On September 5, 2012, the Financial Industry Regulatory Authority (“FINRA”) issued a regulatory notice informing members that new FINRA Rule 5123—Private Placements of Securities, which was approved by the Securities and Exchange Commission (“SEC” or the “Commission”) on June 7, 2012, will take effect on December 3, 2012, and will apply prospectively to private placements that begin selling efforts on or after that date.1 In light of the impending implementation date, this Client Alert reviews the requirements of the rule, which will impact both FINRA member firms and certain companies raising capital in private placements.2

Overview of Rule 5123

Subject to broad exceptions discussed below, Rule 5123 requires each FINRA member firm that sells an issuer’s securities in a private placement to file with FINRA a copy of any private placement memorandum (“PPM”), term sheet or other offering document the firm used within 15 calendar days of the date of the sale, or indicate to FINRA that it did not use any such offering documents. The rule requires firms to file any materially amended versions of the documents originally filed. Firms must file the required offering documents or provide the notification electronically with FINRA through the FINRA Firm Gateway.

Prior to the adoption of FINRA Rule 5123, FINRA required only FINRA members or their affiliates that issued their own securities in a private placement to file a copy of the PPM under Rule 5122—Private Placements of Securities Issued by Members. Rule 5123 effectively extends this obligation to non-member offerings subject to broad exceptions.  

Definition of Private Placement and Impact of the Exemptions

A private placement is defined in Rule 5123 as “a non-public offering of securities conducted in reliance on an available exemption from registration under the Securities Act.” The rule exempts a broad range of private placements from this definition based on the type of purchaser, the type of offering or the type of security. A detailed list of the exemptions is set forth in Appendix A (exempt purchasers), Appendix B (exempt offerings) and Appendix C (exempt securities) to this Client Alert. The rule also permits FINRA member firms to apply for an exemption for good cause.

The breadth of the exemptions are such that only a limited range of private placements will be captured within the new rule. For example, private placements to most institutional accredited investors or to qualified institutional buyers, or private placements conducted pursuant to Regulation S, are exempted from Rule 5123. The net result is that offerings to individual accredited investors or pursuant to the exemption for up to 35 unaccredited investors under Regulation D are likely to trigger the filing requirement unless those individual accredited investors fall within another exemption or the offering or security is exempt. It should be noted in particular that a private fund relying on Section 3(c)(1) of the Investment Company Act in which individual accredited investors participate will not fall within an exemption and FINRA members involved in the sale of such securities should plan for compliance with the additional filing requirements.

Additionally, FINRA continues to emphasize its views regarding FINRA member firm due diligence obligations in Regulation D private placements. FINRA member firms are reminded that they must conduct thorough due diligence of both the issuer conducting a private offering and the terms of the offering itself. Failure to conduct thorough due diligence “could constitute a violation of the antifraud provisions of the federal securities laws and, particularly, Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.” 3

FINRA emphasized that a wide range of regulatory responses is available for violations of FINRA Rule 5123, as is the case for violations of any FINRA rule. The regulatory response depends on the facts and circumstances of the violation, and any sanction imposed is subject to oversight and review by the SEC.4  

Notice Filings

Filings under FINRA Rules 5122 and 5123 are “notice” filings, meaning that FINRA will not respond to the filings with a comment letter or provide a clearance letter. Any disclosure document used in the private placement containing information about proceeds, expenses and compensation must be filed with FINRA. If none, a member must still file with FINRA within the filing deadline a notice identifying the private placement and the participating members, stating that no disclosure document was used. FINRA has noted that (1) the notice filing requirement does not establish any review and approval process by FINRA for private placements, (2) each member participating in an offering (or a member’s designee) is required to file the disclosure document with FINRA, (3) the filing requirement refers to the first sale by the member making the filing (or on whose behalf a designated member is filing), rather than the first sale by another member, and (4) FINRA does not require the member to make any additional disclosure to investors in such offerings.

Private Placement Filing System

On December 3, 2012, the new private placement filing system FINRA has been developing will become operational to receive the offering documents or notifications that firms must file under FINRA Rules 5122 and 5123. The filing system, which can be accessed through the FINRA Firm Gateway, will allow electronic submissions of the filings in searchable Portable Document Format (PDF) to FINRA. One firm can submit a filing on behalf of other firms involved in the sale of the private placement but must identify the other firms as part of its submission.

Confidential Treatment

Similar to Rule 5122, FINRA will accord confidential treatment to all documents and information filed pursuant to Rule 5123 and utilize the documents and information for the purpose of review to determine compliance with the provisions of applicable FINRA rules or for other regulatory purposes deemed appropriate by FINRA.

Click here to view Appendix A - Exempt Purchasers

Click here to view Appendix B - Exempt Offerings

Click here to view Appendix C - Exempt Securities