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All Or None Escrow Mess Seems A Hopeless Situation

June 18, 2015

Many industry participants think that they understand the regulatory nuances of an All-Or-None offering. Yeah, right. In the end, some AONs wind up a hopeless mess of a busted deal and follow-on regulatory sanctions. All of which recalls the lyrics of Pearl Jam's "All Or None":

It's a hopeless... situation
And I'm starting to believe
That this hopeless... situation
Is what I'm trying to achieve

Consider a recent FINRA regulatory settlement involving All-Or-None offerings. Maybe we can get Eddie Vedder to sing about it?

Case In Point

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Core Financial, LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Core Financial, LLC, Respondent (AWC  # 2014039217201, June 4, 2015).

Since 2010, Core Financial, LLC has been a registered broker-dealer, which employs six registered representatives at one branch office. Core Financial's primary business is acting as a placement agent for private real estate syndications structured as direct participation programs, also known in industry lingo as DPPs. The AWC asserts that Core Financial had no prior relevant disciplinary history.

AONs

The AWC asserts that during the relevant period between November 2010 and February 2014, Core Financial acted as a placement agent for six contingent offerings of securities issued by the firm's affiliated companies. These contingent offerings were of the All Or None ("AON") variety.

Broker-dealers selling AONs must comply with SEC Rules 10b-9 and 15c2-4 [Ed: yellow highlighting provided]:

§ 240.10b-9 Prohibited representations in connection with certain offerings.

(a) It shall constitute a manipulative or deception device or contrivance, as used in section 10(b) of the Act, for any person, directly or indirectly, in connection with the offer or sale of any security, to make any representation:

(1) To the effect that the security is being offered or sold on an "all-or-none" basis, unless the security is part of an offering or distribution being made on the condition that all or a specified amount of the consideration paid for such security will be promptly refunded to the purchaser unless (i) all of the securities being offered are sold at a specified price within a specified time, and (ii) the total amount due to the seller is received by him by a specified date; or

(2) To the effect that the security is being offered or sold on any other basis whereby all or part of the consideration paid for any such security will be refunded to the purchaser if all or some of the securities are not sold, unless the security is part of an offering or distribution being made on the condition that all or a specified part of the consideration paid for such security will be promptly refunded to the purchaser unless (i) a specified number of units of the security are sold at a specified price within a specified time, and (ii) the total amount due to the seller is received by him by a specified date.

(b) This rule shall not apply to any offer or sale of securities as to which the seller has a firm commitment from underwriters or others (subject only to customary conditions precedent, including "market outs") for the purchase of all the securities being offered.

§ 240.15c2-4 Transmission or maintenance of payments received in connection with underwritings.

It shall constitute a "fraudulent, deceptive, or manipulative act or practice" as used in section 15(c)(2) of the Act, for any broker, dealer or municipal securities dealer participating in any distribution of securities, other than a firm-commitment underwriting, to accept any part of the sale price of any security being distributed unless:

(a) The money or other consideration received is promptly transmitted to the persons entitled thereto; or

(b) If the distribution is being made on an "all-or-none" basis, or on any other basis which contemplates that payment is not to be made to the person on whose behalf the distribution is being made until some further event or contingency occurs, (1) the money or other consideration received is promptly deposited in a separate bank account, as agent or trustee for the persons who have the beneficial interests therein, until the appropriate event or contingency has occurred, and then the funds are promptly transmitted or returned to the persons entitled thereto, or (2) all such funds are promptly transmitted to a bank which has agreed in writing to hold all such funds in escrow for the persons who have the beneficial interests therein and to transmit or return such funds directly to the persons entitled thereto when the appropriate event or contingency has occurred.

AON Recap

Federal rules define an AON offering as one based upon an offering/distribution conditioned on a threshold requirement that:
  • all or a specified amount of the consideration paid for such security
  • will be promptly refunded to the purchaser unless
    • the securities are sold at a specified price within a specified time, and
    • the total amount due to the seller is received by him by a specified date.
Federal rules further provide that payment is not to be made to the person on whose behalf the AON distribution until the designated contingency occurs. In the interim, received funds are to be promptly deposited in a:
  • separate bank account, as agent or trustee for the persons who have the beneficial interests; or
  • bank which has agreed in writing to hold all such funds in escrow for the persons who have the beneficial interests.
NOTE: So-called "$5,000 Broker Dealers" -- those with a minimum $5,000 Net Capital requirement pursuant to SEC Rule 15c3-1(a)(2)(vi) -- must resort to the bank escrow option (#2 above).

SIDE BAR: $5,000 Broker Dealers are subject to certain restrictions on the extent of their business and do not:
  • receive or hold funds or securities for, or owe funds or securities to, customers; and
  • carry accounts of or for customers (generally accounts are carried by "clearing" firms for these "introducing" firms).
Escr-Ow!

The AWC alleges that during the relevant period between November 2010 and February 2014, Core Financial was "$5,000 broker-dealer" and should have transmitted funds to a compliant bank escrow account for each of the subject AONs. Contrary to its obligations, Core Financial purportedly deposited investor funds into an escrow account for which the escrow agent was not the bank but an individual who was both the firm's attorney and the issuer's attorney, in violation of SEC Rule 15c2-4 and FINRA Rule 2010.

(Aw)Fully Paid

In connection with two of AONs, the AWC asserts that although Core Financial sold all of the securities required to be placed in bona fide transactions, the securities were not "fully paid for" within the specified period in violation of SEC Rule 10b-9 and FINRA Rule 2010. Allegedly, Core Financially substituted its own funds for funds not yet received from an investor. That substitution-payment apparently gave the firm the false impression that it could close the two cited AONs and release proceeds from the escrow and transmit to the issuer. In fact, the AWC deemed the substitution as not constituting a timely full-payment by the investor and, as such, the immediate termination of the offerings was required with the prompt return of escrowed funds to the investors.

Sanctions

In accordance with the terms of the AWC, FINRA imposed upon Core Financial a Censure and $17,500 fine.

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