
[Federal Register: March 25, 2009 (Volume 74, Number 56)]
[Notices]               
[Page 12913-12918]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25mr09-185]                         

=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59599; File No. SR-FINRA-2008-020]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving Proposed Rule Change, as Modified by 
Amendment No. 2 Thereto, Relating to Private Placements of Securities 
Issued by Members

March 19, 2009.

I. Introduction

    The Financial Industry Regulatory Authority, Inc. (``FINRA'') (f/k/
a National Association of Securities Dealers, Inc. (``NASD'')) filed 
with the Securities and Exchange Commission (``Commission'' or ``SEC'') 
on September 11, 2008, and amended on January 7, 2009,\1\ pursuant to 
Section 19(b)(1) of

[[Page 12914]]

the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \2\ 
and Rule 19b-4 thereunder,\3\ a proposal to adopt new FINRA Rule 5122 
(``Rule'') which would prohibit FINRA members or associated persons 
from offering or selling any security in a ``Member Private Offerings'' 
unless certain conditions have been met. This proposal was published 
for comment in the Federal Register on January 26, 2009.\4\ The 
Commission received two comments on the proposal.\5\ This order 
approves this proposed rule change.
---------------------------------------------------------------------------

    \1\ 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replaced and superseded the original filing submitted to the SEC on 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2008, was withdrawn on January 7, 2009.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
    \4\ Exchange Act Release No. 59262 (January 16, 2009), 74 FR 
4487 (January 26, 2009) (SR-FINRA-2008-020).
    \5\ See letter from Neville Golvala for ChoiceTrade dated 
February 7, 2009 (``2009 ChoiceTrade letter'') and letter from Jack 
L. Hollander for the Investment Program Association (``IPA'') dated 
February 17, 2009 (``IPA letter'').
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    FINRA proposed to adopt new FINRA Rule 5122, which 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.

A. Background

    FINRA proposed the Rule 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.\6\ 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.
---------------------------------------------------------------------------

    \6\ 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.
---------------------------------------------------------------------------

    Because 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.\7\ 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.\8\
---------------------------------------------------------------------------

    \7\ FINRA Rule 5110 and NASD Rules 2720 and 2810 govern member 
participation in public offerings of securities.
    \8\ 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, FINRA issued Notice to Members 
07-27 (``NTM 07-27'') in June 2007 to solicit comment on a proposed new 
rule regarding MPOs (then numbered proposed NASD Rule 2721). FINRA 
received sixteen comment letters in response to NTM 07-27.\9\ These 
comments were varied. Some of these commenters expressed support for 
the intent of the proposed rule but voiced concerns about its breadth 
and scope,\10\ while others questioned the benefit or necessity of the 
proposed rule.\11\ Most of these comment letters also suggested edits 
to the proposed rule.\12\ These comments received in response to NTM 
07-27, and changes to the Rule as proposed as compared to the rule as 
it appeared in NTM 07-27, are described in more detail below in 
Sections II.B through II.F.
---------------------------------------------------------------------------

    \9\ 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 
(``ABA'') 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 (``2007 ChoiceTrade letter''), 
letter from Stephen E. Roth, et al of Sutherland, Asbill & Brennan, 
LLP for the Committee of Annuity Insurers (``CAI'') dated July 20, 
2007 (``CAI letter''), letter from Peter J Chepucavage for the 
International Association of Small Broker-Dealers and Advisors 
(``IASBDA'') 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 (``MFA'') 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 (``NFA'') 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 
Distribution Co. dated July 19, 2007 (``PFG letter''), letter from 
Mary Kuan for Securities Industry and Financial Markets Association 
(``SIFMA'') dated July 27, 2007 (``SIFMA letter''), and letter from 
Bill Keisler for Stephens Inc. dated July 20, 2007 (``Stephens 
letter'').
    \10\ See MFA letter, CAI letter, and Alston & Bird letter.
    \11\ See Anders letter, Mallon & Johnson letter, 2007 
ChoiceTrade letter, ABA letter, and SIFMA letter. FINRA did 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 believed that offerings by members 
raise unique conflicts that require the protections of the proposed 
rule change. FINRA also disagreed with SIFMA's contention that they 
do not have legal authority to adopt the proposed rule change.
    \12\ See Alston & Bird letter, ABA letter, LEC letter, Mallon & 
Johnson letter, MFA letter, MGL letter, PFG letter, and SIFMA 
letter.
---------------------------------------------------------------------------

B. 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 defines a 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 received in response to NTM 07-27,\13\ FINRA 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 [of 1933].''
---------------------------------------------------------------------------

    \13\ See ABA letter and SIFMA letter.

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

[[Page 12915]]

    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.'' \14\ 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, FINRA 
clarified that 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.
---------------------------------------------------------------------------

    \14\ 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 and SIFMA letter.
---------------------------------------------------------------------------

    FINRA also reaffirmed, 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 received in response to NTM 07-27 
advocating that the timing for determining control take place at the 
conclusion rather than the commencement of an offering,\15\ FINRA 
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'').
---------------------------------------------------------------------------

    \15\ See Alston & Bird letter, ABA letter, LEC letter, MFA 
letter, MGL letter, NYC Bar letter, and SIFMA letter.
---------------------------------------------------------------------------

C. 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.\16\ 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. FINRA clarified that the 
Rule is not meant to require a particular form of disclosure, however. 
To emphasize this point, FINRA proposed 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 Rule 502 under the Securities Act of 1933 
(``Securities Act'').
---------------------------------------------------------------------------

    \16\ Given that FINRA is not imposing limits on selling 
compensation as it does in other rules, they did not believe it was 
necessary to provide a detailed definition of ``selling 
compensation'' as urged by SIFMA. FINRA believed that the term 
``selling compensation'' for purposes of a disclosure requirement is 
sufficiently clear.
---------------------------------------------------------------------------

    FINRA believed that every investor in an MPO should receive basic 
information concerning the offering. FINRA also believed that none of 
the disclosures required in the proposed rule change would conflict 
with requirements under Federal or State securities laws.\17\
---------------------------------------------------------------------------

    \17\ See SIFMA letter.
---------------------------------------------------------------------------

    In response to comments received in response to NTM 07-27,\18\ 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 at the 
time 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 differed from the expectations 
of the SEC and the courts.\19\While FINRA omitted these disclosures 
from the proposed rule change, they specifically requested comment on 
their decision to exclude such disclosures.\20\
---------------------------------------------------------------------------

    \18\?????
    \19\ See ABA letter.
    \20\ Exchange Act Release No. 59262 (January 16, 2009), 74 FR 
4487 (January 26, 2009).
---------------------------------------------------------------------------

D. 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 affirmed, in response to concerns raised in comment letters 
received in response to NTM 07-27,\21\ that information filed with the 
Department pursuant to proposed FINRA Rule 5122 would be subject to 
confidential treatment. FINRA included a provision in the proposed rule 
change explicitly clarifying this position.\22\ FINRA has stated that 
the Department plans to develop a Web-based filing system that would 
allow for the filing to be deemed filed upon submission.\23\ In 
addition, the proposed rule change would not impose any additional 
requirements regarding filing of advertisements or sales materials, 
which

[[Page 12916]]

would continue to be governed by NASD Rule 2210.\24\
---------------------------------------------------------------------------

    \21\ See ABA letter, Mallon & Johnson letter, and SIFMA letter.
    \22\ See proposed 5122(d). This confidential treatment provision 
is similar to that provided in FINRA Rule 5110(b)(3).
    \23\ 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, FINRA has 
stated that if it subsequently determined that disclosures in the 
offering document appeared to be incomplete, inaccurate or 
misleading, they 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.
    \24\ See NYC Bar letter and SIFMA letter.
---------------------------------------------------------------------------

    One commenter responding to NTM 07-27 suggested that a member's 
filing of Form D pursuant to Securities Act Regulation D should provide 
sufficient information to FINRA.\25\ FINRA staff disagreed. For 
example, FINRA noted 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.
---------------------------------------------------------------------------

    \25\ See Mallon & Johnson letter.
---------------------------------------------------------------------------

E. 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 noted that the 15 
percent figure is consistent with the limitation of offering fees and 
expenses, including compensation, in NASD Rule 2810 and the North 
American Securities Administrators Association guidelines with respect 
to public offerings subject to State regulation.
    Some commenters responding to NTM 07-27 expressed concern that the 
85 percent limit was arbitrary or unnecessary,\26\ and should be 
reduced or eliminated to allow flexibility for management in MPOs.\27\ 
FINRA believed 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 recognized that changing the 
business purpose or use of proceeds in an offering may in some 
instances benefit investors and reminded 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.
---------------------------------------------------------------------------

    \26\ See IASBDA letter, Mallon & Johnson letter, ABA letter, and 
SIFMA letter.
    \27\ See IASBDA letter, Mallon & Johnson letter, and ABA letter.
---------------------------------------------------------------------------

    One commenter responding to NTM 07-27 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.\28\ FINRA 
believed, 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 clarified that the 85 percent 
limit applies to each MPO.
---------------------------------------------------------------------------

    \28\ See NYC Bar letter.
---------------------------------------------------------------------------

F. Proposed Exemptions

    Proposed Rule 5122 would include a number of exemptions for sales 
to institutional purchasers because FINRA'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 Exchange Act Rule 
15c3-1, Appendix D;\29\
---------------------------------------------------------------------------

    \29\ 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).
---------------------------------------------------------------------------

     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 FINRA 
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 
over-the-counter (``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 FINRA 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.\30\ FINRA clarified that 
exempted securities, as defined by Section 3(a)(12) of the Exchange 
Act, would not be subject to the Rule.\31\ In

[[Page 12917]]

addition, FINRA proposed an exemption for commodity pools in view of 
the oversight and regulation performed by the NFA and the Commodity 
Futures Trading Commission.\32\ FINRA also clarified that variable 
contracts and other life insurance products would be excluded,\33\ 
because the offer and sale of these types of offerings are already 
subject to existing FINRA rules.\34\ FINRA also proposed an exemption 
for member private offerings that are filed with the Department under 
FINRA Rule 5110 or NASD Rules 2720 or 2810.
---------------------------------------------------------------------------

    \30\ See Lombard letter, ABA letter, MGL letter, NYC Bar letter, 
MFA letter, NFA letter, Alston & Bird letter, Anders letter, PFG 
letter, CAI letter, 2007 ChoiceTrade letter, Mallon & Johnson 
letter, and SIFMA letter.
    \31\ Accordingly, FINRA noted 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.
    \32\ See NYC Bar letter, MFA letter, NFA letter, Alston & Bird 
letter, and SIFMA letter.
    \33\ See CAI letter and PFG letter.
    \34\ 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.\35\ 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.\36\
---------------------------------------------------------------------------

    \35\ See MGL letter and SIFMA letter.
    \36\ 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.\37\ 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 Microsoft Corporation), 
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.
---------------------------------------------------------------------------

    \37\ 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.\38\
---------------------------------------------------------------------------

    \38\ See Stephens letter; see also Lombard letter.
---------------------------------------------------------------------------

    Based on the comment letters received in response to NTM 07-27,\39\ 
FINRA also reconsidered whether offerings to accredited investors 
should be exempt. However, FINRA continued 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 noted that the SEC has 
recently proposed clarifying and modernizing its ``accredited 
investor'' standard.\40\
---------------------------------------------------------------------------

    \39\ See 2007 ChoiceTrade letter, PFG letter, and SIFMA letter.
    \40\ 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, FINRA believed that financial products offered by a 
public reporting company,\41\ an investment fund,\42\ or a State or 
Federal bank affiliate of a FINRA member,\43\ should not be excluded 
based solely on their status as a reporting company, a fund, or a bank. 
FINRA's belief was 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 declined 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.\44\ As a 
practical matter, however, many of these products would be exempt 
because they meet one of the other exemptions enumerated in the Rule.
---------------------------------------------------------------------------

    \41\ See ABA letter and SIFMA letter.
    \42\ See MFA letter.
    \43\ See Anders letter and ABA letter.
    \44\ See SIFMA letter.
---------------------------------------------------------------------------

III. Comment Letters

    The Commission received two comment letters in response to the 
proposed rule change.\45\ The Commission also received FINRA's response 
to comments.\46\ One letter voiced serious objections to the Rule,\47\ 
while the other raised issues relating to the scope of the Rule.\48\ 
The specific comments from these two letters, as well as FINRA's 
response to these comments, are discussed in detail below.
---------------------------------------------------------------------------

    \45\ Supra note 5.
    \46\ Letter from Stan Macel, FINRA, dated March 9, 2009.
    \47\ 2009 ChoiceTrade Letter.
    \48\ IPA Letter.
---------------------------------------------------------------------------

    One commenter stated that FINRA did not have jurisdiction to adopt 
the Rule.\49\ FINRA found no basis in this allegation because they 
believe that the Rule is consistent with Section 15A(b)(6) of the 
Exchange Act and that the proposed rule change will provide important 
investor protections. FINRA also points out that the Rule, by its 
terms, would apply to members and their associated persons in 
connection with the offer and sale of a specific type of security 
offering.
---------------------------------------------------------------------------

    \49\ 2009 ChoiceTrade Letter.
---------------------------------------------------------------------------

    Both commenters argued that the requirements of the proposed rule 
change as applied to control entities of a member are overly broad. One 
commenter argued that the Rule would affect private placements by 
control entities that are not members which should not be part of the 
proposal.\50\ The other commenter argued that FINRA did not have 
jurisdiction over control entities that are not broker-dealers.\51\ 
FINRA disagreed with the commenters, stating that it has narrowly 
tailored the Rule to apply only in those instances where it believes 
oversight is warranted. For example, the definition of ``control'' in 
the Rule was limited to situations where the member owns more than 50% 
of the shares or distributable profits of the entity, where control has 
been found elsewhere at as little as 10%. Further, FINRA asserts that 
the Rule is designed to address conflicts attendant to private 
offerings by the member and its control entities. FINRA does not 
believe that this conflict is any less relevant when the capital is not 
being raised directly for the member's business purpose.
---------------------------------------------------------------------------

    \50\ IPA letter.
    \51\ 2009 ChoiceTrade letter. See also supra for FINRA's 
response to the jurisdictional question.
---------------------------------------------------------------------------

    One commenter argued that FINRA should issue no-objection letters 
or otherwise demarcate the end of their review process.\52\ FINRA 
responded that the purpose of their review is to find filings that are 
deficient on their face, and thus does not intend to engage in an 
extended review as it does in other situations. FINRA did note that the 
filed documents may be utilized in the member examination process.
---------------------------------------------------------------------------

    \52\ IPA letter.
---------------------------------------------------------------------------

    Both commenters raised objections to the imposition of a limit on 
offering expenses. FINRA disagrees with the commenters and believes 
that the limits placed on members in the Rule are warranted based on 
the abuses FINRA has found. They believe that investors should be 
assured that in the case where

[[Page 12918]]

members are placing their own or a control entity's securities. They 
also point out that some limits are already in place via other rules or 
guidelines.
    NTM 07-27 required additional disclosures beyond what was proposed 
by FINRA to the Commission, but FINRA requested specific comment as to 
whether those additional disclosures should be put back into the 
Rule.\53\ Only one commenter addressed this question, but did support 
FINRA's decision to remove these additional disclosures.\54\
---------------------------------------------------------------------------

    \53\ Exchange Act Release No. 59262 (January 16, 2009), 74 FR 
4487 (January 26, 2009). See also supra Section II.C.
    \54\ IPA letter.
---------------------------------------------------------------------------

    One commenter objected to limiting the requirement of filing the 
offering document with FINRA to FINRA members only.\55\ FINRA responded 
that private offerings by members raise unique conflicts that 
necessitate the Rule. Further, that there is potential for abuse in 
private offerings by non-members is not a rationale for abandoning the 
proposal.
---------------------------------------------------------------------------

    \55\ 2009 ChoiceTrade letter.
---------------------------------------------------------------------------

    One commenter challenged FINRA's ability to keep the documents 
submitted to them confidential in spite of the promise of confidential 
treatment in proposed Rule 5122(d).\56\ FINRA strongly disagreed with 
this assessment. This commenter also argued that there were 
insufficient occurrences of disconcerting behavior by members to 
warrant a rule, asserted that the Rule required a private placement 
memorandum and objected to a new requirement to do so, argued that the 
anti-fraud rules were sufficient to address the behavior FINRA was 
concerned with, objected to the filing requirement generally, objected 
to making the offering document available for the member examination 
process, argued that accredited investors should be excepted from the 
Rule, and argued that the Rule was an over-reaction to the findings 
cited by FINRA in the proposal.\57\
---------------------------------------------------------------------------

    \56\ Id.
    \57\ Id.
---------------------------------------------------------------------------

IV. Discussion and Findings

    After careful review of the proposed rule change, the comments, and 
FINRA's response to the comments, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and the rules and regulations thereunder that are applicable to a 
national securities association.\58\ In particular, the Commission 
believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\59\ which requires, among 
other things, that FINRA rules 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. The Commission believes that FINRA is seeking to 
protect investors and the public interest as a result of numerous 
findings of disconcerting behavior by its members in connection with 
MPOs. The Commission also believes that FINRA has tailored the Rule to 
prohibit members or associated persons from offering or selling 
securities in certain MPOs in order to ensure that investors are 
protected from such abusive conduct with minimal disruption on capital 
formation. The Commission notes that, as explained in the supplementary 
material to the Rule, nothing in the Rule shall require a member to 
prepare a private placement memorandum that meets the additional 
requirements of Securities Act Rule 502.
---------------------------------------------------------------------------

    \58\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \59\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\60\ that the proposed rule change (File No. SR-FINRA-2008-020), as 
modified by Amendment No. 2, be, and hereby is, approved.
---------------------------------------------------------------------------

    \60\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\61\
---------------------------------------------------------------------------

    \61\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-6466 Filed 3-24-09; 8:45 am]

BILLING CODE 8010-01-P
