United States: FINRA Proposes Amendments To The Rule Governing Member Firm Participation In Private Placements

The Financial Industry Regulatory Authority (FINRA) has proposed amendments to Rule 5122 (the rule), which governs a member firm's participation in private placements.¹ The rule initially was developed in response to abuses in the sale of private placements issued by broker-dealers and their control entities. Because the rule does not apply to private placements in which the issuer is neither a broker-dealer nor its control entity, the vast majority of private placements are outside the scope of the rule. In an effort to provide investors with additional protection from fraud and abuse, FINRA is now proposing to amend Rule 5122 to bring all private placements in which a member participates within the rule's scope.

Current Rule 5122

Rule 5122 generally requires, subject to certain exemptions, that a member firm or associated person engaging in a private placement of unregistered securities issued by the firm (or a control entity of the firm):

• disclose to investors in an offering document of the intended use of offering proceeds, expenses, and the amount of selling compensation to be paid to the broker-dealer and its associated persons;
• submit, via e-mail, the offering document to FINRA prior to the time it is provided to any prospective investor to allow the staff to conduct ex post reviews to assess compliance with the rule and to identify problematic terms and conditions; and
• comply with the requirement that at least 85 percent of the offering proceeds be used for the business purposes identified in the offering document, and not to pay for offering costs, discounts, commissions, or other cash or noncash sales incentives.

Proposed Amendments

FINRA has proposed to expand the rule to reach any private placement in which a member participates, subject to all but one of the exemptions that currently exist in the rule.

Scope

The rule would incorporate the definition of "participation" from Rule 5110, which corresponds to the types of services typically provided by a broker-dealer in a private placement. The term "control entity" would become irrelevant to the scope of the rule; and therefore, would be deleted.

Disclosure Requirements

As proposed, the rule would require that the offering document disclose if a participating member is an affiliate of the issuer and the nature of the affiliation. Additionally, under the proposed amendments, the term "selling compensation" would be replaced by "compensation" to ensure the disclosure of any amount and type of compensation to be paid to a participating member firm for its associated persons in connection with a private placement subject to the rule.

Wholesaling Exemption

The proposed amendments eliminate the existing exemption under subsection (c) of the Rule for offerings in which a member acts primarily in a wholesaling capacity.

The proposed amendments do not include any substantive changes to the filing requirements applicable to the offering document or the limits on the use of offering proceeds.

The comment period for the proposed amendments to Rule 5122 expires on March 14, 2011.

Footnote

1 FINRA Regulatory Notice 11-04.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.