FINRA Rule 5123 Becomes Effective December 3, 2012

Simon Riveles Accredited Investor, FINRA Rule 5123, Private Placement, Reg D Rule 506

On September 5, 2012, FINRA issued a regulatory notice informing its members that Rule 5123, approved by the SEC in June, will become effective December 3, 2012. The rule requires that FINRA registered broker-dealers provide a notice filing to FINRA within 15 days of making a private placement of securities to certain classes of investors. The notice filing will consist of the private placement memorandum used in the offering, or if no memoranda was used, a statement to that effect or any other type of term sheet used in the offering. The rule also requires firms to file any materially amended versions of the documents originally filed.

The rule defines a private placement as “a non-public offering of securities conducted in reliance on an available exemption from registration under the Securities Act.” The rule exempts a broad range of private placements based on the type of purchaser of the offering, the type of offering and the type of security. In fact, a broad range of private placements are exempt from the rule, including private placements to most institutional investors, qualified institutional buyers and private placements conducted pursuant to regulation S. In effect, the only offerings subject to the rule are those made to individual accredited investors or non-accredited investors under Rule 506 of Regulation D. The rule will impact many hedge funds relying on Section 3(c)(1) of the Investment Company Act who use registered broker dealers as third party marketers. The rule is an additional regulatory requirements for broker dealers marketing on behalf of 3(c)(1) hedge funds insofar as these FINRA firms already face strict due diligence requirements when facilitating a Reg. D offering in that they must conduct thorough due diligence on both the issuer of the offering and the terms of the offering itself.

Among the private offerings exempt from the rule are those made only to the following types of purchasers:

  • certain defined institutions, including banks, savings and loan associations, broker dealers, insurance companies, investment companies, government pension plans;
  • qualified institutional buyers (“QIBs”) – entities that discretionarily own or invest in the aggregate at least $100 million securities of issuers that are not affiliated with that entity, as well as entities entirely composed of QIBs.
  • qualified purchasers (persons, companies, or trusts not created to avoid the rule owning more than $5 million), investment companies under Section 3 of the Investment Company Act, and banks.
  • employees and affiliates (entities controlling or controlled by FINRA members) of issuers, knowledgeable employees of private funds (certain managers and executive as defined by the Investment Company Act) and eligible contract participants (a wide range of financial institutions) are also exempted under the rule.

To implement the rule FINRA will have a new private placement filing system in place by December 3rd. The system will be incorporated within FINRA’s existing electronic Gateway portal, and any one broker dealer representing an issuer can file on behalf of all broker dealers representing an offering. All rule 5123 submissions will be confidential and accessible only to FINRA in determining compliance with its requirements.

It should also be noted that Rule 144A offerings (offerings made to QIBs) and Regulation S offerings (offerings made abroad, to foreign entities, or subject to foreign securities laws) are also exempt, and a number of securities are exempt under the rule as well. These include government securities, securities with short-term maturities, subordinated loans, “variable contracts,” certain annuities and life insurance policies, certain non-convertible debt and preferred securities, and commodity pool securities.

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