The Securities and Exchange Commission (SEC) recently issued Release No. 34-66203, which seeks comments on the Financial Industry Regulatory Authority's (FINRA) Partial Amendment No. 1 (the Amendment) to proposed FINRA Rule 5123 (the Rule), which was released in October 2011. The Rule would require FINRA members that offer covered private placements to provide disclosures to investors prior to sale, describing the intended use of proceeds and the amount and type of offering expenses and compensation. The Amendment signals FINRA's attempt to address some of the more substantial issues with the Rule, as originally proposed, regarding its scope, filing requirements, and exemptions.

The SEC requests that comments on the Amendment be submitted on or before February 27, 2012. Rebuttals to any submissions will be accepted by the SEC and must be submitted by March 12, 2012.

The Partial Amendment

The Amendment clarifies that the term "private placement" in the Rule would mean a non-public offering of securities made in reliance on an available Securities Act of 1933 (Securities Act) registration exemption. The clarified definition would be consistent with FINRA Rule 5122 and would not apply to offerings and sales made in reliance upon:

  • Sections 4(1), 4(3) and 4(4) of the Securities Act;
  • Sections 3(a)(2), 3(a)(9), 3(a)(10) or 3(a)(12) of the Securities Act; and
  • Section 1145 of the U.S. Bankruptcy Code.

The Amendment also revises the filing and disclosure requirements of the Rule, so they apply only to sales in which the issuer drafts or uses a private placement memorandum (PPM), term sheet, or other disclosure document. Those FINRA members would be required to provide, prior to any sale, the disclosure document to each investor in a private placement other than those for which an exemption has been provided by the Amendment. The filing of the disclosure document can be made either by each participating FINRA member or by a member designated to make such filing on behalf of members identified in the filing, so long as the document is filed with FINRA no later than 15 calendar days after the date of first sale.

The Rule as originally proposed would have required that every FINRA member participating in a private placement provide to clients, prior to any sale, a PPM, term sheet or other disclosure document containing information required under the Rule. If there was no such disclosure document, the FINRA member would be required to create a separate disclosure document containing information required by the Rule. Under the Amendment, a FINRA member participating in a private placement for which there is no disclosure document would not be required to create this separate document. Rather, that FINRA member would be required to make a notice filing with FINRA no later than 15 calendar days after the date of first sale. The notice filing must identify the private placement, note the participating members, and state that no disclosure document was used in connection with the offering. Under the Amendment, the Rule would not require the member to make any additional disclosure to investors in private placements for which there is no disclosure document.

FINRA also proposes to add supplementary material to the Rule clarifying that delivery of multiple copies of a disclosure document to a single customer is not required. Disclosure documents must be delivered only to persons to whom the FINRA member sells shares in the private placement.

Regulatory Posture

The SEC has decided to institute proceedings, pursuant to Section 19(b)(2)(B) of the Securities Exchange Act of 1934 (Exchange Act), in order to determine whether to approve the Rule, as modified by the Amendment. The SEC believes the Rule, as amended, raises questions as to whether it is consistent with the requirements of Section 15A(b)(6) of the Exchange Act. Among other things, the section requires that FINRA rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and to protect both investors and the public interest. The SEC also believes the Rule, as amended, raises questions as to whether it is consistent with the findings that the SEC must make as set forth in Section 3(f) of the Exchange Act, including whether the Rule, as amended, promotes efficiency, competition, and capital formation.

The Amendment and Rule may be accessed at: Regulation/RuleFilings/2011/P124600.

The previous Investment Management Alert summarizing the Rule as originally proposed can be read at: FINRAProposesRule5123.pdf.

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