Evergreen Guide: Broker-Dealer Due Diligence Obligations in Regulation D Offerings

Overview

Private placements under Regulation D of the Securities Act of 1933 remain a critical avenue for capital formation, particularly among early-stage and smaller companies. Despite their exemption from registration, these offerings are not exempt from the antifraud provisions of the federal securities laws. Broker-dealers that recommend Regulation D securities must undertake a reasonable investigation into the offering, the issuer, and the surrounding circumstances. This obligation stems from SEC and FINRA rules and is central to satisfying suitability, antifraud, and supervisory compliance requirements.

This guide summarizes the regulatory foundation and outlines best practices for broker-dealers conducting due diligence in Regulation D offerings, with particular reference to FINRA Regulatory Notice 10-22.

Key Legal and Regulatory Framework

  • Securities Act of 1933 – Section 17(a)

  • Securities Exchange Act of 1934 – Section 10(b) and Rule 10b-5

  • FINRA Rules:

    • Rule 2010 (Standards of Commercial Honor)

    • Rule 2020 (Fraudulent Conduct)

    • Rule 2111 (Suitability)

    • Rule 3110 (Supervision)

  • Relevant Predecessor NASD Rules: 2210, 2310, 3010

The Duty to Conduct a Reasonable Investigation

Broker-dealers are fiduciaries of investor trust. When recommending a private placement, they implicitly represent that they have conducted a reasonable investigation and reached informed conclusions. Failure to perform adequate diligence exposes the firm to regulatory sanctions, civil liability, and reputational damage.

Factors influencing the scope of the investigation include:

  • The size, stability, and business model of the issuer

  • The role of the broker-dealer in the offering (e.g., syndicate member vs. underwriter)

  • Whether the broker-dealer is affiliated with the issuer

  • The sophistication of the target investor (retail vs. institutional)

  • Presence of any red flags

Red flags demand heightened scrutiny and must be independently investigated. Blind reliance on the issuer, its counsel, or promotional materials is not sufficient.

Suitability Obligations

Under FINRA Rule 2111, suitability analysis entails:

  1. Reasonable Basis Suitability – Determining that the investment is suitable for at least some investors, based on an investigation into the product.

  2. Customer-Specific Suitability – Determining that the investment is suitable for the specific customer based on their profile, including income, net worth, investment objectives, risk tolerance, and liquidity needs.

Being an accredited investor does not automatically make a private placement suitable. Broker-dealers must ensure that investors understand the risks and have the capacity to bear them.

Core Areas of Inquiry for Due Diligence

Broker-dealers must tailor their diligence to each offering but generally should include the following areas:

1. Issuer and Management

  • Governance documents (charters, bylaws, partnership agreements)

  • Financial statements and audit letters

  • Management biographies and track records

  • Compensation structure and potential conflicts of interest

  • Regulatory or litigation history

  • Prior offering performance

2. Business Prospects

  • Industry outlook and regulatory landscape

  • Competitive position

  • Business plans and financial models

  • Underlying assumptions behind revenue and growth projections

3. Assets and Use of Proceeds

  • Physical inspections (if applicable)

  • Key contracts, leases, and IP rights

  • Plans for the use of offering proceeds and assessment of alignment with business strategy

Responding to Red Flags

Any material omission, inconsistency, or refusal to provide information may constitute a red flag. Examples include:

  • Overly optimistic projections unsupported by data

  • Incomplete or stale financials

  • Unwillingness to provide a private placement memorandum

  • Unexplained delays or inconsistencies in disclosure

Broker-dealers must not rely solely on issuer representations or third-party opinions in the face of red flags. Independent corroboration is required.

Documentation and Supervision

Broker-dealers must retain documentation evidencing the diligence process, including:

  • Due diligence memos

  • Meeting notes with management

  • Review summaries of financial and legal documents

  • Records of red flags identified and resolved

Supervisory systems must be designed under FINRA Rule 3110 to ensure:

  • Diligence processes are rigorously followed

  • Representatives understand and implement suitability obligations

  • Communications and offering materials are compliant with Rule 2210 standards

Leveraging Experts and Syndicates

Broker-dealers may engage outside counsel, consultants, or rely on syndicate managers—but such reliance must be reasonable and does not absolve the firm of responsibility. Where reliance is placed on others, the broker-dealer should:

  • Evaluate qualifications and independence of the third party

  • Ensure thoroughness of investigation

  • Confirm that key diligence areas are not overlooked

Conclusion

Regulation D offerings play a critical role in capital formation but demand rigorous diligence from broker-dealers. Firms that approach each offering with a bespoke, documented, and skeptical investigative process are best positioned to satisfy regulatory obligations and protect investor interests.

For further guidance or compliance strategy design, consult experienced securities counsel.

* * *

Attorney Advertising—Anderson P.C. is a U.S. law firm and provides this information as a service to clients, prospective clients, and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.

Anderson P.C. is a boutique law firm dedicated to defending clients in government investigations and securities enforcement actions initiated by the SEC, FINRA, DOJ, and other regulatory bodies. We provide focused, strategic counsel and regulatory guidance across the full spectrum of federal laws and regulations affecting broker-dealers, investment advisers, banks, asset managers, private funds, public companies, senior executives, and digital assets. Our deep expertise allows us to navigate complex legal challenges and deliver results-driven solutions tailored to our clients' unique needs.

If you have any questions or need legal assistance related to government investigations, securities enforcement actions, or regulatory compliance, please don't hesitate to contact us. Our team at Anderson P.C. is here to provide the expert guidance and support you need to navigate these complex challenges.

Next
Next

FINRA Proposes Modernization of Rules Governing Member Firm Workplaces