An independent broker-dealer with a few hundred advisors cannot staff an in-house team capable of examining every sponsor and program it might distribute. Neither can most RIAs. The economics do not work, and the expertise required — real estate underwriting, credit analysis, securities structuring, operational review — is not a natural fit for a distribution business.
A market emerged to fill that gap. Third-party due diligence providers review sponsors and offerings and produce reports that firms use in their own process.
The reports are genuinely useful. How they are used is where firms get into difficulty.
What these reports contain
Scope varies, but a typical report covers:
The sponsor. History, ownership, financial condition, principals and their backgrounds, personnel, and any regulatory or litigation history.
The offering. Structure, terms, fee load, distribution arrangements, and the governing documents.
The assets. For real estate programs, the properties, leases, tenants, debt, and underwriting assumptions. For credit programs, the loan book and its characteristics.
The projections. The sponsor assumptions and an assessment of whether they are reasonable — exit assumptions, growth rates, and financing costs.
Track record. Prior programs, their outcomes, and whatever verification the provider performed.
Risk factors. Identified risks, often the most useful section.
A conclusion, sometimes as a rating or a recommendation.
The question to ask first: who paid?
This is the structural issue in the sector and it deserves to be addressed directly rather than left implied.
Arrangements vary. In some, the sponsor commissions and pays for the report, often as part of preparing a program for distribution. In others, the broker-dealer or platform commissions it, sometimes through a subscription to a provider research.
A sponsor-paid report carries an obvious conflict: the entity being reviewed is the client. This does not mean such reports are unreliable — reputable providers manage the conflict through methodology, editorial independence, and the knowledge that their value to distributors depends on their credibility. Rating agencies operate under a structurally similar conflict and remain useful.
But it does mean the conflict should be known and factored in. A reader who does not know who paid for a report is missing information relevant to how to weight it. That information is generally disclosed in the report itself, and it is worth locating before the summary conclusion.
What reliance does and does not do
This is the point that matters most for firms.
A broker-dealer recommending a private placement has an obligation to conduct a reasonable investigation of the offering. FINRA has addressed the point directly, and the position is consistent: a firm may use third-party reports as part of its process, and doing so does not discharge the obligation.
What the firm still owes:
An assessment of the report adequacy. Does its scope cover what the firm needs? Was the work performed by people competent for it? Is it current relative to when the recommendation is made?
Independent judgment on the findings. A report that identifies significant risks and reaches a favourable conclusion still requires the firm to form its own view. Adopting the conclusion without engaging the findings is not investigation.
Its own file. The firm needs a record of what it reviewed, what it considered, and why it concluded the offering was suitable for its platform. A third-party report in a folder is not a substitute for that reasoning.
Customer-specific analysis. Product-level diligence is separate from whether a recommendation is in a particular customer best interest under Regulation Best Interest or an adviser fiduciary duty. See reasonable-basis diligence.
The failure mode is a firm that treats a favourable report as the decision rather than as an input, and has no record of its own reasoning. That position is difficult to defend after the fact regardless of how good the report was.
How to read one
Start with scope and limitations. What did the provider examine, what did it rely on the sponsor to represent, and what did it explicitly not do? Providers disclose this, usually in a section readers skip. It is the most important part of the document.
Note the date. Diligence is a snapshot. A report prepared before a material change in the sponsor circumstances, the debt markets, or the asset class describes a situation that may no longer exist.
Read the risk section before the conclusion. A report that identifies serious risks and concludes favourably is telling the reader two things, and the first is more specific than the second.
Distinguish verified from represented. Independently confirmed facts are worth more than restated sponsor assertions. Good reports mark the difference; readers should look for it.
Check track record treatment. Whether prior program results were verified, and whether the record includes everything the sponsor has done rather than a selection. See evaluating a sponsor track record.
Look at assumptions. In real estate programs particularly, exit assumptions drive projected outcomes more than anything else, and a report that tests them is doing real work.
Using them well
For a firm building a process, third-party reports work best as one documented input among several:
- Obtain the report and read it fully, including scope limitations.
- Record the firm own assessment of the findings, including any disagreement.
- Perform the checks the report did not — particularly independent confirmation of service providers.
- Read the governing documents directly rather than relying on a summary of them.
- Document the platform decision and its reasoning.
- Refresh for continuing offerings, since both the program and the sponsor circumstances change.
For an individual investor, third-party reports are generally not directly available, but their existence is a reasonable question to ask an advisor recommending a program: has the firm reviewed third-party diligence on this sponsor, and what did it find? An advisor who cannot answer has told you something about the process behind the recommendation.
For an independent, unaffiliated list of due diligence providers active in the space, see the SQX Alts directory.
This guide is educational and general; it is not legal, compliance, or investment advice.
Frequently Asked Questions
What is a third-party due diligence provider?
A firm that independently reviews alternative investment sponsors and programs and produces written reports used by broker-dealers, advisors, and platforms in their own review process. Reports typically cover the sponsor, the offering structure, the assets, the terms, the track record, and identified risks.
Who pays for third-party due diligence reports?
It varies, and it matters. In some arrangements the sponsor commissions and pays for the report; in others the broker-dealer or platform commissions it, sometimes through a subscription. Knowing which applies is part of reading the report, because a sponsor-paid report has a conflict that a purchaser-paid report does not.
Does relying on a third-party report satisfy a broker-dealer diligence obligation?
Not by itself. The firm remains responsible for conducting a reasonable investigation, which includes evaluating whether the third-party work is adequate, current, and independent enough for the purpose. Reports are an input to the firm process rather than a substitute for it.
What is in a third-party due diligence report?
Typically a description of the sponsor and its principals, the offering structure and terms, the underlying assets and their underwriting, the fee load, the track record with any verification performed, identified risk factors, and often a summary rating or conclusion. Scope varies by provider and by engagement.
How should a report be read?
Start with who commissioned it, what the stated scope was, what was and was not independently verified, the date, and the identified risks rather than the summary conclusion. The risk section and the scope limitations are usually more informative than the rating.
Sources
- FINRA Regulatory Notice 10-22 (obligation to conduct a reasonable investigation in Regulation D offerings)
- FINRA Rule 2310 (Direct Participation Programs)
- SEC Regulation Best Interest (Exchange Act Rule 15l-1)
