Table of Contents
SERIES 7 | SERIES 65 | FINANCIAL REGULATION COURSES
FINRA Rule 5122 — Private Placements of Securities Issued by Members — establishes the specific regulatory framework governing private placements of unregistered securities issued by FINRA member firms themselves or by entities that control, are controlled by, or are under common control with a member firm — commonly called control entities — requiring that prospective investors receive an offering document disclosing the intended use of proceeds, offering expenses, and selling compensation before investing, mandating that the offering document be filed with FINRA's Corporate Financing Department at or prior to the time it is provided to any prospective investor, and imposing a mandatory minimum use-of-proceeds requirement that at least eighty-five percent of offering proceeds must be used for genuine business purposes rather than for offering costs, commissions, and other selling incentives.
Rule 5122 addresses a specific and historically significant category of regulatory concern in the private placement market — the situation where a broker-dealer raises capital for itself or an affiliated entity through private placements sold to its own customers or other investors, creating an acute conflict of interest between the member's interest in maximising the capital raised and minimising investor protections, and the investors' interest in receiving adequate disclosure, fair dealing, and assurance that the proceeds of their investment will be used productively rather than consumed in excessive compensation and related party benefits.
The rule operates alongside FINRA Rule 5123 — which governs private placements of securities issued by third-party issuers — and the two rules together form the comprehensive FINRA framework for private placement regulatory oversight. Understanding the distinction between them — Rule 5122 for member and control entity issuances, Rule 5123 for all other private placements — is directly tested on the Series 7 examination.
Rule 5122 applies specifically to Member Private Offerings — defined as private placements of unregistered securities issued by a member firm or a control entity of the firm.
A control entity is any entity that controls the member, is controlled by the member, or is under common control with the member — capturing the full range of affiliated entity relationships that create the same fundamental conflict of interest as a direct member issuance. A member firm that raises capital for a sister entity within the same financial holding company — where the member and the issuer share common ownership — is engaged in a Member Private Offering subject to Rule 5122 even though the securities are technically issued by a separate legal entity rather than by the member itself.
The member private offering classification captures situations that present heightened investor protection concerns relative to third-party private placements — where the member's financial interest in the success of the offering is direct and substantial, where the incentive to oversell the offering and understate risks is most acute, and where the potential for conflicts of interest to harm investors is greatest. By singling out member and control entity offerings for specific and more demanding regulatory treatment Rule 5122 acknowledges that the standard private placement regulatory framework is insufficient for these inherently conflicted transactions.
Rule 5122 requires that member firms or their control entities provide each prospective investor in a Member Private Offering with a private placement memorandum, term sheet, or other offering document that contains specified minimum disclosures before the investor makes any investment decision.
The required disclosures address three categories of information that FINRA has determined are material to every investment decision in a member private offering — the intended use of the offering proceeds, the offering expenses, and the amount of selling compensation that will be paid to the member and its associated persons.
The use-of-proceeds disclosure — requiring a specific description of how the capital raised will be deployed — is the most fundamental investor protection requirement in Rule 5122. An investor who does not know how their investment will be used cannot make an informed decision about whether the proposed use justifies the risks and costs of the investment. The use-of-proceeds disclosure also provides the baseline against which the eighty-five percent minimum business purpose requirement can be monitored — ensuring that the disclosed use of proceeds is consistent with the substantive requirement that most proceeds be used productively.
The offering expenses disclosure — identifying all costs associated with the offering including legal fees, accounting costs, printing, and other administrative expenses — gives investors a complete picture of the total cost of the offering and its impact on the actual capital available for business purposes. The selling compensation disclosure — identifying all cash and non-cash compensation payable to the member and its associated persons in connection with the offering — gives investors essential information about the incentives shaping the sales process and the cost of the compensation being extracted from the offering.
The most distinctive and most investor-protective substantive requirement of Rule 5122 is the mandatory minimum use-of-proceeds requirement — at least eighty-five percent of the offering proceeds raised in a Member Private Offering must be used for business purposes, which shall not include offering costs, discounts, commissions, or any other cash or non-cash sales incentives.
This requirement directly addresses the abusive practice that motivated Rule 5122's adoption — situations where member firms raised capital through private placements of their own or affiliated entities' securities and then consumed a substantial portion of the proceeds in excessive selling compensation, finder's fees, and related party payments that left little of investors' capital available for the productive business purposes that justified the investment.
The fifteen percent maximum that may be consumed by offering costs and compensation is not a floor — it is a ceiling. A member private offering that devotes forty percent of proceeds to commissions and selling expenses violates Rule 5122 regardless of whether investors received adequate disclosure of this allocation. The eighty-five percent requirement is a substantive protection that cannot be waived or contracted away by disclosure — the proceeds must actually be used for business purposes, not merely disclosed as being so used.
The use of proceeds must also be consistent with what was disclosed in the offering document — a member private offering that discloses a specific use of proceeds but then applies the funds to a materially different purpose violates both the disclosure requirements and the substantive use-of-proceeds requirement of Rule 5122.
Rule 5122's filing requirement operates differently from the post-first-sale filing requirement of Rule 5123 — reflecting the heightened regulatory concern about member private offerings that warrants earlier regulatory visibility.
For Member Private Offerings the member must file the private placement memorandum, term sheet, or other offering document with FINRA's Corporate Financing Department at or prior to the first time the document is provided to any prospective investor. This pre-distribution filing requirement means that FINRA has the opportunity to review the offering document before any investors are solicited — enabling FINRA to identify compliance concerns before they affect actual investors rather than after the offering has been completed.
Any amendments or exhibits to the offering document must be filed within ten days of being provided to any investor or prospective investor — ensuring that FINRA's filed record of the offering remains current throughout the offering process and reflects any material changes to the offering terms or disclosures.
Retail communications that promote or recommend the Member Private Offering — as defined under FINRA Rule 2210 — must also be filed with FINRA's Corporate Financing Department at or prior to the first time they are provided to any prospective investor. This communications filing requirement ensures that FINRA can review not only the formal offering documents but also the marketing materials used to attract investors — materials that may present the offering in a more favourable light than the formal private placement memorandum and that warrant independent regulatory review.
Rule 5122 provides specific exemptions from its filing requirements for certain categories of investors and offerings where the regulatory concern is reduced — recognising that sophisticated investors and certain well-established offering structures present lower risk that warrants the full filing and review process.
Member private offerings sold solely to institutional accounts as defined in FINRA Rule 4512(c) are exempt from the filing requirements — banks, insurance companies, registered investment companies, registered investment advisers, governmental entities, employee benefit plans with at least ten million dollars in assets, and other specified institutional categories. The institutional investor exemption reflects the regulatory judgement that these sophisticated entities possess the analytical resources and negotiating leverage to protect their own interests without requiring FINRA pre-review of the offering materials.
Offerings sold solely to qualified purchasers as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940 — individuals or family companies owning at least five million dollars in investments and institutions owning at least twenty-five million dollars — are exempt on the same basis of investor sophistication.
Offerings sold solely to qualified institutional buyers as defined in SEC Rule 144A — institutions managing at least one hundred million dollars in securities — are similarly exempt.
Member private offerings that are sold solely through associated persons who are acting primarily in a wholesaling capacity — where the member's role is limited to making the offering available to other broker-dealers who will distribute it to retail investors rather than selling directly to retail investors — are subject to a modified exemption from certain filing requirements under specific conditions.
All documents and information filed with FINRA's Corporate Financing Department pursuant to Rule 5122 are accorded confidential treatment by FINRA — they are not publicly disclosed and are not shared with parties other than FINRA staff and, where appropriate, other regulators.
This confidentiality commitment enables issuers and member firms to include sensitive business information in offering documents filed with FINRA without concern that competitive intelligence will be disclosed to the public or to competitors. The confidentiality protection is essential to making the filing requirement operationally workable — without it issuers might structure offerings to avoid filing or might provide incomplete documents to FINRA to protect sensitive information.
Rule 5122 and Rule 5123 are companion rules governing different categories of private placements — understanding their relationship is essential to applying the correct regulatory framework to any specific private placement situation.
Rule 5122 applies exclusively to Member Private Offerings — private placements of securities issued by the member or a control entity. It requires pre-investor-contact filing of offering documents with FINRA, mandatory use-of-proceeds and selling compensation disclosure to investors, and the eighty-five percent business use requirement. Rule 5123 — described in the FINRA Rule 5123 entry of this dictionary — applies to all other private placements in which FINRA members participate as distributors — third-party issuer private placements where the member is not itself the issuer. Rule 5123 requires filing within fifteen calendar days of the date of first sale — a post-first-sale rather than pre-investor-contact requirement — and does not impose the eighty-five percent business use requirement because the member's conflict of interest is less acute in third-party offerings.
FINRA Rule 5122 is tested on the Series 7 examination in the context of private placements, member self-offerings, the use-of-proceeds requirement, and the distinction from Rule 5123.
The key points to retain are these.
FINRA Rule 5122 — Private Placements of Securities Issued by Members — applies to Member Private Offerings — private placements of unregistered securities issued by a FINRA member or a control entity of the member. Member firms must provide each prospective investor with an offering document — private placement memorandum, term sheet, or similar — disclosing the intended use of proceeds, offering expenses, and selling compensation before any investment is made.
At least eighty-five percent of offering proceeds must be used for genuine business purposes — not for offering costs, commissions, discounts, or other selling incentives. This substantive requirement cannot be waived by disclosure. Offering documents must be filed with FINRA's Corporate Financing Department at or prior to the first time they are provided to any prospective investor — Rule 5122's pre-investor-contact filing requirement contrasts with Rule 5123's fifteen-day post-first-sale filing deadline. Retail communications promoting Member Private Offerings must also be filed before being provided to prospective investors. Exemptions from filing are available for offerings sold solely to institutional accounts, qualified purchasers, and qualified institutional buyers. All information filed with FINRA's Corporate Financing Department is accorded confidential treatment.
