FINRA published its proposed amendments to FINRA Rule 5122, which requires, subject to certain exemptions, the following:

• disclosure in the 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, in any private placement in which a participating broker-dealer (or its control entity) is the issuer. 
• at least 85% of the offering proceeds be used for the business purposes identified in the offering document.
• each offering document must be be submitted to FINRA to allow the staff to conduct ex post reviews to assess compliance with the rule and to identify problematic terms and conditions.

Comments should be submitted by 3/14/11.

The amendments proposed in this Notice expand Rule 5122 to reach all private placements in which a member firm participates - not just those in which the member firm (or its control entity) is the issuer- while retaining nearly all of the existing exemptions, including those for offerings sold solely to certain institutions, qualified purchasers and other sophisticated investors.  However, to reflect the broader scope of the proposed rule and its prior experience with Rule 5122, FINRA proposes to eliminate the exemption for offerings in which a member acts primarily in a wholesaling capacity.

    FINRA Staff Contacts.  Questions should be directed to:  Joseph Price, CorpFin/Advertising, at (240) 386-4623; Gary Goldsholle, Office of General Counsel , at (202) 728-8104.

    Background & Discussion.   FINRA Rule 5122 was developed in response to abuses in the sale of PP's issued by B/D's and their control entities.  The rule 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 a PP memorandum, term sheet or other offering document the intended use of offering proceeds, the offering expenses and the amount of compensation that will be paid to the broker-dealer and its associated persons;
• submit, via email, the offering document to the FINRA CorpFin Department at or prior to the time it is provided to any prospective investor; and
• comply with the requirement that at least 85% of the offering proceeds raised may not be used to pay for offering costs, discounts, commissions or any other cash or non-cash sales incentives, and must be used for the business purposes disclosed in the offering document.

FINRA staff conducts ex post reviews of offering documents to assess compliance with the rule and to identify problematic terms and conditions.  Occasionally, when warranted, FINRA will contact a member firm and request additional information regarding the use of proceeds or other clarifying information. The rule does not require that completion of an offering be delayed until FINRA staff has issued a “no-objections” letter, as FINRA Rule 5110 requires with respect to public offerings.  Rule 5122 defines “control” as beneficial interest of more than 50 percent of the outstanding voting securities of a corporation or the right to more than 50 percent of the distributable profits or losses of a non-corporate entity. The rule also provides various exemptions, including offerings of private placements:

• to institutional accounts, qualified purchasers, qualified institutional buyers, investment companies and banks;
• to employees of the issuer (or its control entity) and securities issued in certain conversions, stock splits and restructuring transactions;
• of exempted securities, certain notes with short-term maturities, variable contracts, modified guaranteed annuity contracts and life insurance policies, commodity pools,options and other derivatives not based principally on the member’s (or its control entity’s) securities, unregistered investment grade rated debt and preferred securities; and
• in which the member acts primarily in a wholesaling capacity, as evidenced by an agreement to sell less than 20% of the offered securities in retail transactions.

Rule 5122 plays an important part in the effort to protect investors in the narrow segment of the PP market it was designed to address.  It does not, however, address PP's in which the issuer is neither a B/D nor its control entity.  The vast majority of PP's remain outside the scope of the rule.

e.g. - FINRA has received approximately 300 filings pursuant to Rule 5122 during the first year that the rule has been in effect, whereas several thousand Form D's are filed annually with the SEC in connection with PP's.  To provide investors with additional protection from fraud and abuse, FINRA proposes to amend Rule 5122 to govern all PP's in which a member participates, subject to certain exemptions.

Click on the link above for specific proposed rule changes.