FINRA Proposes Amendment To Expand The Scope Of Rule 5122

Financial Industry Regulatory Authority ("FINRA") Rule 5122 regulates member firms (or its control entities1, collectively ("Members")) that issue unregistered securities of such Member.2 In a sign of increased interest by FINRA into private placements,3 on January 11, 2011, FINRA issued Regulatory Notice 11-04,4 proposing to extend the reach of FINRA Rule 5122 (the "Rule") to any private placement in which a Member "participates."

If the amendments are adopted, as currently proposed, Members will be required to file the private placement memorandum, term sheet or other offering circular (the "Offering Document") for any private placement in which such Members participate. However, the Rule includes a number of important exceptions that substantially reduce the Members' burden, particularly with respect to securities offerings that are limited to institutional investors.

Set forth below is a summary of Rule 5122 as it is currently constituted, and as proposed to be amended by FINRA.

Background and Current Rule 5122

FINRA Rule 5122 was developed in response to abuses in the sale of private placements issued by Members and their Control Entities. Subject to certain exemptions, a Member firm engaging in a private placement of unregistered securities issued by the firm (or a Control Entity) is required to: (i) disclosure to investors in an Offering Document the intended use of proceeds, the offering expenses and the amount of compensation that will be paid to the Member and its associated persons; (ii) file the Offering Document with FINRA's Corporate Financing Department at or prior to the time it is provided to any prospective investor; and (iii) comply with the requirement that at least eighty-five percent (85%) of the offering proceeds raised 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.5

Proposed Changes

As part of the ongoing reform of the financial services industry, FINRA proposed amendments to Rule 5122, which, if adopted, would greatly increase a Member firm's disclosure requirements to include those instances where the Member firm "participates" in the offering, subject to certain specified exemptions (below), whether or not it is the issuer.

Participation

The definition of the term "participation" is incorporated from FINRA Rule 5110, which refers to the performance of services that a...