What is a “Reasonable Investigation” of a Regional Center Project?

As a registered representative of a broker/dealer firm, I am obligated to follow the Financial Industry Regulatory Association’s (“FINRA”) guidance when investigating private placement offerings such as those offered by EB-5 Regional centers. A “reasonable investigation” is defined in  FINRA Regulatory Notice 10-22. My checklist for compliance with this rule appears at EB-5 Analytics Checklist for Compliance with FINRA Regulatory Notice 10-22, and in text version below.

A.   Antifraud Provisions and FINRA Rules

____ Disclosed lack of essential information as well as the risks that arise from lack of information

____ Exercised a high degree of care in investigating and independently verifying an issuer’s representations and claims

____ Regarding new speculative ventures, was particularly careful in verifying the issuer’s obviously self-serving statements

 

B.  FINRA Suitability Obligations

___  Had reasonable grounds to believe that a recommendation to purchase, sell or exchange a security is suitable for the customer

____  Conducted a suitability analysis when recommending securities to both accredited and non- accredited investors that will take into account the investors’ knowledge and experience

____  Made reasonable efforts to gather and analyze information about the customer’s other holdings, financial situation and needs, tax status, investment objectives and such other information that would enable the firm to make its suitability determination

____  Is satisfied that the customer fully understands the risks involved and is able to take those risks

Conducted, at a minimum, a reasonable investigation concerning:

____ the issuer and its management;

____ the business prospects of the issuer;

____ the assets held by or to be acquired by the issuer;

____ the claims being made;  and

____ the intended use of proceeds of the offering.

____  Conducted a reasonable investigation in connection with each offering, notwithstanding that a subsequent offering may be for the same issuer

C.  Specific Issues Related to a BD’s Responsibilities

____  Identified and conducted independent investigation of any red flags

____  Identified and conducted further, independent investigation of substantial adverse information about the issuer

____  Disclosed adverse information about issuer

____  Disclosed conflicts of interest where present between broker/dealer and customer

___   Carefully reviewed the qualifications and competency of counsel or experts retained to perform an investigation on its behalf

___   Separately addressed all gaps or omissions in the investigation by counsel or experts

___   Conducted further investigation of issues and concerns identified in the counsel’s or expert’s report

D.  Supervision

Firm ensured that the firm’s personnel, including its registered representatives:

___  Engaged in an inquiry that is sufficiently rigorous to comply with their legal and regulatory requirements

___  Performed the analysis required by NASD Rule 2310

___  Qualified their customers as eligible to purchase securities offered pursuant to Regulation D

___   Did not violate the antifraud provisions of the federal securities laws or FINRA rules in connection with their preparation or distribution of offering documents or sales literature

E.  Documentation of Reasonable Investigation

Descriptions of the meetings that were conducted in the course of the investigation, including meetings with the issuer or other parties, showing:

___ tasks performed the documents and other information reviewed

___ results of such reviews,

___ date such events occurred

___ individuals who attended the meetings or conducted the reviews.

Reasonable Investigation Practices

A.   Issuer and Management

___   Examined the issuer’s governing documents, including any charter, bylaws and partnership agreement, noting particularly the amount of its authorized stock and any restriction on its activities. If the issuer is a corporation, a broker/dealer might determine whether it has perpetual existence

___   Examined historical financial statements of the issuer and its affiliates, with particular focus, if available, on financial statements that have been audited by an independent certified public accountant and auditor letters to management

___   Looked for any trends indicated by the financial statements

___   Inquired about the business of affiliates of the issuer and the extent to which any cash needs or other expectations for the affiliate might affect the business prospects of the issuer

___   Inquired about internal audit controls of the issuer

___   Contacted customers and suppliers regarding their dealing with the issuer

___   Reviewed the issuer’s contracts, leases, mortgages, financing arrangements, contractual arrangements between the issuer and its management, employment agreements and stock option plans

___   Inquired about past securities offerings by the issuer and the degree of their success while keeping in mind that simply because a certain product or sponsor historically met obligations to investors, there are no guarantees that it will continue to do so, particularly if the issuer has been dependent on continuously raising new capital

___   Inquired about pending litigation of the issuer or its affiliates

____  Inquired about previous or potential regulatory or disciplinary problems of the issuer

____   Requested credit check of the issuer

Made reasonable inquiries concerning the issuer’s management, including:

___  Expertise of management for the issuer’s business

___  The extent to which management has changed or is expected to change

___  Any regulatory or disciplinary history on the part of management

___  Any loans or other transactions between the issuer or its affiliates and members of management that might be inappropriate or might otherwise affect the issuer’s business

___   Inquired about the forms and amount of management compensation, who determines the compensation and the extent to which the forms of compensation could present serious conflicts of interest

___   Inquiring about the length of time that the issuer has been in business and whether the focus of its business is expected to change

B.   Issuer’s Business Prospects

Reasonable investigations of the issuer’s business prospects, and the relationship of those prospects to the proposed price of the securities being offered, might include:

___   Inquired about the viability of any patent or other intellectual property rights held by the issuer

___   Inquired about the industry in which the issuer conducts its business, the prospects for that industry, any existing or potential regulatory restrictions on that business and the competitive position of the issuer

___   Requested any business plan, business model or other description of the business intentions of the issuer and its management and their expectations for the business

___  Analyzed management’s assumptions upon which any business forecast is based

___   Tested models with information from representative assets to validate projected returns, break-even points and similar information provided to investor

___  Requested financial models used to generate projections or targeted returns

___   Maintained in the BD’s files a summary of the analysis that was performed on financial models provided by the issuer that detailed the results of any stress tests performed on the issuer’s assumptions and projections

C.    Issuer’s Assets

___  Visited and inspected a sample of the issuer’s assets and facilities

___  Determined whether the value of assets reflected in the financial statements are reasonable

___  Determined that management’s assertions concerning the condition of the issuer’s physical plants and the adequacy of its equipment are accurate

___   Carefully examined any geological, land use, engineering or other reports by third-party experts that may raise red flags

___  Obtained, with respect to energy development and exploration programs, expert opinions from engineers, geologists and others are necessary as a basis for determining the suitability of the investment prior to recommending the security to investors

___  Adopted practices specifically tailored to current offering to ensure adequate investigation

 

 


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