FINRA Rule 5123 – Private Placement Filing Requirements

The SEC Approves FINRA Rule 5123 – Filing Requirements for Private Placement Memorandums

The Securities Exchange Commission (SEC) approved late last year approved FINRA Rule 5123 requiring broker/dealers that sell an issuer’s (company’s) securities in a private placement to file with FINRA a copy of the private placement memorandum (PPM) as well as the term sheet or any other offering documents used by the broker/dealer with FINRA withing 15 calendar days of the of the date of the first sale, or indicate that it did not use any such offering documents.  FINRA Rule 5123 was detailed to members in FINRA Regulatory Notice 12-40.  This new rule is part of FINRA’s ongoing efforts to enhance the oversight and investor protection relating to investments in the private placements of securities.  FINRA Rule 5123 took effect on December 3rd, 2012 with the launching of its new electronic private placement filing system.

These filings are “notice” type filings and as a result,  FINRA says that it will not respond to the filings with a comment letter or provide any form of a clearance letter.

New Private Placement Filing System:

FINRA has developed a new electronic filing system for private placements that allows broker/dealers to electronically submit the system filings in  searchable Portable Document Format (PDF) file.  The new filing system will allow broker/dealers to submit filings on behalf of itself and other firms involved in the filings process.  Any firm that submits a filing to the system on behalf of other broker/dealers must identify the other broker/dealers as part of the submission process.

Confidential Treatment

FINRA has also stated in Regulatory Notice 12-40 that it will provide confidential treatment to all documents and notices filed pursuant to the underlying FINRA Rule 5123.  This pretty much means that the investing and general public will not have access to these private placement memorandums and other documents.   We tend to feel that this is somewhat of a disservice to the shareholders of the issuing company, and that upon the conclusion of the offering the documents should be made available to the general public, particularly if the issuing company is publicly traded.

Exemptions to Filing Requirements:

The following private placements are exempt from the requirements of this Rule:
  1. offerings of exempted securities, as defined in Section 3(a)(12) of the Exchange Act;
  2. offerings made pursuant to Securities Act Rule 144A or SEC Regulation S;
  3. offerings of exempt securities with short term maturities under Section 3(a)(3) of the Securities Act and debt securities sold by members pursuant to Section 4(2) of the Securities Act so long as the maturity does not exceed 397 days and the securities are issued in minimum denominations of $150,000 (or the equivalent thereof in another currency);
  4. offerings of subordinated loans under SEA Rule 15c3-1, Appendix D (see NASD Notice to Members 02-32 (June 2002));
  5. offerings of “variable contracts,” as defined in Rule 2320(b)(2);
  6. offerings of modified guaranteed annuity contracts and modified guaranteed life insurance policies, as referenced in Rule 5110(b)(8)(E);
  7. offerings of non-convertible debt or preferred securities that meet the transaction eligibility criteria for registering primary offerings of non-convertible securities on Forms S-3 and F-3;
  8. offerings of securities issued in conversions, stock splits and restructuring transactions that are executed by an already existing investor without the need for additional consideration or investments on the part of the investor;
  9. offerings of securities of a commodity pool operated by a commodity pool operator, as defined under Section 1a(11) of the Commodity Exchange Act;
  10. business combination transactions as defined in Securities Act Rule 165(f);
  11. offerings of registered investment companies;
  12. standardized options, as defined in Securities Act Rule 238; and
  13. offerings filed with FINRA under Rules 2310, 5110, 5121 and 5122, or exempt from filing thereunder in accordance with Rule 5110(b)(7).
  14. offerings sold by the member or person associated with the member solely to any one or more of the following:
  • institutional accounts, as defined in Rule 4512(c);
  • qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act;
  • qualified institutional buyers, as defined in Securities Act Rule 144A;
  •  investment companies, as defined in Section 3 of the Investment Company Act;
  • an entity composed exclusively of qualified institutional buyers, as defined in Securities Act Rule 144A;
  • banks, as defined in Section 3(a)(2) of the Securities Act;
  • employees and affiliates, as defined in Rule 5121, of the issuer;
  • knowledgeable employees as defined in Investment Company Act Rule 3c-5;
  • eligible contract participants, as defined in Section 3(a)(65) of the Exchange Act; and
  • accredited investors described in Securities Act Rule 501(a)(1), (2), (3) or (7).

There are also several notable exemptions from the filing requirements.  The most notable, and probably the one open to the most potential abuse is the last one,  the exemption from filing if the offering is only to accredited investors.  The potential for abuse comes in when the offering is made to non-institution (or retail) accredited investors.  We are of the opinion that this is a loophole that FINRA needs to look at revising.

Our Take on the New Rules Surrounding Private Placements:

Overall we feel that FINRA Regulatory Notice 12-40 and Rule 5123 are a solid step in the right direction of enhancing investor protection, but it is not completely there yet.  Like a lot of things in life, it will require some revision before it is all said and done.  What we see is that this filing system and the documents required to be filed with FINRA are potentially subject to inclusion in investor lawsuits when the private placements are not profitable for investors. We all know that not every company succeeds and not every investment will be profitable.  It is just a fact of life.

However, when an investor looses money,  their attorneys are going to very quickly start looking at the documents filed to see if they were done properly and where the weaknesses in them were.  Gaps and deficiencies in these documents will create liability for broker/dealers participating in the private placements.  Our expectations are that once the attorneys representing investors who have lost money in a private placement start looking at what has been, or wasn’t,  filed with FIRNA, then they are going to start looking at what sort of due diligence was performed.   Our expectations are that FINRA will eventually require the due diligence performed in accordance with FINRA 10-22 to eventually be filed as well.  Yes, it is going to be more difficult for broker/dealers to be active in the private placement market; however we think proper and full adherence to the new regulations from FINRA over the course of the last several years will also help protect broker/dealers from unwarranted investor litigation.

To learn more about Coral Capital Partners and its due diligence services and activities please visit our Due Diligence Services page.

If you have any questions about the above blog post, please feel free to visit our web site, and check out we have to offer.  Feel free to contact us if you have any questions.  We can be reached at 404-816-9220 and are always willing to speak with you.

About Coral Capital Partners

Coral Capital Partners is an independent consulting and advisory firm focused on companies and participants in the lower and middle markets. We partner with our clients to provide cost effective solutions to real world issues and situations. Our experienced team brings a diverse set of skills that allows us to service a wide variety of needs.  Our area of services and expertise focuses on bringing services and solutions to our clients that are normally only available to much larger firms.  Coral Capital Partners, Inc.  provides services to Investment Banks,  Private Equity Funds, investors, and both privately held and publicly traded companies, as well as various stakeholders in those organizations.  This has included international public companies with operations on three (3) continents to smaller privately held domestic companies.  Our experience in the areas of corporate advisory, due diligence reviews, and regulatory compliance allows for a cost effective and efficient solution to the issues at hand.  Please feel free to contact our offices to see how we may be of assistance.