The core issue revolves around the interpretation of SEC Rule 10b-9 and its application to contingent offerings, specifically a mini-max offering. Rule 10b-9 makes it a manipulative or deceptive practice to represent that an offering is being made on a “part-or-none” basis unless the stated minimum number of securities are sold in bona fide transactions by the specified deadline. If this condition is not met, all consideration received from investors must be promptly refunded. A bona fide transaction is a sale to a genuine purchaser who is at risk for their investment. Purchases made by the issuer, sponsor, or their affiliates to close a contingency are scrutinized to ensure they are not merely a mechanism to create the appearance of a successful offering. A key factor in this determination is the nature of the purchase. A purchase financed by a non-recourse loan from an affiliate of the sponsor is generally not considered bona fide. The purchaser, in this case the sponsor, is not truly at risk because if the investment fails, the lender (an affiliate) bears the loss, not the purchaser. Furthermore, the stated intent to immediately resell the units after the escrow breaks indicates a lack of genuine investment intent and reinforces the conclusion that the purchase is a contrivance to meet the minimum. Therefore, allowing the sponsor to make this purchase would violate Rule 10b-9. The firm would be improperly breaking escrow and retaining investor funds based on non-bona fide sales. The correct action under both Rule 10b-9 and Rule 15c2-4, which governs the handling of funds in contingent offerings, is to recognize that the minimum contingency has not been met and to promptly return all funds from the escrow account to the subscribers.

The correct answer is based on the net capital requirements outlined in SEC Rule 15c3-1. A broker-dealer that does not carry customer accounts and does not receive or hold customer funds or securities can operate with a minimum net capital of $5,000. This is common for firms that exclusively participate in direct participation program offerings on a best efforts, all-or-none, or mini-max basis. A critical condition for maintaining this lower net capital status is strict adherence to procedures that prevent the firm from handling customer funds. SEC Rule 15c2-4 requires that in such contingent offerings, investor payments must be promptly transmitted to a separate bank account, as escrow agent. The proper procedure is for investors to make checks payable directly to the escrow agent or the issuer, and for the broker-dealer to merely forward these instruments. When the broker-dealer’s cashier deposits investor subscription checks into the firm’s own general operating account, the firm is considered to be receiving and holding customer funds, even if the intention is to forward them later. This action fundamentally changes the firm’s operational profile. It is no longer a firm that does not handle customer funds. As a result, it becomes subject to a significantly higher minimum net capital requirement. Specifically, a broker-dealer that engages in a general securities business and handles customer funds is typically subject to a minimum net capital requirement of $250,000. This single procedural error constitutes a major compliance failure and immediately changes the firm’s required net capital category, necessitating a report to FINRA and the SEC under Rule 17a-11.

The scenario describes a mini-max offering, which is a type of contingent offering subject to specific SEC rules. Under SEC Rule 15c2-4, in a contingent offering, all investor funds must be promptly transmitted to a separate escrow account held by an independent bank or other qualified financial institution. These funds must remain in escrow until the contingency is met. SEC Rule 10b-9 deems it a manipulative or deceptive practice to represent an offering on a contingent basis unless the offering is conducted in accordance with the stated terms. This means the minimum amount of securities must be sold to bona fide purchasers within the specified time period. If the contingency is not met by the deadline, Rule 15c2-4 requires that all subscription monies be promptly returned to the investors. In this case, the minimum contingency of $5,000,000 was not met by the 90-day deadline. Any attempt to artificially satisfy the contingency is a violation of Rule 10b-9. Arranging for an affiliate of the issuer to purchase the remaining units to meet the minimum, especially if this possibility was not disclosed in the original offering documents, is a prohibited manipulative act. It creates a false impression that the offering was successful in attracting sufficient independent interest. The only proper course of action when a contingency fails is the prompt return of all investor funds. Extending the offering period is only permissible if the offering documents allow for it and if all subscribers are given a right of rescission to have their funds returned or to reconfirm their investment for the extended period.

The proposed payment is a transaction-based fee to an unregistered individual for introducing an investor, which is a prohibited practice under FINRA rules. The calculation for the proposed fee is: \[\$2,000,000 \text{ (Investment)} \times 2\% \text{ (Fee)} = \$40,000\] Regardless of the calculated amount, the nature of this compensation is the critical issue. FINRA Rule 2040 explicitly prohibits member firms from directly or indirectly paying any compensation, fees, concessions, discounts, commissions, or other allowances to any person who is not registered with FINRA for any securities business. A “finder’s fee” or “success fee” that is contingent upon the successful completion of a securities transaction is considered transaction-based compensation. A principal’s due diligence responsibility, as outlined in FINRA Rule 2310, requires a thorough review of all aspects of the offering, including the distribution of proceeds and all compensation arrangements. Even if the sponsor makes the payment directly, the broker-dealer’s participation in the offering would be considered facilitating a prohibited payment. The principal must ensure the firm does not participate in any offering that violates these rules. Simply disclosing the payment or re-characterizing it without changing its contingent nature does not cure the violation. The principal’s primary duty is to prevent the firm’s involvement in this prohibited activity. Therefore, the arrangement must be rejected, and the sponsor must be informed that such a payment is impermissible for the broker-dealer to proceed with the offering.

First, the total underwriting compensation is calculated. This includes selling commissions, the dealer-manager fee, and wholesaling fees. \[ \text{Underwriting Compensation} = 7.0\% + 2.5\% + 1.0\% = 10.5\% \] Next, the total organization and offering (O&O) expenses are calculated. This includes all underwriting compensation plus other offering-related expenses like due diligence reimbursement and the issuer’s legal and accounting fees. \[ \text{Total O\&O Expenses} = (7.0\% + 2.5\% + 1.0\%) + 0.5\% + 4.5\% = 15.5\% \] The calculated underwriting compensation is \(10.5\%\) of the gross offering proceeds. The calculated total organization and offering expenses are \(15.5\%\) of the gross offering proceeds. According to FINRA Rule 2310, for public direct participation program offerings, there are specific and strict limits on compensation. The first limit is on underwriting compensation, which cannot exceed 10% of the gross proceeds of the offering. Underwriting compensation includes all commissions, fees, and expenses paid to member firms for their role in distributing the program. This encompasses selling commissions paid to the syndicate, fees paid to the dealer-manager, and compensation for wholesaling activities. In this scenario, the sum of these items is 10.5% of the gross offering proceeds, which is a clear violation of the 10% cap. The second, broader limit is on total organization and offering expenses, which cannot exceed 15% of the gross proceeds. This category is more inclusive and contains all underwriting compensation plus any other expenses paid by the issuer in connection with the offering. These additional expenses include items such as legal and accounting fees for structuring the program, printing costs, and reimbursements for bona fide due diligence. In this case, the sum of all listed expenses amounts to 15.5% of the gross offering proceeds. This figure also exceeds its respective regulatory cap of 15%. Therefore, the proposed compensation structure is non-compliant on two separate grounds. A principal must be able to distinguish between these two caps and correctly categorize all fees to ensure compliance.

Total subscriptions from public investors = \( \$9,500,000 \) Minimum offering contingency = \( \$10,000,000 \) Shortfall = \( \$10,000,000 – \$9,500,000 = \$500,000 \) The sponsor’s proposed purchase of \( \$500,000 \) is intended to satisfy the minimum contingency. However, this action is not permissible under these circumstances. SEC Rule 10b-9 prohibits manipulative or deceptive practices in connection with offerings represented to be on an all or none or other contingent basis. A mini-max offering is a type of contingent offering. The rule implies that the contingency must be satisfied through bona fide purchases from the public. Purchases by the issuer, sponsor, or their affiliates that are arranged to give the appearance of a successful offering when it would have otherwise failed are generally considered a violation, unless the possibility of such purchases to satisfy the contingency was fully disclosed in the offering documents. Since the prospectus did not contain this disclosure, the sponsor’s purchase would not be considered a bona fide transaction for the purpose of meeting the minimum threshold. Treating it as such would mislead the public investors who subscribed based on the premise that their funds would be returned if a certain level of genuine public interest was not achieved. Furthermore, SEC Rule 15c2-4 governs the handling of customer funds in contingent offerings. It requires that investor funds be held in a separate escrow account until the contingency is satisfied. If the contingency is not met, the funds must be promptly returned to the investors. Because the sponsor’s purchase cannot be used to legitimately satisfy the minimum offering amount, the contingency has technically failed. Therefore, the principal must direct the escrow agent to return all subscription monies to the investors. Releasing the funds to the issuer would constitute a violation of both Rule 15c2-4 and Rule 10b-9.

Step 1: Identify the core regulatory conflict. The dealer-manager has discovered a material fact (the zoning change) that makes the projections in the prospectus potentially misleading. Step 2: Recall the relevant statutory liability. Under Section 11 of the Securities Act of 1933, underwriters, which include dealer-managers in a public offering, face strict liability for material misstatements or omissions in a registration statement. Step 3: Analyze the available defense. The primary defense against Section 11 liability is the due diligence defense. This requires the underwriter to prove that, after a reasonable investigation, they had reasonable grounds to believe and did believe that the statements in the registration statement were true and that there were no material omissions. Step 4: Apply the defense to the scenario. Knowledge of the adverse zoning change and the resulting inaccuracy of the projections means the dealer-manager can no longer claim a reasonable belief in the truthfulness of the offering documents. Proceeding without correction would negate the due diligence defense. Step 5: Determine the necessary action. To re-establish a basis for the due diligence defense and comply with securities law, the dealer-manager must ensure the offering documents are corrected. The only way to do this is to stop the process and demand that the sponsor amend the registration statement and prospectus to accurately reflect the new information and its potential impact. A dealer-manager in a direct participation program offering has a significant legal obligation to perform due diligence. This duty, codified in the Securities Act of 1933, is not merely a procedural step but a fundamental responsibility to the investing public. The due diligence defense, available under Section 11, protects an underwriter from liability for material misstatements or omissions in a registration statement only if the underwriter can demonstrate it conducted a reasonable investigation into the statements made. In a situation where the dealer-manager uncovers adverse information that contradicts the disclosures in the prospectus, it has actual knowledge of a material deficiency. Continuing the offering would constitute a knowing violation. The fact that the dealer-manager is an affiliate of the sponsor creates a conflict of interest that necessitates even more rigorous adherence to due diligence standards. Simply documenting the issue internally or seeking indemnification from the sponsor is insufficient, as the dealer-manager’s duty is to the public, and such indemnification agreements are typically unenforceable as a matter of public policy in cases of securities fraud. The only proper course of action is to insist on the correction of the offering documents before any sales are made to the public.

In a “best efforts” mini-max underwriting, the offering is contingent upon a minimum amount of securities being sold by a specific date. If this minimum is not met, the offering is cancelled, and all investor funds must be promptly returned. SEC Rule 15c2-4 specifically governs the handling of these funds. The rule mandates that the broker-dealer participating in such a contingent offering must promptly transmit all investor payments to a separate bank account, acting as an escrow agent. The funds are to be held by this independent third party until the contingency is satisfied. In the described scenario, the minimum sales contingency of $10 million was successfully met within the specified 120-day offering period, as total subscriptions reached $12 million. The failure to reach the maximum offering amount of $25 million does not invalidate the offering. Once the minimum threshold is crossed, the offering is considered successful, and the deal can close. Therefore, upon the expiration of the offering period, the condition for releasing the funds has been met. The correct procedure is for the broker-dealer to direct the escrow agent to release the collected proceeds directly to the issuer, which is the program sponsor. The funds should not be returned to investors, nor should they be commingled with the broker-dealer’s own funds at any point.

The calculation to determine compliance with FINRA Rule 2310 compensation limits is as follows. First, identify and sum all components defined as “underwriting compensation”: Selling Commissions: 7.0% Dealer-Manager Fee: 2.5% Wholesaling Fees: 1.0% Total Underwriting Compensation = \(7.0\% + 2.5\% + 1.0\% = 10.5\%\) This total is compared against the FINRA limit for underwriting compensation. Calculated Underwriting Compensation: 10.5% FINRA Rule 2310 Limit: 10.0% Result: The structure is non-compliant as \(10.5\% > 10.0\%\). Second, identify and sum all components of Organization and Offering (O&O) expenses: Total Underwriting Compensation: 10.5% Bona Fide Due Diligence Reimbursement: 0.5% Issuer’s Legal and Accounting Fees: 4.5% Total O&O Expenses = \(10.5\% + 0.5\% + 4.5\% = 15.5\%\) This total is compared against the FINRA limit for total O&O expenses. Calculated O&O Expenses: 15.5% FINRA Rule 2310 Limit: 15.0% Result: The structure is also non-compliant with the O&O limit as \(15.5\% > 15.0\%\). The primary violation stems from the underwriting compensation exceeding its specific cap. FINRA Rule 2310 imposes strict limits on the compensation and expenses related to public offerings of Direct Participation Programs. There are two key caps to consider. The first is a 10% limit on total underwriting compensation. This category includes all compensation paid to member firms and their associated persons for their roles in distributing the program. It encompasses items such as selling commissions paid to the selling group, dealer-manager fees, and wholesaling fees, regardless of whether the wholesaler is an affiliate or a third party. The second key cap is a 15% limit on total Organization and Offering expenses. This is a broader category that includes all of the underwriting compensation plus other bona fide issuer costs associated with structuring and launching the offering. These additional costs typically include reimbursement for bona fide due diligence expenses, legal fees, accounting fees, and printing costs. In the given scenario, the sum of the selling commissions, the dealer-manager fee, and the wholesaling fees exceeds the 10% threshold for underwriting compensation. This is a direct violation. Consequently, because the underwriting compensation is a component of the total O&O expenses, the 15% O&O limit is also breached. The fundamental compliance failure originates with the excessive underwriting compensation.

The offering is a mini-max, which is a type of contingent offering. The controlling regulations are SEC Rule 10b-9, which prohibits manipulative practices in connection with such offerings, and SEC Rule 15c2-4, which governs the handling of investor funds. 1. Identify the contingency: The offering must raise a minimum of $5 million from bona fide purchasers by a specific deadline. 2. Analyze the situation: The offering has only raised $4.5 million from bona fide purchasers, and the deadline is imminent. 3. Evaluate the sponsor’s proposal: The sponsor proposes to use an affiliate to purchase the remaining $500,000 to meet the minimum. 4. Apply SEC Rule 10b-9: This rule requires that the conditions of the contingency (e.g., the minimum sales threshold) be met through bona fide, good-faith transactions. A purchase by an affiliate or the sponsor made solely to satisfy the minimum and allow the offering to close is not considered a bona fide sale. Such an action would render the initial representation of the offering as a mini-max a fraudulent and manipulative device, as the investing public was led to believe their funds would be returned if a certain level of genuine public interest was not achieved. 5. Apply SEC Rule 15c2-4: This rule requires that in a contingent offering, investor funds must be held in a separate escrow account. If the specified contingency is not fully satisfied by the deadline, the broker-dealer must ensure all funds are promptly returned to the subscribers. 6. Conclusion: Since the minimum threshold was not met through bona fide sales by the deadline, the contingency has failed. The principal’s only permissible action under these rules is to reject the sponsor’s manipulative proposal and ensure the prompt return of all investor funds from the escrow account. The core principle is that the integrity of the offering’s contingency must be maintained. The minimum threshold serves as a key protection for investors, indicating that the program has achieved a sufficient level of funding from genuine investors to be viable. Artificially meeting this threshold through non-bona fide purchases undermines this protection and violates federal securities laws. The broker-dealer and its principal have a direct responsibility to prevent such practices and to execute the return of funds when a contingency fails.

The total underwriting compensation is calculated by summing all compensation paid to member firms and their associated persons for selling the DPP units. This includes selling commissions paid to soliciting dealers, the dealer-manager’s fee, and any compensation paid to wholesalers, whether they are affiliated or unaffiliated. In this scenario, the calculation is as follows: Selling Commissions (\(7\%\)) + Dealer-Manager Fee (\(2\%\)) + Wholesaler Compensation (\(1.5\%\)) = \(10.5\%\). According to FINRA Rule 2310, the maximum allowable underwriting compensation for a public Direct Participation Program offering is limited to \(10\%\) of the gross offering proceeds. Since the calculated total of \(10.5\%\) exceeds this regulatory limit, the compensation structure is non-compliant. All forms of compensation paid for the distribution of the program, including fees to wholesalers, must be aggregated under this \(10\%\) cap. The reimbursement for bona fide due diligence expenses is a separate allowance and is not included in the \(10\%\) underwriting compensation calculation, but it is subject to the overall \(15\%\) limit on total Organization and Offering (O&O) expenses. The primary violation here is that the direct underwriting compensation components surpass the established \(10\%\) threshold. A principal must be able to identify and aggregate all relevant compensation items to ensure adherence to this critical rule.

In a contingent public offering of a Direct Participation Program, such as a mini-max offering, the principal of the dealer-manager has several critical, interlocking responsibilities under SEC and FINRA rules. SEC Rule 10b-9 prohibits misrepresentations about the nature of a contingent offering. To comply, the terms of the contingency, such as the minimum sales threshold, must be strictly adhered to. If the minimum is not met by the specified date, all investor funds must be promptly returned. SEC Rule 15c2-4 directly governs the handling of these investor funds. It mandates that the dealer-manager must not have access to the funds and must promptly transmit them to a separate bank account, acting as agent or trustee, or to a qualified, independent escrow agent. These funds are held for the benefit of the investors until the contingency is satisfied. Concurrently, the principal must oversee all underwriting compensation. Under FINRA Rule 2310, total underwriting compensation in a public DPP offering is generally limited to 10 percent of the gross offering proceeds. This includes all forms of compensation paid to broker-dealers, their associated persons, and others involved in the distribution. When an outside wholesaling firm is used, any payments made to that firm for its services in distributing the offering are considered underwriting compensation. The principal must ensure these payments are properly accounted for, run through the member firm’s books and records, and included within the 10 percent cap. The offering documents must accurately disclose all these arrangements, including the escrow procedures and the complete compensation structure.

A dealer-manager in a direct participation program offering has a non-delegable, affirmative duty to conduct a reasonable investigation, or due diligence, into the statements made in the offering documents. This responsibility is a cornerstone of investor protection under the Securities Act of 1933, particularly Section 11, which provides a statutory defense against liability for material misstatements or omissions if the underwriter can prove it conducted a reasonable investigation. Hiring a third-party, unaffiliated wholesaler to assist in the distribution and marketing of the DPP does not transfer or mitigate this core due diligence obligation. The dealer-manager remains the party ultimately responsible to the investing public for the veracity of the offering materials. Relying solely on a summary provided by the issuer, or on a superficial review conducted by the wholesaler, fails to meet the standard of a reasonable investigation. The dealer-manager must independently verify the material facts presented by the issuer. Therefore, if the wholesaler’s due diligence is found to be inadequate, the dealer-manager cannot use its contract with the wholesaler as a shield and remains fully exposed to potential statutory liability for any deficiencies in the offering’s disclosure. The compensation arrangement with the wholesaler is an aspect of underwriting expenses and does not alter fundamental compliance and liability responsibilities.

This scenario involves the regulations governing contingent offerings, specifically SEC Rule 10b-9 and SEC Rule 15c2-4. SEC Rule 10b-9 makes it a manipulative and deceptive practice for a person to represent that a security is being offered on a “part-or-none” (mini-max) basis unless the funds are promptly returned to investors if the stated minimum number of securities are not sold in bona fide transactions by a specified date. A core component of this rule is the requirement for sales to be bona fide. Purchases made by the issuer, sponsor, or their affiliates with the purpose of merely satisfying the contingency, especially with a pre-arranged agreement for repurchase, are not considered bona fide transactions. Such actions create a false appearance of public interest and investor demand, deceiving legitimate investors who rely on the minimum contingency as an indicator of the program’s economic viability and the sponsor’s ability to raise sufficient capital to execute the business plan. Simultaneously, SEC Rule 15c2-4 dictates the proper handling of investor funds in contingent offerings. It requires that the broker-dealer promptly transmit all investor payments to a separate bank account or a qualified third-party escrow agent. These funds must remain in escrow and be returned to the subscribers if the contingency is not successfully met. Triggering the release of these escrowed funds based on non-bona fide sales constitutes a violation of both rules. The arrangement described constitutes a fraudulent scheme to misrepresent the satisfaction of the offering’s contingency, which is a direct violation of Rule 10b-9, and it results in the improper release of funds held in escrow under Rule 15c2-4.

For a public direct participation program offering with gross proceeds of $30,000,000, FINRA Rule 2310 imposes specific limits on compensation and expenses. The total for all organization and offering expenses (O&O) is limited to 15% of the gross proceeds. Within this overall limit, there is a sub-limit for total underwriting compensation, which cannot exceed 10% of the gross proceeds. First, calculate the maximum dollar amounts for these limits: Maximum O&O Expenses: \[ \$30,000,000 \times 0.15 = \$4,500,000 \] Maximum Underwriting Compensation: \[ \$30,000,000 \times 0.10 = \$3,000,000 \] Underwriting compensation includes items such as selling commissions paid to soliciting dealers and wholesaling fees paid to individuals or firms for their role in distributing the offering. It is crucial to correctly categorize all payments to broker-dealers and their affiliates. The proposed compliant structure includes selling commissions of $2,400,000 and wholesaling fees of $450,000. The sum of these items constitutes the total underwriting compensation: Total Underwriting Compensation: \[ \$2,400,000 + \$450,000 = \$2,850,000 \] This amount is less than or equal to the $3,000,000 maximum allowed for underwriting compensation. Next, evaluate the total O&O expenses. These include all underwriting compensation plus other offering-related expenses borne by the issuer, such as legal, accounting, and printing costs. FINRA rules also permit reimbursement for bona fide, itemized due diligence expenses up to 0.5% of gross proceeds. This due diligence reimbursement is considered part of the 15% O&O limit but is separate from the 10% underwriting compensation limit. Maximum Due Diligence Reimbursement: \[ \$30,000,000 \times 0.005 = \$150,000 \] The proposed structure includes a $150,000 reimbursement for due diligence and $500,000 for the issuer’s legal and accounting fees. The total O&O is the sum of all these components: Total O&O Expenses: \[ \$2,850,000 \text{ (Underwriting)} + \$150,000 \text{ (Due Diligence)} + \$500,000 \text{ (Issuer Costs)} = \$3,500,000 \] This total of $3,500,000 is less than or equal to the $4,500,000 maximum allowed for total O&O expenses. Since the structure adheres to both the 10% underwriting compensation sub-limit and the 15% overall O&O limit, it is compliant.

The firm must provide written notice to the SEC and its Designated Examining Authority (DEA) within 24 hours of receiving the accountant’s report identifying the material inadequacy. Following this initial notice, the firm must file a subsequent report within 48 hours detailing the steps being taken to correct the situation. SEC Rule 17a-11 serves as an early warning system, requiring broker-dealers to provide prompt notification to regulators upon the occurrence of certain financial or operational difficulties. One of the specific triggering events is when a broker-dealer discovers, or is notified by an independent public accountant, that a material inadequacy exists in its internal accounting controls, accounting system, or procedures for safeguarding securities. The rule mandates a two-part response. First, the firm must transmit a notice of this event by telegraphic notice or facsimile within 24 hours. This notice must be sent to the SEC’s principal office in Washington, D.C., the relevant SEC regional office, and the firm’s DEA, which for most firms is FINRA. Second, the firm must file a report within 48 hours of the initial notice, providing details about the material inadequacy and outlining the corrective actions the firm has taken or intends to take. This requirement is absolute and is not contingent on the firm’s net capital position at the time of discovery. The principal’s responsibility is to ensure these notifications are made accurately and within the prescribed timeframes to maintain compliance.

N/A Under SEC Rule 10b-9, it is considered a manipulative or deceptive practice to represent that a security is being offered on an “all-or-none” or “part-or-none” (mini-max) basis unless the offering is contingent upon the sale of a specified number of securities by a specific date. The core principle of this rule is to ensure that investor funds are not committed to a project unless a predetermined level of minimum funding, representing genuine public interest and economic viability, is achieved. Purchases made by the issuer, sponsor, or their affiliates to satisfy the minimum contingency are generally not considered bona fide sales for the purposes of this rule. Such actions would create a false impression that the required level of investor interest has been met, misleading public investors who relied on the contingency as a measure of the program’s viability. The dealer-manager has a significant due diligence responsibility to ensure the terms of the contingency are met through legitimate, arm’s-length transactions with the public. Allowing the sponsor’s purchase to count toward the minimum would likely constitute a violation of Rule 10b-9, potentially invalidating the offering and exposing the firm to significant liability. While other issues like conflicts of interest are present and require management and disclosure, the potential violation of Rule 10b-9 is the most immediate and critical threat to the integrity and legality of the offering’s closing.

The scenario describes a contingent “mini-max” offering, which is subject to specific SEC regulations, namely Rule 15c2-4 and Rule 10b-9. Rule 15c2-4 dictates the handling of investor funds in such offerings, requiring that all subscription monies be deposited into a separate escrow account and held until the contingency is satisfied. Rule 10b-9 makes it a manipulative or deceptive device to represent an offering as being on an “all-or-none” or other contingent basis unless the offering terms are strictly adhered to. In this case, the offering has a minimum subscription level of \(\$10\) million and a specified 90-day contingency period. The offering has failed to meet the minimum threshold within the specified time. Extending the offering period is a material change to the terms of the contingency. According to SEC guidance on these rules, if the issuer and underwriter wish to extend the offering period, they cannot simply continue holding the funds. Doing so would violate the original terms presented to investors. The only compliant way to proceed with an extension is to first offer every single subscriber the unconditional right to a full and immediate refund of their subscription money. The offering can then be extended, but it may only proceed with the funds from those investors who affirmatively reconfirm their investment decision after being notified of the extension and their rescission rights. Simply extending the deadline without this rescission offer would violate Rule 10b-9 by misrepresenting the contingent nature of the offering and Rule 15c2-4 by improperly holding investor funds beyond the satisfaction of the original contingency terms. Therefore, the required action is to provide all subscribers with a rescission offer before any extension can be valid.

This scenario involves a private securities transaction by an associated person under FINRA Rule 3280. When an associated person intends to participate in any private securities transaction, they must provide prior written notice to their member firm. The notice must describe the proposed transaction in detail and state the person’s proposed role. If the associated person is to receive selling compensation for their participation, the member firm must issue written approval or disapproval. If the firm approves the participation, it has a significant supervisory obligation. Specifically, the rule requires that the member firm must record the transactions on its books and records and supervise the associated person’s activities as if the transaction were being executed on behalf of the member firm itself. This means the firm must apply its own supervisory procedures, including suitability reviews and other compliance checks, to the transaction. The firm’s responsibility is to treat the activity as its own, subjecting it to the full scope of its supervisory system established under rules like FINRA Rule 3110. The responsibility for regulatory filings, such as Form D for a Regulation D offering, rests with the issuer, not the broker-dealer in this capacity. Similarly, specific compensation limits like the 10% cap under FINRA Rule 2310 apply to public offerings of DPPs, not necessarily to all private securities transactions conducted under Rule 3280, although the firm would still need to ensure any compensation is reasonable. The core, overriding requirement for the firm is the recording and supervision of the activity as its own.

The offering is a mini-max contingent offering, which is subject to SEC Rule 10b-9 and Rule 15c2-4. 1. Identify the offering terms: Minimum of $5,000,000 and a maximum of $10,000,000. The contingency is that at least $5,000,000 must be raised from bona fide sales by the specified deadline. 2. Analyze the situation: By the deadline, only $4,500,000 in bona fide public subscriptions has been received. The sponsor’s proposal to use an affiliated entity to purchase the remaining $500,000 to meet the minimum threshold is not a bona fide sale in the context of the public offering’s contingency. 3. Apply SEC Rule 10b-9: This rule makes it a manipulative or deceptive practice to represent an offering as being on a “part-or-none” (mini-max) basis unless the funds are promptly returned if the stated minimum is not sold by the specified date. The SEC has interpreted this to mean that purchases by the general partner, sponsor, or their affiliates, if not disclosed in the offering documents, cannot be used to satisfy the minimum contingency. Such purchases undermine the premise that a certain level of independent public interest is required for the venture to be viable. 4. Apply SEC Rule 15c2-4: This rule governs the handling of customer funds in contingent offerings. It requires the broker-dealer to promptly transmit funds to a qualified escrow agent. If the terms of the contingency are not met, the broker-dealer must ensure the prompt return of all funds to subscribers. 5. Conclusion: Since the $5,000,000 minimum was not met through bona fide public sales, the contingency has failed. Allowing the offering to close under these circumstances would violate Rule 10b-9. The correct action under Rule 15c2-4 is to terminate the offering and ensure all investor funds held in escrow are returned promptly. SEC Rule 10b-9 is critical for ensuring the integrity of contingent offerings. It prevents issuers and underwriters from creating a false impression of public interest to induce investment. Investors in a mini-max offering rely on the minimum contingency as a key measure of the project’s viability and the sponsor’s ability to attract sufficient capital from the public. Using undisclosed, non-bona fide affiliate purchases to satisfy this minimum is considered a fraudulent and manipulative act because it misleads investors about the true level of public support for the program. The principal’s supervisory duty is to uphold these rules, protect investors, and prevent the firm from participating in a prohibited practice. Therefore, the only appropriate course of action when a bona fide minimum is not met is the termination of the offering and the full, prompt return of investor capital from the escrow account as required by Rule 15c2-4.

The calculation to determine compliance with FINRA’s underwriting compensation limits for a public Direct Participation Program offering is as follows. First, establish the maximum allowable underwriting compensation based on the gross offering proceeds. Under FINRA Rule 2310, this is limited to 10% of the gross proceeds. Maximum Underwriting Compensation = \(10\% \times \$25,000,000 = \$2,500,000\) Next, calculate the total proposed underwriting compensation. This includes all forms of compensation paid to the underwriter and related parties for their role in the distribution. It includes the dealer-manager’s fee, commissions to the selling group, and any fees paid to wholesalers. Dealer-Manager Fee = \(1.5\% \times \$25,000,000 = \$375,000\) Selling Group Commissions = \(7.5\% \times \$25,000,000 = \$1,875,000\) Wholesaler Fee = \(\$300,000\) Total Proposed Underwriting Compensation = \(\$375,000 + \$1,875,000 + \$300,000 = \$2,550,000\) Finally, compare the total proposed compensation to the maximum allowable limit. Total Proposed Compensation (\(\$2,550,000\)) > Maximum Allowable Compensation (\(\$2,500,000\)) The proposed compensation exceeds the FINRA limit by \(\$50,000\). FINRA Rule 2310 imposes a strict 10% cap on total underwriting compensation for public DPP offerings. This compensation includes all cash and non-cash payments made to broker-dealers involved in the offering’s distribution. Critically, fees paid to wholesalers, whether they are employees of the member firm or unaffiliated third parties, are considered underwriting compensation and must be included under this 10% ceiling. Separately, the rule allows for the reimbursement of bona fide due diligence expenses up to an additional 0.5% of gross proceeds, but these are distinct from wholesaling fees. In this scenario, the sum of the dealer-manager fee, the selling group commissions, and the wholesaler’s fee constitutes the total underwriting compensation. The analysis reveals that this total figure surpasses the 10% threshold, creating a significant compliance violation that the Direct Participation Programs Principal must identify and rectify before the offering proceeds.

The logical analysis of the scenario is as follows: 1. Identify the total gross proceeds of the offering: \(\$50,000,000\). 2. Analyze the payment to the unregistered consultant, Leo. FINRA Rule 2040 prohibits member firms from paying transaction-based compensation (such as a finder’s fee for introducing investors) to any person who is not registered with FINRA. This payment of \(\$300,000\) for introducing investor groups is a direct and serious violation of this fundamental rule. 3. Calculate the total underwriting compensation. Under FINRA Rule 2310, all items of value received by the underwriter or related persons are included. This includes the selling commissions and the finder’s fee. Total Underwriting Compensation = Commissions + Finder’s Fee Total Underwriting Compensation = \(\$4,800,000 + \$300,000 = \$5,100,000\). 4. Calculate the maximum allowable underwriting compensation under FINRA Rule 2310, which is \(10\%\) of gross offering proceeds. Maximum Underwriting Compensation = \(10\% \times \$50,000,000 = \$5,000,000\). The proposed compensation of \(\$5,100,000\) exceeds this limit. 5. Calculate the total Organization and Offering (O&O) expenses. This includes all underwriting compensation plus other issuer expenses like the “issuer organizational and marketing support.” Total O&O Expenses = Total Underwriting Compensation + Other O&O Expenses Total O&O Expenses = \(\$5,100,000 + \$2,600,000 = \$7,700,000\). 6. Calculate the maximum allowable O&O expenses, which is \(15\%\) of gross offering proceeds. Maximum O&O Expenses = \(15\% \times \$50,000,000 = \$7,500,000\). The proposed O&O expenses of \(\$7,700,000\) also exceed this limit. 7. Compare the violations. While exceeding the \(10\%\) and \(15\%\) compensation and expense limits are clear violations of FINRA Rule 2310, the payment of a finder’s fee to an unregistered person for brokerage activities is a more fundamental breach of securities regulations. It violates FINRA Rule 2040 and undermines the core principle of registration and licensing for investor protection. Therefore, it represents the most critical issue that must be addressed. The payment of transaction-based compensation to an unregistered individual for activities requiring registration, such as soliciting or finding investors, is a significant violation of FINRA Rule 2040. This rule is foundational to the regulatory framework, ensuring that only qualified and supervised individuals engage with the investing public. While the compensation limits established under FINRA Rule 2310 are also critical, the act of paying an unregistered person strikes at the heart of the licensing and registration system. In the scenario, the \(\$300,000\) fee to Leo is explicitly for introducing investor groups, an activity that requires registration. This fee must also be included as underwriting compensation when calculating the percentage limits. The calculation reveals that both the \(10\%\) underwriting compensation limit and the \(15\%\) total organization and offering expense limit are exceeded. However, a principal’s primary duty is to uphold the integrity of the regulatory system. The payment to an unregistered finder is a more severe and elemental violation than exceeding a numerical cap, as it involves a prohibited practice with an unauthorized party, posing a direct risk to the firm and the public.

The core issue revolves around the discovery of a material adverse change to the offering terms after subscriptions have been received but before the contingency in a mini-max offering has been formally met and funds released from escrow. Under SEC Rule 10b-9, it is a manipulative or deceptive device to represent that a security is being offered on a mini-max basis unless the securities are sold in bona fide transactions and the consideration is promptly refunded to purchasers if the minimum is not sold by the specified date. A bona fide transaction requires that the investor’s decision is based on accurate and complete information. The departure of a key anchor tenant is a material fact that renders the Private Placement Memorandum misleading. Therefore, the subscriptions received prior to this disclosure may no longer be considered bona fide. The supervising principal’s primary duty, under FINRA Rule 3110 (Supervision) and anti-fraud provisions like SEC Rule 10b-5, is to ensure the integrity of the offering and protect investors. The correct procedure is not to simply terminate the offering or proceed with the closing. Instead, the firm must halt the process and re-solicit the existing subscribers. This involves promptly providing all subscribers with a supplement to the offering document that discloses the material adverse change and offering them the affirmative right to either rescind their subscription and receive a full refund from escrow, or to reaffirm their investment decision in light of the new information. Only after this re-solicitation can the firm determine if the minimum contingency has been legitimately met with fully informed investors.

The analysis of the offering’s compensation structure begins with calculating the maximum allowable amounts under FINRA rules based on the \( \$60,000,000 \) gross offering proceeds. First, calculate the total proposed underwriting compensation. This includes selling commissions, the dealer-manager fee, and wholesaling fees. Selling Commissions: \( \$60,000,000 \times 7.5\% = \$4,500,000 \) Dealer-Manager Fee: \( \$60,000,000 \times 1.5\% = \$900,000 \) Wholesaling Fees: \( \$60,000,000 \times 1.0\% = \$600,000 \) Total Proposed Underwriting Compensation: \( \$4,500,000 + \$900,000 + \$600,000 = \$6,000,000 \) Next, determine the FINRA limit for underwriting compensation, which is 10% of gross proceeds. Maximum Underwriting Compensation: \( \$60,000,000 \times 10\% = \$6,000,000 \) The proposed underwriting compensation of \( \$6,000,000 \) is equal to the maximum limit and is therefore compliant. Then, evaluate the reimbursement for bona fide due diligence expenses. FINRA rules allow for reimbursement of these expenses in addition to the 10% underwriting compensation, but this reimbursement is limited to 0.3% of gross proceeds. Maximum Due Diligence Reimbursement: \( \$60,000,000 \times 0.3\% = \$180,000 \) The proposed reimbursement of \( \$480,000 \) exceeds the maximum allowable amount of \( \$180,000 \). Finally, check the total Organization and Offering Expenses (O&OE), which includes all underwriting compensation, due diligence reimbursements, and other offering expenses like legal and accounting fees. The limit for O&OE is 15% of gross proceeds. Total Proposed O&OE: \( \$6,000,000 \text{ (Underwriting)} + \$480,000 \text{ (Due Diligence)} + \$2,000,000 \text{ (Other)} = \$8,480,000 \) Maximum O&OE: \( \$60,000,000 \times 15\% = \$9,000,000 \) The total proposed O&OE is within the 15% limit. The primary compliance issue is that the specific sub-limit for due diligence expense reimbursement has been violated, even though the other major compensation limits are met. A principal must ensure that all components of the compensation structure adhere to their specific regulatory caps.

The calculation to assess the underwriting compensation against the regulatory limit is as follows. First, determine the maximum allowable underwriting compensation based on FINRA Rule 2310. The rule limits underwriting compensation to 10% of the gross offering proceeds. For a $50,000,000 offering, this limit is: \[\$50,000,000 \times 10\% = \$5,000,000\] Next, calculate the proposed underwriting compensation. This includes the selling commissions and the marketing allowance. The due diligence fee is treated separately. Selling Commissions: \(\$50,000,000 \times 7\% = \$3,500,000\) Marketing Allowance: \(\$50,000,000 \times 2.5\% = \$1,250,000\) Total Proposed Underwriting Compensation: \(\$3,500,000 + \$1,250,000 = \$4,750,000\) This total of $4,750,000 is within the $5,000,000 maximum allowable limit. Under FINRA Rule 2310, reimbursement for bona fide due diligence expenses is not considered part of the 10% underwriting compensation limit, provided these expenses are itemized and supported by a detailed accounting. The core responsibility of the Direct Participation Program Principal is to ensure that a reasonable and thorough due diligence investigation is actually conducted. The principal must exercise reasonable care to verify that the disclosures in the offering documents are accurate and complete. Therefore, the primary concern is not merely the numerical compliance of the compensation figures, but the substance and adequacy of the due diligence process itself. A flat, unsubstantiated fee for due diligence raises a significant red flag. The principal must be able to demonstrate that the fee corresponds to actual, legitimate, and necessary activities undertaken to investigate the issuer, its management, the program’s underlying assets, and the reasonableness of its projections. Simply accepting a fee without ensuring a robust due diligence process has occurred would represent a failure of the principal’s fundamental supervisory and statutory obligations.

Calculation: Step 1: Identify and sum all forms of underwriting compensation. Under FINRA Rule 2310, underwriting compensation includes selling commissions, dealer-manager fees, and wholesaling fees. Underwriting Compensation = Selling Commissions + Dealer-Manager Fee + Wholesaling Fees Underwriting Compensation = \(8.0\% + 2.5\% + 1.0\% = 11.5\%\) Step 2: Compare the calculated underwriting compensation to the FINRA limit. FINRA Rule 2310 limits total underwriting compensation to 10% of the gross proceeds of the offering. Calculated Compensation (11.5%) > Allowable Limit (10%). This is a violation. Step 3: Identify and sum all Organization and Offering (O&O) expenses. O&O expenses include all underwriting compensation plus other issuer expenses related to the offering, such as legal, accounting, and printing costs. The bona fide due diligence reimbursement is also included under the overall O&O cap. O&O Expenses = Underwriting Compensation + Due Diligence Reimbursement + Issuer Legal/Accounting + Printing Costs O&O Expenses = \(11.5\% + 0.5\% + 3.0\% + 1.0\% = 16.0\%\) Step 4: Compare the calculated O&O expenses to the FINRA limit. FINRA Rule 2310 limits total O&O expenses to 15% of the gross proceeds of the offering. Calculated O&O (16.0%) > Allowable Limit (15%). This is also a violation. The primary cause of the O&O violation is the excessive underwriting compensation. FINRA Rule 2310 establishes strict limits on the compensation and expenses associated with public offerings of Direct Participation Programs. There are two primary caps that a principal must verify for compliance. The first is that total underwriting compensation cannot exceed 10% of the gross offering proceeds. This category is broadly defined and includes not only the sales commissions paid to soliciting dealers but also dealer-manager fees, wholesaling compensation, and other similar payments for the distribution of the program. It is critical to correctly identify all these components to ensure the aggregate amount is compliant. The second cap is on total Organization and Offering expenses, which is limited to 15% of gross proceeds. This is a broader, all-inclusive limit that contains all underwriting compensation plus the issuer’s own expenses for structuring the program, such as legal fees, accounting fees, and prospectus printing costs. In the given scenario, the sum of the selling commissions, dealer-manager fee, and wholesaling fees results in total underwriting compensation that is above the 10% threshold. This initial violation directly causes the total O&O expenses to also exceed their 15% limit. While bona fide due diligence expenses can be reimbursed up to 0.5% in addition to the 10% underwriting compensation limit, they are still counted towards the overall 15% O&O cap. The fundamental issue is that the core compensation for distribution activities surpasses its specific regulatory ceiling.

Total Gross Offering Proceeds = $50,000,000 Calculation of Maximum Allowable Underwriting Compensation (FINRA Rule 2310): Maximum Underwriting Compensation = 10% of Gross Offering Proceeds \[\$50,000,000 \times 0.10 = \$5,000,000\] Calculation of Proposed Underwriting Compensation: Underwriting compensation includes sales commissions and wholesaling fees. Proposed Underwriting Compensation = Sales Commissions + Wholesaling Fees \[\$4,000,000 + \$1,200,000 = \$5,200,000\] Comparison: The proposed underwriting compensation of $5,200,000 exceeds the maximum allowable limit of $5,000,000. Calculation of Maximum Allowable Organization & Offering (O&O) Expenses (FINRA Rule 2310): Maximum O&O Expenses = 15% of Gross Offering Proceeds \[\$50,000,000 \times 0.15 = \$7,500,000\] Calculation of Proposed Total O&O Expenses: O&O expenses include all underwriting compensation, plus other offering costs like legal, accounting, and due diligence reimbursements. Proposed O&O Expenses = Proposed Underwriting Compensation + Due Diligence Reimbursement + Issuer’s Legal/Accounting Fees \[\$5,200,000 + \$300,000 + \$2,100,000 = \$7,600,000\] Comparison: The proposed total O&O expenses of $7,600,000 also exceed the maximum allowable limit of $7,500,000. The primary violation for the member firm, however, relates to the compensation it receives and pays. Under FINRA Rule 2310, which governs direct participation programs, there are strict limits on the compensation and expenses related to a public offering. The rule establishes two critical caps based on the gross proceeds of the offering. The first cap limits total underwriting compensation to 10% of the gross proceeds. Underwriting compensation is broadly defined and includes not only the sales commissions paid to the selling group but also any fees paid to the dealer-manager, wholesaling compensation, and other forms of compensation paid to the member firm and its associated persons for their role in distributing the program. The second, broader cap limits total organization and offering expenses to 15% of gross proceeds. This category includes all underwriting compensation plus additional expenses incurred by the issuer, such as legal fees, accounting fees, and printing costs associated with the offering. Reimbursements for bona fide due diligence expenses are also included under this 15% O&O cap. A principal must review the entire expense structure to ensure both limits are respected. In this scenario, the sum of sales commissions and wholesaling fees constitutes the total underwriting compensation, which must be compared against the 10% limit. The sum of all listed expenses must be compared against the 15% limit. A failure to adhere to these limitations would make the offering’s terms unfair and unreasonable.

Under FINRA Rule 2310, there are strict limits on the compensation and expenses related to public offerings of Direct Participation Programs. The rule establishes two primary caps based on the gross proceeds of the offering. First, total Organization and Offering (O&O) expenses cannot exceed 15% of the gross offering proceeds. O&O expenses are broadly defined to include all items of compensation paid to broker-dealers as well as bona fide issuer expenses such as legal, accounting, and printing costs. Second, and more restrictively, a sub-cap within the O&O limit states that total underwriting compensation cannot exceed 10% of the gross offering proceeds. Underwriting compensation includes selling commissions, dealer-manager fees, wholesaling fees, and other forms of compensation paid to member firms for their role in the distribution. In the given scenario, the components of underwriting compensation must be aggregated. These are the selling commissions of 7.0%, the dealer-manager fee of 2.0%, and the wholesaling fees of 1.5%. The sum of these items is \(7.0\% + 2.0\% + 1.5\% = 10.5\%\). This amount, representing the total underwriting compensation, exceeds the 10% limit established by FINRA Rule 2310. Furthermore, when calculating the total O&O expenses, all underwriting compensation is included along with other issuer expenses. This includes the 10.5% calculated above, the 0.5% for due diligence reimbursement, and the 4.5% for other O&O costs. The total O&O expense is \(10.5\% + 0.5\% + 4.5\% = 15.5\%\). This total exceeds the 15% overall limit for O&O expenses. Therefore, the proposed compensation structure is non-compliant on two fronts, with the violation of the 10% underwriting compensation limit being a critical failure point.

The calculation determines if the proposed underwriting compensation for the Direct Participation Program (DPP) offering complies with FINRA Rule 2310. The rule limits total underwriting compensation to 10% of the gross proceeds of a public offering. First, calculate the maximum allowable underwriting compensation: Gross Offering Proceeds = $50,000,000 Maximum Underwriting Compensation = 10% of Gross Proceeds \[ \$50,000,000 \times 0.10 = \$5,000,000 \] Next, calculate the total proposed underwriting compensation. This includes all cash and non-cash compensation paid to the member firm and its associated persons. It does not include bona fide due diligence expenses, which fall under the separate, broader 15% limit for total Organization and Offering (O&O) expenses. Proposed Underwriting Compensation Components: 1. Selling Commissions (7%): \( \$50,000,000 \times 0.07 = \$3,500,000 \) 2. Dealer-Manager Fee (2%): \( \$50,000,000 \times 0.02 = \$1,000,000 \) 3. Wholesaling Fees (0.5%): \( \$50,000,000 \times 0.005 = \$250,000 \) 4. Non-Cash Compensation (Trip Value): $400,000 Total Proposed Underwriting Compensation: \[ \$3,500,000 + \$1,000,000 + \$250,000 + \$400,000 = \$5,150,000 \] Finally, compare the total proposed underwriting compensation to the maximum allowed: \[ \$5,150,000 > \$5,000,000 \] The proposed compensation exceeds the 10% limit by $150,000. Under FINRA Rule 2310, all forms of compensation received by the underwriter in connection with a public DPP offering are subject to a strict limit of 10% of the gross offering proceeds. This includes, but is not limited to, cash commissions, dealer-manager fees, wholesaling fees, and the value of any non-cash compensation such as incentive trips or merchandise. The principal at the dealer-manager firm has a supervisory responsibility to ensure that the aggregate value of all these components does not breach this regulatory ceiling. Separately, FINRA rules allow for total organization and offering expenses, which include the 10% underwriting compensation plus other items like legal, accounting, and bona fide due diligence expenses, to be up to 15% of gross proceeds. However, the 10% limit on the underwriting portion is a distinct and critical threshold. In this scenario, the sum of all cash and non-cash items intended as underwriting compensation surpasses the 10% maximum, creating a significant compliance violation that must be rectified before the offering can proceed. The principal must identify this overage and work with the sponsor to restructure the compensation to fall within the acceptable regulatory limits.

The scenario describes a mini-max offering, which is a type of contingent offering subject to specific SEC rules. The core issue revolves around SEC Rule 10b-9, which prohibits manipulative or deceptive practices in connection with such offerings. This rule makes it unlawful to represent that a security is being offered on an “all-or-none” or “part-or-none” (mini-max) basis unless the offering is contingent upon the sale of a specified number of securities by a specified date. Crucially, the rule implies that these sales must be bona fide, good-faith purchases. A purchase by the sponsor or an affiliate, particularly one financed through a non-recourse loan where the purchaser has no genuine economic risk, is generally not considered a bona fide sale for the purpose of satisfying the minimum contingency. Such a transaction is viewed as a contrivance to create the appearance that the contingency has been met, thereby deceiving the initial, legitimate investors who subscribed on the condition that a certain level of public interest would be achieved. Allowing the sponsor’s non-bona fide purchase to count toward the minimum would trigger the improper release of investor funds from escrow, as governed by SEC Rule 15c2-4. The principal’s primary responsibility is to prevent the firm from participating in this potentially fraudulent act. The fundamental problem is not the source of the funds or the need for disclosure, but the very nature of the purchase itself in the context of a contingent offering’s legal requirements. The offering’s contingency has not been legitimately satisfied, and therefore, the offering must be terminated and all investor funds must be promptly returned.