Pursuant to a sweep exam program of member firms who engaged in self-offerings of unregistered securities, FINRA has issued Rule 5122, which will regulate the private offering of securities of member firms, or entities that have control over, are controlled by or are under common control of the member firms. FINRA determined that many member firms were using funds raised through private offerings to finance bonuses, sales contest awards and commissions.
FINRA Rule 5122, which was effective June 17, 2009, requires firms that engage in private placements of unregistered securities issued by the member (or a related “control” entity) to submit a private placement memorandum or other similar offering documents to FINRA’s corporate finance department on or before the date on which such documents are provided to potential investors and within 10 days of any amendments to these documents being presented to an existing or prospective investor. Firms must furnish the memorandum/offering document to every investor, whether or not they may be considered accredited.
Further, the rule requires:
- that prospective investors in an public offering receive written disclosure of the intended use of offering proceeds, as well as the amount of offering expenses and sales compensation payable in connection with the offering;
- filing with, although not approval by, FINRA of the document containing the disclosure required in the previous bullet point; and
- at least 85 percent of the offering proceeds must be used for the business purpose stated in the disclosure document, excluding offering costs, discounts, commissions or any other cash or non-cash sales incentives.
"Control," for the purposes of this rule, is defined as a 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 of a non-corporate entity. The power to direct the management of an entity does not constitute control for these purposes. The determination of control is made after the offering closes.
There are a large number of exemptions from the rule, based primarily on the type of offering or type of investors to whom the offering is directed. Most notable among the exempt offerings are:
- Rule 144A and Regulation S offerings;
- Offerings of equity or credit derivatives, including OTC options, provided that the derivative is not based principally on the member or any of its control entities; and
- Offerings of investment grade rated debt or preferred securities.
The requirements of the rule are also inapplicable to offerings to certain institutional accounts, including qualified purchasers, as defined in the Investment Company Act, and qualified institutional buyers, as defined in Rule 144A under the Securities Act. In addition, the rule does not apply when the member issuing the securities, or the member controlled by the issuer of the securities, does not offer or sell the securities or acts primarily in a wholesaling capacity in selling the securities through other FINRA members.
Additional exceptions based on the types of securities offered, including variable contracts, investment grade debt, preferred stock, guaranteed annuity contracts, certain derivatives, subordinated loans, and commodity-related deals, among others, are also available. In addition, FINRA reserves the right to make discretionary exclusions for good cause in accordance with its code of procedure under the Rule 9600 series.
The rule provides few exceptions based on organizational status, as FINRA has taken the position that private securities offered by a public company, an investment fund or a state or federal bank affiliate of a member should not be excluded from the rule. Nevertheless, offerings to the member’s employees and affiliates will be excluded.
For more information about the requirements under Rule 5122 and how they may apply to your firm, please contact your account manager at 603-434-3594.
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