In the wake of recent disastrous blowups of high-commission private placements, some broker-dealers are anxious about whether their advisers should sell the offerings.
In the wake of recent disastrous blowups of high-commission private placements, some broker-dealers are anxious about whether their advisers should sell the offerings.
Independent broker-dealers have long been a conduit for such deals, and firms that package and sell private oil-and-gas or real estate partnerships depend on the channel for access to capital from individual investors.
As a result, private placements are for many independent broker-dealers and their representatives what hedge funds or funds of hedge funds are for wirehouses and their clients: products that offer cachet, exclusivity and promises of high returns. At the same time, however, private placements carry risk, are often illiquid and lack transparency.
They are also lightly regulated, receive little oversight and are often meant to be sold to wealthy “accredited” investors — who may be charged loads of as much as 30%.
When the stock market hit its peak in October 2007 and then began its descent, many independent broker-dealers decided that private partnerships were suited to clients who wanted an investment uncorrelated with the stock market.
However, since the Securities and Exchange Commission in July leveled charges of fraud at two highly popular private deals — involving Medical Capital Holdings Inc. and Provident Royalties LLC — that raised $2.7 billion, executives with broker-dealers started to scrutinize private partnerships more than ever, at times causing friction be-tween the firms that create the deals and those that sell them.
“The suitability of products and the sales practices are under much more scrutiny,” said David Levine, executive vice president of Gunn-Allen Financial Inc. He said his firm has implemented a more rigorous process of presenting such investments to an internal group that assesses risk.
New offerings are being more closely scrutinized, and broker-dealers are skittish, another executive said.
“We've done a lot of due diligence, and we'll do more due diligence. You can't go with new guys,” said Mark Goldwasser, chief executive of National Holdings Corp. “
“We need transparency, and we need accounting, or else the [private-placement] industry will be in a lot of trouble,” he said.
The shift in the market for private placements could also signal a cultural change for some small or independent broker-dealers, one compliance executive noted.
“Unregistered offerings can blow up on a firm fast,” said Carrie Wisniewski, president of B/D Compliance Associates Inc., which provides consulting services to broker-dealers and investment advisers. Executives and reps with broker-dealers often think such disasters will never happen to them, she said.
“In the past, brokers could talk firms into selling deals,” she said. “Now firms are much more timid.”
GREATER DEMANDS
One oil-and-gas executive who sells private partnerships finds that broker-dealers are requiring more information from the issuers of the partnerships.
Broker-dealers “are demanding third-party reports and more due diligence,” said Michael Windisch, chief financial officer of NGAS Resources Inc., which focuses on natural-gas exploration in the eastern half of the United States. “You pay for [the report], but you don't know what it will say until it's published.”
Mr. Windisch said that the loads for NGAS deals range from 20% to 30%, but in-vestors in exploration of natural resources can get big tax breaks under certain Internal Revenue Service codes.
Many broker-dealers have likely had clients in bad deals, he said.
“They're being more cautious, and I can't blame them,” Mr. Windisch said.
Oil-and-gas firms bringing private deals to the market are extremely sensitive to broker-dealers' and investors' perceptions that link them to faulty deals. In July, days after the SEC charged Provident Royalties LLC with fraud, the chief executive of Noble Royalties Inc. sent a letter to broker-dealers and advisers which warned them about the market.
“Noble has always raised questions about the Provident model, as it lured investors into its programs with a 15% to 18% “dividend” for a period of years ... Several other drillers still in our energy space” employ similar come-ons, wrote Scott Noble, the chief executive.
“We want to continue to warn about those companies who offer "dividend options.' You cannot pay a dividend that exceeds the natural yield or profits of the business model. Early dividend options are used as bait and mask the true yield of the underlying business; it is unsustainable.”
Mr. Noble added: “I would like to take this opportunity to comment on how Noble Royalties Inc. is a best-in-class company, and the many measures Noble Royalties Inc. takes to make sure our investors' funds are handled safely and invested properly.”
Noble is shopping a $45 million offering, Noble Royalty Access Fund Five, to broker-dealers and their reps.
Noble, which has about $1 billion in assets under management, raises money from investors and then acquires royalties from properties containing oil and gas, such as wells. The return to Noble investors comes from those royalties.
According to a filing with the SEC, Noble Royalty Access Fund Five offers a 6% commission to reps who sell the product, and 16% of the money raised — $7.2 million — is slated to be used for payments to Mr. Noble, who is general partner of the fund.
Many in the brokerage and oil-and-gas industries said such payments to the general partner are typical and used for fees and reimbursements in the search for oil wells.
When asked about the fund's fee structure, Jack Nihem, Noble Royalties' general counsel, said he would not comment about the offering.
According to market sources, Noble Royalties has a strong track record, producing an average yield over the last dozen years of 11.04% net of all fees and sales charges.
E-mail Bruce Kelly at bkelly@investmentnews.com.
