The calculation to determine the maximum additional compensation for the managing broker-dealer is based on FINRA Rule 2310, which governs compensation in public offerings of Direct Participation Programs. The rule imposes two key limits on the gross proceeds of the offering: a 15% limit on total Organization and Offering (O&O) expenses and a 10% limit on total underwriting compensation. The 10% underwriting compensation is a component of the 15% O&O expenses, not in addition to it. First, calculate the dollar value of these limits based on the $50,000,000 offering: Maximum Total O&O Expenses: \( \$50,000,000 \times 0.15 = \$7,500,000 \) Maximum Underwriting Compensation: \( \$50,000,000 \times 0.10 = \$5,000,000 \) Next, categorize and sum the existing expenses: Expenses that count as Underwriting Compensation include sales commissions, wholesaler’s fees, and due diligence expenses reimbursed to the broker-dealer. Current Underwriting Compensation = \( \$3,500,000 + \$400,000 + \$250,000 = \$4,150,000 \) Expenses that count toward the total O&O limit include all underwriting compensation plus other offering costs like legal fees, printing, and filing fees. Current Total O&O Expenses = \( \$4,150,000 \text{ (Underwriting)} + \$600,000 \text{ (Legal)} + \$300,000 \text{ (Printing)} + \$150,000 \text{ (Filing)} = \$5,200,000 \) Finally, determine the remaining capacity under each limit. The additional compensation for the broker-dealer is constrained by the more restrictive of the two limits. Remaining capacity under 10% Underwriting Comp limit = \( \$5,000,000 – \$4,150,000 = \$850,000 \) Remaining capacity under 15% O&O limit = \( \$7,500,000 – \$5,200,000 = \$2,300,000 \) The binding constraint is the 10% underwriting compensation limit. Therefore, the maximum additional compensation that can be paid to the managing broker-dealer is $850,000. FINRA Rule 2310 establishes strict guidelines on the expenses related to the public offering of a Direct Participation Program to ensure that a sufficient portion of the investors’ capital is actually used for the program’s stated purpose. The rule sets a ceiling of 15% of the gross offering proceeds for all organization and offering expenses combined. This category is broad and includes all costs incurred to structure, register, and sell the program to the public. Within this 15% cap, there is a more restrictive sub-limit of 10% of gross proceeds specifically for underwriting compensation. Underwriting compensation encompasses all payments to the broker-dealer and its affiliates for their role in the distribution, including sales commissions, wholesaling fees, and reimbursements for due diligence activities. Other costs, such as legal fees for prospectus preparation, accounting fees, and state blue-sky filing fees, fall under the 15% O&O umbrella but are not considered underwriting compensation. To determine compliance, a representative must correctly classify each expense and calculate the cumulative totals against both the 10% and 15% thresholds. The maximum allowable compensation is always dictated by the limit that is reached first, which in this case is the underwriting compensation cap.

The calculation for the investor’s maximum deductible loss is as follows: Investor’s At-Risk Basis = Cash Contribution + Share of Recourse Debt + Share of Qualified Non-Recourse Financing Investor’s At-Risk Basis = \(\$60,000 + \$15,000 + \$50,000 = \$125,000\) The partnership reported a loss of \(\$140,000\) allocable to the investor. The maximum deductible loss is the lesser of the reported loss or the at-risk basis. Maximum Deductible Loss = Lesser of \(\$140,000\) or \(\$125,000\) Maximum Deductible Loss = \(\$125,000\) The Internal Revenue Code’s “at-risk” rules, found in Section 465, generally limit an investor’s deductible losses from an activity to the amount the investor has at risk in that activity. This at-risk amount includes the cash contributed by the investor, the adjusted basis of any property contributed, and any amounts borrowed for use in the activity for which the investor is personally liable, known as recourse debt. Typically, non-recourse debt, where the lender’s only remedy in case of default is to seize the collateral, is not included in the at-risk basis. However, a critical exception exists for activities involving the holding of real property. For these specific activities, an investor’s at-risk amount is increased by their share of “qualified non-recourse financing.” This is financing secured by the real property, borrowed from a qualified person or government entity, and for which no person is personally liable for repayment. In this scenario, the investor’s total at-risk basis is calculated by summing their initial cash investment, their share of the recourse debt, and their share of the qualified non-recourse financing. The deductible loss for the year is then limited to this calculated at-risk amount, even if the actual loss passed through from the partnership is higher. The remaining non-deductible portion of the loss can be carried forward to future years and deducted when the at-risk basis increases.

Total Gross Proceeds = $50,000,000 FINRA Rule 2310 imposes two key limits on compensation for public DPP offerings: 1. Total Organization and Offering (O&O) Expenses cannot exceed 15% of gross offering proceeds. Maximum O&O = \( \$50,000,000 \times 15\% = \$7,500,000 \) 2. Total Underwriting Compensation cannot exceed 10% of gross offering proceeds. This is a sub-limit within the 15% O&O cap. Maximum Underwriting Compensation = \( \$50,000,000 \times 10\% = \$5,000,000 \) First, we must identify and sum all forms of underwriting compensation paid to the dealer-manager and its affiliates: Sales Commission: \( \$50,000,000 \times 8\% = \$4,000,000 \) Due Diligence Expense Reimbursement: \( \$50,000,000 \times 1\% = \$500,000 \) Wholesaling Fees: \( \$50,000,000 \times 2\% = \$1,000,000 \) Total Underwriting Compensation = \( \$4,000,000 + \$500,000 + \$1,000,000 = \$5,500,000 \) Comparing this to the limit: Calculated Underwriting Compensation (\(\$5,500,000\)) > Maximum Allowable Underwriting Compensation (\(\$5,000,000\)). This is a violation of the 10% rule. Next, we calculate the total O&O expenses, which includes all underwriting compensation plus bona fide issuer costs: Total Underwriting Compensation = $5,500,000 Issuer’s Legal and Printing Costs: \( \$50,000,000 \times 3\% = \$1,500,000 \) Total O&O Expenses = \( \$5,500,000 + \$1,500,000 = \$7,000,000 \) Comparing this to the limit: Calculated O&O Expenses (\(\$7,000,000\)) < Maximum Allowable O&O Expenses (\(\$7,500,000\)). The total O&O is within the 15% limit. However, the violation of the 10% underwriting compensation sub-limit still makes the overall compensation structure non-compliant. FINRA Rule 2310 establishes strict guidelines on the compensation structure for public offerings of Direct Participation Programs to ensure fairness and protect investors from excessive costs that could erode their investment. The rule sets a cap on total Organization and Offering expenses at 15% of the gross proceeds from the offering. These O&O expenses encompass all costs associated with bringing the program to market. Within this 15% overall limit, there is a more restrictive sub-limit for underwriting compensation, which cannot exceed 10% of the gross proceeds. It is critical to understand that underwriting compensation is not limited to just the sales commission. It includes all items of value received by the underwriter or its affiliates from the issuer in connection with the offering, such as wholesaling fees, due diligence expense reimbursements, and marketing allowances. Bona fide issuer costs, such as legal, accounting, and printing fees, are part of the total 15% O&O calculation but are not part of the 10% underwriting compensation calculation. A common mistake is to only check the 15% overall limit. An offering's compensation structure must comply with both the 15% O&O limit and the 10% underwriting compensation sub-limit independently. An offering can be within the 15% overall cap but still be in violation if the specific payments to the underwriting syndicate exceed the 10% threshold.

The calculation to determine the total underwriting compensation is as follows: Identify the components classified as underwriting compensation under FINRA Rule 2310: 1. Sales commissions paid to broker-dealers: \(7.0\%\) 2. Wholesaler’s override fee: \(1.5\%\) 3. Bona fide due diligence expenses reimbursed to the broker-dealer: \(0.5\%\) Sum these components: \[ 7.0\% + 1.5\% + 0.5\% = 9.0\% \] This total of \(9.0\%\) is then measured against the \(10\%\) limit for total underwriting compensation. The other costs, such as the issuer’s legal and accounting fees (\(2.0\%\)) and printing and filing costs (\(1.0\%\)), are considered part of the total Organization and Offering (O&O) expenses but not part of the underwriting compensation sub-limit. The total O&O expenses would be \(9.0\% + 2.0\% + 1.0\% = 12.0\%\), which is measured against the separate \(15\%\) limit for total O&O. FINRA Rule 2310 establishes a two-tiered cap on the front-end expenses of a public direct participation program to protect investors and ensure a sufficient amount of capital is directed toward the program’s assets. The first, broader limit is that total Organization and Offering expenses cannot exceed 15% of the gross proceeds of the offering. This category is comprehensive and includes all costs associated with structuring and selling the program. Within this 15% cap, there is a second, more restrictive limit. Total underwriting compensation cannot exceed 10% of the gross proceeds. It is critical to distinguish between the two categories. Underwriting compensation specifically refers to all compensation paid to broker-dealers and their associated persons for their roles in the distribution of the DPP. This includes direct sales commissions, wholesaling fees paid to firms that market the program to other broker-dealers, and reimbursements for bona fide, itemized due diligence expenses. Costs incurred directly by the issuer, such as its own legal counsel fees, accounting fees for preparing financial statements, and administrative costs like printing the prospectus and paying SEC filing fees, are part of the overall 15% O&O limit but are not included in the 10% underwriting compensation calculation.

The investor’s initial at-risk amount is calculated differently for the two direct participation programs due to specific provisions in the tax code regarding non-recourse financing. The general principle of the at-risk rules, under IRC Section 465, is to limit an investor’s deductible losses to the amount they personally stand to lose in an investment. This amount typically includes the cash contributed and any debt for which the investor is personally liable, known as recourse debt. Non-recourse debt, where the lender’s only remedy in case of default is to seize the collateral, generally does not increase an investor’s at-risk basis. For the Gusher Quest Partners oil and gas program, the at-risk amount is limited to the direct cash investment. The investor’s at-risk amount is calculated as their cash contribution. The share of non-recourse debt is not included. Calculation: At-Risk Amount = Cash Contribution = \( \$100,000 \). For the Metroplex Realty Partners real estate program, a significant exception applies. The tax code provides that “qualified non-recourse financing” is treated as an amount at risk for activities involving the holding of real property. Qualified non-recourse financing is typically debt from a commercial lender that is secured by the real property itself. Therefore, the investor’s at-risk basis in the real estate partnership includes both their cash contribution and their pro-rata share of this specific type of debt. Calculation: At-Risk Amount = Cash Contribution + Share of Qualified Non-Recourse Financing = \( \$100,000 + \$400,000 = \$500,000 \). This distinction is critical for investors to understand, as it directly impacts the amount of partnership losses they can deduct on their personal tax returns in a given year. The special treatment for real estate is a long-standing feature of the tax code designed to encourage investment in real property.

The logical determination for the required action is based on the interplay between SEC Rule 10b-9 and SEC Rule 15c2-4, which govern contingent offerings such as “all-or-none” or “part-or-none” deals. The offering has a minimum contingency of \(\$15,000,000\) and has only raised \(\$14,500,000\) from the public. The sponsor’s proposal to have an affiliate purchase the remaining \(\$500,000\) in an undisclosed, non-bona fide manner to meet the threshold is a prohibited manipulative act under SEC Rule 10b-9. This rule makes it a fraudulent practice to represent an offering as “all-or-none” unless the stated conditions are strictly met through bona fide sales. A purchase made by the issuer or an affiliate solely to satisfy the contingency and trigger the release of escrowed funds is not considered a bona fide sale. For such a purchase to be permissible, it must be for investment purposes and must have been fully disclosed in the offering prospectus. Since the proposed purchase is undisclosed and its purpose is to circumvent the contingency, it violates the rule. Consequently, the minimum contingency has not been legitimately met. Under both SEC Rule 10b-9 and SEC Rule 15c2-4, if the contingency is not satisfied by the specified date, the offering must be terminated, and the dealer-manager must ensure that the escrow agent promptly returns all subscription funds to the investors. Participating in the sponsor’s scheme would expose the dealer-manager to severe liability for securities fraud.

The solution requires an analysis of the expense structure based on FINRA Rule 2310(b)(4), which governs Organization and Offering (O&O) expenses for public Direct Participation Programs. This rule establishes two distinct and independent limits: total underwriting compensation cannot exceed \(10\%\) of the gross offering proceeds, and total O&O expenses cannot exceed \(15\%\) of the gross offering proceeds. First, identify and sum the components of underwriting compensation. These are costs paid to FINRA members for their role in distributing the securities. In this scenario, they include the broker-dealer sales commissions (\(9.0\%\)) and the wholesaler fees (\(1.5\%\)). Total Underwriting Compensation = \(9.0\% + 1.5\% = 10.5\%\) Next, identify all other O&O expenses. These are costs related to organizing the partnership and the offering itself. They include due diligence expenses reimbursed to the broker-dealer (\(0.5\%\)), legal and accounting fees for structuring the partnership (\(2.5\%\)), and state registration fees (\(0.5\%\)). The property acquisition fee (\(3.0\%\)) is a program cost, representing the use of capital to purchase the program’s primary asset, and is not considered an O&O expense. Then, calculate the total O&O expenses by summing the underwriting compensation and the other O&O expenses. Total O&O Expenses = \(10.5\% (\text{Underwriting}) + 0.5\% (\text{Due Diligence}) + 2.5\% (\text{Legal/Acct}) + 0.5\% (\text{State Fees}) = 14.0\%\) Finally, compare these calculated percentages to the regulatory limits. The total O&O expenses of \(14.0\%\) are within the \(15\%\) overall limit. However, the total underwriting compensation of \(10.5\%\) exceeds the \(10\%\) limit. Because both limits must be met independently, the offering’s expense structure is non-compliant due to the excessive underwriting compensation.

The scenario involves a private placement conducted under SEC Rule 506(c) of Regulation D. A critical feature of a Rule 506(c) offering is that it permits the use of general solicitation and advertising to market the securities. However, this permission comes with a strict condition: all purchasers in the offering must be accredited investors, and the issuer must take reasonable steps to verify that the purchasers are, in fact, accredited investors. This verification standard is higher than for other offerings, such as those under Rule 506(b), where an investor can simply self-certify their status. The firm’s procedure must therefore integrate the requirements of both the Securities Act of 1933 and FINRA rules. First, under FINRA Rule 2210, all public communications, including websites and social media content, must be reviewed and approved by a registered principal of the firm before use. The content must be fair, balanced, and not misleading. It should also contain prominent legends indicating that the securities are speculative, involve a high degree of risk, and are being offered only to accredited investors. Second, and most critically for a Rule 506(c) offering, the firm must establish and follow a robust process to verify the accredited investor status of anyone who expresses interest through the public advertisements. This verification must occur before the firm accepts a subscription agreement or any funds from the investor. Methods for verification can include reviewing recent tax returns, bank statements, or obtaining a written confirmation from a registered broker-dealer, investment adviser, licensed attorney, or certified public accountant. Simply having the investor check a box on a questionnaire is not sufficient to meet the “reasonable steps” standard. Therefore, the complete and compliant process involves principal approval of the advertising, inclusion of appropriate risk disclosures, and a documented, active verification of accredited status for every purchaser prior to finalizing the sale.

The core issue revolves around the integrity of a contingent offering, specifically a “part-or-none” or “mini-max” offering, as governed by SEC Rule 10b-9. This rule makes it a manipulative or deceptive practice to represent an offering as contingent unless the terms of the contingency are strictly met. A key component is that the minimum subscription amount must be raised through bona fide, arm’s-length transactions with public investors. Purchases by the issuer, sponsor, general partner, or their affiliates are not considered bona fide for the purpose of satisfying the minimum threshold unless the possibility of such purchases was clearly and specifically disclosed in the offering documents, such as the prospectus, from the outset. In this scenario, the prospectus did not contain such a disclosure. Therefore, the sponsor’s proposed purchase of units to meet the $10 million minimum would be a violation of Rule 10b-9, as it would create the false impression that the offering had sufficient public interest to meet its viability threshold. The dealer-manager has a regulatory obligation to prevent this. If the contingency is not met by the deadline through legitimate sales, SEC Rule 15c2-4 mandates that all subscription payments held in escrow must be promptly returned to the investors. The dealer-manager’s primary duty is to ensure compliance with these rules, which means rejecting the sponsor’s purchase and initiating the return of funds.

Anya’s initial at-risk amount is her cash contribution of $100,000. The partnership’s loss attributable to her is $125,000. Under the general at-risk rules of IRC Section 465, a taxpayer cannot deduct losses from an activity in excess of the amount they have at risk in that activity. For a limited partner, the at-risk amount typically includes their cash contribution and any partnership debt for which they are personally liable (recourse debt). Non-recourse debt, where the lender’s only remedy is to seize the collateral, generally does not increase a limited partner’s at-risk amount. However, there is a critical exception for activities involving the holding of real property. In this case, a partner’s at-risk amount is increased by their share of “qualified non-recourse financing.” This is financing secured by the real property, borrowed from a qualified person (like a bank or government agency), and for which no person is personally liable. The loan in the scenario meets these criteria. Assuming Anya has a 10% interest in the partnership ($100,000 contribution out of $1,000,000 total partner capital), her share of the qualified non-recourse financing is 10% of $4,000,000, which is $400,000. Therefore, Anya’s total at-risk amount is calculated as: \[ \text{Cash Contribution} + \text{Share of Qualified Non-Recourse Financing} \] \[ \$100,000 + \$400,000 = \$500,000 \] Since her at-risk amount of $500,000 is greater than her pro-rata loss of $125,000, she can deduct the full amount of the loss, subject to other limitations like the passive activity loss rules. The primary determinant under the at-risk rules is this combined figure.

The proposed action by the general partner is a violation of SEC Rule 10b-9. This rule addresses representations made in connection with contingent offerings, such as “all-or-none” or “part-or-none” offerings. It makes it a manipulative or deceptive device to represent that a security is being offered on an all-or-none basis unless the offering is contingent upon the sale of all securities being offered. A critical component of this rule is that the sales must be bona fide. Purchases made by the issuer, sponsor, or their affiliates that are not genuine investments, but are instead designed solely to satisfy the offering contingency, are not considered bona fide. In this scenario, the general partner’s purchase of the remaining units using a non-recourse loan from an affiliate of the underwriter is not a bona fide transaction. The funds are not truly at risk in the same manner as those from unaffiliated public investors. This action creates the false appearance that the required level of public interest has been met, thereby inducing other investors to remain in a deal they might have otherwise exited if the contingency failed. This manipulation directly undermines the investor protections inherent in contingent offerings. While SEC Rule 15c2-4 governs the handling and prompt return of funds from escrow in such offerings, the root violation here is the manipulative act of creating a sham closing, which is specifically addressed by Rule 10b-9.

The calculation to determine the compliance of the fee structure involves summing all components of underwriting compensation and comparing the total to the regulatory limit. Under FINRA Rule 2310, underwriting compensation includes sales commissions, dealer-manager fees, and wholesaling fees. Bona fide due diligence expenses and issuer costs like legal and printing are considered part of the broader Organization and Offering (O&O) expenses but are not included in the specific 10% underwriting compensation limit. The components of underwriting compensation are: Sales Commissions: 7.0% Dealer-Manager Fee: 2.0% Wholesaling Fees: 1.5% Total Underwriting Compensation = \(7.0\% + 2.0\% + 1.5\% = 10.5\%\) The total calculated underwriting compensation is 10.5%. FINRA Rule 2310(b)(4) imposes a strict limit on the total underwriting compensation that a member firm can receive in a public DPP offering. This limit is set at 10% of the gross proceeds of the offering. This compensation cap includes all commissions paid to the selling group, fees paid to the dealer-manager for managing the offering, and fees for wholesaling activities. It is crucial to distinguish these distribution-related costs from other offering expenses. For instance, bona fide due diligence expenses, provided they are substantiated with itemized invoices, are not counted toward this 10% limit. However, these due diligence costs, along with other issuer-paid expenses like legal, accounting, and printing fees, are subject to a separate, broader limit. This second limit restricts total organization and offering expenses to 15% of gross proceeds. In the given scenario, the sum of the sales commissions, dealer-manager fee, and wholesaling fees amounts to a figure that exceeds the 10% threshold for underwriting compensation. Therefore, the proposed fee structure is in violation of FINRA rules.

The scenario describes a “mini-maxi” offering, which is a type of contingency offering governed by specific SEC rules. The core issue is the proposal by the General Partner to purchase the remaining units to meet the minimum sales threshold. This action directly implicates SEC Rule 10b-9 and SEC Rule 15c2-4. SEC Rule 10b-9 makes it a manipulative or deceptive device to represent that a security is being offered on an “all-or-none” or “part-or-none” basis unless the offering is contingent upon the sale of all or a specified number of securities within a specified time, and the total amount due to the seller is promptly refunded to the purchaser if the contingency is not fully satisfied. A critical interpretation of this rule is that the sales required to meet the contingency must be bona fide public sales. Purchases by the issuer, general partner, or their affiliates, particularly if financed with non-recourse loans, are not considered bona fide. Such purchases artificially create the appearance that the offering was successful and that a sufficient number of independent investors deemed it a worthy investment. In this case, the GP’s purchase is not a bona fide transaction. It is a mechanism to ensure the minimum is met and that the escrowed funds from other investors are released. This action deceives the legitimate investors who relied on the minimum offering condition as a measure of the project’s viability and market acceptance. Therefore, proceeding with this plan would constitute a fraudulent and manipulative practice under SEC Rule 10b-9. While SEC Rule 15c2-4, which governs the handling of funds in escrow, would also be violated by the improper release of funds, the root of the violation lies in the failure to meet the contingency through bona fide sales as required by Rule 10b-9.

The core issue making this offering prohibitive for a FINRA member firm is the compensation structure. FINRA Rule 2310, which governs Direct Participation Programs, places strict limits on the compensation and expenses associated with public offerings of DPPs. Specifically, total organization and offering expenses (O&O) cannot exceed \(15\%\) of the gross proceeds of the offering. More importantly, within that \(15\%\) cap, the portion attributable to underwriting compensation is limited to a maximum of \(10\%\) of the gross proceeds. In this scenario, the proposed underwriting compensation is \(12\%\) of gross proceeds. This figure, by itself, already violates the \(10\%\) cap on underwriting compensation. When combined with the \(5\%\) non-accountable expense allowance, the total compensation package reaches \(17\%\), which also breaches the overall \(15\%\) O&O limit. While private placements under Regulation D are not identical to registered public offerings, FINRA applies these compensation guidelines to member firms participating in the distribution of DPPs to ensure fairness and reasonableness. A compensation structure that is non-compliant with these established limits is a fundamental flaw in the offering’s terms and would prevent a member firm from participating. Other issues, such as conflicts of interest in due diligence reports or unbalanced marketing materials, are extremely serious and represent significant compliance and reputational risks. However, they are issues that could potentially be rectified through enhanced disclosures or corrected materials. The compensation structure is a direct violation of the foundational rules governing a member firm’s participation and compensation in the offering itself, making it the most immediate and definitive reason to reject participation.

The scenario presented involves a “mini-max” offering, which is a type of best efforts underwriting contingent upon a minimum amount of securities being sold. SEC Rule 10b-9 defines such offerings and stipulates that the offering is considered fraudulent unless the stated contingency is met. If the minimum sales figure is not achieved by the specified expiration date, the offering must be cancelled. In conjunction with Rule 10b-9, SEC Rule 15c2-4 requires that in a contingent offering, the broker-dealer must promptly transmit all investor funds to a separate bank account, acting as escrow agent, or to a qualified independent escrow agent. These funds must remain in escrow until the contingency is satisfied. If the terms of the contingency are not met, the rule mandates that the broker-dealer must promptly return all funds directly to the persons who subscribed. While the proposed fee structure also presents regulatory issues, the failure to meet the offering’s minimum contingency is the most critical and immediate problem. The compensation structure includes an 8 percent underwriting commission and a 2.5 percent wholesaling fee, totaling 10.5 percent in underwriting compensation. This exceeds the 10 percent limit on underwriting compensation stipulated by FINRA Rule 2310(b)(4). Furthermore, the total organization and offering expenses, which include the 10.5 percent underwriting compensation, a 0.75 percent due diligence reimbursement, and 4 percent in legal and accounting fees, sum to 15.25 percent. This figure exceeds the 15 percent cap on total organization and offering expenses under the same FINRA rule. However, these fee violations are secondary to the failed contingency. The absolute requirement upon the failure of a mini-max offering is the immediate and full return of investor capital.

The calculation first determines the total Organization and Offering (O&O) expenses and the total underwriting compensation as percentages of the gross offering proceeds to verify compliance with FINRA Rule 2310. Gross Offering Proceeds = $50,000,000 Step 1: Calculate the total dollar amount of underwriting compensation. This includes sales commissions, wholesaler fees, and bona fide due diligence expense reimbursements. Sales Commissions: \(0.08 \times \$50,000,000 = \$4,000,000\) Wholesaler’s Override: \(0.01 \times \$50,000,000 = \$500,000\) Due Diligence Reimbursement: \(0.005 \times \$50,000,000 = \$250,000\) Total Underwriting Compensation = \(\$4,000,000 + \$500,000 + \$250,000 = \$4,750,000\) Step 2: Calculate the total underwriting compensation as a percentage of gross proceeds and check against the 10% limit. Percentage = \(\frac{\$4,750,000}{\$50,000,000} = 0.095\) or 9.5% Since 9.5% is less than the 10% limit, this component is compliant. Step 3: Calculate the total dollar amount of all Organization and Offering (O&O) expenses. This includes all underwriting compensation plus the issuer’s direct offering costs. Issuer’s Legal & Accounting Fees: $750,000 Printing & Marketing Costs: $500,000 Total O&O Expenses = Total Underwriting Compensation + Issuer’s Costs Total O&O Expenses = \(\$4,750,000 + \$750,000 + \$500,000 = \$6,000,000\) Step 4: Calculate the total O&O expenses as a percentage of gross proceeds and check against the 15% limit. Percentage = \(\frac{\$6,000,000}{\$50,000,000} = 0.12\) or 12% Since 12% is less than the 15% limit, this component is also compliant. Both the 10% underwriting compensation limit and the 15% total O&O expense limit are met. FINRA Rule 2310 establishes specific limits on the expenses that can be charged in connection with a public offering of a direct participation program. The rule sets a comprehensive cap on all organization and offering expenses at 15% of the gross proceeds from the offering. These O&O expenses encompass all costs incurred by the issuer and its affiliates related to forming the program and distributing the securities. This includes items such as legal and accounting fees for the issuer, printing costs, and all forms of underwriting compensation. Within this 15% overall limit, there is a more restrictive sub-limit specifically for underwriting compensation, which cannot exceed 10% of the gross offering proceeds. Underwriting compensation is broadly defined to include not only direct sales commissions paid to broker-dealers but also other payments like wholesaler’s fees, marketing allowances, and bona fide due diligence expenses reimbursed to the underwriters. To determine compliance, one must first aggregate all components of underwriting compensation and ensure this total does not surpass the 10% threshold. Then, this underwriting compensation total must be added to all other organizational and offering costs to calculate the total O&O expense, which must not exceed the 15% threshold. Both tests must be passed for the offering’s expense structure to be considered compliant.

The core issue revolves around the integrity of a contingent offering, specifically an “all-or-none” offering, as governed by SEC Rules 10b-9 and 15c2-4. SEC Rule 10b-9 defines it as a manipulative and deceptive practice to represent an offering as being on an “all-or-none” or other contingent basis unless the securities are sold to the public through bona fide transactions and the offering is contingent upon the sale of all or a specified number of securities. A bona fide sale is a transaction with a genuine, independent public investor. A purchase by the issuer or an affiliate, made solely to satisfy the minimum contingency and create the appearance of a successful offering, is not considered a bona fide sale. In this scenario, the sponsor, through its affiliate, made a non-bona fide purchase to meet the minimum threshold. This action artificially satisfied the contingency, which is a direct violation of Rule 10b-9. Consequently, the condition for releasing funds from escrow under SEC Rule 15c2-4 was not legitimately met. The proper course of action, upon failing to meet the minimum through bona fide sales by the deadline, would have been to terminate the offering and promptly return all funds from the escrow account to the subscribers. The sponsor’s action misled the genuine investors who committed capital based on the premise that their investment was protected by a minimum level of independent public interest.

The primary due diligence failure is the lack of independent verification of the program’s economic assumptions and projections. Under FINRA Rule 2310, a member firm has an obligation to conduct a reasonable basis investigation before recommending a Direct Participation Program. This means the firm cannot simply rely on the materials and projections provided by the program’s sponsor, especially when certain red flags are present. In this scenario, several red flags exist: the sponsor has a limited operating history, the proposed underwriting compensation of 12% is high (exceeding the general 10% guideline for public offerings), and the disproportionate sharing arrangement is highly favorable to the sponsor. These factors significantly increase the dealer-manager’s responsibility to perform heightened due diligence. This includes, but is not limited to, retaining independent experts to review geological data, analyzing the reasonableness of drilling cost estimates and commodity price forecasts, and scrutinizing the sponsor’s background and capabilities. Approving the program for distribution based solely on the sponsor’s unverified claims would represent a failure to establish that the program has a reasonable chance of economic success, which is the core of the reasonable basis due diligence obligation. While other issues like compensation levels and investor accreditation are important, they are secondary to the fundamental viability of the underlying investment.

The core issue is the structure of the offering’s expenses, which violates the limitations set forth in FINRA Rule 2310 concerning Direct Participation Programs. This rule establishes specific caps on the costs associated with organizing and offering a DPP to the public. First, FINRA Rule 2310(b)(4)(B)(i) states that total organization and offering expenses (O&O) are limited to a maximum of 15% of the gross proceeds of the offering. O&O includes all expenses paid by the issuer in connection with the offering, such as underwriting compensation, legal fees, accounting fees, and printing costs. Second, FINRA Rule 2310(b)(4)(B)(ii) specifies that underwriting compensation itself cannot exceed 10% of the gross proceeds. Underwriting compensation includes commissions, wholesaling fees, and due diligence expense reimbursements paid to the broker-dealer. In this scenario, the expenses are: 1. A sales commission of \(9\%\). 2. A due diligence expense reimbursement to the dealer-manager of \(2\%\). 3. An organizational fee paid to an affiliate of the sponsor of \(5\%\). To assess compliance, we must calculate the total underwriting compensation and the total O&O. The underwriting compensation is the sum of the sales commission and the due diligence reimbursement: \[ 9\% + 2\% = 11\% \] This \(11\%\) figure exceeds the \(10\%\) limit for underwriting compensation. The total organization and offering expenses are the sum of all three components: \[ (9\% + 2\%) + 5\% = 16\% \] This \(16\%\) figure exceeds the \(15\%\) overall limit for O&O. Because both the underwriting compensation limit and the total O&O limit are breached, the offering is not in compliance with FINRA rules. A dealer-manager has a due diligence obligation to ensure that the terms of an offering are fair and reasonable, and participating in an offering with excessive compensation would be a violation of this responsibility. The other points mentioned, such as the sponsor’s track record or use of proceeds for working capital, are important due diligence considerations but do not represent a direct violation of a specific percentage-based rule in this context.

The analysis of this Direct Participation Program’s compensation structure focuses on the alignment of interests between the General Partner (GP) and the Limited Partners (LPs). The structure presented is a disproportionate sharing arrangement, where the GP’s potential revenue share is significantly larger than their initial capital contribution percentage. While such arrangements can create conflicts, the key is to evaluate the mechanisms in place that mitigate this conflict and ensure the GP is incentivized to act in the LPs’ best interests. In this scenario, the most critical feature is the subordination of the GP’s primary profit participation, the reversionary working interest, to the LPs’ financial success. The GP does not receive this 20% interest until the LPs have achieved a full return of their invested capital (payout) plus a 6% cumulative preferred return. This hurdle rate ensures that the LPs are made whole and receive a baseline profit before the GP shares significantly in the program’s revenues. This structure directly ties the GP’s major compensation to the ultimate profitability of the venture for the investors. It incentivizes the GP not merely to find resources, but to manage the program efficiently and profitably over the long term to surpass the threshold required to trigger their own substantial reward. While the GP’s payment of non-deductible costs is a favorable tax feature for LPs, it is the performance-based hurdle for the reversionary interest that provides the strongest alignment of economic interests, which is a cornerstone of a sound due diligence review under FINRA rules.

The offering contingency has failed because the minimum subscription amount was not met through bona fide purchases by the specified deadline. The total funds required to meet the minimum contingency were \(\$10,000,000\). The amount raised from unaffiliated, public investors was \(\$9,800,000\), leaving a shortfall of \(\$200,000\). Under SEC Rule 10b-9, it is a manipulative and deceptive practice for a person to represent that a security is being offered on an “all-or-none” or “part-or-none” basis unless the offering is contingent upon the sale of a specified amount of securities by a specified date. The rule requires that these sales be bona fide. While purchases by the sponsor or its affiliates for investment purposes can be considered bona fide if they are disclosed in the offering documents, the use of non-recourse financing arranged by the issuer or its affiliates specifically to satisfy the minimum sales contingency is generally viewed as a sham transaction that violates Rule 10b-9. The purpose of such a loan is not for genuine investment but to create the misleading appearance that the offering was successful, thereby inducing other investors to part with their funds. Since the minimum was not met with bona fide sales, the contingency has failed. According to SEC Rule 15c2-4, when a contingency offering fails to meet its terms, the broker-dealer must ensure that all consideration received from investors is promptly returned. Therefore, the only appropriate course of action is to terminate the offering and return all investor funds from the escrow account. Extending the offering period or accepting non-bona fide funds would violate federal securities regulations.

The calculation to determine compliance with FINRA Rule 2310 is as follows. First, calculate the underwriting compensation as a percentage of the gross offering proceeds: \[ \frac{\text{Underwriting Compensation}}{\text{Gross Offering Proceeds}} = \frac{\$2,200,000}{\$20,000,000} = 0.11 \text{ or } 11\% \] Next, calculate the total organization and offering expenses (O&O) by summing the underwriting compensation and other direct costs, and then find its percentage of the gross offering proceeds: \[ \text{Total O\&O} = \$2,200,000 + \$1,100,000 = \$3,300,000 \] \[ \frac{\text{Total O\&O}}{\text{Gross Offering Proceeds}} = \frac{\$3,300,000}{\$20,000,000} = 0.165 \text{ or } 16.5\% \] The analysis shows that the underwriting compensation of 11% exceeds the 10% limit, and the total O&O of 16.5% exceeds the 15% limit. FINRA Rule 2310 imposes strict limits on the compensation and expenses associated with public offerings of direct participation programs. These regulations are designed to protect investors by ensuring that a substantial portion of their investment capital is directed toward the program’s underlying assets and operations, rather than being diluted by excessive upfront fees. The rule establishes two critical thresholds based on the gross proceeds of the offering. First, the total underwriting compensation, which includes all commissions, wholesaling fees, and other forms of compensation paid to broker-dealers for distributing the program, cannot exceed 10% of the gross offering proceeds. Second, the total organization and offering expenses (O&O) are capped at 15% of the gross proceeds. This broader category includes the 10% underwriting compensation plus all other issuer costs related to structuring and offering the program, such as legal fees, accounting expenses, and printing costs. A broker-dealer has a due diligence obligation to analyze the offering’s compensation structure. If either of these limits is breached, the offering is considered to have unfair and unreasonable terms, and FINRA members are prohibited from participating in its sale.

The calculation for the investor’s adjusted at-risk basis at year-end is as follows: Initial Basis Calculation: \[ \text{Initial Cash Investment} + \text{Share of Recourse Debt} + \text{Share of Qualified Non-Recourse Financing} \] \[ \$100,000 + \$15,000 + \$40,000 = \$155,000 \] Adjustments during the year: \[ \text{Basis before loss} = \$155,000 – \text{Cash Distribution} \] \[ \$155,000 – \$5,000 = \$150,000 \] The investor’s at-risk basis before accounting for the current year’s loss is \( \$150,000 \). The passive loss for the year is \( \$20,000 \). Since the basis is sufficient to cover the loss, the entire loss is deductible against other passive income. The basis is then reduced by the amount of the deductible loss. Final Year-End Basis Calculation: \[ \text{Basis before loss} – \text{Deductible Passive Loss} \] \[ \$150,000 – \$20,000 = \$130,000 \] An investor’s basis in a direct participation program, particularly a limited partnership, is a critical calculation for tax purposes as it determines the extent to which partnership losses can be deducted. The initial basis begins with the investor’s capital contribution. This basis is then increased by the investor’s pro-rata share of partnership liabilities for which they are personally responsible, known as recourse debt. It is also increased by their share of partnership income. Conversely, the basis is decreased by any cash or property distributions received from the partnership and by their share of partnership losses. A crucial concept tested here relates to the at-risk rules and a specific exception for real estate programs. Generally, an investor is only considered at-risk for the amount of their cash contribution and any debt for which they have personal liability. However, for activities involving the holding of real property, the tax code allows qualified non-recourse financing to be included in the at-risk amount. This type of financing is secured by the real property itself and is provided by a qualified lender. Therefore, for a real estate DPP, the at-risk basis includes cash contributions, recourse debt, and qualified non-recourse debt. This total amount is then adjusted for distributions and losses to arrive at the year-end basis.

The situation described involves a contingent offering, specifically an “all-or-none” offering. These offerings are governed by SEC Rule 10b-9, which defines the terms of the contingency, and SEC Rule 15c2-4, which dictates the handling of investor funds. Under Rule 10b-9, an all-or-none offering requires that if all the securities are not sold to bona fide purchasers by a specified date, all subscription funds must be promptly returned to investors. A key element is the term “bona fide purchaser.” A purchase is not considered bona fide if the investor does not bear the full economic risk of the investment. In this scenario, the sponsor is arranging for an affiliated entity to purchase the remaining units using a non-recourse loan from the sponsor. This means the purchaser is not truly at risk; if the investment fails, they can simply default on the non-recourse loan with no personal liability. This is a prohibited practice designed to artificially meet the offering contingency. Such a purchase is not a bona fide sale. Therefore, the minimum sales contingency has not been legitimately met. The dealer-manager has a regulatory obligation to recognize this fact. The only permissible action is to declare that the offering has failed to meet its terms. Consequently, in accordance with the offering documents and Rule 15c2-4, all funds held in the escrow account must be promptly returned in full to the original subscribers. Proceeding with the closing would constitute a fraudulent act.

The core of the analysis rests on the representative’s due diligence obligations under FINRA Rule 2310 and suitability obligations under FINRA Rule 2111. In a disproportionate sharing arrangement within an oil and gas program, the limited partners typically fund the intangible drilling costs (IDCs), which are 100% deductible but represent the highest-risk portion of the venture. The general partner, or sponsor, typically funds the tangible, non-deductible costs, such as equipment. In return for bearing a smaller, less risky portion of the costs, the sponsor receives a disproportionately large share of the program’s revenues. This structure creates a significant potential conflict of interest and economic misalignment. The primary due diligence concern is not merely the tax benefits or the general risk of drilling, but the fundamental economic soundness of the program for the limited partners. The representative must ensure the client understands that because of this structure, the sponsor could achieve profitability on a well that is only marginally successful or even unprofitable for the limited partners. The risk-reward profile for the investor is skewed, as they are funding the riskiest activities for a reduced share of the potential upside. Therefore, the most critical disclosure is the potential for the sponsor to profit even when the limited partners do not, which stems directly from the sponsor’s disproportionate revenue interest relative to their actual cost and risk contribution.

Total offering size = \(\$50,000,000\) According to FINRA Rule 2310(b)(4), there are two primary limits on compensation for public direct participation programs. First, total Organization and Offering (O&O) expenses cannot exceed 15% of the gross proceeds of the offering. Second, total underwriting compensation cannot exceed 10% of the gross proceeds. A critical aspect of this rule is understanding which expenses fall into each category. Underwriting compensation includes commissions, wholesaling fees, and non-accountable expense allowances. Bona fide, itemized, and accountable due diligence expenses are considered part of the overall 15% O&O limit but are not included within the 10% underwriting compensation limit. Let’s analyze the correct compensation structure: 1. Calculate total underwriting compensation: – Underwriting commission: \(8\%\) – Wholesaling fees: \(1.5\%\) – Non-accountable expense allowance: \(0.5\%\) – Total Underwriting Compensation Percentage = \(8\% + 1.5\% + 0.5\% = 10\%\) – In dollar terms: \(10\% \times \$50,000,000 = \$5,000,000\) – This meets the 10% limit exactly. 2. Calculate total Organization and Offering (O&O) expenses: – Total Underwriting Compensation: \(\$5,000,000\) – Bona fide due diligence expenses: \(\$200,000\) – Total O&O Expenses = \(\$5,000,000 + \$200,000 = \$5,200,000\) – As a percentage of gross proceeds: \(\frac{\$5,200,000}{\$50,000,000} = 10.4\%\) – This is well below the 15% limit for total O&O expenses. Since both the 10% underwriting compensation limit and the 15% total O&O expense limit are met, this structure is compliant with FINRA Rule 2310. The key is recognizing that bona fide due diligence costs are part of the O&O calculation but are excluded from the underwriting compensation calculation. This allows a firm to be compensated for its due diligence work without it eroding the 10% compensation available for the syndicate.

The calculation to determine the compliance of the compensation structure is as follows: Identify all components that constitute underwriting compensation under FINRA Rule 2310. Underwriting Commission: \(8.00\%\) Wholesaling Fee: \(2.00\%\) Non-Accountable Due Diligence Allowance: \(0.75\%\) Marketing and Administrative Support Fee: \(1.00\%\) Sum these components to find the total underwriting compensation: \[ 8.00\% + 2.00\% + 0.75\% + 1.00\% = 11.75\% \] Compare the total underwriting compensation to the regulatory limit. FINRA Rule 2310(b)(4) limits total underwriting compensation in a public Direct Participation Program offering to \(10\%\) of the gross offering proceeds. The proposed compensation of \(11.75\%\) exceeds the maximum allowable compensation of \(10\%\). Therefore, the arrangement is non-compliant. FINRA rules for Direct Participation Programs establish strict limits on the compensation that can be paid to member firms and their associated persons for distributing a public offering. Specifically, FINRA Rule 2310(b)(4) states that total underwriting compensation received from any source cannot exceed ten percent of the gross proceeds of the offering. It is critical to understand that “underwriting compensation” is a broad term that encompasses more than just the stated sales commission. It includes all items of value that flow from the issuer or sponsor to the distributor. In this context, wholesaling fees paid to the dealer-manager’s employees, non-accountable expense allowances for due diligence, and vaguely defined payments like marketing and administrative support fees are all considered forms of underwriting compensation. These must be aggregated with the primary commission to determine compliance with the ten percent cap. This rule is separate from, but a component of, the overall limit on total organization and offering expenses, which generally cannot exceed fifteen percent of gross proceeds. The fifteen percent limit includes the ten percent underwriting compensation plus other bona fide issuer expenses like legal, accounting, and printing costs. A failure to correctly identify and aggregate all forms of underwriting compensation can lead to a significant regulatory violation.

Total Offering = $30,000,000 Underwriting Commissions = 10% of $30,000,000 = $3,000,000 Non-accountable Expense Allowance = 1% of $30,000,000 = $300,000 Legal and Accounting Costs = 5% of $30,000,000 = $1,500,000 Total Organization and Offering Expenses (O&O) = $3,000,000 + $300,000 + $1,500,000 = $4,800,000 Total O&O as a percentage of Gross Proceeds = \(\frac{\$4,800,000}{\$30,000,000} = 16\%\) FINRA Rule 2310 establishes critical guidelines for the compensation and expenses related to public offerings of Direct Participation Programs. While this scenario involves a private placement under Regulation D, the principles of this rule are a benchmark for broker-dealers when conducting the required due diligence to ensure that the terms of an offering are fair and reasonable. The rule sets specific limits on the total amount of organization and offering expenses that can be charged. These expenses encompass all costs associated with structuring and selling the program. This includes, but is not limited to, underwriting commissions, wholesaling fees, advertising costs, legal and accounting fees related to the offering, and any expense reimbursements to the underwriter. The rule stipulates two primary limitations. First, the total for all organization and offering expenses may not exceed 15% of the gross proceeds of the offering. Second, within that 15% cap, the portion paid as underwriting compensation may not exceed 10% of the gross proceeds. In this situation, the 10% underwriting commission is at the maximum allowable limit for that specific component. However, when the separate 1% non-accountable expense allowance and the 5% for legal and accounting are included, the aggregate O&O totals 16%. This combined figure surpasses the 15% overall limitation, creating a significant regulatory issue and indicating that the offering’s terms are unreasonable from a compliance perspective.

The calculation to determine the acceptability of the expense structure under FINRA Rule 2310 is as follows. First, identify the gross proceeds of the offering, which is \( \$50,000,000 \). Second, determine the maximum allowable underwriting compensation, which is 10% of the gross proceeds. Maximum Underwriting Compensation = \( \$50,000,000 \times 0.10 = \$5,000,000 \). Third, calculate the proposed total underwriting compensation by summing all relevant components. Underwriting compensation includes commissions, wholesaler fees, and due diligence expense reimbursements. Legal and accounting fees are considered organization and offering expenses but not underwriting compensation. Underwriting Commission = \( \$50,000,000 \times 0.070 = \$3,500,000 \) Wholesaler Fees = \( \$50,000,000 \times 0.025 = \$1,250,000 \) Due Diligence Reimbursement = \( \$50,000,000 \times 0.0075 = \$375,000 \) Total Proposed Underwriting Compensation = \( \$3,500,000 + \$1,250,000 + \$375,000 = \$5,125,000 \). Finally, compare the proposed total underwriting compensation to the maximum allowed. The proposed compensation of \( \$5,125,000 \) exceeds the \( \$5,000,000 \) limit. As a percentage, the proposed compensation is \( \frac{\$5,125,000}{\$50,000,000} = 10.25\% \), which is greater than the 10% limit. FINRA Rule 2310 imposes specific limits on the expenses associated with public offerings of Direct Participation Programs. The rule establishes a two-tiered cap. The first is a limit on total organization and offering expenses (O&O), which cannot exceed 15% of the gross proceeds of the offering. O&O expenses include all costs incurred to structure and sell the program. The second, more restrictive limit is a sub-cap on underwriting compensation, which cannot exceed 10% of the gross proceeds. Underwriting compensation is a component of the total O&O expenses and includes items such as selling commissions, wholesaling fees, and other forms of compensation paid to member firms for their role in the distribution. It is critical to understand that bona fide due diligence expense reimbursements paid to the dealer-manager are also included in the calculation of the 10% underwriting compensation limit. In this scenario, the sum of the commission, wholesaler fees, and due diligence reimbursement exceeds the 10% threshold, making the expense structure non-compliant, even if the total O&O expenses fall below the 15% overall cap.

The scenario describes a public webinar that constitutes general solicitation. According to SEC rules, general solicitation is permissible for private placements conducted under Rule 506(c) of Regulation D. However, using this exemption carries a specific and critical obligation for the issuer or broker-dealer. While Rule 506(b) offerings, which prohibit general solicitation, allow the issuer to rely on an investor’s self-certification of accredited status, Rule 506(c) imposes a more stringent standard. When an issuer engages in general solicitation to attract investors, it must take reasonable steps to verify that all purchasers are, in fact, accredited investors. This verification standard is a principles-based requirement, meaning the specific steps can vary depending on the circumstances and the nature of the investor. Methods can include reviewing recent tax returns or W-2s, bank or brokerage statements, or obtaining a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant. Simply accepting an investor’s questionnaire or documentation without this verification process would not satisfy the rule’s requirements when general solicitation has been used. Therefore, the most critical compliance step directly resulting from this method of solicitation is the heightened verification of the investor’s accredited status.