Recent FINRA Decisions Shows FINRA Hearing Can Lead to Fines, Expulsion

In Dept. of Enforcement v. Red River Securities, LLC and Keith Hardwick, a complaint was raised due to the sale of certain joint venture interests in oil and gas operations. A threshold question in the matter was whether the joint venture interest could be considered a security. Generally, joint venture interests are not considered to be securities. However, in this instance, the board found that  “the general partnership interests are securities because the investors could not exercise ultimate control, as a majority, over the joint ventures’ business activities.” Baltimore business attorney William S. Heyman explains:

FINRA and Fines

Following this threshold question, the board turned its attention to whether the marketing and written materials utilized by Red River contained misrepresentations and omissions. If so, the board would then determine if the misrepresentation or omissions were fraudulent in nature. The alleged misrepresentations include:

• Red River failed to update marketing materials to accurately reflect that wells were still producing oil when they had already been shut down.
• Red River failed to disclose Authorizations for Expenditure.
• The company misrepresented the amount of income delivered to investors in similar projects.
• The company failed to disclose conflicts of interest.
• A well’s “wildcat” (unproven and exploratory) status was not disclosed.
• The company concealed it participation in writing a report that it claimed was prepared by an independent geologist.  

The board found that Red River and Hardwick engaged in intentional material representations regarding its marketing and sales of the securities. The panel noted that these investments were high-risk citing to the above allegations and finding that Red River and Hardwick engaged in misrepresentations regarding each.

In two particular instances, the board found that the security did not meet the suitability standard. In one instance, the investment was recommended to a 74-year-old farmer and dog breeder with a net worth of $2 million, liquidity of $20,000, and $150,000 in annual income. The board found the investment cost of $94,754 into a high-risk endeavor unsuitable for this individual. The investment was far too aggressive and consumed more than half of the individual’s annual income.

What Penalties did Company and CEO Face?

The FINRA board ordered Red River and Hardwick to jointly and severally re-pay $24.6 million in restitution to customers affected by the fraudulent sales of five oil and gas joint ventures. Furthermore, the panel ordered Red River Securities expelled and barred the company’s CEO from future activities in this field.

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One reason for the harsh penalties is the fact that the FINRA board found the misrepresentations to be “egregious.” The board noted that the company did not develop, implement, or enforce any system that would create necessary controls to detect and prevent fraudulent actions. Furthermore, the board also expressed surprise at “the extent of the respondents’ monetary gain” which included more than $3.5 million in due diligence fees.

For help with your business or legal issue, contact Maryland fiduciary litigation lawyer William S. Heyman.