Advisor Alert — FINRA Proposes That Member Firms File Private Placement Retail Communications
On October 28, 2020, FINRA filed a proposed rule change with the SEC related to the scope of information that member firms must provide to FINRA regarding private placements. FINRA is proposing to amend Rule 5122 (Private Placements of Securities Issued by Members) and 5123 (Private Placements of Securities) to require the filing of retail communications (such as web pages, slide presentations, pitch decks, and fact sheets) related to certain private placement offerings. While the amendments would impose new requirements on member firms and not brokers per se, brokers should be aware of the proposed changes because the new rules, if approved, will place more regulatory scrutiny on private placement communications provided by brokers to retail investors.
Rule 5122 applies to private placements of unregistered securities issued by a member firm or one of its affiliates (a member private offering). Under the current rule, member firms or their affiliates must provide prospective investors with a private placement memorandum (PPM), term sheet, or other offering document disclosing the intended use of the offering proceeds, the offering expenses, and the amount of selling compensation that will be paid to the member firm and its associated persons. The offering documents must be filed with FINRA at or prior to the first time the document is provided to any prospective investor. For private placements other than member private offerings, Rule 5123 requires that the PPM, term sheet, or other offering document be filed within 15 days of the date of the offering’s first sale.
Both rules contain numerous exceptions to the filing requirements, primarily when the private placement offering is made to sophisticated parties such as institutional accounts, qualified purchasers, qualified institutional buyers, investment companies, and banks, or the offering involves exempted securities or other listed products. Private offerings made to accredited investors under Rule 5123 are also exempt from the filing requirements. Given the number of exceptions, Rules 5122 and 5123 effectively focus on private placements sold to retail investors who do not meet certain high net worth thresholds, whether or not accredited—a category that raises “the greatest concerns” for FINRA.
According to the SEC’s notice and request for public comments published on November 6, 2020, FINRA’s proposal is motivated by “the comparatively high rate of non-compliance of private placement retail communications, and the increased risk of investor harm associated with those communications.” Reviews of materials filed in connection with private placements, conducted by FINRA’s Corporate Financing Department and Advertising Regulation Department, demonstrate that retail communications, to the extent some firms already file those materials, can contain inaccuracies or violations that require revision, and in some cases are so non-compliant that FINRA must issue “do not use” letters. FINRA finds that retail communications filed by new member firms are more prone to these compliance issues. The most common violation is the inclusion of prohibited projections of performance or unreasonable forecasts. As such, private placement retail communications also feature prominently in FINRA’s enforcement program.
The SEC is currently reviewing FINRA’s proposal for consistency with Section 15(A)(b)(6) of the Securities Exchange Act of 1934, requiring, among other things, that FINRA rules be designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and, in general, protect investors and the public interest. The Commission anticipates that requiring “the filing of retail communications under Rules 5122 and 5123 will improve members’ compliance and understanding . . . and reduce the likelihood that retail investors would receive false or misleading sales material for private placements.”
The SEC’s public comment period ended on November 27, 2020. If the Commission approves the proposal following its internal review, FINRA will then announce an effective date for the rule change in a Regulatory Notice. It is uncertain what effect the change in administration in January may have on this or any other current regulatory actions.
The attorneys at Giarrusso Law Group LLC have considerable experience with issues unique to the financial services industry, including FINRA rules and regulatory developments affecting member firms and their registered persons. If you have a question regarding this recent announcement or any other FINRA matter, you may contact us at (201) 771-1115 or info@gialawgroup.com for a no-cost and confidential consultation.