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FinLaw: Raising Money online with a Participating Broker-Dealer? Welcome to the World of FINRA Regulation

In my last article regarding Regulation A+ filing requirements, I discussed how when raising funds for a Reg A offering you are required not only to make a Form 1-A filing with the SEC, but also one with FINRA pursuant to FINRA Rule 5110. Rule 5110, known as the Corporate Financing Rule, enables FINRA to review and evaluate the fairness of underwriting terms and arrangements.  However, this is not the only FINRA rule that those seeking to publicly raise funds over the internet need to understand.  FINRA recently issued Regulatory Notice 15-32 to provide industry guidance regarding FINRA filing requirements and review procedures that apply in Regulation A+ offerings.

Even without final rules approved (yet) for Title III Crowdfunding under the JOBS Act, where FINRA is to be a central regulator of “funding portals,[1]” FINRA has already made its presence known in the budding JOBS Act industry.  Through the regulation of its own member firms, over 4,000 broker-dealers in the United States, and their 600,000+ associated persons, FINRA requires that public offerings meet FINRA standards.  FINRA’s impact as a regulator is enlarged by prohibiting broker-dealers from participating in any offering that does not meet its requirements.  Simply stated, if you need a broker-dealer to assist you with your securities offering, if that broker-dealer is unable to participate then your securities offering likely is in jeopardy.  And a broker-dealer cannot participate in a public securities offering unless all filings required by FINRA are made and receive FINRA’s “no objection” opinion.

Here is an overview of the Regulatory Notice:  In addition to FINRA Rule 5110, you may also need to make filings under FINRA Rules 2310 and 5121.  FINRA Rule 2210 governs all broker-dealer communications with the public.  These communications may include general solicitation materials and, in certain instances, must be filed pre-use, like communications for a direct participation program.  Direct participation programs are programs that provide for flow-through tax consequences regardless of the structure of the legal entity or vehicle for distribution including, but not limited to, real estate programs (other than REITs), condominium securities, and oil and gas programs.[2]   Lastly, the suitability rule and broker-dealer supervision standards are applicable to the broker-dealer’s participation in the public offering.

Briefly, here are the filing requirements:

FINRA Rule 5110 requires the filing of details of underwriting terms and arrangements.  The filing is required when any broker-dealer is participating in a public offering, including Reg A, and the applicability of the rule is much broader than where a broker-dealer acts as an underwriter.  FINRA reviews specified documents and information, and prohibits unfair compensation arrangements in public offerings.

FINRA Rule 2310 addresses the regulation of compensation, fees and expenses in offerings for direct participation programs and nontraded REITs[3], including ensuring that organization and offering expenses (O&O expenses) are fair and reasonable.  This Rule prohibits broker-dealers from participating in certain offerings, unless (i) standards of investor suitability are established, (ii) the broker-dealer has reasonable grounds to believe all material facts are properly disclosed, including facts relating to  compensation, physical properties, financial stability and experience of sponsor, conflicts of interest and risk factors; (iii) the broker-dealer prior to executing any transaction must first inform an investor about the liquidity and marketability of the investment, including whether the sponsor has offered other programs or REITs and facts concerning the liquidation of those earlier offerings; and (iv) the sponsor must agree to disclose in each annual report a per share estimated value of the securities, the method by which it was developed, and the date of the data used to develop the estimated value.[4]

FINRA Rule 5121 is limited to those instances where broker-dealers participating in a public offering have a conflict of interest.  A conflict of interest includes circumstances where the broker-dealer is the issuer of the securities; where the issuer controls, is controlled by or is under common control with the broker-dealer or its associated persons; or where at least 5% of the net offering proceeds, not including underwriting compensation, are intended to pay a loan or credit facility extended by the broker-dealer, among other things.  Requirements for the broker-dealer’s participation include that the nature of the underlying conflict of interest is prominently disclosed in the offering circular, that an independent underwriter be involved in, or an un-conflicted broker-dealer manage, the underwriting.  Or that the securities offered be either investment grade rated or have a bona fide public market.  There are specific escrow account and net capital requirements too.

Regulatory Notice 15-32 highlights already existing FINRA rules that are applicable to Reg A offerings, and shows what FINRA views to be important for industry consideration.  More guidance will be forthcoming from FINRA and other regulators, as the budding JOBS Act industry grows.  Shortly, the much anticipated Title III Crowdfunding rules should be approved which will increase the FINRA’s overall involvement in the space.  As you are preparing your offering, remain mindful that securities anti-fraud rules are applicable, so you must carefully prepare your offering documents to disclose all material facts.  Always consult with an experienced securities attorney, and when you utilize a broker-dealer to facilitate your securities offering — welcome to the world of FINRA regulation.


[1] See Proposed SEC Rules for Crowdfunding, at at p. 129 (“We anticipate that the regulatory framework FINRA creates for funding portals would play an important role in the oversight of these entities and, through the information that FINRA shares with the Commission, the Commission’s ability to effectively regulate registered funding portals’ activities”).

[2] Direct Participation Programs are defined in FINRA Rule 2310(4) as: “a program which provides for flow-through tax consequences regardless of the structure of the legal entity or vehicle for distribution including, but not limited to, oil and gas programs, real estate programs, agricultural programs, cattle programs, condominium securities, Subchapter S corporate offerings and all other programs of a similar nature, regardless of the industry represented by the program, or any combination thereof. A program may be composed of one or more legal entities or programs but when used herein and in any rules or regulations adopted pursuant hereto the term shall mean each of the separate entities or programs making up the overall program and/or the overall program itself. Excluded from this definition are real estate investment trusts, tax qualified pension and profit sharing plans pursuant to Sections 401 and 403(a) of the Internal Revenue Code and individual retirement plans under Section 408 of that Code, tax sheltered annuities pursuant to the provisions of Section 403(b) of the Internal Revenue Code, and any company including separate accounts, registered pursuant to the Investment Company Act.”

[3] The Rule also applies to limited partnership rollup transactions, which I do not address in this article.

[4] While FINRA only regulates broker-dealers and its associated persons, FINRA’s rules frequently impact the behavior of those it does not regulate, such as sponsors, by prohibiting broker-dealers from participating in offerings unless certain requirements are met.


The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.


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