FINRA Amends Proposal Requiring Filings for Private Placements

February 01, 2012

On January 20, 2012, FINRA filed with the SEC a partial amendment to proposed FINRA Rule 5123 (Private Placement of Securities). This proposed rule would require broker-dealers to make filings with FINRA concerning most private placements they sell to investors. The most recent partial amendment would narrow the proposed definition of “private placement," as well as alter the disclosure and filing requirements of proposed Rule 5123. The same day, the SEC published an order pursuant to Securities Exchange Act § 19(b)(1) and Rule 19b-4, instituting proceedings to determine whether to disapprove the proposed rule change.


In January of 2011, FINRA proposed a sweeping amendment to FINRA Rule 5122 (Private Placements of Securities Issued by Members) that would have expanded the reach of the rule’s disclosure and filing requirements to almost all private placements, no longer limiting those requirements just to private placements of securities issued by either FINRA members or affiliates of a member firm.1 FINRA pointed to (and continues to point to) what it views as pervasive problems of fraud and lack of disclosure in the private placement market, and unsuitable recommendations of private placements to retail investors, as the justifications for this new requirement. FINRA would treat the private placement filings as confidential.

In October 2011, in response to concerns expressed in public comments, FINRA dropped the proposed amendment to Rule 5122. Instead, FINRA proposed to adopt an entirely new FINRA Rule 5123. The proposed rule would have required members selling a private placement to file with FINRA and deliver to clients a Private Placement Memorandum (PPM), term sheet or other disclosure document that contained information on the use of the offering proceeds, the amount and type of offering expenses, and the amount and type of compensation to be paid to sponsors, finders consultants, FINRA members and their associated persons. The October 2011 proposal exempted sales to seven categories of persons or entities, including institutional accounts as defined in NASD Rule 3110(c)(4), qualified purchasers under the Investment Company Act, qualified institutional buyers (QIBs) under Rule 144A and entities composed exclusively of QIBs, investment companies, banks, and employees of the issuer. The proposed rule also excluded several types of transactions, including offerings of exempted securities, offerings under Rule 144A and Regulation S, and non-convertible debt or preferred securities offered by issuers eligible for Form S-3 or Form F-3. However, FINRA and the SEC received many comments arguing that these exemptions were too limited.

The Current Partial Amendment to Proposed FINRA Rule 5123

On January 19, 2012, FINRA sent to the SEC a letter responding to the comments, and on January 20, 2012, FINRA filed a partial amendment to proposed Rule 5123 to address concerns expressed during the comment period. First, FINRA took note that many comment letters had argued that the definition of “private placement” was overly broad because it was not limited to “non-public” offerings, as it is in Rule 5122, and could thus apply to public offerings that are nonetheless exempt from SEC registration, such as secondary trading. The amendment clarifies the term “private placement” so that it will only refer to “non-public” offering of securities conducted in reliance on an available exemption from registration and will not apply to securities offered pursuant to:

  • Securities Act Sections 4(1), 4(3) and 4(4) (which generally exempt secondary transactions);
  • Securities Act Sections 3(a)(2) (offerings by banks), 3(a)(9) (exchange transactions with an existing holder, where no one is paid to solicit the exchange), 3(a)(10) (securities subject to a fairness hearing), or 3(a)(12) (securities issued by a bank or bank holding company pursuant to reorganization or similar transactions); or
  • Section 1145 of the Bankruptcy Code (securities issued in a court-approved reorganization plan that are not otherwise entitled to the exemption from registration afforded by Securities Act Section 3(a)(10)).

Second, the amendment creates several new exemptions and clarifies others. New exemptions include offerings sold to “knowledgeable employees” of a private fund or “institutional” accredited investors under Regulation D and “business combination transactions [under] Securities Act Rule 165(f).” However, in its letter, FINRA rejected comments that suggested extending the exemptions to all transactions involving accredited investors or all transactions involving qualified clients. Thus, all private funds relying on the exemption provided by Section 3(c)(7) of the Investment Company Act would be exempt from the rule, but those relying on the exemption under Section 3(c)(1) of the Act may not. FINRA also did not accept comments suggesting an exemption for private placements not recommended by the broker-dealer (for example, private placements purchased by an independent investment adviser on behalf of a client account custodied at a broker-dealer). FINRA also adopted exceptions for commercial paper, standardized options, OTC options and swaps sold to eligible contract participants, and private placements of closed-end funds, registered on Form F-2.

Third, to address concerns that a broker-dealer might be forced to create its own disclosure document in situations where the issuer does not create one, the amendment eliminates the requirement that member firms provide investors with the required disclosures if no PPM is used in connection with the private placement. However, if a PPM is used, Rule 5123(a) would require members to provide investors the PPM, which must include, among other things:

  • disclosure of 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.

Each member participating in the offering, or one member designated to make the filing on behalf of all members identified in the filing, must file the PPM with FINRA no later than 15 calendar days after the date of first sale. In the event of any material amendment to the PPM during the course of the offering, the amendment also would have to be filed within 15 days of first use with an investor or potential investor. In the event that no PPM is used, each participating member (or a designated member) will be required to file a notice of the offering with FINRA that identifies the private placement and the participating members and states that no disclosure document was used. The amendment also clarifies that the rule would not require the delivery of multiple copies of a disclosure document to a single customer, and a broker-dealer must deliver the document only to its own customers.

The SEC noticed FINRA’s most recent version of Rule 5123 for disapproval, while indicating that the Commission in fact has made no determination whether or not to approve it. This somewhat counterintuitive procedure is how the SEC now addresses controversial proposals for which it wants additional time to consider public comments. Under the Dodd-Frank Act, the SEC’s time to consider self-regulatory organization proposals is very limited, and the proposals become automatically effective if the SEC does not act, unless the SEC notices them for disapproval.

Proposed FINRA Rule 5123 still represents a sea-change for private placements. Until now, the only private placements filed with FINRA have been the small number of transactions in which a broker-dealer or its affiliate was the issuer. Under the proposed rule, almost all private placements intended for retail investors would be required to be filed if the placement agent is a broker-dealer and member of FINRA. This step will add to the cost of those private placements, as will the (inevitable) regulatory investigations that result from the new filing requirement. Interested parties should review the proposal as it is currently written to determine if its exemptions are sufficiently broad, and what its impact will be on capital formation. All comments should be submitted on or before 30 days from publication in the Federal Register. FINRA will then have an opportunity to file rebuttal comments in support of the rule.

*This alert was co-authored by W. Hardy Callcott, David Boch, Michael Weissmann and James Magid.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:


1 See Bingham Alert "FINRA Proposes Expansion of Rule Governing Private Placements"

This article was originally published by Bingham McCutchen LLP.