Act of 1933.

Kirkpatrick signed new account forms for the customers, did not review them in depth, neither met nor spoke with the customers, and communicated with them solely via email and instant message. Kirkpatrick failed to conduct the necessary due diligence prior to the entityís stock sales from the customersí accounts; the circumstances surrounding the entityís stock and the firmís customers presented numerous red flags of a possible unlawful stock distribution.

The sales through one of the customersí accounts at Kirkpatrickís firm realized approximately $5.8 million in proceeds for the customer, and another customer realized approximately $3.5 million in proceeds; the total commissions generated for these sales were $481,398 of which Kirkpatrick received commissions totaling $91,466.

Kirkpatrick admitted that he did not determine if a registration statement was in effect with respect to the customersí entity shares, or if there was an applicable exception; instead he relied on the issuerís transfer agent to determine if the entity stock the customers deposited could be sold.

Kirkpatrick did not review the customersí incoming stock questionnaires, nor did he request or review the stock certificates, which indicated information about how and from whom the shares were purchased, whether the customer was affiliated with the issuer and whether the stock was restricted. In addition, Kirkpatrick noticed that the accounts seemed to have the same trading pattern, yet he failed to investigate and failed to make any effort to determine the source of the customersí shares.

Ryan Jeffrey Kirkpatrick: Fined $25,000; Suspended 6 months; Ordered to disgorge $91,466, which represents the commissions earned on the sales of unregistered securities
Tags:  Due Diligence    Unregistered Securities     |    In: Cases of Note : FINRA
May 2011
Brewer Financial Services, LLC , Adam Gary Erickson (Principal) and Steven John Brewer
AWC/2010023252701/May 2011

Acting through Erickson and Brewer, the Firm:

  • sold the private placement offerings of a company formed exclusively to acquire and provide growth to its parent company and a limited liability company for which Brewer was a director, without disclosing to the investors material facts that:
    • the parent company had defaulted on a $2.5 million loan,
    • had reported an operating loss of $1,622,912 for one calendar year and an approximate operating loss of $4.5 million for another calendar year, and
    • had defaulted on interest payments to note-holders.
  • continued to sell the limited liability companyís private placement offering to new investors, knowing that it had defaulted on its interest payments to existing investors and without disclosing that material fact to new investors.

The firm sold the private placement offerings to non-accredited investors without providing them with the financial statements required under Securities and Exchange Commission (SEC) Rule 506, resulting in the loss of exemption from the registration requirements of Section 5 of the Securities Act of 1933. Because no registration statement was in effect for the offerings and the registration exemption was ineffective, the firm sold these securities in contravention of Section 5 of the Securities Act of 1933.

Acting through Erickson, the Firm conducted inadequate due diligence related to its sale of the offerings in that it failed to ensure the issuers had retained a custodian to handle certain investorsí qualified funds prior to accepting investment of Individual Retirement Account (IRA) funds into the offerings.

Ating through Erickson and Brewer, the Firm offered to sell and sold the companyís private placement offering by distributing to the public a private placement memorandum (PPM) containing unbalanced, unjustified, unwarranted or otherwise misleading statements; among other things, the PPM implied that the parent company was not experiencing financial difficulty and failed to disclose that it reported a significant loss one year. In addition, the investors in the companyís notes were not provided with financial statements for either the company or the parent company. Moreover, the PPM was misleading in that it failed to state clearly how offering proceeds would be used, lacked clarity regarding the relationship between the issuer and its affiliates, and failed to provide the basis for claims made regarding the performance expectations of the issuer or its affiliates.

Furthermore, the firm failed to establish adequate written supervisory procedures related to its sales of private placement offerings, in that the firmís procedures failed to require that financial statements be provided to investors when private placement offerings are sold to non-accredited investors, pursuant to SEC Rule 506.

The Firm allowed Brewer to be actively engaged in managing the firmís securities business without being registered as a principal and a representative although Brewer signed and submitted an attestation to FINRA stating he would not be actively engaged in the management of the firmís securities business until he completed registration as a representative and principal. Among other things, Brewer reviewed and revised the firmís recruitment brochure, approved offer letters to prospective firm registered representatives, dictated the structure of new representativesí compensation, including the level of commissions and loan repayment terms, and instructed firm personnel to send private placement offering documents to prospective investors.

The firm maintained the registrations for individuals who were not active in the firmís investment banking or securities business or were no longer functioning as registered representatives.

The Firm conducted a securities business on a number of days even though it had negative net capital on each of those dates. The firmís net capital deficiencies were caused by its failure to classify contributions from the parent company as liabilities after the firm returned the contributions to the parent company within a one-year period of having received them, and improperly treating its assets as allowable even though all of its assets had been encumbered as security for a loan agreement the parent company executed. Moreover, the Firm had inaccurate general ledgers, trial balances and net capital computations, and filed inaccurate Financial and Operational Uniform Single

Brewer Financial Services, LLC: Expelled

Adam Gary Erickson (Principal) and Steven John Brewer: Barred

Tags:  Private Placement    Due Diligence    Unregistered Principal    Parking    Net Capital     |    In: Cases of Note : FINRA
Newbridge Securities Corporation
AWC/2009016159401/May 2011

The Firm failed to establish, maintain and enforce a supervisory system and written procedures relating to private offerings the firm sold to its customers. The firmís supervisory system and written procedures for private offerings were deficient; they did not identify due diligence steps to be taken for private offerings. The firm approved for sale, and sold, various private offerings by an entity that raised approximately $2.2 billion from over 20,000 investors through several Regulation D offerings.

The entity made all interest and principal payments on these Regulation D offerings until it began experiencing liquidity problems and stopped making payments on some of its earlier offerings; nevertheless, the entity proceeded with another offering. The firmís due diligence for the offering consisted merely of reviewing the PPM and investor subscription documents, without seeking or obtaining financial documents or information from the issuer regarding the offering, nor did the firm obtain any due diligence report for the offering or visit the issuerís facilities or meet with its key personnel. The firm approved for sale, and sold, a total of $258,597.16 to its customers for interests in another entityís private offering. In addition, the firm failed to conduct due diligence for these offerings; among other things, it did not obtain offering documentation beyond the investor subscription documents. Moreover, the firm sold additional unregistered offerings to its customers and failed to conduct adequate due diligence for each of these other offerings.

Newbridge Securities Corporation : Censured; Fined $25,000
Bill Singer's Comment
There's no more sleepwalking through Due Dilly.  You got to visit the car lot and kick the tires.
Penena Karpel McRoberts
AWC/2009017606101/May 2011

McRoberts effected private securities transactions without requesting and receiving her member firmsí permission. McRoberts sold $142,128 in promissory notes secured by pooled life settlements. Prior to engaging in these transactions, while associated with one of the firms, McRoberts had signed an Acknowledgement of Receipt and Review of Compliance Procedure Manual which stated that no private securities (or other investment or insurance) transaction may in any way be participated in by a representative unless the compliance director approves it in advance. Despite McRobertsí acknowledgement of the firmís procedures, she failed to give written notice of her intention to participate in the sale of the securities to, and failed to obtain written approval from, her firm prior to the transactions. McRoberts effected private securities transactions while registered with another member firm and also failed to give written notice of her intention to participate in the sale of the securities, and failed to obtain her firmís written approval prior to the transaction. McRoberts received $9,600 in commissions from the transactions. In addition,

McRoberts failed to conduct adequate due diligence and thus had no reasonable basis to determine whether the investments were suitable for her clients.

Penena Karpel McRoberts : Fined $20,000 including $9,600 in disgorged commissions; Suspended 1 year
Tags:  Due Diligence    Promissory Notes     |    In: Cases of Note : FINRA
Robin Fran Bush (Principal)
AWC/2009016159402/May 2011

As her member firmís CCO, Bush was responsible for creating, maintaining and updating her firmís Written Supervisory Procedures (WSPs) and for conducting due diligence for private offerings. Bushís firm approved for sale, and sold, various private offerings, and for one offering, Bushís due diligence consisted of reviewing the PPM and investor subscription documents, but she did not seek or obtain financial documents or information from the issuer regarding the offering, did not obtain any due diligence report, did not visit the issuerís facilities or meet with its key personnel. Bush did not take steps to ensure, or otherwise verify, that other firm principals were conducting any due diligence of the offeringís issuer.

The firm and Bush obtained a third-party due diligence report after firm customers had already invested in the offering. In regards to a third private offering that her firm approved for sale and sold, Bush conducted due diligence after the product had been sold to customers -- and her due diligence consisted of obtaining investor subscription documents without obtaining PPMs for the offerings, did not obtain any due diligence report from an independent third party and did not meet with any executives to understand the nature of the offerings.

Bushís firm sold additional, different unregistered offering to customers, and Bush, acting in her capacity as CCO and the designed principal for private offerings, failed to conduct due diligence for each of these other offerings.

Moreover, the firmís supervisory system and the firmís written procedures for private offerings Bush drafted and maintained were deficient because the procedures Bush drafted and maintained did not identify, in any detail, specific due diligence steps to be taken for private offerings or identify specific documents to be obtained for private offerings the firm was contemplating selling. Furthermore, the firmís written procedures for private offering due diligence were conclusory, non-specific and lacking in the requisite minimum detail regarding steps to be taken and firm personnel responsible for such steps.

Robin Fran Bush (Principal): Fined $15,000; Suspended 6 months in Principal capacity only
Tags:  Due Diligence    Private Placement    WSP     |    In: Cases of Note : FINRA
Bill Singer's Comment

FINRA has certainly been on a tear when it comes to private placements, and has not been shy about going after supervisors for their lapses. Note FINRA's suggestion that you need to go and physically kick the tires on a deal.

Robin Fran Bush (Principal)
AWC/2009016159402/May 2011

As her member firmís CCO, Bush was responsible for creating, maintaining and updating her firmís Written Supervisory Procedures (WSPs) and for conducting due diligence for private offerings. Bushís firm approved for sale, and sold, various private offerings, and for one offering, Bushís due diligence consisted of reviewing the PPM and investor subscription documents, but she did not seek or obtain financial documents or information from the issuer regarding the offering, did not obtain any due diligence report, did not visit the issuerís facilities or meet with its key personnel. Bush did not take steps to ensure, or otherwise verify, that other firm principals were conducting any due diligence of the offeringís issuer.

The firm and Bush obtained a third-party due diligence report after firm customers had already invested in the offering. In regards to a third private offering that her firm approved for sale and sold, Bush conducted due diligence after the product had been sold to customers -- and her due diligence consisted of obtaining investor subscription documents without obtaining PPMs for the offerings, did not obtain any due diligence report from an independent third party and did not meet with any executives to understand the nature of the offerings.

Bushís firm sold additional, different unregistered offering to customers, and Bush, acting in her capacity as CCO and the designed principal for private offerings, failed to conduct due diligence for each of these other offerings.

Moreover, the firmís supervisory system and the firmís written procedures for private offerings Bush drafted and maintained were deficient because the procedures Bush drafted and maintained did not identify, in any detail, specific due diligence steps to be taken for private offerings or identify specific documents to be obtained for private offerings the firm was contemplating selling. Furthermore, the firmís written procedures for private offering due diligence were conclusory, non-specific and lacking in the requisite minimum detail regarding steps to be taken and firm personnel responsible for such steps.

Robin Fran Bush (Principal): Fined $15,000; Suspended 6 months in Principal capacity only
Tags:  Due Diligence    Private Placement    WSP     |    In: Cases of Note : FINRA
Bill Singer's Comment

FINRA has certainly been on a tear when it comes to private placements, and has not been shy about going after supervisors for their lapses. Note FINRA's suggestion that you need to go and physically kick the tires on a deal.

April 2011
Alvin Waino Gebhart Jr. (Principal) and Donna Traina Gebhart (Principal)
C0220020057/April 2011

The sanctions were based on findings that Alvin and Donna Gebhart engaged in private securities transactions without prior written notification to, or prior approval from, their member firm. The findings stated that Alvin and Donna Gebhart sold unregistered securities that were not exempt from registration, and recklessly made material misrepresentations and omissions in connection with the sale of securities. Donna Gebhartís suspension is in effect from June 7, 2010, through June 6, 2011.

Alvin Waino Gebhart Jr.: Barred

Donna Traina Gebhart: Fined $15,000; Suspended 1 year; Must requalify by exam in all capacities.

Tags:  Due Diligence    NAC    Appeal     |    In: Cases of Note : FINRA
Bill Singer's Comment

The Weigh In

The 2004 NASD Hearing Decision

  • Alvin W. Gebhart, Jr. was suspended for 12 months in all capacities and fined $100,000.
  • Donna T. Gebhart was suspended for 7 months in her capacity as general securities representative and fined $7,500.
  • Both Respondents found jointly and severally liable for $5,141.21 in hearing costs.

The 2005 National Adjudicatory Council Decision

Round One: 2006 SEC Opinion

In 2006, the SEC reviewed the Gebharts' appeal of NASD findings and sanctions. In the 2006 SEC Opinion, the SEC held that the Gebharts, registered representatives of member firm of the NASD, had engaged in private securities transactions without giving prior written notification to, or obtaining prior approval from, member; sold unregistered securities; and made material misrepresentations and omissions in the sale of securities. The SEC sustained the NASD's findings of violation. The SEC also sustained NASD's sanctions:

  • Alvin Gebhart: Barred
  • Donna Gebhart: Fined $15,000 and suspended  for one year. NASD imposed two separate one-year suspensions on D. Gebhart (one year for private securities transactions and sales of unregistered securities and one year for violations of federal and NASD antifraud provisions) that were to be served concurrently.
  • NASD also assessed costs against the Gebharts, jointly and severally, in the amount of $5,141.21.

Round Two: 9th Circuit Remand on "scienter" issue

Following appeal to the Ninth Circuit Court of Appeals, that court affirmed the SEC's finding that registered representatives of member firm of registered securities association engaged in private securities transactions without giving prior written notification to, or obtaining prior approval from, member. However, the Circuit Court remanded for further findings on whether representatives violated antifraud provisions with the requisite scienter when they made material misrepresentations and omissions in the sale of securities.

Round Three: SEC's 2008 clarification

Upon remand, the SEC held in a 2008 Opinion that the representatives recklessly made material misrepresentations and omissions, and association's findings of liability. Accordingly the SEC sustained the sanctions imposed.  

Round Four: Case Closed

Thereafter, the Supreme Court of the United States denied a petition following the United States Court of Appeals for the Ninth Circuitís denial of petition for review.

The Nitty Gritty: Scienter Is Not Mere Negligence

An interesting aspect of this case is the issue of whether "scienter" is satisfied by mere negligence or whether the state of mind requires something more. In responding to this issue, the SEC's 2008 Opinion provides an interesting commentary (pages 15 - 17 of the Opinion):

The Gebharts nevertheless argue that they should not be found liable for fraud because they acted in good faith, and therefore without the requisite state of mind. They contend that, as found by the NASD Hearing Panel, the Gebharts "truly believed that they had fulfilled their responsibilities to assure that MHP and CSG were appropriate investments . . . ." The Hearing Panel decision on this point was overturned by NASD's National Adjudicatory Council ("NAC"), which found that the Gebharts were reckless and concluded that the four factors identified by the Hearing Panel provided "scant reasons for the Gebharts to believe they had fulfilled their duty to investigate." The NAC decision is NASD's final action. 33/

The Court of Appeals in its remand opinion identified subjective and objective components in an analysis of recklessness, and we acknowledge the Gebharts' assertions that they believed they had done enough to confirm the truthfulness of their statements to clients. We consider evidence of good faith to be relevant to a determination of whether a respondent acted with the requisite state of mind. That evidence must be considered with all other evidence of knowledge or recklessness because the reasonableness and, therefore, the credibility of that claim of good faith must be evaluated in light of the circumstances of each case and in light of the conduct expected from a reasonable person.

The Court questioned whether the 2006 Opinion should be interpreted as holding that good faith cannot be a defense to a finding of scienter whenever the evidence indicates that the respondents lacked a "reasonable basis for recommending the [securities], because they failed to discharge [their] duty to investigate before making the recommendations." 34/ The Court seems concerned that our view is that a good faith belief founded on negligent actions satisfies the recklessness prong of scienter. We take this opportunity to reiterate our adherence to the recklessness standard as an extreme departure from the standards of ordinary care and our view that negligence does not qualify as scienter.

Thus, the evidence the Gebharts forward to demonstrate their good faith beliefs is and should be part of the complete mix of facts bearing on an evaluation of their state of mind, but, in the end, a respondent's belief that he acted in good faith must be tested by reference to objective criteria; i.e., the applicable standard of conduct is determined in accordance with the degree to which the respondent had acted extremely unreasonably. A respondent's asserted good faith belief is not plausible if he ignores facts that place him on notice of a risk of misleading clients. The Court in remanding this proceeding recognized this when it said: "When warranted, the SEC is entitled to infer from circumstantial evidence that a defendant must have been cognizant of an extreme and obvious risk and reject as implausible testimony to the contrary." 35/ The Sundstrand court also emphasized the need to refer to external standards when it originally defined recklessness, 36/ and other courts have similarly identified the ultimate importance of objective measures in securities fraud cases. 37/

Unlike the examples given by the Sundstrand court in which the subjective component would preclude liability for objectively reckless misconduct, the Gebharts do not claim that they "genuinely forgot" to disclose material information, i.e., that their statements had no basis in fact. Rather, their claim is that they were not reckless because, even though they knew their representations were based primarily on Archer's assertions and the silence of others, they nonetheless thought that they had done enough. The Gebharts similarly argue that they were truly and completely unaware of the fraud that the principals of MHP were perpetrating, that they were victims themselves of that fraud, and that they therefore lacked scienter. As the Gebharts assert, "It is simply implausible to suggest that the Gebharts knew or suspected that MHP would be unable to repay these loans while, at the same time, loaning it money."

These arguments are insufficient. As discussed above, the Gebharts made no meaningful attempts to confirm the validity of their assertions to clients that the Notes would be fully secured. They made these unsupported representations to clients despite not knowing whether they were true or false and despite having several and varied reasons to doubt the truth of their own statements. Our de novo review of the evidence in this case therefore leads us to conclude that, contrary to the Gebharts' assertions, they must have known when they made their misrepresentations that their actions presented an unacceptable danger of misleading their clients.

Moreover, accepting arguendo that the Gebharts were unaware of MHP's fraud, this does not alter our conclusion: the Gebharts face liability not because they knew of or failed to discover MHP's fraud, but because they made specific representations to clients about the security of the Notes without taking any basic steps to verify the truthfulness of those representations. Even if the Gebharts were unaware of MHP's actual fraud, we conclude that they still must have known of the risk of misleading their clients given their extreme departure from the standards of ordinary care. The Gebharts are legally bound as knowing that the representations were false. 38/

 

Workman Securities Corporation
AWC/2009018818401/April 2011

The Firm failed to:

  • have reasonable grounds to believe that a private placement an entity offered pursuant to Regulation D was suitable for any customer, after it received red flags that the entity had financial issues and was not timely making interest payments, but continued to sell the offering to customers;
  • enforce a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations, and NASD and FINRA rules in connection with the sale of private placements;
  • conduct adequate due diligence of the private placements or confirm that its representatives were doing their own due diligence;
  • conduct adequate due diligence of private placements other entities offered; and
  • enforce a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations, and NASD and FINRA rules in connection with the sale of the private placements the entities offered pursuant to Regulation D.

The Firm reviewed cursory private placement memoranda (PPMs) for the offerings but failed to investigate red flags or analyze third-party sources of information or take affirmative steps to ensure the information in the offering documents was accurate.

The Firm failed to preserve electronic communications in a non-rewritable, non-erasable or ďWORMĒ format that complied with books and records requirements, and the firm used third-party software for storing and retaining electronic communications that did not comply with the requirements of SEC Rule 17a-4(f). Although the Firm was informed that its electronic storage medium was non-compliant but did not take adequate remedial action to retain email properly.

Workman Securities Corporation : Censured; Ordered to pay $700,000 as partial restitution to investors; Ordered to certify in writing to FINRA that it has established and implemented a system and procedures reasonably designed to achieve compliance with recordkeeping requirements related to electronic communications, and provide a written report to FINRA describing the policies, procedures and controls it has established and implemented related to the integrity of the retention and retrieval process for electronic communications, and the supervisory system it has implemented to oversee the preservation of electronic communications.
Bill Singer's Comment
In 2011 we see a continuation of FINRA's enforcement focus on private placements, with an emphasis on members' responses to "red flags" and the sincerity of the firm's due diligence efforts.  The day's of taking a piece of a private placement and sleepwalking through your obligations to your clients is a vestige of the past.  There's no easy money in Reg D. You have to do your homework and put your money where your mouth is.
March 2011
Joe Evan Still and John Richard Still
OS/2008014358101/March 2011

Joe and John Still  engaged in outside business activities for compensation without disclosing this to their member firm, in writing or otherwise. Joe and John Still referred or introduced prospective investors, including a customer of Joe Stillís member firm, to an individual and to the individualís business, and failed to conduct any due diligence on the individual and his business prior to referring or introducing the prospective investors; the investors subsequently invested over $4.8 million with the individualís business.

John Still received compensation totaling over $300,000 for the referrals and Joe Still received compensation totaling over $120,000 for the referrals and, with the exception of two checks, the referral fee checks were made payable to relatives who were not securities professionals and who had no role in referring customers to the business. John and Joe Still falsely represented on annual compliance questionnaires that they had disclosed all outside business activities.

Joe Evan Still: Fined $25,000; Suspended 18 months

John Richard Still: Barred

Tags:  Due Diligence     |    In: Cases of Note : FINRA
Puritan Securities Inc. aka First Union Securities, Inc.
AWC/2008012927503/March 2011

The Firm entered into an agreement with an entity to sell a private placement for which the firmís brokers sold $1,415,940 of the private placement interests to customers, and the firm failed to create and maintain a reasonable supervisory system to detect and prevent sales practice violations in these transactions. The firm did not collect financial and other relevant information for the customers who purchased the private placement, and did not review these transactions to determine if the recommendations for the purchases were suitable for these customers.

Also, the firm failed to implement a supervisory system reasonably designed to review and retain electronic correspondence. The firm did not establish an email retention system that captured all of its brokersí emails. The firmís brokers were allowed to use email addresses using external domains, and the firm did not have the capability to review, capture and retain these emails.

Puritan Securities Inc. aka First Union Securities, Inc.: Censured; Fined $10,000 (in light of the firm's revenues and financial resources, a "lower fine" was imposed)
Tags:  Private Placement    Suitability    Due Diligence    Electronic Communications    Email     |    In: Cases of Note : FINRA
Bill Singer's Comment
As I've noted over the years, permitting registered persons to use email addresses that are off the firm's platform poses significant supervisory issues.  Here, brokers were permitted to use external domains but the firm did not have the ability to review, capture, and retain the subject communications. That's going to be a problem for FINRA.
Vincent Michael Bruno (Principal)
AWC/2009018771701/March 2011

As his member firmís Chief Compliance Officer, Bruno failed to ensure that his firm established, maintained and enforced a supervisory system and WSPs reasonably designed to achieve compliance with the rules and regulations in connection with private offering solicitations. Acting through Bruno, his firm maintained a deficient supervisory system and WSPs with respect to private offering solicitations in that those procedures did not specify who at the firm was responsible for performing due diligence, what activities firm personnel were required to satisfy the due diligence requirement, how due diligence was to be documented, who at the firm was responsible for reviewing and approving the due diligence that was performed and for authorizing the sale of the securities, and who was to perform ongoing supervision of the private offerings once customer solicitations commenced.

As a result of its deficient WSPs, the firm failed to conduct adequate due diligence on private placement offerings, and Bruno failed to take any other steps to otherwise ensure that it was conducted.

Vincent Michael Bruno (Principal): Fined $10,000; Suspended 1 month in Principal capacity only.
Tags:  Private Placement    CCO    Due Diligence    WSPs     |    In: Cases of Note : FINRA
February 2011
Bobb Arthur Meckenstock (Principal)
OS/2008011612602/February 2011

Meckenstock failed to reasonably supervise a registered representative at his member firm in that the registered representative participated in sales of stock that were outside the course or scope of the registered representativeís employment with the firm. Meckenstock participated in certain sales of the stock himself, and failed to record the sales on the firmís books and records as required by NASD Rule 3040(c).

Meckenstock failed to submit a written request to participate in the sale of stock, failed to receive written approval to participate in the transactions and failed to provide written approval to the registered representative to participate in the sales.

Meckenstock failed to conduct sufficient due diligence on the offering, failed to investigate the nature of the individual with the issuer, failed to investigate his relationship with the issuer, failed to question him about any additional sales he may have made to firm customers, and failed to investigate compensation that the registered representative was promised or received from the sale of the interests in the company.

Meckenstock failed to adequately supervise the resale of stock through a registered investment adviser (IA) the representative owned, and failed to review the IAís books and records, which would have disclosed the representativeís sale of his shares of the stock to public customers.

Meckenstock reviewed a private placement memorandum and offering for his firm and approved it as a suitable investment, but failed to ensure that the issuer had established an escrow account, thereby failing to adequately supervise the sale of the offering and causing his firm to violate Securities Exchange Act Rule 15c2-4. In addition, Meckenstock failed to evidence his supervisory review and approval of customersí purchases of interests in numerous offerings.

Bobb Arthur Meckenstock (Principal): Fined $10,000; Suspended 30 days in Principal capacity only
Tags:  Supervision    Due Diligence    Escrow    Private Placement     |    In: Cases of Note : FINRA
Bill Singer's Comment
A classic private placement cascade effect that flows into everything that it touches -- failure to supervise, due dilly, escrow, outside activities, and on and on.
Todd Randall Ware (Principal)
AWC/2007008935007/February 2011

Ware introduced several customers to a Stock to Cash program under which customers would pledge stock to obtain loans to purchase other products. Ware recommended a customer participate in the program under which the customer obtained loans of approximately $388,000 and pledged securities in support of these loans, using the proceeds to purchase fixed annuities through Ware.

Ware failed to conduct adequate due diligence concerning the operations or financial stability of the Stock to Cash program lender and failed to take sufficient action to determine whether his clientsí ownership interest in the pledged securities was adequately protected. Ware did not understand the potential risks inherent in the program and therefore did not have a reasonable basis for his recommendations.

Todd Randall Ware (Principal): Fined $15,000; Suspended 15 business days
Tags:  Stock To Cash    Due Diligence    Annuities     |    In: Cases of Note : FINRA
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