On October 18, 2011 the S.E.C. published for comment1 FINRA’s proposed Rule 5123 relating to private placements. Rule 5123 would be the companion to Rule 5122, which currently applies only to private placements of securities issued by FINRA members or their control affiliates.2 Although it would impose new requirements on offerings not heretofore subject to regulation by FINRA, the proposed rule contains exemptions for certain types of offerings, including offerings made pursuant to SEC Regulation S or Securities Act Rule 144A, offerings of non-convertible debt or preferred securities by issuers that meet the eligibility criteria for incorporation by reference in Forms S-3 and F-3, and offerings made solely to investment companies, as defined in Section 3 of the Investment Company Act (see infra).” The new Rule would require that each FINRA member or associated person selling a security in a private placement3 or participating in the preparation of an offering document or term sheet for such a private placement:

  • provide each investor with a private placement memorandum or term sheet containing disclosures 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, consultants, and members and their associated persons in connection with the offering; if the private placement does not have a PPM or term sheet, the FINRA member must prepare a disclosure document that contains the required disclosures and provide that document to each investor;
  • file with FINRA, on a confidential basis, any private placement memorandum, term sheet or other disclosure document, and any exhibits thereto, no later than 15 calendar days after the date of first sale; and
  • file with FINRA, on a confidential basis, any material amendments to the private placement memorandum, term sheet or other disclosure document, or any amendments to the disclosures mandated by the rule, no later than 15 calendar days after the date such document is provided to any investor or prospective investor.

Due to the requirement that specific disclosure be provided in all offerings in which FINRA members participate, the proposed rule would, for the first time, specifically impose an informational requirement on offerings made pursuant to Section 4(2), as well as offerings made solely to accredited investors pursuant to Regulation D, Rule 506. In addition, it is unclear if the rule would apply to underwritten public offerings not specifically exempted, since, unlike Rule 5122, the definition of private placement in proposed Rule 5123 does include the words “non-public.” For example, the proposed rule could be read to apply to public offerings exempt from registration pursuant to Sections 3(a) of the Securities Act which are not exempted securities, as defined by Section 3(a)(12) of the Exchange Act or exempt securities with short term maturities under Section 3(a)(3) of the Securities Act. We have raised this issue with FINRA and we understand that they are discussing the issue internally.  

Although the definition of private placement in the rule is extremely broad, the rule contains exemptions for private placements sold only to the following types of buyers (or combinations thereof):

  • institutional accounts, as defined in NASD Rule 3110(c)(4)4;
  • qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act;
  • qualified institutional buyers (QIBs), as defined in Securities Act Rule 144A;
  • investment companies, as defined in Section 3 of the Investment Company Act;
  • an entity composed exclusively of qualified institutional buyers, as defined in Securities Act Rule 144A;
  • banks, as defined in Section 3(a)(2) of the Securities Act; and
  • employees and affiliates of the issuer.

In addition, the following types of offerings would also be exempt:

  • offerings of exempted securities, as defined by Section 3(a)(12) of the Exchange Act;
  • offerings made pursuant to Securities Act Rule 144A or SEC Regulation S;
  • offerings of exempt securities with short term maturities under Section 3(a)(3) of the Securities Act;
  • offerings of subordinated loans under Exchange Act Rule 15c3-1, Appendix D;
  • offerings of “variable contracts” as defined in FINRA Rule 2320(b)(2);
  • offerings of modified guaranteed annuity contracts and modified guaranteed life insurance policies, as referenced in FINRA Rule 5110(b)(8)(E);
  • offerings of non-convertible debt or preferred securities by issuers that meet the eligibility criteria for incorporation by reference in Forms S-3 and F-3;
  • offerings of securities issued in conversions, stock splits and restructuring transactions that are executed by an already existing investor without the need for additional consideration or investments on the part of the investor;
  • offerings of securities of a commodity pool operated by a commodity pool operator as defined under Section 1a(11) of the Commodity Exchange Act; and
  • offerings filed with FINRA under Rules 2310, 5110, 5121 and 5122.

The comment period on the proposed rule expires on November 14, 2011. In addition to general comments, the S.E.C. has specifically asked for comments on the following issues:

  • Whether the proposed rule would impact issuers’ access to capital via the private placement market, particularly small issuers.
  • Whether the proposed rule would impact investors purchasing private placement securities through a broker-dealer subject to the new rule.
  • Whether the proposed rule would impact registered broker-dealers’ participation in private placements.