Firm Settles FINRA Charges for Misleading Projections and Reporting Failures
Commentary by Sebastian Souchet
A broker-dealer settled FINRA charges for distributing misleading performance projections in private placement materials and failing to properly report customer complaints.
According to the AWC, the firm distributed retail communications regarding private placement offerings that included aggregated Internal Rates of Return ("IRR") and Cash Multiple Values which "mask[ed] the performance of the individual closed deals." FINRA found that the firm also distributed communications that projected investment performance, including specific "target IRR[s] and ... cash multiple[s] over a four-year hold period."
FINRA found that the firm failed to report statistical and summary information regarding 15 written customer complaints because it "mistakenly believed that grievances about private placement transactions" related to the issuer rather than the broker-dealer. Additionally, FINRA found the firm failed to update registered representatives' Form U4 filings for three customer complaints due to a "narrow interpretation" of its reporting obligations. FINRA further found that the firm failed to maintain a supervisory system reasonably designed to achieve compliance, noting that its procedures lacked guidance on "how to discern whether a ... complaint concerned the non-regulated issuer or the broker-dealer."
FINRA concluded that the firm violated FINRA Rules 2210 ("Communications with the Public"), 4511 ("General Requirements"), 4530 ("Reporting Requirements"), 3110 ("Supervision"), 2010 ("Standards of Commercial Honor and Principles of Trade"), and Article V, Section 2(c) ("Application for Registration") of FINRA’s By-Laws.
The firm agreed to (i) a censure and (ii) a $175,000 fine.
Commentary
This enforcement action should remind firms that they must carefully consider the following FINRA Rule 2210 requirements when engaging in communications regarding offerings of investment programs, and particularly when distributing marketing materials for private placement offerings:
- Target Returns. Inclusion of target returns in retail communications is prohibited under FINRA Rule 2210. FINRA Regulatory Notice 20-21 states that “retail communications concerning private placements may not project or predict returns to investors such as yields, income, dividends, capital appreciation, percentages or any other future investment performance." FINRA reasserted in FAQs on Rule 2210 that such prohibition applies to retail communications that include target returns to investors.
- Aggregate IRR. In its FAQs on Rule 2210, FINRA also made clear that, in the context of an investment program that involves both realized and unrealized holdings, inclusion of aggregate IRR for only realized holdings is considered misleading. FINRA states that "it is misleading for a communication to include metrics that combine or average the performance of only the individual realized holdings. Such metrics may mask unequal or poor returns and the results may not be representative of the ultimate performance of the unrealized holdings or the program as a whole. This is the case whether or not the total fund IRR is included."
- General Content Standards Requirements. FINRA Rule 2210(d)(1) requires that all marketing materials and other communications distributed by a broker-dealer in relation to a private placement offering "be based on principles of fair dealing and good faith...be fair and balanced, and...provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service."