Questionable Regulation S Sales of Structured Products Result in FINRA Fine

Firms that offer unregistered securities under Regulation S must conduct appropriate procedures to determine whether potential customers are eligible to purchase these securities. Otherwise, they may subject themselves to regulatory scrutiny not only for potential 1933 Act violations, but also for inadequate supervision of sales activity in violation of FINRA Rule 3110. FINRA's March 2026 censure of a broker-dealer and its imposition of a $200,000 fine illustrates that obtaining customer certifications as to their Regulation S status is not in and of itself an adequate supervision program, and reminds member firms of FINRA's continued focus on firms' need to comply with their supervisory obligations. Moreover, this action also serves to remind member firms of the breadth of FINRA's regulatory authority under Rule 3110, including its ability to take enforcement action even where there has not been an independent finding of non-compliance with applicable securities laws or regulations.

In connection with a periodic examination, FINRA found that a broker-dealer that had handled more than $650 million in customer transactions of unregistered securities—mostly structured products—during the relevant period had no system in place to ensure that the firm's offers and sales of unregistered securities complied with Section 5 of the Securities Act of 1933. This failure, FINRA alleged, violated FINRA Rule 3110, which requires firms, among other things, to establish and enforce supervisory systems and policies reasonably designed to achieve compliance with applicable securities laws and regulations and applicable FINRA rules.

In order for the subject securities to qualify for the Regulation S safe harbor, the firm was generally prohibited from offering the unregistered securities to customers within the United States and, with regard to the structured products in particular, the firm was prohibited from selling such securities to U.S. persons¹  until the expiration of a 40-day "distribution compliance period."²  Accordingly, the firm was required to ensure that any offer of the securities would not be made within the United States and that any customer purchasing the securities during the distribution compliance period was not a U.S. person.

However, the firm's efforts in this regard were limited to requiring customers to sign a risk disclosure that included a "U.S.-person status" disclaimer before being granted permission to purchase structured products. FINRA concluded that this requirement was inadequate for purposes of Rule 3110, because it was not periodically updated to ensure that a particular customer's U.S.-person status had not changed since initially obtaining approval to purchase structured products. In addition, the firm had no system or policies in place to flag and resolve obvious discrepancies, such as in the case of a customer with a U.S. residential address and tax domicile but who nevertheless signed the risk disclosure in which the customer acknowledged it was not a U.S. person for purposes of Regulation S. Indeed, FINRA identified more than $5.8 million in sales of the relevant securities to customer accounts that may not have qualified for the safe harbor because they took place during the distribution compliance period and potentially involved U.S. persons, based on customer records providing a U.S. residential address (notwithstanding the relevant customer's self-certification of U.S.-person status). These "red flags," as FINRA indicated, should have been surfaced in connection with an adequate supervisory system reinforced by appropriate written policies and procedures reasonably designed to ensure Regulation S compliance.

FINRA also alleged that the firm violated Rule 2010 based on the same supervisory failure. FINRA Rule 2010 relates to the maintenance of high standards of commercial honor and just and equitable principles of trade.

Of note to issuers, broker-dealers and other regulated persons and entities, Regulation S compliance is squarely within the enforcement authority of the Securities Exchange Commission, but not exclusively so. As FINRA did here, other regulators may have authority to investigate Regulation S violations under other regulatory frameworks. Importantly, FINRA's enforcement activity against the firm in this case did not require any independent SEC finding of actual non-compliance with the rules.