Executive Summary

Effective June 17, 2009, new FINRA Rule 5122 will require FINRA member firms and associated persons that engage in a private placement of the member firm’s securities or those of a control entity to comply with (1) certain disclosure requirements, (2) certain filing requirements and (3) certain limitations on the use of offering proceeds.1

The rule will not apply retroactively to any offerings that have already commenced selling efforts as of the effective date, June 17, 2009.

Overview of FINRA Rule 5122

FINRA Rule 5122 provides additional regulation of certain private placements that are generally excluded from the scope of current existing rules. The new FINRA Rule 5122 requires a member firm or associated person that engages in a private placement of unregistered securities issued by the firm or a control entity of such firm (“Member Private Offering,” or MPO) to  

  1. disclose to investors in a private placement memorandum, term sheet or other offering document the intended use of offering proceeds and the offering expenses;  
  2. file such offering document with FINRA’s Corporate Financing Department at or prior to the time it is provided to any investor; and  
  3. commit that at least 85 percent of the offering proceeds will be used for business purposes, which shall not include offering costs, discounts, commissions and any other cash or non-cash sales incentives.

1) Disclosure Requirements

Rule 5122 requires firms to provide a written offering document to each prospective investor in an MPO. Rule 5122 requires that the offering document disclose the intended use of offering proceeds, as well as offering expenses and selling compensation. If the offering has a private placement memorandum or term sheet, then such memorandum or term sheet must be provided to each prospective investor and must contain these disclosures. If the offering does not have a private placement memorandum or term sheet, then the member firm must prepare an offering document that discloses the intended use of offering proceeds, as well as offering expenses and selling compensation. Rule 5122, however, does not require a particular form of disclosure.

2) Filing Requirements

Rule 5122 also requires that a member firm file a private placement memorandum, term sheet or other offering document with FINRA’s Corporate Financing Department at or prior to the first time such document is provided to any prospective investor. Any amendment or exhibit must also be filed with the Corporate Financing Department within 10 days of being provided to any investor or prospective investor.

Unlike in the case of public offerings subject to FINRA Rule 5110, FINRA staff will not review the offering and issue a “no objections” letter before the member may commence the offering. Accordingly, FINRA staff could notify a member of a potential regulatory issue identified in connection with its review of the offering document after the MPO has commenced and the offering document has been distributed to investors.

Offering documents may be submitted to the Corporate Financing Department by electronic means. Offering documents should be submitted as to the Corporate Financing Department via email at corpfin@finra.org. FINRA considers the material as “filed” upon submission. The filed information will be subject to confidential treatment.

3) Use of Offering Proceeds

Rule 5122 requires that, each time an MPO is closed, at least 85 percent of the offering proceeds be used for business purposes (excluding offering costs, discounts, commissions and any other cash or no-cash sales incentives). The use of offering proceeds must also be consistent with the required disclosures to investors. The rule does not, however, limit the total amount of underwriting compensation, although no more than 15 percent of the money raised from investors in the private placement can be used to pay underwriting expenses.

Exemptions

Rule 5122 provides a number of exemptions based on the type of investors and type of offerings.

The rule exempts MPOs sold solely 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 (the “1940 Act”); qualified institutional buyers, as defined in Rule 144A under the Securities Act of 1933 (the “Securities Act”); investment companies, as defined in Section 3 of the 1940 Act; an entity composed exclusively of qualified institutional buyers, as defined in Rule 144A; and banks, as defined in Section 3(a)(2) of the Securities Act.

Rule 5122 also exempts certain types of offerings, including exempted securities, as defined by Section 3(a)(12) of the Securities Exchange Act of 1934 (the “Exchange Act”); offerings made pursuant to Rule 144A or SEC Regulation S; offerings in which the member acts primarily in a wholesaling capacity; offerings of exempted securities with short term maturities under Section 3(a)(3) of the Securities Act; offerings of subordinated loans under Appendix D of Rule 15c3-1 under the Exchange Act; offerings of “variable contracts,” as defined in NASD Rule 2820(b)(2); offerings of modified guaranteed annuity contracts and modified guaranteed life insurance policies, as referred to in FINRA Rule 5110(b)(8)(E); offerings of securities of a commodity pool operated by a commodity pool operator, as defined under Section 1a(5) of the Commodity Exchange Act; offerings of equity and credit derivatives, including OTC options, provided that the derivative is not based principally on the member or any of its control entities; and offerings filed with FINRA under FINRA Rule 5110 or NASD Rules 2720 or 2810.

FINRA members can rely on more than one exemption to avoid triggering the requirements of Rule 5122—e.g., a combination of the employee and qualified purchaser exemptions.

Conclusion

In the absence of an applicable exemption, Rule 5122 will increase disclosure and filing requirements, as well as tighten restrictions on the use of offering proceeds in MPOs. Applicable FINRA member firms and associated persons should plan for the effective date of June 17, 2009, accordingly.