Recently, the National Association of Securities Dealers, Inc. (“NASD”) issued Notice to Members 07-27 soliciting comments from NASD members and other interested parties on proposed Rule 2721 that would regulate private placement offerings by a broker/dealer of its own securities, or those of a “control entity” of a broker/dealer (“Member Private Offerings”). In the Notice to Members, NASD stated that Rule 2721 is proposed in response to problems NASD has identified in connection with the Member Private Offerings. The new rule could add significantly to the regulatory burden of certain broker-dealers and issuers in private placement offerings. The rule represents a departure from prior NASD practice by regulating certain private offerings of securities. Currently, NASD Conduct Rule 2710(b) (8) exempts private securities offerings from filing and review requirements of Rules 2710, 2720 and 2810. However, under the proposed rule, the NASD would be granted the authority to substantively regulate the disclosure of Member Private Offerings, a form of regulation that has traditionally been outside of the NASD’s jurisdiction. NASD requested that all comments on the proposal be received by July 20, 2007.

Proposed Rule

Proposed Rule 2721 would establish disclosure and filing requirements, as well as limits on offering expenses for private placement offerings by a broker-dealer of its own securities or those of a “control entity.” A “control entity,” for purposes of the rule, will be defined as an entity that controls, is controlled by, or is under common control with a broker-dealer or its associated persons.1 The term “control” would be determined based on the beneficial ownership of more than 50 percent of the outstanding voting securities of a corporation, or the right to more than 50 percent of the distributable profits and losses of a partnership.2

Under the proposed rule, the NASD members will be required to file the private placement memorandum (“PPM”) with NASD prior to the first time the PPM is provided to any investor.3 Also, any amendments and exhibits would be required to be filed with the NASD within 10 days of being provided to the investor. The rule would also require that: (i) a PPM be provided to each investor (whether accredited or unaccredited) with information regarding risk factors associated with investment, including company risks, industry risks and market risks; intended use of offering proceeds, offering expenses and selling compensation; and any other information necessary to ensure that required information is not misleading; and (ii) at least 85 percent of the offering proceeds be used for the business purposes identified under the “use of proceeds” disclosure in the PPM. As a result, a broker-dealer would no longer simply be able to rely on SEC Rule 502 of Regulation D (which does not require disclosure documents to be prepared or provided in offerings made solely to accredited investors), for these types of private offerings.

The proposed rule would exempt, however, offerings that are sold solely to: (i) institutional accounts (as defined in NASD Rule 3110(c)(4)); (ii) qualified purchasers (as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940); (iii) qualified institutional buyers (as defined in SEC Rule 144A of the Securities Act); (iv) investment companies (as defined in Rule SEC Rule 144A); (v) an entity composed exclusively of qualified institutional buyers (as defined in SEC Rule 144A); and (vi) banks (as defined in SEC Rule 144A). It should be noted that Member Private Offerings made solely to “accredited investors,” as defined in Rule 501 of Regulation D under the Securities Act—which investors do not otherwise meet one of the exemptions described above—would be subject to the proposed rule. In addition, the following types of offerings would be exempt from the proposed rule: (i) offerings made pursuant to Rule 144A or Regulation S under the Securities Act; (ii) offerings in which a member acts solely in a wholesaling capacity and sells unregistered securities to other unaffiliated broker-dealers; (iii) offerings of exempt securities with short-term maturities under Section 3(a)(3) of the Securities Act; and (iv) offerings of subordinated loans under Rule 15c3-1 under the Securities Exchange Act of 1934. Also, the following types of offerings would be exempt from the rule: (i) offerings of unregistered investment grade rated debt; (ii) offerings to employees and affiliates of the issuer; and (iii) offerings of securities issued in stock splits and restructuring transactions.

The Notice to Members states that proposed Rule 2721 is intended to provide investor protection with respect to Member Private Offerings. Even though NASD would not issue a “no objections opinion,” the NASD may make further inquiries about an offering if subsequently it determines that disclosures in the PPM are incomplete, inaccurate or misleading. Having received written comments from the NASD with respect to adequacy of the disclosure in the PPM after the PPM has been distributed to prospective investors could, potentially, raise liability issues for the issuer and broker-dealer. Therefore, as a practical matter, the issuer and broker-dealer may want to wait for the NASD’s comments before mailing the PPM to investors. Since the proposed rule does not impose any specific time limit on the NASD’s review of a PPM, the filing and review process may substantially delay the offering. The proposal also states that the NASD intends to create a database of Member Private Offerings to be used in connection with the NASD's examination process.

A copy of the Notice to Members can be found in the list of Notices to Members on the NASD website at