In a recent regulatory notice, FINRA Notice 16-08, FINRA noted that its review of securities offering documents has revealed instances in which broker-dealers have not been complying with the contingency offering requirements of Rules 10b-9 and 15c2-4 under the Securities Exchange Act of 1934. The most common type of contingency offerings are referred to as “all-or-none” or “part-or none” offerings that require all or a certain amount of the securities to be sold for the offering to close. Under Rule 10b-9, a best efforts offering subject to an “all-or-none” or “part-or-none” contingency must provide for the prompt return of investor funds in the event the contingency fails to be met by a specific date. Rule 15c2-4 requires that upon receiving money or other consideration from an investor in a contingency offering, a broker-dealer promptly: (1) deposits the funds into a separate bank account for which the broker-dealer is the account holder and is designated as agent or trustee for the investors; or (2) transmits the funds to a bank that has agreed in writing to act as the escrow agent for the offering.
A broker-dealer that participates in an offering and recommends a security must, among other things, conduct a reasonable investigation of the security and the issuer’s representations about it. In a contingency offering, this includes an investigation of the terms of the contingency as well as ensuring that the escrow agreement and the offering document are consistent as they relate to the terms of the contingency. Broker-dealers should also watch for an issuer’s attempt to use non-bona fide sales in order to claim that an offering has met its contingency. In general, “non-bona fide sales” are sales of undisclosed purchases by the issuer or broker-dealer, their affiliates or associated persons that create the appearance of a successful completion of the contingency.
In addition, broker-dealers that participate in contingency offerings must safeguard investors’ funds that they receive until the contingency is satisfied. If the contingency is not satisfied, the broker-dealer is responsible for ensuring that the investors’ funds are promptly refunded. If the contingency offering has an escrow agent, the escrow agreement must be made with a bank that is unaffiliated with the broker-dealer and the issuer and the escrow account should be established before the broker-dealer receives any investor funds. Under Rule 15c2-4(b) a broker-dealer participating in a contingency offering must promptly transmit funds to either an escrow agent or a separate bank account. The term “promptly” has generally been interpreted to mean by noon of the next business day. However, the broker-dealer’s responsibility continues after it transmits the investors funds. The broker-dealer is also responsible for promptly refunding investors’ funds if the contingency is not met.
In light of FINRA’s renewed interest in contingency offerings, broker-dealers that do participate in such offerings should review their policies and procedures governing contingency offerings to ensure that they adequately reflect the SEC rules and FINRA guidance highlighted in FINRA Notice 16-08.