State securities regulators are asking Congress for expanded powers to review offerings of private securities.
State securities regulators are asking Congress for expanded powers to review offerings of private securities.
They say these offerings, which are exempt from Securities and Exchange Commission registration under a safe-harbor provision known as Regulation D, can be an open invitation for fraudsters.
Stanford Group Co.'s Stanford International Bank Ltd. of Antigua, West Indies, for example, raised money for its allegedly fraudulent certificates of deposit through a Reg D offering. Stanford Group is located in Houston.
Many hedge funds use these private placements to raise money.
Reg D offerings are generally limited to wealthier investors and cannot be marketed to the general public.
The recent spate of scandals didn't spark the latest effort by state regulators, who have long sought to regain powers they previously had to review Reg D deals and keep known bad actors from raising money.
Those powers were taken away from them by the National Securities Market Improvement Act of 1996, which harmonized rules and limited states to enforcing anti-fraud laws.
But with broad regulatory reform now on the table, state regulators have been pushing to regain lost ground.
"I'm hopeful Congress will revisit it," said Rex Staples, general counsel of the North American Securities Administrators Association Inc. of Washington.
"It's always a possibility, now that attention has been drawn to [the issue]," he said.
Meanwhile, a March 31 report from the SEC inspector general's office has given states some ammunition.
The report confirmed what state regulators have been saying all along: that the SEC does not review the more than 20,000 Reg D filings that it receives every year, and has done little to follow up on questionable offerings.
The SEC "has never brought a single action against a company for ... not filing a Form D," said the inspector general's report, which added that the commission relies upon the "honor system" for compliance.
Last year, private deals under Reg D raised an estimated $609 billion, the report said.
"We think [the Reg D forms] should be reviewed routinely," said James Ropp, securities commissioner for the state of Delaware in Wilmington, who heads NASAA's enforcement section.
"If federal regulators don't have the manpower to do it, then the states should," he said.
Last month, Mr. Ropp told the House Committee on Financial Services that federal law should be changed to allow state regulators to scrutinize Reg D offerings for signs of potential abuse.
Also last month, NASAA president and Colorado securities commissioner Fred Joseph delivered the same message to the Senate Banking Committee.
Since the National Securities Market Improvement Act was passed, states have seen a "steady and significant rise in [Reg D deals] that are later discovered to be fraudulent," Mr. Joseph testified at a banking committee hearing.
The inspector general's report recommended that the SEC consider approving a proposed rule that would let the commission keep repeat violators from participating in Reg D offerings.
That action would formally give the SEC power the states used to possess.
The SEC had an early intervention program to stop abuses of Reg D, the report said, but that program ended in 2005 due to lack of staffing.
Even if the SEC gets the authority to stop bad actors, the commission still may not step up its review of Reg D filings, even if it gets more money, Mr. Staples said.
"Reg D has been a zero priority at the commission," he said.
SEC spokesman John Nester declined to comment.
Industry observers doubt that more state oversight will prevent Reg D abuse.
Unless an offering memorandum for a deal "says flat out that it's a Ponzi scheme, how do you know it's a fraud?" said Alan Parness, counsel at Cadwalader Wickersham & Taft LLP in New York.
"That doesn't mean no one should attempt to reduce the fraud," Mr. Staples said."Why put more police on the homicide beat if it doesn't prevent all murders?"
Greater state regulation will just make offerings more expensive and cause delays, Mr. Parness said."The whole reason for NSMIA [was] the lack of uniformity" among the states in reviewing private placements, he said.
Before 1996, when the new law was passed, states varied on the timing of when an offering had to be filed, what materials had to be provided to states, and the type and scope of review, industry lawyers said.
"They were all over the map," Mr. Parness said.
Now, aside from some "minor differences," states are "about as uniform as can be as far as Reg D filings go," Mr. Staples said.
State reviews were also a help to issuers, who would often make technical mistakes, he added.
Industry observers say that states can still use Reg D to chase questionable promoters.
Reg D filings identify the firms selling deals and what they are being paid, which can help spot possible frauds, said Jack Hollander, chairman of the Investment Program Association, a Washington trade group for direct-participation programs.
States can nail an offerer for failure to disclose material information, such as past disciplinary problems, Mr. Parness said.
But Mr. Ropp said that "unless there's evidence of fraud, we're pretty much hamstrung."
E-mail Dan Jamieson at djamieson@investmentnews.com.
