On October 28, 2020, the Financial Industry Regulatory Authority, Inc. (FINRA) proposed amendments to FINRA Rules 5122 (Private Placements of Securities Issued by Members) and 5123 (Private Placements of Securities) (the "Proposal")1 that would require FINRA-member broker-dealers to file retail communications concerning private placement offerings that are subject to filing requirements under those rules. The Proposal follows guidance published by FINRA earlier this year regarding retail communications concerning private placement offerings.2
In proposing the amendments, FINRA stated that it intends to promote greater investor protection and public trust in the private placement markets through increased regulatory oversight of private placement retail communications.3 This note provides a brief overview of FINRA Rules 5122 and 5123, summarizes FINRA's rationale in proposing the amendments and provides an overview of the proposed amendments.
Overview of FINRA Rules 5122 and 5123
FINRA Rule 5122 (Private Placements of Securities Issued by Members)
FINRA Rule 5122 applies to private placements of securities issued by a FINRA-member broker-dealer or a "control entity" thereof, subject to the exemptions described in "Rules 5122 and 5123 Primarily Apply to Private Placements Sold to Retail Investors" below.4
The rule requires that prospective investors of such private placements receive a private placement memorandum, term sheet or other offering document that discloses the intended use of the offering proceeds, the offering expenses and the amount of selling compensation that will be paid to the member broker-dealer and its associated persons.5 The rule also requires FINRA members to file such offering document with the FINRA Corporate Financing Department at or prior to the first time the document is provided to any prospective investor.6
FINRA Rule 5123 (Private Placements of Securities)
FINRA Rule 5123 applies to any private placement in which a FINRA member sells a security, subject to the exemptions described in "Rules 5122 and 5123 Primarily Apply to Private Placements Sold to Retail Investors" below.
The rule requires members to file with FINRA any private placement memorandum, term sheet or other offering document, including any material amended versions thereof, used in connection with a private placement of securities with the FINRA Corporate Financing Department within 15 calendar days of the date of first sale.7
Rules 5122 and 5123 Primarily Apply to Private Placements Sold to Retail Investors
Both FINRA Rule 5122 and Rule 5123 provide a number of exemptions from their respective requirements, including, for example, offerings sold solely to: (i) institutional accounts, as defined in FINRA Rule 4512(c); (ii) qualified purchasers, as defined in the Investment Company Act of 1940, as amended; and/or (iii) qualified institutional buyers, as defined in Rule 144A under the Securities Act of 1933, as amended.8 As such, the requirements set forth in FINRA Rules 5122 and 5123 primarily apply to private placements sold to retail investors.9
FINRA's Review of Private Placement Retail Communications
In proposing the amendments, FINRA noted that it received 2,509 unique Rule 5122 and 5123 filings in 2019.10 While FINRA Rules 5122 and 5123 do not require retail communications other than the above-described offering documents to be filed, many broker-dealers voluntarily file related retail communications in connection with their required Rule 5122 or 5123 filings.11 Examples of these retail communications can include web pages that promote the offering, slide presentations, pitch decks, one-page "teasers," fact sheets, sales brochures, executive summaries and investor packets.12 FINRA's Corporate Financing Department often forwards these retail communications to FINRA's Advertising Regulation Department for review.13 The Proposal states that the private placement retail communications reviewed by FINRA's Advertising Regulation Department raise more compliance issues than those for other products.14
With regard to private placement retail communications filed with FINRA, the Proposal provides the following statistics:
- Between January 1, 2017, and March 31, 2020, FINRA's
Advertising Regulation Department reviewed 1,726 new
member15 and voluntary filings of private placement
- Of these filings, 41 percent required revisions to comply with applicable Rule 2210 content standards, and four percent were sufficiently non-compliant with the standards that FINRA issued "do not use" review letters.
- During this same period, only eight percent of overall FINRA Advertising Regulation Department filings reviewed required revisions, and only 0.1 percent received a "do not use" letter.16
- In 2018, FINRA's Advertising Regulation
Department conducted a spot-check of the private placement retail
communications provided to FINRA's Corporate Finance Department
in connection with Rule 5122 and 5123 filings during the second and
third quarters of 2018.
- This review indicated "significant and pervasive violations of Rule 2210."
- The Proposal notes that 806 of the 1,062 retail communications reviewed (76 percent) did not comply with Rule 2210 content standards.17
- Among the communications reviewed during this
- 45 percent contained prohibited projections or unreasonable forecasts;
- 44.6 percent failed to provide a sound basis to evaluate the facts with respect to the offering, in that the benefits articulated in the marketing materials were not balanced by key specific risks associated with an investment or the issuer;
- 39.9 percent failed to adequately disclose the general risks associated with private placement investments;
- 21.8 percent contained readily apparent false or misleading statements or claims; and
- 7.4 percent contained misleading references to FINRA, other regulators or the benefits of regulation generally.18
The Proposal also provides statistical information with respect to disciplinary actions related to private placement retail communications, noting that since January 1, 2014, FINRA has initiated 49 disciplinary actions related to non-compliant retail communications concerning private placements, which number represents 21 percent of all actions involving private placements.19
Overview of the Proposed Amendments
The Proposal would amend FINRA Rules 5122 and 5123 to require all private placement retail communications to be filed with FINRA, in addition to the documents currently required to be filed under these rules.20 In doing so, the Proposal notes that FINRA Rules 5122 and 5123 focus on the private placements that raise the greatest concerns (i.e., those sold to retail investors, whether or not the investors are accredited investors).21 The proposed amendments to FINRA Rules 5122 and 5123 would not apply to any offerings that are currently exempt from filing (e.g., offerings sold only to "institutional accounts," as that term is defined under FINRA Rule 4512(c)).22
Under the proposed amendments, broker-dealers would be required to file with FINRA private placement retail communications no later than the date on which a filing is required under FINRA Rule 5122 or Rule 5123, as applicable.23 In addition, the requirements under FINRA Rules 5122 and 5123 that material amendments to offering documents must be filed also would apply to material amendments to retail communications.24
The Proposal notes that FINRA considered amending Rule 2210 as an alternative to the proposed amendments to FINRA Rules 5122 and 5123, but ultimately determined that amending FINRA Rules 5122 and 5123 provided a more efficient and cost-effective solution to the perceived issue.25
In filing the Proposal, FINRA stated that it intends to promote greater investor protection and public trust in the private placement markets through increased regulatory oversight of private placement retail communications. The proposed amendments will result in an obligation to file private placement retail communications that broker-dealers are currently not required to file with FINRA. Given FINRA's recent focus on private placement retail communications and the statistics provided in the Proposal with respect to FINRA's review of private placement retail communications and corresponding disciplinary actions, broker-dealers may wish to consider reviewing current policies and procedures with respect to content standards and internal review and approval of private placement retail communications and conducting training for their personnel with respect to the same.
1 Proposed Amendments to FINRA Rules 5122 (Private Placements of Securities Issued by Members) and 5123 (Private Placements of Securities) that Would Require Members to File Retail Communications Concerning Private Placement Offerings, SR-FINRA-2020-038 (Oct. 28, 2020) (the “Proposal”). For additional background with respect to FINRA Rules 5122 and 5123, you may wish to refer to “ Private Placement Update: SEC Approves FINRA Private Placement Rule” (June 2012), “ FINRA Seeks to Expand Regulation of Private Placements” (Oct. 2011) and “ Private Placement Update: FINRA Proposes Rule Amendments to Require Filings for Non-Institutional Private Placements” (Mar. 2011).
2 See “ Communications With the Public: FINRA Provides Guidance on Retail Communications Concerning Private Placement Offerings, FINRA Regulatory Notice 20-21” (July 1, 2020). For additional information regarding Regulatory Notice 20-21, you may wish to refer to “ FINRA Releases New Guidance on Retail Communications Concerning Private Placement Offerings” (July 16, 2020). For more information regarding FINRA regulation of broker-dealer communications with the public, you may wish to refer to “ FINRA Releases New Guidance Regarding Social Media and Digital Communications” (June 26, 2017), “ FINRA Proposes to Permit Use of Predictions/Projections of Investment Strategy Performance” (Mar. 9, 2017) and “New Rules Regarding Communications With the Public by Brokers and Dealers Take Effect” (Nov. 1, 2003).
3 Proposal at p. 19.
4 FINRA Rule 5122(b). Under section (a)(2) of the rule, "control entity" is defined as "any entity that controls or is under common control with a member, or that is controlled by a member or its associated persons."
5 FINRA Rule 5122(b)(1).
6 FINRA Rule 5122(b)(2).
7 FINRA Rule 5123(a).
8 See FINRA Rule 5122(c); FINRA Rule 5123(b).
9 See Proposal at p. 6.
10 Proposal at p. 6.
11 Proposal at p. 7.
12 Proposal at p. 7.
13 Proposal at p. 7.
14 Proposal at p. 8.
15 FINRA Rule 2210(c)(1)(A) requires that new FINRA-member broker-dealers must file all retail communications at least ten business days prior to first use for a period of one year from the date that their FINRA membership becomes effective, subject to certain exceptions set forth in the rule.
16 Proposal at pp. 8-9. The Proposal notes that during the same period, FINRA's Advertising Regulation Department analyzed 1,328 private placement retail communications that were referred from FINRA's Corporate Financing Department, Member Supervision Department or other FINRA departments. Seventy-one percent of these communications required revisions to comply with applicable standards and 13 percent resulted in a "do not use" letter. In contrast, 66 percent of all communications referred by other FINRA Staff were determined to require revisions and four percent resulted in a "do not use" letter.
17 Proposal at 9.
18 Proposal at pp. 12-13, n. 17.
19 Proposal at p. 10.
20 Proposal at p. 10.
21 Proposal at p. 10.
22 Proposal at p. 10.
23 See Proposal at pp. 10-11.
24 Proposal at p. 11.
25 See Proposal at pp. 21-22.
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