The Financial Industry Regulatory Authority (FINRA) has proposed a significant expansion of FINRA Rule 5122 (the Rule) to include certain filing and disclosure obligations with respect to all private placements of securities in which a FINRA member firm (Member Firm) participates, subject to a few notable exemptions. FINRA Regulatory Notice 11-04 (the Notice) explains only that this expansion is intended "[t]o provide investors with additional protection from fraud and abuse," noting that currently the vast majority of private placements remain outside the scope of the Rule.1


The Rule was originally designed to address potential conflicts of interest in private placements by Member Firms. The Rule requires that if a participating broker-dealer or its control entity is the issuer in a private placement, the offering document must disclose the intended use of offering proceeds, the operating expenses and the amount of selling compensation to be paid to the Member Firm and its associated persons, subject to certain exceptions. The rule also requires that at least 85 percent of the offering proceeds be used for the business purposes identified in the disclosure document and that the disclosure document is submitted to FINRA for ex post compliance review.

Proposed Changes

The proposed amendments seek to expand the scope of the Rule by extending its disclosure and filing obligations to all private placements in which a Member Firm participates regardless of the issuer’s affiliation with the Member Firm. "Participation," for this purpose, is defined quite broadly, and includes the preparation of offering documents, participation as an advisor or consultant related to the offering, or even merely the furnishing of customer lists for solicitation.2

The proposed amendments require that the offering document disclose the use of proceeds and offering expenses, including the amount and type of any compensation (as opposed to just "selling compensation" under the current rule) to be paid directly or indirectly to a participating Member Firm or its associated persons. The offering document must also disclose whether a participating member Firm is an affiliate of the issuer and the nature of the affiliation. For purposes of the Rule, "affiliate" is defined with regard to FINRA Rule 5121, which is broader in scope than the more common use of the term under the federal securities laws, and includes owners of 10 percent or more of common equity, preferred equity or subordinated debt.3 As under the current Rule, at least 85 percent of the offering proceeds must be used for the business purposes disclosed in the offering document, and the proceeds may not be used for offering costs and compensation.

Under the amended Rule, it is the obligation of the Member Firm to ensure that an offering document containing the required disclosures is filed with FINRA and provided to each prospective investor. Thus, if no offering document is prepared by the issuer, the Member Firm would be required to prepare and file a document with at least the minimum required disclosures.

In addition, the private placement memorandum, term sheet or other offering document would be required to be filed with FINRA’s Corporate Financing Department at or prior to the first time it is provided to any prospective investor. Any amendment or exhibit must also be filed within 10 days of being provided to any investor or prospective investor. As under the current Rule, the offering may proceed while the FINRA staff reviews the offering document.

Notable Exemptions

The amended rule will be subject to a number of exemptions, including offerings of private placements sold solely to:

  • institutional accounts4
  • qualified purchasers5
  • qualified institutional buyers6
  • investment companies and banks

Thus, for example, private placements involving "accredited investors"7 (who do not otherwise satisfy one of the explicit exemptions, such as natural persons who do not meet the dollar thresholds) would be subject to the disclosure and filing requirements of the Rule.

Other types of exempt offerings under the proposed amendments to the Rule would include:

  • Private placements of investment grade debt and preferred securities
  • Rule 144A offerings
  • Offerings to employees and affiliates of the issuer or its control entities
  • Offerings to existing securityholders of securities issued in conversions, stock splits and other types of restructuring transactions where there is no need for payment of additional consideration by the investor
  • Offerings of equity and credit derivatives, provided that they are not based principally on the Member Firm or its control entities

FINRA has requested that comments on the proposed amendments to the Rule be submitted by March 14, 2011.