
[Federal Register: January 26, 2009 (Volume 74, Number 15)]
[Notices]               
[Page 4487-4491]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26ja09-131]                         

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59262; File No. SR-FINRA-2008-020]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
No. 2 Thereto Relating to Private Placements of Securities Issued by 
Members

January 16, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on September 11, 2008, Financial Industry 
Regulatory Authority, Inc. (``FINRA'') (f/k/a National Association of 
Securities Dealers, Inc. (``NASD'')) filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission''), and amended on January 
7, 2009,\3\ the proposed rule change as described in Items I, II, and 
III below, which Items have been substantially prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 2 to SR-FINRA-2008-020. This amendment 
replaced and superseded the original filing submitted to the SEC on 
September 11, 2008. Amendment No. 1, which was filed on December 22, 
2008, was withdrawn on January 7, 2009.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt new FINRA Rule 5122 (``Rule''). This 
proposed rule change would require a member that engages in a private 
placement of unregistered securities issued by the member or a control 
entity to (1) Disclose to investors in a private placement memorandum, 
term sheet or other offering document the intended use of offering 
proceeds and the offering expenses, (2) file such offering document 
with FINRA, and (3) commit that at least 85 percent of the offering 
proceeds will be used for business purposes, which shall not include 
offering costs, discounts, commissions and any other cash or non-cash 
sales incentives.
    Amendment No. 2 to SR-FINRA-2008-020 makes minor changes to the 
original filing filed on September 11, 2008. The proposed rule change 
replaces and supersedes the proposed rule change filed on September 11, 
2008 in its entirety, except with regard to Exhibit 2, NASD Notice to 
Members 07-27 and comments received in response to NASD Notice to 
Members 07-27.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
Background and Discussion
    FINRA is proposing new FINRA Rule 5122 in response to problems 
identified in connection with private placements by members of their 
own securities or those of a control entity (referred to as ``Member 
Private Offerings'' or ``MPOs''). In recent years, FINRA has 
investigated and brought numerous enforcement cases concerning abuses 
in connection with MPOs.\4\ Among the allegations in these cases were 
that members failed to provide written offering documents to investors, 
or provided offering documents that contained misleading, incorrect or 
selective disclosure, such as omissions and misrepresentations 
regarding selling compensation and the use of offering proceeds. In 
addition, as part of its examination program, FINRA conducted a non-
public sweep of firms that had engaged in MPOs and found widespread 
problems. The MPO sweep revealed that in some cases, offering proceeds 
were used for individual bonuses, sales contest awards, commissions in 
excess of 20 percent, or other undisclosed compensation.
---------------------------------------------------------------------------

    \4\ Franklin Ross, Inc., NASD No. E072004001501 (settled April 
2006), summarized in NASD Notice Disciplinary Actions, p. 1 (May 
2006); Capital Growth Financial, LLC, NASD No. E072003099001 
(settled February 2006), summarized in NASD Notice Disciplinary 
Actions, p. 1 (April 2006); Craig & Associates, NASD No. 
E3B2003026801 (settled August 2005), summarized in NASD Notice 
Disciplinary Actions, p. D6 (October 2005); Online Brokerage 
Services, Inc., NASD No. C8A050021 (settled March 2005), summarized 
in NASD Notice Disciplinary Actions, p. D5 (May 2005); IAR 
Securities/Legend Merchant Group, NASD No. C10030058 (settled July 
2004), summarized in NASD Notice Disciplinary Actions, p. D1 (July 
2004); Shelman Securities Corp., NASD No. C06030013 (settled 
December 2003), summarized in NASD Notice Disciplinary Actions, p. 
D1 (February 2004); Neil Brooks, NASD No. C06030009 (settled June 
2003), summarized in NASD Press Release, NASD Files Three 
Enforcement Actions for Fraudulent Hedge Fund Offerings (August 18, 
2003); Dep't of Enforcement v. L.H. Ross & Co., Inc., Complaint No. 
CAF040056 (Hearing Panel decision January 15, 2005); Dep't of 
Enforcement v. Win Capital Corp., Complaint No. CLI030013 (Hearing 
Panel decision August 6, 2004). In addition to these cases, FINRA 
has numerous ongoing investigations involving MPOs.
---------------------------------------------------------------------------

    Inasmuch as MPOs are private placements, they are not subject to 
existing FINRA rules governing underwriting terms and arrangements and 
conflicts of interest by members in public offerings.\5\ This proposed 
rule change is intended to provide investor protections for MPOs that 
are similar to the protections provided by NASD Rule 2720 for public 
offerings by members.\6\
---------------------------------------------------------------------------

    \5\ FINRA Rule 5110 and NASD Rules 2720 and 2810 govern member 
participation in public offerings of securities.
    \6\ Members would remain subject to other FINRA rules that 
govern a member's participation in the offer and sale of a security, 
including FINRA Rules 2010 and 2020 and NASD Rule 2310. Members also 
are subject to the anti-fraud provisions of the federal securities 
laws, including Sections 10(b), 11, 12 and 17 of the Exchange Act.
---------------------------------------------------------------------------

    In response to concerns about MPOs, in June 2007, FINRA issued 
Notice to Members 07-27 (``NTM 07-27'') soliciting comment on a 
proposed new rule regarding MPOs (then numbered Proposed Rule 2721). 
FINRA received sixteen comment letters in response to NTM 07-27.\7\ The 
comments were

[[Page 4488]]

varied. Some commenters expressed support for the intent of the 
proposed rule, but voiced concerns about its breadth and scope; \8\ 
others questioned the benefit or necessity of the proposed rule.\9\ 
Most comment letters also suggested edits to the proposed rule.\10\ In 
the discussion below, FINRA discusses the comments and note areas that 
differ significantly from the Rule as previously proposed in NTM 07-27.
---------------------------------------------------------------------------

    \7\ The following is a list of persons and entities submitting 
comment letters in response to NTM 07-27: Letter from Timothy P. 
Selby for Alston & Bird LLP dated July 20, 2007 (Alston & Bird 
letter); Letter from Keith F. Higgins for American Bar Association 
Committee on Federal Regulation of Securities dated July 20, 2007 
(ABA letter); Letter from Todd Anders dated July 13, 2007 (Anders 
letter); Letter from Neville Golvala for ChoiceTrade dated July 19, 
2007 (ChoiceTrade letter); Letter from Stephen E. Roth, et al of 
Sutherland, Asbill & Brennan, LLP for the Committee of Annuity 
Insurers dated July 20, 2007 (CAI letter); Letter from Peter J 
Chepucavage for the International Association of Small Broker-
Dealers and Advisors dated July 20, 2007 (IASBDA letter); Letter 
from Alan Z. Engel for LEC Investment Corp. dated June 14, 2007 (LEC 
letter); Letter from Daniel T. McHugh for Lombard Securities Inc. 
dated July 20, 2007 (Lombard letter); Letter from Dexter M. Johnson 
for Mallon & Johnson, P.C. dated July 19, 2007 (Mallon & Johnson 
letter); Letter from John G. Gaine for Managed Funds Association 
dated July 20, 2007 (MFA letter); Letter from Curtis N. Sorrells for 
MGL Consulting Corp. dated July 20, 2007 (MGL letter); Letter from 
Thomas W. Sexton for the National Futures Association dated July 20, 
2007 (NFA letter); Letter from Michael S. Sackheim and David A. Form 
for the New York City Bar Committee of Futures and Derivatives 
Regulation dated July 10, 2007 (NYC Bar letter); Letter from Joseph 
A. Fillip, Jr. for PFG Distribution Co. dated July 19, 2007 (PFG 
letter); Letter from Mary Kuan for Securities Industry and Financial 
Markets Association dated July 27, 2007 (SIFMA letter); and Letter 
from Bill Keisler for Stephens Inc. dated July 20, 2007 (Stephens 
letter).
    \8\ See MFA letter; CAI letter; Alston & Bird letter.
    \9\ See Anders letter; Mallon & Johnson letter; ChoiceTrade 
letter; ABA letter; SIFMA letter. FINRA does not agree with SIFMA 
that the potential for abuses in connection with private offerings 
by non-members is a reason to abandon the proposed rule change. The 
FINRA staff believes that offerings by members raise unique 
conflicts that require the protections of the proposed rule change. 
FINRA also disagrees with SIFMA's contention that they do not have 
legal authority to adopt the proposed rule change.
    \10\ See Alston & Bird letter; ABA letter; LEC letter; Mallon & 
Johnson letter; MFA letter; MGL letter; PFG letter; SIFMA letter.
---------------------------------------------------------------------------

Definitions
    The proposed rule change states that no member or associated person 
may offer or sell any security in a MPO unless certain conditions are 
met. The proposed rule change uses the term ``MPO'' as ``a private 
placement of unregistered securities issued by a member or control 
entity.'' The proposed rule further defines two of the terms in the 
definition of MPO: ``private placement'' and ``control entity.'' In 
response to one comment,\11\ FINRA has defined the term ``private 
placement'' to be ``a non-public offering of securities conducted in 
reliance on an available exemption from registration under the 
Securities Act.''
---------------------------------------------------------------------------

    \11\ See ABA letter; SIFMA letter.
---------------------------------------------------------------------------

    The proposed rule change defines the term ``control entity'' as 
``any entity that controls or is under common control with a member, or 
that is controlled by a member or its associated persons.'' The term 
``control'' is defined as ``a beneficial interest, as defined in Rule 
5130(i)(1), of more than 50 percent of the outstanding voting 
securities of a corporation, or the right to more than 50 percent of 
the distributable profits or losses of a partnership or other non-
corporate legal entity.'' \12\ The power to direct the management or 
policies of a corporation or partnership alone (e.g., a general 
partner)--absent meeting the majority ownership or right to the 
majority of profits--would not constitute ``control'' as defined in 
proposed FINRA Rule 5122. For purposes of this definition, entities may 
calculate the percentage of control using a ``flow through'' concept, 
by looking through ownership levels to calculate the total percentage 
of control. For example, if broker-dealer ABC owns 50 percent of 
corporation DEF that in turn holds a 60 percent interest in corporation 
GHI, and ABC is engaged in a private offering of GHI, ABC would have a 
30 percent interest in GHI (50 percent of 60 percent), and thus GHI 
would not be considered a control entity under this definition.
---------------------------------------------------------------------------

    \12\ FINRA added language regarding ``other non-corporate legal 
entities'' based on commenters' suggestions to clarify that control 
would extend to entities other than corporations or partnerships. 
See ABA letter; SIFMA letter.
---------------------------------------------------------------------------

    FINRA also reaffirms, as stated in NTM 07-27, that performance and 
management fees earned by a general partner would not be included in 
the determination of partnership profit or loss percentages. However, 
if such performance and management fees are subsequently re-invested in 
the partnership, thereby increasing the general partner's ownership 
interest, then such interests would be considered in determining 
whether the partnership is a control entity.
    In response to several comments advocating that the timing for 
determining control take place at the conclusion rather than the 
commencement of an offering,\13\ FINRA has revised the definition of 
control to be determined immediately after the closing of an offering. 
The definition also clarifies that, in the case of multiple closings, 
control will be determined immediately after each closing. If an 
offering is intended to raise sufficient funds such that the member 
would not control the entity under the control standard, but fails to 
raise sufficient funds, the member must promptly come into compliance 
with the Rule, including providing the required disclosures to 
investors and filings with FINRA's Corporate Financing Department 
(``Department'').
---------------------------------------------------------------------------

    \13\ See Alston & Bird letter; ABA letter; LEC letter; MFA 
letter; MGL letter; NYC Bar letter; SIFMA letter.
---------------------------------------------------------------------------

Disclosure Requirements
    The proposed rule change would require that a member provide a 
written offering document to each prospective investor in an MPO, 
whether accredited or not, and that the offering document disclose the 
intended use of offering proceeds as well as offering expenses and 
selling compensation.\14\ If the offering has a private placement 
memorandum or term sheet, then such memorandum or term sheet must be 
provided to each prospective investor and must contain these 
disclosures. If the offering does not have a private placement 
memorandum or term sheet, then the member must prepare an offering 
document that discloses the intended use of offering proceeds as well 
as offering expenses and selling compensation. The Rule is not meant to 
require a particular form of disclosure; to emphasize this point, FINRA 
proposes to issue Supplemental Material 5122.01, which would note that 
nothing in the Rule shall require a member to prepare a private 
placement memorandum that meets the additional requirements of 
Securities Act Rule 502.
---------------------------------------------------------------------------

    \14\ Given that FINRA is not imposing limits on selling 
compensation as it does in other rules, they do not believe it is 
necessary to provide a detailed definition of ``selling 
compensation'' as urged by SIFMA. FINRA believes that the term 
``selling compensation'' for purposes of a disclosure requirement is 
sufficiently clear.
---------------------------------------------------------------------------

    FINRA believes that every investor in an MPO should receive basic 
information concerning the offering. FINRA also believes that none of 
the disclosures required in the proposed rule change would conflict 
with requirements under federal or state securities laws.\15\
---------------------------------------------------------------------------

    \15\ See SIFMA letter.
---------------------------------------------------------------------------

    In response to comments,\16\ the proposed rule change eliminates 
the previously proposed requirements to disclose risk factors and ``any 
other information necessary to ensure that required information is not 
misleading.'' One commenter was concerned that requiring disclosure of 
these items could lead to an inconsistent scheme of regulation in 
interpreting the application of the federal securities laws to private 
placements if FINRA's expectation of what should be disclosed

[[Page 4489]]

differed from the expectations of the SEC and the courts.\17\ While 
FINRA has omitted these disclosures from the proposed rule change, they 
specifically request comment on their decision to exclude such 
disclosures.
---------------------------------------------------------------------------

    \16\ See ABA letter.
    \17\ See ABA letter.
---------------------------------------------------------------------------

Filing Requirements
    The proposed rule change would require that a member file a private 
placement memorandum, term sheet or other offering document with the 
Department at or prior to the first time such document is provided to 
any prospective investor. Any amendments or exhibits to the offering 
document also must be filed by the member with the Department within 
ten days of being provided to any investor or prospective investor. The 
filing requirement is intended to allow the Department to identify 
those offering documents that are deficient ``on their face'' from the 
other requirements of the proposed rule change. Notably, the filing 
requirement in the proposed rule change differs from that in Rule 5110 
(Corporate Financing Rule) in that the Department would not review the 
offering and issue a ``no-objections'' letter before a member may 
commence the offering.
    FINRA affirms, in response to concerns raised in the comment 
letters,\18\ that information filed with the Department pursuant to 
FINRA Rule 5122 would be subject to confidential treatment. FINRA has 
included a provision in the proposed rule change explicitly clarifying 
this position.\19\ The Department plans to develop a Web-based filing 
system that would allow for the filing to be deemed filed upon 
submission.\20\ In addition, the proposed rule change would not impose 
any additional requirements regarding filing of advertisements or sales 
materials, which would continue to be governed by NASD Rule 2210.\21\
---------------------------------------------------------------------------

    \18\ See ABA letter; Mallon & Johnson letter; SIFMA letter.
    \19\ See 5122(d). This confidential treatment provision is 
similar to that provided in Rule 5110(b)(3).
    \20\ As noted supra, and in NTM 07-27, neither FINRA nor the 
Department would issue a ``no objections opinion'' regarding any 
offering document filed with the Department. However, if FINRA 
subsequently determined that disclosures in the offering document 
appeared to be incomplete, inaccurate or misleading, FINRA could 
make further inquiries. The filing requirement also could facilitate 
the creation of a confidential Department database on MPO activity 
that would be used in connection with the member examination 
process.
    \21\ See NYC Bar letter; SIFMA letter.
---------------------------------------------------------------------------

    One commenter suggested that a member's filing of Form D pursuant 
to Securities Act Regulation D should provide sufficient information to 
FINRA.\22\ FINRA staff disagrees. For example, FINRA notes that the 
information in Form D does not include information on a wide variety of 
expenses or applications of proceeds, nor does Form D require that such 
information is contained in the offering documents.
---------------------------------------------------------------------------

    \22\ See Mallon & Johnson letter.
---------------------------------------------------------------------------

Use of Offering Proceeds
    Proposed Rule 5122(b)(3) would require that each time an MPO is 
closed at least 85 percent of the offering proceeds raised be used for 
business purposes, which would not include offering costs, discounts, 
commissions or any other cash or non-cash sales incentives. The use of 
offering proceeds also must be consistent with the disclosures to 
investors, as described above. This requirement was created to address 
the abuses where members or control entities used substantial amounts 
of offering proceeds for selling compensation and related party 
benefits, rather than business purposes. The proposed rule change does 
not limit the total amount of underwriting compensation. Rather, under 
the proposed rule change, offering and other expenses of the MPO could 
exceed a value greater than 15 percent of the offering proceeds, but no 
more than 15 percent of the money raised from investors in the private 
placement could be used to pay these expenses. FINRA notes the 15 
percent figure is consistent with the limitation of offering fees and 
expenses, including compensation, in NASD Rule 2810 (Direct 
Participation Programs), and the North American Securities 
Administrators Association (``NASAA'') guidelines with respect to 
public offerings subject to state regulation.
    Some commenters expressed concern that the 85 percent limit was 
arbitrary or unnecessary \23\ and should be reduced or eliminated to 
allow flexibility for management in MPOs.\24\ FINRA believes that when 
a member engages in a private placement of its own securities or those 
of a control entity, investors should be assured that, at a minimum, 85 
percent of the proceeds of the offering are dedicated to business 
purposes. FINRA recognizes that changing the business purpose or use of 
proceeds in an offering may in some instances benefit investors, and 
remind members that the member may change its use of proceeds, provided 
it makes appropriate disclosure to investors and files the amended 
offering document with the Department.
---------------------------------------------------------------------------

    \23\ See IASBDA letter; Mallon & Johnson letter; ABA letter; 
SIFMA letter.
    \24\ See IASBDA letter; Mallon & Johnson letter; ABA letter.
---------------------------------------------------------------------------

    One commenter requested that, when an issuer plans a series of 
MPOs, the issuer should be allowed to calculate the 85 percent limit at 
the end of the series.\25\ FINRA believes, however, that the limit 
should apply to each MPO in order to assure investors that at least 85 
percent of each offering in a series is dedicated to the business 
purposes described in that offering's offering document. As a result, 
FINRA has clarified that the 85 percent limit applies to each MPO.
---------------------------------------------------------------------------

    \25\ See NYC Bar letter.
---------------------------------------------------------------------------

Proposed Exemptions
    Proposed Rule 5122 would include a number of exemptions for sales 
to institutional purchasers because the staff's findings did not reveal 
abuse vis-[agrave]-vis such purchasers, who are generally sophisticated 
and able to conduct appropriate due diligence prior to making an 
investment. Specifically, the proposed Rule would exempt MPOs sold 
solely to the following:
     Institutional accounts, as defined in NASD Rule 
3110(c)(4);
     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; and
     Banks, as defined in Section 3(a)(2) of the Securities 
Act.
    In addition, the proposed rule change excludes the following types 
of offerings, which do not raise the concerns identified in the sweep 
or enforcement actions:
     Offerings of exempted securities, as defined by Section 
3(a)(12) of the Exchange Act;
     Offerings made pursuant to Securities Act Rule 144A or SEC 
Regulation S;
     Offerings in which a member acts primarily in a 
wholesaling capacity (i.e., it intends, as evidenced by a selling 
agreement, to sell through its affiliate broker-dealers, less than 20% 
of the securities in the offering);
     Offerings of exempted securities with short term 
maturities under Section 3(a)(3) of the Securities Act;
     Offerings of subordinated loans under SEA Rule 15c3-1, 
Appendix D; \26\
---------------------------------------------------------------------------

    \26\ Members' offerings of subordinated loans are subject to an 
alternative disclosure regime. In 2002, the SEC approved a rule 
change to require, as part of a subordination agreement, the 
execution of a Subordination Agreement Investor Disclosure Document. 
See Exchange Act Release No. 45954 (May 17, 2002), 67 FR 36281 (May 
23, 2002); see also Notice to Members 02-32 (June 2002).

---------------------------------------------------------------------------

[[Page 4490]]

     Offerings of ``variable contracts,'' as defined in NASD 
Rule 2820(b)(2);
     Offerings of modified guaranteed annuity contracts and 
modified guaranteed life insurance policies, as referred to in Rule 
5110(b)(8)(E);
     Offerings of securities of a commodity pool operated by a 
commodity pool operator, as defined under Section 1a(5) of the 
Commodity Exchange Act;
     Offerings of equity and credit derivatives, including OTC 
options, provided that the derivative is not based principally on the 
member or any of its control entities; and
     Offerings filed with the Department under Rule 5110 or 
NASD Rules 2720 or 2810.
    Finally, the proposed rule change also would exempt MPOs in which 
investors would be expected to have access to sufficient information 
about the issuer and its securities in addition to the information 
provided by the member conducting the MPO. These exemptions include:
     Offerings of unregistered investment grade rated debt and 
preferred securities;
     Offerings to employees and affiliates of the issuer or its 
control entities; and
     Offerings of securities issued in conversions, stock 
splits and restructuring transactions executed by an already existing 
investor without the need for additional consideration or investments 
on the part of the investor.
    This list of exemptions is largely based on the exemptions 
previously proposed in NTM 07-27, with a few additions and 
clarifications in response to comments.\27\ FINRA clarified that 
exempted securities, as defined by Section 3(a)(12) of the Exchange 
Act, would not be subject to the Rule.\28\ In addition, FINRA proposes 
an exemption for commodity pools \29\ in view of the oversight and 
regulation performed by the National Futures Association and the 
Commodity Futures Trading Commission. FINRA also clarified that 
variable contracts and other life insurance products \30\ would be 
excluded, because the offer and sale of these types of offerings are 
already subject to existing FINRA rules.\31\ FINRA also proposes an 
exemption for member private offerings that are filed with the 
Department under Rule 5110 or NASD Rules 2720 or 2810.
---------------------------------------------------------------------------

    \27\ See Lombard letter; ABA letter; MGL letter; NYC Bar letter; 
MFA letter; NFA letter; Alston & Bird letter; Anders letter; PFG 
letter; CAI letter; ChoiceTrade letter; Mallon & Johnson letter; 
SIFMA letter.
    \28\ Accordingly, FINRA notes that in connection with this 
proposed Rule, they do not plan to recommend amending NASD Rule 0116 
or the List of NASD Conduct Rules and Interpretive Materials that 
apply to Exempted Securities. See CAI letter.
    \29\ See NYC Bar letter; MFA letter; NFA letter; Alston & Bird 
letter; SIFMA letter.
    \30\ See CAI letter; PFG letter.
    \31\ See, e.g., NASD Rule 2820.
---------------------------------------------------------------------------

    In addition, FINRA clarified aspects of other previously proposed 
exemptions. FINRA clarified that their intent regarding the exemption 
for wholesalers is to provide an exemption for those that do not 
primarily engage in direct selling to investors.\32\ FINRA also 
clarified that 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 
investment on the part of the investor would be exempt.\33\
---------------------------------------------------------------------------

    \32\ See MGL letter; SIFMA letter.
    \33\ See Mallon & Johnson letter.
---------------------------------------------------------------------------

    FINRA also noted that equity and credit derivatives, such as OTC 
options, would be exempt, provided that the derivative is not based 
principally on the member or any of its control entities.\34\ As a 
technical matter, the issuer of an equity or credit derivative is the 
member firm, and thus would make such offering an MPO. However, where 
the security offered is not based principally on the member or any of 
its control entities (e.g., an OTC option on MSFT), FINRA does not 
believe such sale should be subject to the provisions of the proposed 
rule change. On the other hand, if the derivative is based principally 
on the member or a control entity (e.g., an OTC option overlying the 
member), then the sale of such security should be treated as an MPO and 
subject to the requirements of the proposed rule change.
---------------------------------------------------------------------------

    \34\ See SIFMA letter.
---------------------------------------------------------------------------

    Finally, FINRA clarified that the exemption for employees and 
affiliates of issuers would apply to employees and affiliates of 
control entities as well, because these persons are expected to have 
access to a level of information about the securities of the issuer 
similar to employees and affiliates of the issuer itself.\35\
---------------------------------------------------------------------------

    \35\ See Stephens letter; see also Lombard letter.
---------------------------------------------------------------------------

    Based on the comment letters,\36\ FINRA also reconsidered whether 
offerings to accredited investors should be exempt. However, FINRA 
continues to believe that an exemption for offerings made to accredited 
investors would not be in the public interest due to the generally low 
thresholds for meeting the definition of the term ``accredited 
investor.'' FINRA notes that the SEC has recently proposed clarifying 
and modernizing its ``accredited investor'' standard due to concerns 
that the definition is overbroad.\37\
---------------------------------------------------------------------------

    \36\ See ChoiceTrade letter; PFG letter; SIFMA letter.
    \37\ See, e.g., Securities Act Release No. 8828 (Aug. 3, 2007), 
72 FR 45116 (Aug. 10, 2007); Securities Act Release No. 8766 (Dec. 
27, 2006), 72 FR 400 (Jan. 4, 2007).
---------------------------------------------------------------------------

    Additionally, it is FINRA's view that financial products offered by 
a public reporting company,\38\ an investment fund \39\ or a state or 
federal bank affiliate of a FINRA member \40\ should not be excluded 
based solely on their status as a reporting company, a fund or a bank. 
FINRA's belief is that, as a general matter, exemptions are best 
tailored based on the type of securities offered or the type (and 
sophistication) of the purchaser rather than the type of offeror. FINRA 
also declines to exempt offerings that contribute below a specified 
level of a member's net worth (e.g., 5%), to create a categorical 
exemption for all exempted securities under Section 3(a) of the 
Securities Act, or to expand the exemption for securities with short 
term maturities under Section 3(a)(3) of the Securities Act to include 
all securities with a maturity of nine months or less.\41\ As a 
practical matter, however, many of these products would be exempt 
because they meet one of the other exemptions enumerated in the Rule.
---------------------------------------------------------------------------

    \38\ See ABA letter; SIFMA letter.
    \39\ See MFA letter.
    \40\ See Anders letter; ABA letter.
    \41\ See SIFMA letter.
---------------------------------------------------------------------------

Implementation and Compliance
    FINRA will announce the implementation date of the proposed rule 
change in a Regulatory Notice to be published no later than 60 days 
following Commission approval. The implementation date will be 30 days 
following publication of the Regulatory Notice announcing Commission 
approval, but will not apply retroactively to any offerings that have 
already commenced selling efforts.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\42\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes the proposed rule change will provide 
important investor protections in

[[Page 4491]]

connection with private placements of securities by members and control 
entities.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published in Notice to Members 07-27 
(June 2007). Sixteen comments were received in response to Notice to 
Members 07-27. A copy of Notice to Members 07-27 is attached as Exhibit 
2a to this rule filing. A list of the comment letters received in 
response to Notice to Members 07-27 is attached as Exhibit 2b to this 
rule filing. Copies of the comment letters received in response to 
Notice to Members 07-27 are attached as Exhibit 2c to this rule filing. 
The comments are summarized above.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2008-020 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2008-020. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549, on official business days between the hours 
of 10 a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2008-020 and should be 
submitted on or before February 17, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
---------------------------------------------------------------------------

    \43\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E9-1466 Filed 1-23-09; 8:45 am]

BILLING CODE 8011-01-P
