FINRA Proposes New Private Placement Requirements
Last month the Financial Industry Regulatory Association announced a proposal to regulate all private placements in which FINRA member firms participate. The proposal, set forth in FINRA Regulatory Notice 11-4, increases the scope of FINRA Rule 5122 to require every private placement, subject to certain exemptions, to have an offering document that is provided to investors and filed with FINRA and to restrict the use of proceeds. Currently, Rule 5122 imposes similar requirements, but only on private placements of securities of member firms and their controlling entities. Thus, the proposed amendments would significantly expand FINRA’s oversight of the private placement market. The comment period on the proposal ends March 14, 2011.
Amended Rule 5122 would prohibit member firms from participating in a private placement unless an offering document meeting certain requirements is provided to prospective investors and concurrently filed with FINRA and at least 85% of offering proceeds are used for the purposes disclosed in the offering document and not for offering costs or broker-dealer compensation. For this purpose, “participation” has the broad meaning provided in FINRA Rule 5110(a)(5), i.e., participating in the preparation of offering documents or in the distribution of the offering, furnishing customer or broker lists, or providing the issuer advice related to the offering.
The offering document, whether in the form of a private placement memo or a term sheet, must disclose the intended use of proceeds, the offering expenses, the amount and type of broker-dealer compensation, and any affiliation between the issuer and participating broker-dealers. If such a document is not prepared by the issuer, participating broker-dealers must prepare and provide the document to investors. There is no requirement for FINRA approval of the document before its use, and thus an offering may commence without waiting for FINRA review. However, whether or not the offering has commenced, FINRA will contact the broker-dealer if FINRA determines that a document “presents an apparent investor protection issue.”
Certain aspects of the rule may need clarification and are likely to generate comments from interested parties. For example, paragraph (b)(4) of the proposed rule would require participating broker-dealers to “conform” offerings that do not comply with the rule. This requirement posed few difficulties when Rule 5122 applied only to offerings of a broker-dealer’s own securities. However, while proposing to apply the rule to all private placements, FINRA has not clarified whether paragraph (b)(4) would require a broker-dealer to monitor the post-offering use of proceeds by an issuer not controlled by the broker-dealer.
The amended rule would continue to exempt offerings to certain purchasers including institutional accounts, qualified institutional buyers and employees and affiliates of the issuer; offerings of specified types of securities; offerings pursuant to Rule 144A or Regulation S; and offerings filed with the FINRA Corporate Financing Department under FINRA Rules 2310, 5110 or 5121. Notably, the amended rule as proposed contains no exemption for offerings made solely to accredited investors.