Alert October 18, 2011

FINRA Proposes New Rule 5123 Governing Private Placements of Securities by Member Firms

On October 4, 2011, FINRA filed with the SEC a proposal to adopt new FINRA Rule 5123 governing private placements of securities.  The subject matter of this filing was originally proposed in January 2011 in FINRA Regulatory Notice 11-04 as an expansion of FINRA Rule 5122 (Member Private Offerings).  Rule 5122 governs member participation in private placements of securities issued by the member firm or a close affiliate of the member.  In April 2011, in response to comments on the proposal, FINRA announced that it was planning revisions to the proposed rule amendment (see “Director of FINRA Corporate Financing Department Discusses Possible Significant Changes to Proposed Expansion of Member Private Offering Rule“ in the April 19, 2011 Financial Services Alert).  Proposed Rule 5123 reflects those revisions.

The new proposal creates a separate rule for private placements other than member private offerings (as defined in Rule 5122) and imposes disclosure and filing requirements similar to those applicable to member private offerings.  Rule 5123 also contains most of the exemptions found in Rule 5122, with two exceptions discussed below.  A critical difference between Rule 5122 and proposed Rule 5123 is that the proposed rule does not include the substantive requirement that at least 85% of offering proceeds be used for the business purposes disclosed in the offering material.  That requirement received the largest number of comments in opposition to the January proposal.

Proposed Rule Provisions

Applicability and Exemptions.  Rule 5123 would apply to participation by a member or associated person of a member in any offering conducted in reliance on an exemption from registration under the Securities Act of 1933 (“Securities Act”), unless one of the exemptions under Rule 5123 applies.  “Participation” includes not only offering and selling securities in the offering but also “participation in the preparation of a private placement memorandum, term sheet or other disclosure document in connection with such private placement.” 

Most of the exemptions available under Rule 5122 would be available under the proposed rule.  Those include exemptions for sales to certain categories of investors, including:

  • institutional accounts, as defined in NASD Rule 3110(c)(4);

  • qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940; and

  • qualified institutional buyers, as defined in Securities Act Rule 144A.

There are also exemptions for specified types of offerings, including:

  • offerings of exempted securities, as defined in Section 3(A)(12) of the Securities Exchange Act of 1934;

  • offerings made pursuant to Securities Act Rule 144A;

  • Offerings made pursuant to Securities Act Regulation S; and

  • offerings filed with FINRA under Rules 2310, 5110, 5121 and 5122.

The exemption for offerings filed under Rule 5110 (the Corporate Financing Rule) is necessary because Rule 5110 requires filing of some exempt offerings, including offerings by banks exempt under Securities Act Section 3(a)(2) and offerings exempt under Rule 504 of Regulation D.

The two exemptions provided by Rule 5122 that would not be available under proposed rule 5123 are the exemptions for (1) offerings in which a member acts in a wholesaling capacity and (2) offerings of certain credit derivatives.

Disclosure.  A member participating in a private placement subject to Rule 5123 would be required to provide to each investor prior to sale a private placement memorandum or term sheet describing the anticipated use of offering proceeds, the amount and type of offering expenses and the amount and type of compensation provided or to be provided to sponsors, finders and consultants and members and their associated persons in connection with the offering.  If the private placement issuer has not prepared a private placement memorandum or term sheet, the member must prepare and provide to investors a disclosure document that contains the disclosures required by the rule. 

Filing with FINRA.  The private placement memorandum, term sheet or other disclosure document, and any exhibits thereto, must be filed with FINRA by the participating member or associated person no later than 15 calendar days after the date of first sale, and any material amendment to the offering material must be filed with FINRA no later than 15 days after the date of first use. In response to comments to the earlier rule proposal, FINRA has removed any reference in the proposed rule to review by FINRA of the filed offering material.  Commenters were concerned about the possibility of receiving requests by FINRA staff to amend offering material after it had already been provided to investors.  In its statement in response to comments, FINRA said:

Moreover, by requiring a “notice” filing [i.e., post-sale] FINRA will remove any implication that the FINRA staff will provide comments on a filing; that such filing with FINRA could be a precondition to commencing an offering; or that members should expect to receive any FINRA staff input before proceeding with an offering.  The proposed filing requirement would nevertheless provide FINRA staff with timely access to information about the private placement business of FINRA members.

The proposed rule would require every participating member to make its own filing rather than to rely on a filing made by another member.  There would be no fee for filing in the rule as proposed.

Request For Comments

FINRA has requested that comments on the proposed rule be submitted to the SEC within 21 days after publication in the Federal Register.