The opinion of the SEC in KCD Financial Inc. upholds a FINRA disciplinary action against a FINRA member broker-dealer that sold securities in a private placement when no exemption from registration was available. KCD’s Dallas office also did business under the name Westmount Realty Finance LLC. Testimony indicated that Westmount Realty Finance had an “issuer side” that put together offerings and a “FINRA sales side” comprised of a “captive” team of registered representatives who sold no securities other than those offered by Westmount Realty Finance.
Westmount Realty Finance sponsored an offering of the WRF Distressed Residential Fund 2011, LLC (the “WRF Fund” or the “Fund”). The PPM stated that the offer and sale of interests in the Fund were being offered only to persons who were accredited investors as set forth in Regulation D. In a Notice of Exempt Offering of Securities it filed with the SEC, the WRF Fund claimed that the offering was exempt pursuant to Rule 506 under Regulation D. After the PPM and associated documents were completed, KCD sent e-mails to approximately 1,200 individual accredited investors and registered investment advisors in KCD’s database of preexisting investors, informing them that the new offering was available.
Before KCD’s registered representatives had sold any interests in the WRF Fund, two Dallas newspapers published articles about the WRF Fund, based on a press release issued by Westmount Realty Finance. Both articles were generally available without restriction on the websites of the respective newspapers. The attorney that drafted the PPM learned of the newspaper articles, and contacted the Senior Vice-President of capital markets for Westmount Realty Finance, who was also the branch manager of the Dallas office. The attorney advised the Senior Vice-President that the articles were a “breach of the prohibition against general solicitation.” The attorney also warned the Senior Vice President not to post the Dallas Business Journal article on “the Westmount website,” apparently referring to a website maintained by Westmount Realty Capital, LLC (“WRC”), an affiliate of Westmount Realty Finance.
The Senior Vice-President promptly telephoned the Chief Compliance Officer to tell him about the attorney’s concerns. Rather than terminating the offering, the Senior Vice-President and the Chief Compliance Officer decided to tell the representatives that if anyone who did not have a prior business relationship with Westmount Realty Finance or KCD contacted them about the WRF Fund, they should ask how that person learned about the offering. If the potential investor learned of the offering from a newspaper article, the representatives were not to let that person invest. At least one potential investor who had learned about the offering from a news article was told by a representative that he could not participate in the offering.
The newspaper articles were published on an unrestricted portion of the WRC website. During a FINRA examination of KCD in the fall of 2011, a FINRA examiner found that the articles were still posted on the WRC website. KCD registered representatives first sold interests in the WRF Fund on May 5, 2011, nine days after the newspaper articles were published. Sales continued until at least October 2011.
The SEC found that the newspaper articles published on WRC’s website were designed to arouse public interest in the WRF Fund offering and therefore constituted offers. The articles were based on a press release issued by Westmount Realty Finance, the promoter of the WRF Fund, and sought to draw attention to the Fund. They cast the Fund’s objective in a favorable light, stating that the United States was “experiencing record-level foreclosure activity” and predicting a bright future for the Fund.
KCD argued that the articles were “not even aimed at investors, but at owners of distressed residential properties from whom the WRF Fund sought to purchase investment properties.” The SEC found that even if the articles were designed in part to alert potential sellers of distressed properties to the WRF Fund’s possible interest, that did not preclude the articles from also constituting offers.
KCD also argued that it did not use the articles to offer or sell securities because it took steps to insure that all sales were to accredited investors with whom the firm had a prior relationship. The SEC found that whether the purchasers were accredited or had a prior relationship to the firm is irrelevant to whether or not the newspaper articles constituted a general solicitation for purposes of Regulation D.
Finally, KCD argued that a letter from Commission staff stating that the staff did not intend to recommend enforcement action against Westmount Realty Capital after an investigation that allegedly encompassed the WRF Fund offering suggested that the staff determined that the WRF Fund investors were accredited and had a pre-existing relationship with KCD or Westmount Realty Finance. The Commission’s opinion states whether the investors were accredited or had such a pre-existing relationship was irrelevant because Rule 506 was not available where, as here, there was a general solicitation. In any case, staff letters advising that an investigation has been terminated without recommending enforcement action do not establish that no violations of the securities laws occurred.