Are Captive Broker-Dealers In The Tenant-In-Common (TIC) And Oil And Gas Direct Participation Industry On The Road To Extinction?

Author:Mr Stephen Burr
Profession:Foley & Lardner

The stresses in the commercial real estate and oil and gas industries in the recent past have required the full concentration of sponsors, broker-dealers, and investors in the direct participation private placement market. Much of this product, particularly commercial real estate and oil and gas royalty interests, is sold through the TIC distribution channel.

While the sponsors, broker-dealers, and investors have been forced to focus more on resolving existing problems than on new sales or planning for the future, some observers of the problems, notably government regulators and or quasi-governmental regulators such as the SEC and FINRA, have increasingly focused on tightening the controls on participants in the private placement marketplace. While some of these regulatory initiatives may provide necessary curbs on abuses, others may cast too wide a net and produce unintended consequences, or consequences that are greater than is necessary to curb alleged abuses.

One example of this may be the recent adoption of FINRA Rule 5122 (Rule) relating to private placements of securities by "a Member Firm," i.e., a broker-dealer issuing securities in itself or by a "Control Entity." (See FINRA Regulatory Notice 09-27)

The thrust of the Rule is to require that 85 percent of the proceeds of a "Member Private Offering" must be used "for business purposes, which shall not include offering costs, discounts, commissions, or other cash or non-cash sales incentives." The term Member Private Offering includes a private placement of securities by a "Control Entity" of a broker-dealer. There are two definitions for "Control." The first is beneficial ownership of more than 50 percent of the outstanding voting securities of a corporation. The second is the right to more than 50 percent of the distributable profits or losses of a partnership or non-corporate entity. Both tests are determined "immediately following each closing."

The Rule clearly appears to apply to offerings by a broker-dealer of its own securities or of securities issued by an affiliate where the affiliate will retain more than 50 percent of the voting securities or the right to more than 50 percent of the distributable profits of the broker-dealer or broker-dealer affiliate after the closing. This does not appear to pose a problem for an offering by a pre-closing affiliated entity, i.e., the typical real estate or oil and gas offering of interests in a partnership or LLC where after the...

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