Due Diligence ‘Kicking the Tires’ on an Investment

Before an investment can be offered to investors a licensed FINRA broker dealer has an affirmative obligation to investigate the product being sold. For large cap publicly traded stocks the investigation might simply be insuring the company is current in its SEC filings. For private placement investments, the due diligence requirement is more substantial.

On private placement investments like REITs, oil and gas programs and other “con conventional investments, broker dealers have an affirmative duty to challenge the assumptions in the offering documents provided by the sponsor of the investments. This might entail hiring an independent company to review the financials, visiting the company’s headquarters or place of business site to “eyeball” the operations, and a reviewing credit reports, the track record of the sponsor, and any other documents to help gain a better understanding of whether the company is on sound financial footing.

It is not sufficient for a broker dealer to simply rely on the representations and written materials provided by the sponsor, which clearly has a conflict of interest in providing the materials to a broker dealer. A broker dealer must conduct a thorough and independent investigation prior to offering a private placement to investors. FINRA Notices to Members NTM 03-71, NTM 05-18 and NTM 10-22 all discuss the duties of broker dealers to undertake a vigorous investigation into the investments they approve for sale.

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