[Federal Register Volume 84, Number 250 (Tuesday, December 31, 2019)]
[Notices]
[Pages 72396-72409]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-28216]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87855; File No. SR-FINRA-2019-012]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Partial Amendment No. 2 and Order
Granting Accelerated Approval of the Proposed Rule Change To Amend
FINRA Rule 5110 (Corporate Financing Rule--Underwriting Terms and
Arrangements) To Make Substantive, Organizational, and Terminology
Changes, as Modified by Partial Amendment No. 1 and Partial Amendment
No. 2
December 23, 2019.
I. Introduction
On April 11, 2019, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (the
``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend FINRA Rule 5110
(Corporate Financing Rule--Underwriting Terms and Arrangements)
(``Rule'' or ``Rule 5110'') to make substantive, organizational, and
terminology changes to the Rule.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in the Federal
Register on May 1, 2019.\3\ On June 12, 2019, the Commission extended
to July 30, 2019, the time period in which to approve the proposed rule
change, disapprove the proposed rule change, or institute proceedings
to determine whether to approve or disapprove the proposed rule
change.\4\ The Commission received six comment letters on the
proposal.\5\ On July 11, 2019, FINRA responded to the comments and
filed Partial Amendment No. 1 to the proposal.\6\ On July 29, 2019, the
Commission published Partial Amendment No. 1 for notice and comment and
instituted proceedings pursuant to Section 19(b)(2)(B) of the Exchange
Act \7\ to determine whether to approve or disapprove the proposed rule
change, as modified by Partial Amendment No. 1.\8\ The Commission
received three comment letters in response to the Order Instituting
Proceedings.\9\ On October 28, 2019, the
[[Page 72397]]
Commission extended the time period in which the Commission must
approve or disapprove the proposed rule change, as amended by Partial
Amendment No. 1.\10\ On November 8, 2019, FINRA responded to the
comments and filed Partial Amendment No. 2 to the proposal.\11\ This
order provides notice of filing of Partial Amendment No. 2 and approves
the proposal, as modified by Partial Amendments No. 1 and No. 2, on an
accelerated basis.
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\3\ See Securities Exchange Act Release No. 85715 (April 25,
2019), 84 FR 18592 (May 1, 2019) (``Notice'').
\4\ See Securities Exchange Act Release No. 86091 (June 12,
2019), 84 FR 28371 (June 18, 2019).
\5\ See letter from Suzanne Rothwell, Managing Member, Rothwell
Consulting LLC, to Secretary, Commission, dated May 14, 2019
(``Rothwell''); letter from Stuart J. Kaswell, Esq., to Vanessa
Countryman, Acting Director, Commission, dated May 17, 2019
(``Kaswell Letter No. 1''); letter from Eversheds Sutherland (US)
LLP, on behalf of the Committee of Annuity Insurers, to Brent J.
Fields, Secretary, Commission, dated May 21, 2019 (``CAI''); letter
from Aseel Rabie, Managing Director and Associate General Counsel,
Securities Industry and Financial Markets Association, to Vanessa
Countryman, Acting Secretary, Commission, dated May 30, 2019
(``SIFMA Letter No. 1''); letter from Robert E. Buckholz, Chair,
Federal Regulation of Securities Committee, ABA Business Law
Section, American Bar Association, to Vanessa Countryman, Acting
Secretary, Commission, dated May 30, 2019 (``ABA''); letter from
Davis Polk & Wardwell LLP, to Vanessa Countryman, Acting Secretary,
Commission, dated June 5, 2019 (``Davis Polk'').
\6\ See letter from Jeanette Wingler, Associate General Counsel,
FINRA, to Vanessa Countryman, Secretary, Commission, dated July 11,
2019 (``FINRA Response No. 1''). Partial Amendment No. 1 is
available at https://www.finra.org/industry/rule-filings/sr-finra-2019-012. See also Order Instituting Proceedings, infra note 8.
\7\ 15 U.S.C. 78s(b)(2)(B).
\8\ See Securities Exchange Act Release No. 8650977391 (July 29,
2019), 84 FR 37921 (August 2, 2019) (``Order Instituting
Proceedings'').
\9\ See letter from Hardy Callcott and Joseph McLaughlin, to
Vanessa Countryman, Secretary, Commission, dated August 14, 2019
(``Callcott''); letter from Stuart J. Kaswell, Law Office of Stuart
J. Kaswell, LLC, to Jill M. Peterson, Assistant Secretary,
Commission, dated August 16, 2019 (``Kaswell Letter No. 2''); and
letter from Aseel Rabie, Managing Director and Associate General
Counsel, Securities Industry and Financial Markets Association, to
Vanessa Countryman, Secretary, Commission, dated August 23, 2019
(``SIFMA Letter No. 2'').
\10\ See Securities Exchange Act Release No. 87407 (October 28,
2019), 84 FR 58794 (November 1, 2019).
\11\ See letter from Jeanette Wingler, Associate General
Counsel, FINRA, to Vanessa Countryman, Secretary, Commission, dated
November 8, 2019 (``FINRA Response No. 2''). Partial Amendment No. 2
is available at https://www.finra.org/industry/rule-filings/sr-finra-2019-012. See also Section II.B infra.
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II. Description of the Proposed Rule Change
Below is a description of FINRA's proposal as modified by Partial
Amendment No. 1, followed by a description of Partial Amendment No. 2.
A. Proposed Rule Change as Modified by Partial Amendment No. 1
12
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\12\ For a more detailed description of the proposed rule change
as modified by Partial Amendment No. 1, see Notice, supra note 3,
and Order Instituting Proceedings, supra note 8. See also Partial
Amendment No. 1 available at https://www.finra.org/sites/default/files/2019-07/sr-finra-2019-012-amendment-no1.pdf.
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FINRA proposes to modify Rule 5110 in an effort to modernize,
simplify, and streamline the Rule. Specifically, FINRA proposes changes
to the following: (1) Filing requirements; (2) filing requirements for
shelf offerings; (3) exemptions from filing and substantive
requirements; (4) underwriting compensation; (5) venture capital
exceptions; (6) treatment of non-convertible or non-exchangeable debt
securities and derivatives; (7) lock-up restrictions; (8) prohibited
terms and arrangements; and (9) defined terms. FINRA states that these
changes should lessen the regulatory costs and burdens incurred when
complying with the Rule.
Filing Requirements
FINRA proposes to allow members more time to make the required
filings with FINRA from one business day after filing with the SEC or a
state securities commission or similar state regulatory authority to
three business days.\13\
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\13\ See proposed Rule 5110(a)(3)(A).
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FINRA also proposes to clarify and reduce filing requirements by
directing members to provide SEC document identification number if
available.\14\ FINRA proposes to require filing: (1) Industry-standard
master forms of agreement only if specifically requested to do so by
FINRA; \15\ (2) amendments to previously filed documents only if there
have been changes relating to the disclosures that impact the
underwriting terms and arrangements for the public offering in those
documents; \16\ (3) a representation as to whether any associated
person or affiliate of a participating member is a beneficial owner of
5% or more of ``equity and equity-linked securities''; \17\ and (4) an
estimate of the maximum value for each item of underwriting
compensation.\18\
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\14\ See proposed Rule 5110(a)(4)(A).
\15\ See proposed Rule 5110(a)(4)(A)(ii).
\16\ See proposed Rule 5110(a)(4)(A)(iii).
\17\ See proposed Rule 5110(a)(4)(B)(iii) and proposed Rule
5110(j)(7).
\18\ See proposed Rule 5110(a)(4)(B)(ii).
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Proposed Rule 5110(a)(4)(B)(iv) would not require filing a
description of any securities acquired in accordance with Supplementary
Material .01(b), which sets forth a non-exhaustive list of payments
that generally would not be deemed to be underwriting compensation.\19\
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\19\ See Order Instituting Proceedings, supra note 8, 84 FR at
37927-28, and Partial Amendment No. 1, supra note 6.
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FINRA also proposes to make a number of other clarifications
regarding filing requirements to FINRA.\20\ For example, the proposed
rule change would clarify that a member participating in an offering is
not required to file with FINRA if the filing has been made by another
member participating in the offering.\21\ In addition, rather than
providing a non-exhaustive list of types of public offerings that are
required to be filed, the proposed rule change would instead state that
a public offering in which a member participates must be filed for
review unless exempted by the Rule.\22\ The proposed rule change,
moreover, would clarify the general standard that no member may engage
in the distribution or sale of securities unless FINRA has provided an
opinion that it has no objection to the proposed underwriting terms and
arrangements.\23\ The proposed rule change also would clarify that any
member acting as a managing underwriter or in a similar capacity must
notify the other members participating in the public offering if
informed of an opinion by FINRA that the underwriting terms and
arrangements are unfair and unreasonable and the proposed terms and
arrangements have not been appropriately modified.\24\
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\20\ See proposed Rule 5110(a)(3)(B), 5110(a)(2), 5110(a)(1)(C),
and 5110(a)(1)(B). See also Notice, supra note 3, 84 FR at 18593.
\21\ See proposed Rule 5110(a)(3)(B). Participating members are
responsible for filing public offerings with FINRA. While an issuer
may file an offering with FINRA if a participating member has not
yet been engaged, a participating member must assume filing
responsibilities once it has been engaged.
\22\ See proposed Rule 5110(a)(2).
\23\ See proposed Rule 5110(a)(1)(C).
\24\ See proposed Rule 5110(a)(1)(B).
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Further, FINRA proposes to adopt a new provision addressing
terminated offerings, which provides that, when an offering is not
completed according to the terms of an agreement entered into by the
issuer and a member, but the member has received underwriting
compensation, the member must give written notification to FINRA of all
underwriting compensation received or to be received, including a copy
of any agreement governing the arrangement.\25\
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\25\ See proposed Rule 5110(a)(4)(C) and proposed Rule
5110(g)(5).
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Filing Requirements for Shelf Offerings
FINRA proposes to codify exemptions from the filing requirements
for certain shelf offerings that have historically been exempt from
Rule 5110 and to streamline the filing requirements for the remaining
shelf offerings.\26\
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\26\ See Notice, supra note 3, 84 FR at 18593-594.
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Public Offerings Exempt From Substantive and/or Filing Requirement
FINRA proposes to expand and clarify the scope of the exemptions
under current Rule 5110. For example, FINRA proposes to exempt from
Rule 5110's filing requirement a public offering by an ``experienced
issuer.'' \27\ And although the proposed rule change would continue to
apply Rule 5110's filing requirement to shelf offerings by issuers that
do not meet the ``experienced issuer'' standard, such issuer would only
need to file the following: (1) The Securities Act of 1933
(``Securities Act'') registration statement number; and (2) if
specifically requested by FINRA, other documents and
[[Page 72398]]
information set forth in Rule 5110(a)(4)(A) and (B).\28\
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\27\ The proposed rule change would delete references to the
pre-1992 standards for Form S-3 and standards approved in 1991 for
Form F-10 and instead codify the requirement that the issuer have a
36-month reporting history and at least $150 million aggregate
market value of voting stock held by non-affiliates or alternatively
the aggregate market value of voting stock held by non-affiliates is
at least $100 million and the issuer has an annual trading volume of
three million shares or more in the stock. See proposed Rule
5110(j)(6), 5110(h)(1)(C), and Notice, supra note 3, 84 FR at 18593-
594.
\28\ See proposed Rule 5110(a)(4)(E).
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Moreover, in proposed Rule 5110(h)(1)(A), FINRA proposes to clarify
that securities of banks that have qualifying outstanding debt
securities are exempt from the filing requirement.\29\ Further, in the
same provision, FINRA proposes to clarify that Treasury securities
would not qualify for an exemption. Accordingly, FINRA proposes to make
clear that the exemption applies to ``securities offered by a bank,
corporate issuer, foreign government or foreign government agency that
has outstanding unsecured non-convertible debt with a term of issue of
at least four years or unsecured non-convertible preferred securities
that are investment grade rated, as defined in Rule 5121(f)(8), or are
outstanding securities in the same series that have equal rights and
obligations as investment grade rated securities, provided that an
initial public offering of equity is required to be filed'' (emphasis
added).\30\
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\29\ See proposed Rule 5110(h)(1)(A).
\30\ See Order Instituting Proceedings, supra note 8, 84 FR at
37926.
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FINRA also proposes to expand the current list of offerings that
are exempt from both the filing requirements and substantive provisions
of Rule 5110. Specifically, FINRA proposes to include from such
exemptions public offerings of closed-end ``tender offer'' funds (i.e.,
closed-end funds that repurchase shares from shareholders pursuant to
tender offers), insurance contracts, and unit investment trusts.\31\ In
addition, FINRA would also include in such exemptions tender offers by
issuers for their own securities made pursuant to Rule 13e-4 under the
Exchange Act.\32\
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\31\ See proposed Rule 5110(h)(2)(E), (K) and (L).
\32\ See Order Instituting Proceedings, supra note 8, 84 FR at
37926, and Partial Amendment No. 1, supra note 6.
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In addition, FINRA proposes to reclassify three items from the
offerings exempt from filing and rule compliance to offerings excluded
from the definition of public offering. These include: (1) Offerings
exempt from registration with the SEC pursuant to Section 4(a)(1), (2)
and (6) of the Securities Act; (2) offerings exempt from registration
under specified Regulation D provisions; and (3) offerings of exempted
securities as defined in Section 3(a)(12) of the Exchange Act.\33\
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\33\ See proposed Rule 5110(j)(18) and Order Instituting
Proceedings, supra note 8, 84 FR at 37922.
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Disclosure Requirements
FINRA states that the proposed rule change would retain the current
requirements for itemized disclosure of underwriting compensation and
for disclosing dollar amounts ascribed to each such item.\34\ Further,
the proposal makes explicit the existing practice of disclosing
specified material terms and arrangements related to underwriting
compensation in the prospectus, and requires a description for: (1) Any
right of first refusal (``ROFR'') granted to a participating member and
its duration; and (2) the material terms and arrangements of securities
acquired by the participating member (e.g., exercise terms, demand
rights, piggyback registration rights, and lock-up periods).\35\
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\34\ See proposed Rule 5110(b)(1) and Supplementary Material .05
to Rule 5110. See also proposed Rule 5110(e)(1)(B) requiring
disclosure of lock-ups.
\35\ See proposed Supplementary Material .05 to Rule 5110.
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Underwriting Compensation
FINRA proposes to define the term ``underwriting compensation'' in
proposed Rule 5110 to mean ``any payment, right, interest, or benefit
received or to be received by a participating member from any source
for underwriting, allocation, distribution, advisory and other
investment banking services in connection with a public offering. In
addition, underwriting compensation shall include finder's fees,
underwriter's counsel fees and securities.'' \36\
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\36\ See proposed Rule 5110(j)(22).
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Further, FINRA provides that payments and benefits received during
the applicable review period would be considered in evaluating
underwriting compensation. According to FINRA, Rule 5110 currently
provides that all items of value received or to be received from any
source are presumed to be underwriting compensation when received
during the period commencing 180 days before the required filing date
of the registration statement or similar document, and up to 90 days
following the effectiveness or commencement of sales of a public
offering.
FINRA states that, to better reflect the different types of
offerings subject to the Rule, the proposed rule change would introduce
the defined term ``review period,'' and that the applicable time period
would vary based on the type of offering. Accordingly, the proposed
rule change would define the term ``review period'' to mean: (1) For a
firm commitment offering, the 180-day period preceding the required
filing date through the 60-day period following the effective date of
the offering; (2) for a best efforts offering, the 180-day period
preceding the required filing date through the 60-day period following
the final closing of the offering; and (3) for a firm commitment or
best efforts takedown or any other continuous offering made pursuant to
Rule 415 of the Securities Act, the 180-day period preceding the
required filing date of the takedown or continuous offering through the
60-day period following the final closing of the takedown or continuous
offering.\37\
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\37\ See proposed Rule 5110(j)(20). FINRA states that, in
accordance with this proposal, payments and benefits received during
the applicable review period would be considered in evaluating
underwriting compensation.
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The proposed rule change would continue to provide two non-
exhaustive lists of examples of payments or benefits that would and
would not be considered underwriting compensation, with streamlining
and clarifying modification.\38\ According to FINRA, the proposed
examples of payments or benefits that would be underwriting
compensation are comparable to the list of items of value in the
current Rule with some additional clarifying changes. For example, the
proposed rule change would expand the current item of value related to
reimbursement of expenses to provide that fees and expenses paid or
reimbursed to, or paid on behalf of, the participating members,
including but not limited to road show fees and expenses and due
diligence expenses, would be underwriting compensation.\39\ Consistent
with current practice, the proposed rule change would also include in
underwriting compensation non-cash compensation.\40\
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\38\ See proposed Supplementary Material .01 to Rule 5110.
\39\ See proposed Supplementary Material .01(a)(2) to Rule 5110.
See also proposed Supplementary Material .01(a)(3) and (4) to Rule
5110 which includes fees and expenses of participating members'
counsel and finder's fees paid or reimbursed to, or paid on behalf
of, the participating members (except for reimbursement of ``blue
sky'' fees) as underwriting compensation.
\40\ See proposed Supplementary Material .01(a)(14) to Rule
5110.
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According to FINRA, the proposed examples of payments or benefits
that would not be underwriting compensation include several new
examples to provide greater clarity and to address questions raised by
members. For instance, the proposed rule change would clarify that the
following would not be considered underwriting compensation: (1)
Payments for records management and advisory services received by
members in connection with some corporate reorganizations; \41\ (2)
payment or reimbursement of legal costs resulting from a contractual
breach
[[Page 72399]]
or misrepresentation by the issuer; \42\ (3) securities acquired
pursuant to a governmental or court approved proceeding or plan of
reorganization as a result of action by the government or court (e.g.,
bankruptcy or tax court proceeding); \43\ (4) non-convertible
securities purchased by the participating member in a public offering
at the public offering price during the review period; \44\ (5)
accountable expenses received pursuant to Rule 5110(g)(5)(A); \45\ and
(6) compensation received through an employee benefit plan that
qualifies under Section 401 of the Internal Revenue Code or a similar
plan.\46\
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\41\ See proposed Supplementary Material .01(b)(3) to Rule 5110.
\42\ See proposed Supplementary Material .01(b)(4) to Rule 5110.
\43\ See proposed Supplementary Material .01(b)(22) to Rule
5110.
\44\ Specifically, FINRA proposes in Partial Amendment No. 1 to
amend proposed Supplementary Material .01(a)(7) to provide that
underwriting compensation includes ``common or preferred stock,
options, warrants, and other equity securities, including debt
securities convertible to or exchangeable for equity securities,
beneficially owned, as defined in Rule 5121 by the participating
members the value of which is determined pursuant to this Rule, and
acquired during the review period, as defined in this Rule, except
that non-convertible securities purchased by a participating member
in a public offering at the public offering price during the review
period shall not be deemed underwriting compensation . . .'' See
FINRA Response No. 1, supra note 6, at 19 n. 27.
\45\ Specifically, Supplementary Material .01(a)(13) would be
revised to provide that underwriting compensation would include
``any compensation paid to any participating member in connection
with a prior proposed public offering that was not completed, if the
member firm participates in the revised public offering, except that
accountable expenses received pursuant to paragraph (g)(5)(A) shall
not be deemed underwriting compensation.'' See Order Instituting
Proceedings, supra note 8, 84 FR at 37926 n.61 and Partial Amendment
No. 1, supra note 6.
\46\ Specifically, Supplementary Material .01(b)(12) would
exclude from underwriting compensation ``compensation received
through any stock bonus, pension, employee benefit plan, or profit-
sharing plan that qualifies under Section 401 of the Internal
Revenue Code or a similar plan, including, but not limited to, an
employee benefit plan as defined in Securities Act Rule 405 or a
compensatory benefit plan or compensatory benefit contract exempt
from registration pursuant to Securities Act Rule 701 . . .'' See
Order Instituting Proceedings, supra note 8, 84 FR at 37927, and
Partial Amendment No. 1, supra note 6.
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In addition, the proposed rule change would take a principles-based
approach in considering whether issuer securities acquired from third
parties or in directed sales programs may be excluded from underwriting
compensation. Such approach would start with the presumption that the
issuer securities received during the review period would be
underwriting compensation. FINRA, however, would consider the following
factors, as well as any other relevant factors and circumstances, when
considering whether securities of the issuer acquired from third
parties may be excluded from underwriting compensation. Specifically,
these include: (1) The nature of the relationship between the issuer
and the third party, if any; (2) the nature of the transactions in
which the securities were acquired, including, but not limited to,
whether the transactions are engaged in as part of the participating
member's ordinary course of business; and (3) any disparity between the
price paid and the offering price or market price.
With respect to issuer securities acquired in directed sales
programs, FINRA would consider the following factors, as well as any
other relevant factors and circumstances, when considering whether an
acquisition of securities by a participating member pursuant to an
issuer's directed sales program may be excluded from underwriting
compensation: (1) The existence of a pre-existing relationship between
the issuer and the person acquiring the securities; (2) the nature of
the relationship; and (3) whether the securities were acquired on the
same terms and at the same price as other similarly-situated persons
participating in the directed sales program.\47\
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\47\ See proposed Supplementary Material .04 to Rule 5110.
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Venture Capital Exceptions
FINRA states that the proposed rule change would modify, clarify,
and expand the venture capital exceptions.\48\ Specifically, the
proposed rule change would no longer treat as underwriting compensation
securities acquisitions covered by two of the current exceptions: (1)
Securities acquisitions and conversions to prevent dilution; and (2)
securities purchases based on a prior investment history. This
treatment is conditioned on prior investments in the issuer occurring
before the review period.\49\ When subsequent securities acquisitions
take place (e.g., as a result of a stock split, a right of preemption,
a securities conversion, or when additional securities are acquired to
prevent dilution of a long-standing interest in the issuer), the
acquisition of the additional securities would not be treated as
underwriting compensation under the proposed Rule.\50\
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\48\ Rule 5110(d)(5) currently provides exceptions designed to
distinguish securities acquired in bona fide venture capital
transactions from those acquired as underwriting compensation (for
brevity, referred to herein as the ``venture capital exceptions'').
See Notice, supra note 3.
\49\ See proposed Supplementary Material .01(b)(14) and (16-18).
\50\ The proposed rule change would add these acquisitions to
the list of examples of payments that are not underwriting
compensation because they are based on a prior investment history
and are subject to the terms of the original securities that were
acquired before the review period. See proposed Supplementary
Material .01(b)(14) and (16-18).
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FINRA also proposes to broaden two of the current venture capital
exceptions regarding purchases and loans by certain affiliates, and
investments in and loans to certain issuers, by removing a limitation
on acquiring more than 25% of the issuer's total equity securities.\51\
Further, FINRA proposes to condition the availability of these
exceptions to require that the affiliate, directly or through a
subsidiary it controls, be in the business of making investments or
loans or is an entity that has been newly formed by such affiliate.\52\
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\51\ See proposed Rule 5110(d)(1) and (2).
\52\ Id.
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With respect to the current venture capital exception relating to
private placements with institutional investors, the proposal would now
clarify that the exception is available where the institutional
investors participating in the offering are not affiliates of a FINRA
member and purchase at least 51% of the total number of securities sold
in the private placement at the same time and on the same terms.\53\ In
addition, the proposed rule change would raise the percentage that
participating members in the aggregate may acquire from 20% to 40% of
the securities sold in the private placement.\54\ Further, the proposed
rule change would expand the scope of the exception to include
providing services for a private placement (rather than just acting as
a placement agent).\55\
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\53\ See Notice, supra note 3, 84 FR at 18596-597.
\54\ See proposed Rule 5110(d)(3)(C).
\55\ See proposed Rule 5110(d)(3).
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FINRA proposes to adopt a new venture capital exception where a
highly regulated entity with significant disclosure requirements and
independent directors who monitor investments is also making a
significant co-investment in an issuer and is receiving securities at
the same price and on the same terms as the participating member. The
exception applies for securities acquired in a private placement before
the required filing date of the public offering by a participating
member if at least 15% of the total number of securities sold in the
private placement were acquired, at the same time and on the same
terms, by one or more entities that is an open-end investment company
not traded on an exchange, and no such entity is an
[[Page 72400]]
affiliate of a FINRA member participating in the offering.\56\
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\56\ See proposed Rule 5110(d)(4).
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The proposed rule change would also provide some additional
flexibility in the availability of the venture capital exceptions for
securities acquired where the public offering has been significantly
delayed. The proposed rule change would take a principles-based
approach in considering whether it is appropriate to treat as
underwriting compensation securities acquired by a member after the
required filing date in a transaction that, except for the timing,
would otherwise meet the requirements of a venture capital
exception.\57\ FINRA would consider the factors in proposed
Supplementary Material .02 in determining whether securities acquired
in a transaction that occurs after the required filing date, but
otherwise meets the requirements of a venture capital exception, may be
excluded from underwriting compensation. Specifically, FINRA would
consider the following factors, as well as any other relevant factors
and circumstances: (1) The length of time between the date of filing of
the registration statement or similar document and the date of the
transaction in which securities were acquired; (2) the length of time
between the date of the transaction in which the securities were
acquired and the anticipated commencement of the public offering; and
(3) the nature of the funding provided, including, but not limited to
the issuer's need for funding before the public offering.\58\
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\57\ See Notice, supra note 3, 84 FR at 18597.
\58\ See proposed Supplementary Material .02(a)-(c) to Rule
5110.
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Treatment of Non-Convertible or Non-Exchangeable Debt Securities and
Derivatives
The proposed rule change would expressly provide that non-
convertible or non-exchangeable debt securities and derivative
instruments \59\ acquired in a transaction unrelated to a public
offering would not be underwriting compensation.\60\ In contrast, for
any non-convertible or non-exchangeable debt securities and derivative
instruments acquired in a transaction related to the public offering,
the proposed rule change would clarify that: (1) A description of those
securities and derivative instruments must be filed with FINRA; and (2)
this description must be accompanied by a representation that a
registered principal or senior manager of the participating member has
determined if the transaction was or will be entered into at a fair
price.\61\
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\59\ Consistent with the current Rule, the proposed rule change
would define the term ``derivative instrument'' to mean any eligible
OTC derivative instrument as defined in Rule 3b-13(a)(1), (2) and
(3) of the Exchange Act. See proposed Supplementary Material .06(b)
to Rule 5110.
\60\ See proposed Supplementary Material .01(b)(19) to Rule
5110.
\61\ See proposed Rule 5110(a)(4)(B)(iv)(a). FINRA states that,
generally consistent with current Rule 5110, the proposed rule
change would define the term ``fair price'' to mean the
participating members have priced a derivative instrument or non-
convertible or non-exchangeable debt security in good faith; on an
arm's length, commercially reasonable basis; and in accordance with
pricing methods and models and procedures used in the ordinary
course of their business for pricing similar transactions. The
proposed rule change would also clarify that a derivative instrument
or other security received as compensation for providing services
for the issuer, for providing or arranging a loan, credit facility,
merger, acquisition or any other service, including underwriting
services will not be deemed to be entered into or acquired at a fair
price. See proposed Supplementary Material .06(b) to Rule 5110.
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FINRA also proposes to clarify that non-convertible or non-
exchangeable debt securities and derivative instruments acquired in a
transaction related to the public offering at a fair price would be
considered underwriting compensation but would have no compensation
value. In contrast, the proposed rule change would provide that non-
convertible or non-exchangeable debt securities and derivative
instruments acquired in a transaction related to the public offering
but not at a fair price would be considered underwriting compensation
and subject to the normal valuation requirements of Rule 5110.\62\
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\62\ See, e.g., proposed Supplementary Material .06(a) to Rule
5110, proposed Rule 5110(c), and Notice, supra note 3.
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Lock-Up Restrictions
FINRA states that, subject to some exceptions, Rule 5110 requires
in any public equity offering a 180-day lock-up restriction on
securities that are considered underwriting compensation. The proposed
rule change would provide that the lock-up period begins on the date of
commencement of sales of the public equity offering (rather than the
date of effectiveness of the prospectus).\63\ The proposed rule change
also would provide that the lock-up restriction must be disclosed in
the section on distribution arrangements in the prospectus or similar
document, consistent with proposed Supplementary Material .05 requiring
disclosure of the material terms and arrangements of any acquisition of
securities by a participating member.\64\
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\63\ See proposed Rule 5110(e)(1)(A).
\64\ See proposed Rule 5110(e)(1)(B).
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FINRA proposes to add an exception from the lock-up restriction for
securities acquired from an issuer that meets the registration
requirements of SEC Registration Forms S-3, F-3 or F-10.\65\ Further,
the proposed rule change would also add an exception from the lock-up
restriction for securities that were acquired in a transaction meeting
one of Rule 5110's venture capital exceptions.\66\ FINRA provides that,
while these securities would not be considered underwriting
compensation and, thus, not subject to the lock-up restriction, the
exception would provide additional clarity with respect to these
securities. Moreover, the proposed rule change would add an exception
from the lock-up restriction for securities that were received as
underwriting compensation and are registered and sold as part of a firm
commitment offering.\67\
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\65\ See proposed Rule 5110(e)(2)(A)(iii).
\66\ See proposed Rule 5110(e)(2)(A)(vi).
\67\ See proposed Rule 5110(e)(2)(A)(viii).
---------------------------------------------------------------------------
FINRA proposes to provide clarity about the treatment of non-
convertible or non-exchangeable debt securities and derivative
instruments acquired in transactions related to a public offering and
whether those securities are subject to the lock-up requirement.\68\
Specifically, FINRA proposes that the lock-up restriction would not
apply to derivative instruments acquired in connection with a hedging
transaction related to the public offering and at a fair price.\69\
Moreover, the lock-up restriction would not apply ``to a security that
is `actively-traded' (as defined in Rule 101(c)(1) of SEC Regulation
M).'' \70\ In addition, the transfer or sale of a security back to the
issuer in a transaction exempt from registration with the SEC would not
be subject to the lockup restriction.\71\ Further, current Rule
5110(g)(2)(A)(ii) would be modified to permit the transfer of any
security to the member's registered persons or affiliates if all
transferred securities remain subject to the restriction for the
remainder of the lock-up period.\72\
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\68\ See proposed Rule 5110(e)(2)(A)(iv).
\69\ See proposed Rule 5110(e)(2)(A)(v). Derivative instruments
acquired in transactions related to the public offering that do not
meet the requirements of the exception would continue to be subject
to the lock-up restriction. See Notice, supra note 3.
\70\ See proposed Rule 5110(e)(2)(A)(ix). See also Order
Instituting Proceedings, supra note 8, 84 FR at 37925, and Partial
Amendment No. 1, supra note 6.
\71\ See proposed Rule 5110(e)(2)(B)(iii).
\72\ See proposed Rule 5110(e)(2)(B)(i). The proposed rule
change would retain the current exception to the lock up for the
exercise or conversion of any security, if all such securities
received remain subject to the lock-up restriction for the remainder
of the 180-day lock-up period. See proposed Rule 5110(e)(2)(B)(ii).
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Finally, because proposed Supplementary Material .01(b)(20)
[[Page 72401]]
would provide that securities acquired subsequent to the issuer's IPO
in a transaction exempt from registration under Rule 144A of the
Securities Act would not be underwriting compensation, FINRA states
that the proposed rule change would correspondingly delete as
unnecessary the current exception from the lock-up restriction for
those securities.\73\
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\73\ See current Rule 5110(g)(2)(A)(viii).
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Prohibited Terms and Arrangements
FINRA proposes to clarify and amend the list of prohibited
unreasonable terms and arrangements in connection with a public
offering of securities.\74\ For example, the proposed rule change would
clarify the scope of relevant activities that would be deemed related
to the public offering \75\ and refer to the commencement of sales of
the public offering (rather than the date of effectiveness) in relation
to the receipt of underwriting compensation consisting of any option,
warrant or convertible security with specified terms.\76\ The proposal
would also clarify that it would be considered a prohibited arrangement
for any underwriting compensation to be paid prior to the commencement
of sales of public offering, except: (1) An advance against accountable
expenses actually anticipated to be incurred, which must be reimbursed
to the issuer to the extent not actually incurred; or (2) advisory or
consulting fees for services provided in connection with the offering
that subsequently is completed according to the terms of an agreement
entered into by an issuer and a participating member.\77\ Finally, the
proposed rule change would also simplify a provision that relates to
payments made by an issuer to waive or terminate a ROFR to participate
in a future capital-raising transaction.\78\ The proposed rule change
would, however, retain the prohibition on any non-cash payment or fee
to waive or terminate a ROFR.\79\
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\74\ See proposed Rule 5110(g).
\75\ See proposed Rule 5110(g)(11). Specifically, to clarify the
scope, the proposed rule change would refer to ``solicitation,
marketing, distribution or sales of the offering'' rather than the
current ``distribution or assisting in the distribution of the
issue, or for the purpose of assisting in any way in connection with
the underwriting.'' See Notice, supra note 3, 84 FR at 18599 n. 63.
\76\ See proposed Rule 5110(g)(8).
\77\ See proposed Rule 5110(g)(4).
\78\ See current Rule 5110(f)(2)(F)(i).
\79\ See proposed Rule 5110(g)(7).
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Defined Terms
The proposal would consolidate the defined terms in one location at
the end of the Rule, which FINRA believes will simplify and clarify
Rule 5110's defined terms. For example, FINRA proposes to consolidate
the various provisions that address what constitutes underwriting
compensation into a single, new definition of ``underwriting
compensation.'' \80\ The proposed rule change also would eliminate the
term ``underwriter and related persons'' and instead use the defined
term ``participating member.'' \81\ Further, the proposed rule change
would move the definition of ``public offering'' from Rule 5121 to Rule
5110 \82\ and would modify the definition to add ``made in whole or in
part in the United States'' to clarify the jurisdictional scope of the
definition.\83\ The proposed rule change would also move, without
modification, the definition of ``Net Offering Proceeds'' from Rule
5110 to Rule 5121.\84\
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\80\ See proposed Rule 5110(j)(22). FINRA proposes to define the
term ``underwriting compensation'' to mean ``any payment, right,
interest, or benefit received or to be received by a participating
member from any source for underwriting, allocation, distribution,
advisory and other investment banking services in connection with a
public offering. In addition, underwriting compensation shall
include finder's fees, underwriter's counsel fees, and securities.''
See id.
\81\ FINRA states that, substantively consistent with the
current Rule, the proposed rule change would define ``participating
member'' to include any FINRA member that is participating in a
public offering, any affiliate or associated person of the member,
and any ``immediate family,'' but does not include the issuer. See
proposed Rule 5110(j)(15). While not included in the ``participating
member'' definition, according to FINRA, the broad definition of
underwriting compensation would include underwriter's counsel fees
and expenses, financial consulting and advisory fees and finder's
fees. As such, FINRA states its belief that the definition of
``underwriting compensation'' would ensure that the Rule addresses
fees and expenses paid to persons previously covered by the term
``underwriter and related persons.'' In addition, according to
FINRA, the term ``immediate family'' is clarified for readability in
proposed Rule 5110(j)(8) to mean the spouse or child of an
associated person of a member and any relative who lives with, has a
business relationship with, or provides to or receives support from
an associated person of a member. See Notice, supra note 3, for a
full description of the proposal as originally filed.
\82\ See proposed Rule 5110(j)(18). Rule 5121 would incorporate
the definition in Rule 5110 by reference. See Rule 5121(f).
\83\ See proposed Rule 5110(j)(18). FINRA is also proposing to
amend the defined term ``public offering'' in proposed Rule
5110(j)(18)(A) to update the reference to offerings pursuant to
``Section 4(6)'' of the Securities Act to refer instead to Section
4(a)(5) of the Securities Act. See Order Instituting Proceedings,
supra note 8, 84 FR at 37927.
\84\ See proposed Rule 5121(f)(9).
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In addition, the proposed rule change would modernize Rule 5110's
language (e.g., by replacing references to specific securities
exchanges to instead reference the definition of ``national securities
exchange'' in the Exchange Act). Furthermore, according to FINRA, the
proposed rule change would include new defined terms to provide greater
predictability for members in applying the Rule (e.g., ``experienced
issuer,'' \85\ ``equity-linked securities,'' \86\ ``overallotment
option'' \87\ and ``review period'' \88\).
---------------------------------------------------------------------------
\85\ As discussed supra, the proposed rule change would delete
references to the pre-1992 standards for Form S-3 and standards
approved in 1991 for Form F-10 and instead codify the requirement
that the issuer have a 36-month reporting history and at least $150
million aggregate market value of voting stock held by non-
affiliates. (Alternatively, $100 million or more aggregate market
value of voting stock held by non-affiliates and an annual trading
volume of at least three million shares). Issuers meeting this
standard would be defined as ``experienced issuers'' and their
public offerings would be exempt from filing, but subject to the
substantive provisions of Rule 5110. See proposed Rule 5110(j)(6).
\86\ See proposed Rule 5110(j)(7).
\87\ See proposed Rule 5110(j)(14).
\88\ See proposed Rule 5110(j)(20).
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The proposed rule change, moreover, would incorporate the
definition of ``associated person'' \89\ in Article I, Section (rr) of
the FINRA By-Laws. Also, the proposed rule change would provide that a
bank is ``a bank as defined in Section 3(a)(6) of the Exchange Act, a
branch or agency in the United States of a foreign bank that is
supervised and examined by a federal or state banking authority and
otherwise meets the requirements of Section 3(a)(6) of the Exchange
Act, or [is] a foreign bank that has been granted an exemption under
this Rule and shall refer only to the regulated entity, not its
subsidiaries or other affiliates.'' \90\ In addition, the proposed rule
change would revise the issuer definition to mean ``a registrant or
other person that is offering its securities to the public, any selling
security holder offering securities to the public, any affiliate of the
registrant or such other person or selling security holder, and the
officers or general partners, and directors thereof, but does not
include a participating member unless the participating member is
itself the registrant or a selling security holder offering its own
beneficially held securities to the public.'' \91\
---------------------------------------------------------------------------
\89\ See proposed Rule 5110(j)(1).
\90\ See proposed Rule 5110(j)(2).
\91\ See proposed Rule 5110(j)(12).
---------------------------------------------------------------------------
Valuation of Securities
The proposal would retain the current method for valuing options,
warrants and other convertible securities received as underwriting
compensation in the current Rule.\92\
---------------------------------------------------------------------------
\92\ See proposed Rule 5110(c). See also Notice, supra note 3,
84 FR at 18600.
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[[Page 72402]]
B. Partial Amendment No. 2 93
---------------------------------------------------------------------------
\93\ The description in this Item II.B is based on Partial
Amendment No. 2, as filed by FINRA. See supra note 11.
---------------------------------------------------------------------------
In response to comments received in response to the Order
Instituting Proceedings, FINRA filed Partial Amendment No. 2 to the
proposed rule change, as modified by Partial Amendment No. 1.\94\
Partial Amendment No. 2 would modify the proposed rule change, as
modified by Amendment No. 1, as follows:
---------------------------------------------------------------------------
\94\ See id.
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Filing Requirements
In Partial Amendment No. 2, FINRA proposes to change the beneficial
ownership threshold with respect to the representation requirement in
proposed Rule 5110(a)(4)(B)(iii) from 5% to 10%. Specifically, as
modified by Partial Amendment No. 2, proposed Rule 5110(a)(4)(B)(iii)
would now require the filing of ``a representation as to whether any
officer or director of the issuer and any beneficial owner of 10% or
more of any class of the issuer's equity and equity-linked securities
is an associated person or affiliate of a participating member''.
Venture Capital Exception
In Partial Amendment No. 2, FINRA proposes new Supplementary
Material .07 to Rule 5110 to expressly provide its interpretation that
the determination of whether a securities acquisition may qualify for a
venture capital exception from underwriting compensation is to be made
at the time of the securities acquisition.\95\
---------------------------------------------------------------------------
\95\ Specifically, as proposed in Partial Amendment No. 2,
proposed new Supplementary Material .07 to Rule 5110 would state
``[t]he determination of whether a securities acquisition may be
excluded from underwriting compensation pursuant to paragraph (d) is
to be made at the time of the securities acquisition.'' See Partial
Amendment No. 2, supra note 11.
---------------------------------------------------------------------------
Investment Grade Debt Exemption
FINRA proposes to revise proposed Rule 5110(h)(1)(A) to add the
term ``foreign bank'' to the list of entities that may rely on the
investment grade exemption.
Definition of ``Participate''
FINRA proposes to revise proposed Rule 5110(j)(16)(B) to delete the
words ``provided that another member or members is participating in the
public offering.''
Underwriting Compensation
FINRA proposes to revise proposed Supplementary Material .01(a)(7)
to provide that purchases of both convertible and non-convertible
securities during the review period by a participating member in a
public offering at the public offering price and on the same terms as
all others that are not participating members not be underwriting
compensation.\96\
---------------------------------------------------------------------------
\96\ Specifically, Supplementary Material .01(a)(7) would now
provide that ``common or preferred stock, options, warrants, and
other equity securities, including debt securities convertible to or
exchangeable for equity securities, beneficially owned, as defined
in Rule 5121 by the participating members the value of which is
determined pursuant to this Rule, and acquired during the review
period, as defined in this Rule, except that any such securities
purchased during the review period by a participating member in a
public offering at the public offering price and on the same terms
as all others purchasing in the public offering that are not
participating members shall not be deemed underwriting
compensation.''
---------------------------------------------------------------------------
Further, FINRA proposes to revise proposed Supplementary Material
.01(b)(21) to provide that securities acquired by a member firm acting
as a bona fide market maker would not constitute underwriting
compensation.\97\
---------------------------------------------------------------------------
\97\ Specifically, Supplementary Material .01(a)(7) would now
provide that underwriting compensation does not include ``securities
acquired in the secondary market by a participating member that is a
broker-dealer in connection with the performance of bona fide
customer facilitation activities and bona fide market making
activities . . .''
---------------------------------------------------------------------------
III. Discussion of Comments Received on the Proposed Rule Change and
FINRA's Response
The Commission received a total of nine comments in response to the
proposed rule change.\98\ Six comment letters were received in response
to the filing as originally proposed.\99\ Subsequently, FINRA filed
Partial Amendment No. 1 and a response to those comments.\100\ The
Commission thereafter received three comments in response to the Order
Instituting Proceedings.\101\ FINRA subsequently filed Partial
Amendment No. 2 and a response to comments received in response to the
Order Instituting Proceedings.\102\ Significant comments received and
FINRA's responses are summarized below.
---------------------------------------------------------------------------
\98\ See supra notes 5 and 9.
\99\ See supra note 5.
\100\ See FINRA Response No. 1, supra note 6.
\101\ See supra note 9.
\102\ See supra note 11.
---------------------------------------------------------------------------
Overall Proposal
Four commenters support FINRA's efforts to review, streamline, and
modernize the Rule for the benefit of market participants but offer
suggested modifications to some aspects of the proposal.\103\ As
discussed below, one commenter expresses support of a proposed
exemption, but otherwise does not comment on other aspects of the
proposal.\104\ In response, FINRA has proposed certain modifications to
the initial proposal as described in detail below.
---------------------------------------------------------------------------
\103\ See ABA, Davis Polk, Rothwell, and SIFMA Letter No. 1,
supra note 5.
\104\ See CAI, supra note 5.
---------------------------------------------------------------------------
Two commenters believe excessive underwriting compensation should
be addressed through disclosure to investors and that Rule 5110 is
inconsistent with the Exchange Act and the Securities Act.\105\ These
commenters suggest eliminating Rule 5110 in its entirety, or amending
it to require only disclosure of underwriting compensation. In
response, FINRA states, among other things, that while disclosure of
underwriting compensation is an important component of Rule 5110,
disclosure alone is not sufficient to prohibit unfair underwriting
terms and arrangements that disadvantage issuers and investors in
public offerings of securities.\106\
---------------------------------------------------------------------------
\105\ See Kaswell Letter Nos. 1 and 2, and Callcott, supra notes
5, 9.
\106\ See FINRA Response No. 1, supra note 6 at 2, and FINRA
Response No. 2, supra note 11 at 5-6.
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Filing Requirements
Three commenters state that several of the proposed filing
requirements are unnecessary.\107\ Namely, commenters argue that the
following filing requirements should be eliminated or modified: (1)
Disclosure of holdings that are excluded from underwriting
compensation; \108\ (2) M&A and private placement engagement letters;
\109\ (3) a representation as to whether any officer or director of the
issuer and any beneficial owner of 5% or more of any class of the
issuer's equity and equity-linked securities is an associated person or
affiliate of a participating member; \110\ (4) notification of
underwriting compensation received in terminated or revised offerings;
\111\ and (5) a description of securities acquired in bona fide venture
capital transactions.\112\
---------------------------------------------------------------------------
\107\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
\108\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
\109\ See ABA, supra note 5. See also SIFMA Letter No. 2, supra
note 9.
\110\ See ABA and SIFMA Letter No. 1, supra note 5, and SIFMA
Letter No. 2, supra note 9.
\111\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
\112\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
---------------------------------------------------------------------------
In response to commenters' concerns regarding disclosure of
holdings that are excluded from underwriting compensation, FINRA
proposes in Partial Amendment No. 1 to revise Rule 5110(a)(4)(B)(iv) to
not require filing a
[[Page 72403]]
description of any securities acquired in accordance with Supplementary
Material .01(b), which sets forth a non-exhaustive list of payments
that generally would not be deemed to be underwriting
compensation.\113\
---------------------------------------------------------------------------
\113\ See FINRA Response No. 1, supra note 6 at 3-4.
---------------------------------------------------------------------------
With respect to M&A and private placement engagement letters, FINRA
states that it continues to believe that such letters should be
required to be filed with FINRA so that it may determine if they impact
the underwriting terms and arrangements for the public offering.\114\
Further, in response to one commenter's concern that FINRA's Public
Offering System does not mirror the requirements of the proposed Rule
and requires filing of stand-alone M&A and private placement engagement
letters otherwise not required by the Rule,\115\ FINRA responds by
stating that proposed Rule 5110(a)(4)(A)(ii) requires filing an
engagement letter with FINRA for review only when the engagement letter
contains terms relevant to the underwriting terms and arrangements.
FINRA states that engagement letters that do not contain terms relevant
to the underwriting terms and arrangements would therefore not be
required.\116\ FINRA further states that, if the proposed rule change
is approved, FINRA's Public Offering System would be revised and
administered consistent with proposed Rule 5110(a)(4)(A)(ii).\117\
---------------------------------------------------------------------------
\114\ See FINRA Response No. 1, supra note 6 at 3.
\115\ See SIFMA Letter No. 2, supra note 9 at 3-5.
\116\ See FINRA Response No. 2, supra note 11 at 2-3.
\117\ See id.
---------------------------------------------------------------------------
In response to comments with respect to the representation
requirement in proposed Rule 5110(a)(4)(B)(iii),\118\ FINRA proposes to
increase the disclosure threshold of beneficial ownership from 5% to
10% or more of an entity's common or preferred equity.\119\
Specifically, in Partial Amendment No. 2, FINRA proposes to revise
proposed Rule 5110(a)(4)(B)(iii) to require filing ``a representation
as to whether any officer or director of the issuer and any beneficial
owner of 10% or more of any class of the issuer's equity and equity-
linked securities is an associated person or affiliate of a
participating member.'' FINRA states that this proposed amendment would
provide greater flexibility to participating members in relation to
beneficial ownership information while still requiring that
participating members provide information needed to identify potential
conflicts of interest.\120\
---------------------------------------------------------------------------
\118\ See FINRA Response No. 1, supra note 6 at 4-5. See also
ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5. ABA and SIFMA
suggest a 25% threshold, while Davis Polk suggests a 10% threshold.
See also SIFMA Letter No. 2, supra note 9.
\119\ See FINRA Response No. 2, supra note 11 at 3.
\120\ See FINRA Response No. 2, supra note 11 at 3.
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Further, with respect to compensation received relating to revised
or terminated public offerings, FINRA states that such underwriting
compensation is relevant for purposes of evaluating compliance with
Rule 5110 and for preventing a member from being compensated twice for
the same services.\121\ In addition, as discussed in Partial Amendment
No. 1, and in response to commenters' concerns, FINRA proposes to
revise Supplementary Material .01(a)(13) to exclude from underwriting
compensation accountable expenses received pursuant to Rule
5110(g)(5)(A).\122\
---------------------------------------------------------------------------
\121\ See FINRA Response No. 1, supra note 6 at 6.
\122\ Specifically, Supplementary Material .01(a)(13) would
provide that underwriting compensation would include ``any
compensation paid to any participating member in connection with a
prior proposed public offering that was not completed, if the member
firm participates in the revised public offering, except that
accountable expenses received pursuant to paragraph (g)(5)(A) shall
not be deemed underwriting compensation.'' See also FINRA Response
No. 1, supra note 6 at 6 n.10.
---------------------------------------------------------------------------
In response to comments regarding description of securities
acquired in bona fide venture capital transactions, FINRA proposes to
retain the requirement. FINRA believes that a description of the
securities is needed for FINRA to assess whether the acquisition meets
the requirements for a venture capital exception or whether the
securities should instead be treated as underwriting compensation.\123\
---------------------------------------------------------------------------
\123\ See FINRA Response No. 1, supra note 6 at 4.
---------------------------------------------------------------------------
Although most commenters suggest scaling back the filing
requirements, one commenter suggests that FINRA withdraw a proposed
exception from the filing requirement.\124\ Specifically, the commenter
proposes that the expansion of the ``seasoned issuer'' filing exemption
to an issuer's public offerings where the issuer has ``securities in
the same series that have equal rights and obligations as investment
grade rated securities'' be removed.\125\ Moreover, this and another
commenter request additional clarification on the ``seasoned issuer''
exemption.\126\ Specifically, one commenter seeks clarification
regarding whether the issuer's qualifying debt or preferred securities
for purposes of the exemption must be issued and outstanding.\127\ The
other commenter requests clarification that the term ``corporate
issuer'' in the exemption is not meant to exclude issuers if they are
not organized in ``corporate'' form.\128\
---------------------------------------------------------------------------
\124\ See Rothwell, supra note 5.
\125\ See id.
\126\ See Rothwell and ABA, supra note 5.
\127\ See Rothwell, supra note 5.
\128\ See ABA, supra note 5.
---------------------------------------------------------------------------
In response to commenters' concerns, FINRA clarifies that it does
not intend the exemption to apply where the issuer has only
outstanding, unrated non-convertible debt or preferred securities that
the issuer deems to be in the same series as qualifying reacquired
Treasury securities that were once rated investment grade. Accordingly,
FINRA proposes to revise Rule 5110(h)(1)(A) to exempt ``securities
offered by a bank, corporate issuer, foreign government or foreign
government agency that has outstanding unsecured non-convertible debt
with a term of issue of at least four years or unsecured non-
convertible preferred securities that are investment grade rated, as
defined in Rule 5121(f)(8), or are outstanding securities in the same
series that have equal rights and obligations as investment grade rated
securities, provided that an initial public offering of equity is
required to be filed'' (emphasis added). In addition, FINRA states that
it would interpret ``corporate issuers'' to include, among other
entities, limited partnerships and limited liability companies.\129\
---------------------------------------------------------------------------
\129\ See FINRA Response No. 1, supra note 6 at 14.
---------------------------------------------------------------------------
Disclosure
One commenter suggests adopting a de minimis exception for itemized
disclosure under which participating members may disclose a maximum
aggregate value for items of underwriting compensation that do not
individually or in the aggregate exceed the lesser of: (1) $50,000; and
(2) 0.1% of the dollar amount of securities offered in the public
offering.\130\ The same commenter also suggests that nominal gifts and
occasional meals or other business entertainment that are provided in
accordance with the limits set forth in proposed Rule 5110(f)(2)(A) and
(B) should not be required to be separately itemized and disclosed as
underwriting compensation because the administrative costs and burdens
would outweigh the benefits.\131\
---------------------------------------------------------------------------
\130\ See SIFMA Letter No. 1, supra note 5, and SIFMA Letter No.
2, supra note 9.
\131\ See SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------
In response, FINRA notes that it previously considered the Rule's
disclosure requirements and continues to believe that the current
itemized
[[Page 72404]]
approach to disclosure is appropriate.\132\ FINRA further states that a
de minimis exception would inherently involve a participating member
categorizing different forms of underwriting compensation and
determining whether the specific category exceeds the de minimis
threshold.\133\
---------------------------------------------------------------------------
\132\ See FINRA Response No. 1, supra note 6 at 7. See also
FINRA Response No. 2, supra note 11 at 4-5.
\133\ See FINRA Response No. 2, supra note 11 at 4-5.
---------------------------------------------------------------------------
FINRA also declines to revise its Rule per commenter's suggestion
regarding nominal gifts and occasional meals or other business
entertainment. FINRA states that the suggested change would not alter
the current requirements for disclosing non-cash compensation because
non-cash compensation in connection with a public offering has long
been considered underwriting compensation under Rule 5110 and is
disclosed to FINRA via a question in FINRA's electronic filing system
for public offerings.\134\
---------------------------------------------------------------------------
\134\ See id. at 5.
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Valuation
Commenters request clarification, as well as offer suggestions, on
FINRA's proposal to modify Rule 5110's calculations for valuing
convertible and non-convertible securities.\135\ Commenters request
alternative valuation methodologies on a case-by-case basis \136\ and
for unit securities.\137\ One commenter also requests, for purposes of
clarification, express exclusion from valuation as underwriting
compensation for options and other derivatives acquired at a fair
price.\138\
---------------------------------------------------------------------------
\135\ See SIFMA Letter No. 1 and Rothwell, supra note 5.
\136\ See SIFMA Letter No. 1, supra note 5 at 8.
\137\ See Rothwell, supra note 5 at 12.
\138\ See SIFMA Letter No. 1, supra note 5 at 8.
---------------------------------------------------------------------------
In response, FINRA states that it proposes to retain the methods in
the current Rule for valuing options, warrants, and other convertible
securities received as underwriting compensation. FINRA states that
exemptive relief may be available on a case-by-case basis pursuant to
Rule 5110(i) for a member firm that seeks to use a single, consistently
applied alternative valuation methodology.\139\ FINRA also notes that
it has previously provided guidance for valuing unit securities.\140\
With respect to options and other derivatives acquired at a fair price,
FINRA notes that the requested clarification is set forth in proposed
Rule 5110(c)(5), which states ``[a]ny non-convertible or non-
exchangeable debt or derivative instrument acquired or entered into at
a `fair price' as defined in Supplementary Material .06(b) and
underwriting compensation received in or receivable in the settlement,
exercise or other terms of such non-convertible or non-exchangeable
debt or derivative instrument shall not have a compensation value for
purposes of determining underwriting compensation.'' \141\
---------------------------------------------------------------------------
\139\ See FINRA Response No. 1, supra note 6 at 8.
\140\ See id.
\141\ See id.
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Venture Capital Exceptions
Commenters generally support the venture capital exceptions.\142\
One commenter, however, contends that the definition of ``institutional
investor'' \143\ renders the venture capital exception unworkable.\144\
The commenter suggests that the definition should focus instead on
whether a participating member manages the investor's investments or
otherwise controls or directs the investment decisions of the investor.
Alternatively, the commenter suggests that the scope of those subject
to the equity interest calculation be limited to the participating
FINRA member firm and its affiliates (i.e., the calculation should not
include associated persons that are not otherwise ``affiliates'' of the
member firm or immediate family of such associated persons). Further,
the commenter suggests that the co-investment exception \145\ be
expanded to include other highly regulated entities that purchase in
the private offering under the same conditions, provided that, in each
case, no participating member manages the entity's investments or
otherwise controls or directs the management or policies of the
entity.\146\ Finally, the commenter also suggests that the venture
capital exceptions should be clarified to provide that a participating
member could make the determination as to the availability of the
exception at the time of the acquisition of the securities.\147\
---------------------------------------------------------------------------
\142\ See Rothwell and SIFMA Letter No. 1, supra note 5.
\143\ Proposed Rule 5110(j)(10) defines the term ``institutional
investor'' to mean ``any person that has an aggregate of at least
$50 million invested in securities in its portfolio or under
management, including investments held by its wholly owned
subsidiaries; provided that no participating members manage the
institutional investor's investments or have an equity interest in
the institutional investor, either individually or in the aggregate,
that exceeds 5% for a publicly owned entity or 1% for a nonpublic
entity.
\144\ See SIFMA Letter No. 1, supra note 5.
\145\ According to FINRA, co-investment exception is a type of
venture capital exception that applies to securities acquired in a
private placement before the required filing date of the public
offering by a participating member if at least 15% of the total
number of securities sold in the private placement were acquired, at
the same time and on the same terms, by one or more entities that is
an open-end investment company not traded on an exchange, and no
such entity is an affiliate of a FINRA member participating in the
offering. See proposed Rule 5110(d)(4). See also Notice, supra note
3, 84 FR at 18612.
\146\ See SIFMA Letter No. 1, supra note 5.
\147\ See id. See also SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------
In response, FINRA declines to revise the definition of
``institutional investor''. FINRA believes that revising the definition
as suggested to focus on controlling or directing investment decisions
would insert uncertainty and subjectivity into the definition and that
the current definition is more objective.\148\ Moreover, because Rule
5110's venture capital exceptions are relied upon by members, FINRA
does not agree that the institutional investor definition makes the
venture capital exceptions unworkable.
---------------------------------------------------------------------------
\148\ See FINRA Response No. 1, supra note 6 at 9-10.
---------------------------------------------------------------------------
As for the comment regarding expanding the venture capital
exception to other highly regulated entities, FINRA states that it will
assess how the exception is operating in practice and may in the future
consider extending the exception to include co-investments with other
highly regulated entities on comparable terms.\149\ In response to the
request that the determination as to the availability of a venture
capital exception be made at the time of the acquisition of the
securities and based on the participating member's knowledge at that
time, FINRA proposes new Supplementary Material .07 to Rule 5110, which
would provide that ``[t]he determination of whether a securities
acquisition may be excluded from underwriting compensation pursuant to
paragraph (d) is to be made at the time of the securities
acquisition.'' \150\
---------------------------------------------------------------------------
\149\ See FINRA Response No. 1, supra note 6 at 9.
\150\ See FINRA Response No. 2, supra note 11 at 6-7. FINRA
points out that a securities acquisition must be made prior to the
required filing date to qualify for the venture capital exceptions;
accordingly, proposed Rule 5110(d)(1)-(4) would retain the language
``before the required filing date of the public offering'' in the
rule text to continue to require that the securities acquisition be
made prior to the required filing date to qualify for a venture
capital exception. See id. at 7.
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Lock-Up Restriction
One commenter suggests several changes to FINRA's proposed lock-up
restriction, such as eliminating the restriction for offerings of
securities that are ``actively-traded,'' making consistent the lock-up
period for participating members in a follow-on offering as the lock-up
period for insiders, and allowing the sale or other disposition of
locked-up securities by registered
[[Page 72405]]
investment advisers who are participating members.\151\
---------------------------------------------------------------------------
\151\ See SIFMA Letter No. 1, supra note 5 at 6.
---------------------------------------------------------------------------
In response, as discussed in Partial Amendment No. 1, FINRA
proposes to add Rule 5110(e)(2)(A)(ix) to provide that the lock-up
restriction will not apply ``to a security that is ``actively-traded''
(as defined in Rule 101(c)(1) of SEC Regulation M).'' \152\ Due to
conflicting views on the issue of follow-on offerings, however, FINRA
states that it will retain the historical approach of a 180-day lock-up
period for both initial and follow-on public offerings.\153\ FINRA
notes that certain follow-on public offerings may qualify for other
exemptions.\154\ FINRA also notes that, with respect to registered
investment advisers who are participating members, it would consider
requests for exemptive relief from the lock-up restriction pursuant to
Rule 5110(i).\155\
---------------------------------------------------------------------------
\152\ See FINRA Response No. 1, supra note 6 at 11.
\153\ See id.
\154\ See id.
\155\ See id.
---------------------------------------------------------------------------
Non-Cash Compensation
Two commenters request clarification that restrictions on non-cash
compensation as set forth in the current Rule and proposed Rule 5110(f)
are not intended to limit or otherwise be inconsistent with other
provisions in the Rule that implicitly permit the receipt by
participating members of non-cash compensation under appropriate
circumstances.\156\
---------------------------------------------------------------------------
\156\ See ABA, supra note 5 at 7, and SIFMA Letter No. 1, supra
note 5 at 9.
---------------------------------------------------------------------------
In response to the commenters' request for clarification, FINRA
confirms the commenters' understanding regarding the restrictions on
receipt of non-cash compensation.\157\
---------------------------------------------------------------------------
\157\ See FINRA Response No. 1, supra note 6 at 12.
---------------------------------------------------------------------------
Prohibited Terms and Arrangements
One commenter, although generally supportive of the proposed
changes relating to prohibited terms and arrangements in connection
with a public offering of securities, offers two suggestions.\158\ The
commenter suggests that payments allowed prior to the commencement of
sales of a public offering also be permitted in respect of offerings
that are not completed, if the payments are for services actually
provided and the issuer has not terminated the services of the
participating member for cause.\159\ The commenter further suggests
that Rule 5110(g)(11), which provides that a FINRA member may not
``participate with an issuer in the public offering of securities if
the issuer hires persons primarily for the purpose of solicitation,
marketing, distribution or sales of the offering, except in compliance
with Section 15(a) of the Exchange Act or [Exchange Act] Rule 3a4-1 and
applicable state law,'' should be further modified to limit this
prohibition to those instances in which the FINRA member knows, or
reasonably should have known, that the issuer had hired persons absent
compliance with applicable federal or state securities laws.\160\
---------------------------------------------------------------------------
\158\ See ABA, supra note 5.
\159\ See ABA, supra note 5 at 7-8.
\160\ See id.
---------------------------------------------------------------------------
In response, FINRA declines to modify the Rule pursuant to the
commenter's suggestions.\161\ FINRA believes that receiving advisory or
consulting fees for services provided in connection with a public
offering that is not completed and, therefore, results in no capital
being raised is an unreasonable term and arrangement for purposes of
Rule 5110. It notes, however, that participating members may receive
termination fees or a ROFR related to an offering that is not completed
consistent with Rule 5110(g)(5).
---------------------------------------------------------------------------
\161\ See FINRA Response No. 1, supra note 6 at 12-13.
---------------------------------------------------------------------------
Further, FINRA believes that reasonable due diligence by a
participating member would generally detect whether an issuer who has
hired persons primarily for the purpose of solicitation, marketing,
distribution, or sales of the offering was not in compliance with
Section 15(a) of the Exchange Act or Rule 3a4-1 under the Exchange Act
and applicable state law. According to FINRA, however, it would
consider whether the participating member knew, or reasonably should
have known, that the issuer had hired such persons absent compliance
with applicable federal or state securities laws in assessing any
violation of Rule 5110(g)(11).
Exemptions From Filing and Substantive Requirements
Commenters are generally supportive of FINRA's proposal to exempt
certain offerings from the filing requirements.\162\ One commenter,
however, requests that FINRA expand the exemptions to include tender
offers by issuers for their own securities under the Exchange Act.\163\
In response to the comment, as discussed in Partial Amendment No. 1 and
described above, FINRA proposes to amend Rule 5110(h)(2)(G) to include
tender offers by issuers for their own securities.\164\
---------------------------------------------------------------------------
\162\ See Rothwell, CAI, and ABA, supra note 5.
\163\ See ABA, supra note 5 at 10.
\164\ See FINRA Response No. 1, supra note 6 at 13-14.
---------------------------------------------------------------------------
Defined Terms
One commenter suggests that the definition of ``bank'' under
proposed Rule 5110(j)(2) should also include the US branches and
agencies of a foreign bank.\165\ In response, as discussed in the
Partial Amendment No. 1 and described above, FINRA proposes to amend
the proposed definition of bank in Rule 5110(j)(2) to include ``a
branch or agency in the United States of a foreign bank that is
supervised and examined by a federal or state banking authority and
otherwise meets the requirements of Section 3(a)(6) of the Exchange
Act.'' \166\
---------------------------------------------------------------------------
\165\ See ABA, supra note 5 at 10.
\166\ See FINRA Response No. 1, supra note 6 at 15.
---------------------------------------------------------------------------
In response to the Order Instituting Proceedings, one commenter
states that it agrees with the proposed modification to the definition
of bank, but further suggests that proposed Rule 5110(h)(1)(A) also be
amended to include ``foreign bank'' to avoid creating a new and
burdensome requirement that foreign banks must apply to FINRA for an
exemption before relying on the investment grade debt exemption from
filing.\167\ In response, FINRA proposes to revise Rule 5110(h)(1)(A)
to add ``foreign bank'' to the list of entities that may rely on the
exemption.\168\
---------------------------------------------------------------------------
\167\ See SIFMA Letter No. 2, supra note 9 at 2.
\168\ See FINRA Response No. 2, supra note 11 at 7-8.
---------------------------------------------------------------------------
Four commenters express concern over the term ``experienced
issuer'' in Rule 5110(j)(6) and suggested alternatives or requested
clarification.\169\ For example, commenters express concern that the
proposal would eliminate SEC and FINRA's past interpretive guidance
relating to the term.\170\ Further, one commenter specifically requests
clarification regarding the extent to which member firms can rely on
prior SEC and FINRA guidance and interpretation associated with the
Form S-3 and F-10 eligibility requirements, including those related to
determining aggregate market value and public float.\171\ Yet another
commenter suggests revising the definition of ``experienced issuer'' to
``explain the requirements that must be met to satisfy the `reporting
history' requirement.'' \172\
---------------------------------------------------------------------------
\169\ See ABA, Davis Polk, SIFMA Letter No. 1, and Rothwell,
supra note 5.
\170\ See id.
\171\ See SIFMA Letter No. 2, supra note 9 at 6-7.
\172\ See Rothwell, supra note 5 at 14.
---------------------------------------------------------------------------
In response, FINRA states that it believes that the proposed
definition of
[[Page 72406]]
``experienced issuer'' codifies standards currently in place and
simplifies the analysis for the benefit of members.\173\ FINRA also
notes that any guidance and interpretation issued by the SEC or FINRA
relating to the term remain valid and illustrative,\174\ including any
guidance and interpretation on determining aggregate market value and
public float issued by the SEC or FINRA at adoption of, or issued
thereafter in connection with, the pre-1992 standards for Forms S-3 and
F-3 and standards approved in 1991 for Form F-10.\175\ Finally, FINRA
states that ``reporting history is commonly understood to mean that the
issuer has filed all material required to be filed for the relevant
period immediately preceding the filing of the registration
statement.'' \176\
---------------------------------------------------------------------------
\173\ See FINRA Response No. 1, supra note 6 at 16.
\174\ See id.
\175\ FINRA further states that the proposed defined term is
intended for simplification only, and incorporation of the standards
into the proposed defined term would not alter the scope of public
offerings subject to Rule 5110. See FINRA Response No. 2, supra note
11 at 8.
\176\ See FINRA Response No. 1, supra note 6 at 15.
---------------------------------------------------------------------------
One commenter requests to expand the defined term ``independent
financial adviser'' in Rule 5110(j)(9) and revise proposed Rule
5110(j)(16) to allow an independent financial adviser to provide
ordinary services to an issuer and assist the issuer in preparing
offering and other documents.\177\
---------------------------------------------------------------------------
\177\ See Rothwell, supra note 5 at 14-15.
---------------------------------------------------------------------------
In response, FINRA disagrees with the suggested expansion of
services that may be provided by the independent financial
adviser.\178\ According to FINRA, the commenter's suggestion would
represent a significant expansion on the scope of services that may be
provided by an independent financial adviser. Moreover, if adopted,
compensation for these expanded services would not be underwriting
compensation under the Rule. FINRA notes that it had previously
concluded that that the advisory or consulting services that an
independent financial adviser may provide minimizes the risk of the
imposition of unfair or unreasonable terms and arrangements on issuers.
---------------------------------------------------------------------------
\178\ See FINRA Response No. 1, supra note 6 at 17.
---------------------------------------------------------------------------
Four commenters seek clarification and/or suggest a variety of
changes to the proposed definitions of ``participate,'' ``issuer,'' and
``participating member'' \179\ Specifically, two commenters seek
clarification on the extent of the ``issuer'' carve out from the
definition of ``participating member.'' \180\ One commenter suggests
amending the proposed defined term ``participate'' to include
additional detail on activities that are considered involvement in the
distribution of an offering by adding ``including solicitation,
marketing, distribution or sales of the offering.'' \181\ Additionally,
two commenters suggest excluding certain broker activities from the
definition of ``participate,'' such as acting as a broker for a selling
shareholder in return for compensation consisting of customary
brokerage commissions and under circumstances in which the broker does
not use special selling efforts and selling methods.\182\ Finally, one
commenter states that it does not believe that an independent financial
adviser that is not engaged in the solicitation or distribution of the
offering should be deemed to be ``participating'' in a public
offering--and thereby subject to the Rule's filing and other
requirements--solely because no other FINRA member is participating in
the offering.\183\
---------------------------------------------------------------------------
\179\ See Rothwell, ABA, SIFMA Letter No. 1, and Davis Polk,
supra note 5.
\180\ See Rothwell and SIFMA Letter No. 1, supra note 5.
\181\ See Rothwell, supra note 5.
\182\ See ABA and Davis Polk, supra note 5.
\183\ See SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------
In response, FINRA states that the addition of ``but does not
include the issuer'' to the definition of participating member is
``intended to make clear that the `issuer' as defined in proposed Rule
5110(j)(12) is entirely excluded from the proposed `participating
member' definition.'' \184\ Moreover, in Partial Amendment No. 1 and as
described above, FINRA proposes to amend the defined term ``issuer'' to
exclude a participating member, except where the participating member
is offering its securities.
---------------------------------------------------------------------------
\184\ See FINRA Response No. 1, supra note 6 at 18.
---------------------------------------------------------------------------
With respect to the term ``participate,'' while FINRA concedes that
adding ``including solicitation, marketing, distribution or sales of
the offering'' is illustrative, FINRA proposes to retain the current
approach in the definition to accommodate a broad range of activities
that may constitute participating in an offering.\185\ Moreover, FINRA
states that it does not agree with the commenters' suggestion to create
additional carve-outs from the definition of ``participate'' for
certain brokerage activities, but notes that a participating members'
compensation for some activities may not be deemed underwriting
compensation.\186\
---------------------------------------------------------------------------
\185\ See FINRA Response No. 1, supra note 6 at 17.
\186\ See id.
---------------------------------------------------------------------------
Finally, with respect to the suggested changes related to
independent financial advisers, FINRA proposes to revise Rule
5110(j)(16)(B) to delete the words ``provided that another member or
members is participating in the public offering.'' FINRA states that
current Rule 5110 does not include this provision and that,
accordingly, deleting the language will make the approach consistent
with the current Rule.\187\
---------------------------------------------------------------------------
\187\ See FINRA Response No. 2, supra note 11 at 9.
---------------------------------------------------------------------------
Two commenters suggest that the defined term ``public offering'' in
proposed Rule 5110(j)(18) should expressly exclude securities offered
or sold by a broker-dealer pursuant to Sections 4(a)(3) and 4(a)(4) of
the Securities Act.\188\ FINRA declines to make the suggested revision,
stating that members have not previously filed these offerings with
FINRA and, consequently, FINRA has not received information on these
offerings.\189\
---------------------------------------------------------------------------
\188\ See ABA, supra note 5 at 11, and SIFMA Letter No. 2, supra
note 9 at 8-9. ABA also suggests a technical change to update the
reference in proposed Rule 5110(j)(18)(A) to offerings pursuant to
Section 4(a)(6) of the Securities Act to Section 4(a)(5) of the
Securities Act. As discussed in the Partial Amendment No. 1 and
described above, FINRA proposes to revise the public offering
definition's reference to these offerings as suggested by the
commenter. See supra note 81.
\189\ See FINRA Response No. 1, supra note 6 at 18.
---------------------------------------------------------------------------
Four commenters assert that participating members' purchases of
securities in a public offering at the public offering price should not
be considered underwriting compensation subject to Rule 5110.\190\
---------------------------------------------------------------------------
\190\ See ABA, Davis Polk, Rothwell, and SIFMA Letter No. 1,
supra note 5.
---------------------------------------------------------------------------
In response, FINRA provides that it would interpret the proposal
not to include as underwriting compensation non-convertible securities
purchased by a participating member in a public offering at the public
offering price during the review period. As discussed in the Partial
Amendment No. 1, FINRA proposes to revise the Supplementary Material to
expressly exclude securities purchased on these terms from being deemed
underwriting compensation.\191\
---------------------------------------------------------------------------
\191\ See FINRA Response No. 1, supra note 6 at 19 n.27.
---------------------------------------------------------------------------
Moreover, two commenters suggest that proposed Supplementary
Material .04, which addresses securities acquired by a participating
member's associated persons or their immediate family members in issuer
directed sales programs, should be modified to focus only on securities
acquired at a price lower than the public offering price.\192\ One
commenter is concerned that the proposed definition of ``review
period'' expands the scope of the Rule and
[[Page 72407]]
suggests that FINRA withdraw Supplementary Material .04.\193\
---------------------------------------------------------------------------
\192\ See ABA and SIFMA Letter No. 1, supra note 5.
\193\ See Rothwell, supra note 5 at 1.
---------------------------------------------------------------------------
In response to concerns regarding proposed Supplementary Material
.04, FINRA states that proposed Supplementary Material .04 takes into
account the price at which the securities are acquired. FINRA notes
that, pursuant to proposed Supplementary Material .04, FINRA would
consider, among other factors, whether the securities were acquired on
the same terms and at the same price as other similarly-situated
persons participating in the directed sales program.\194\ Two
commenters request clarification as to whether certain compensated
parties would be considered ``participating members'' and thus their
compensation be deemed underwriting compensation.\195\ For example, one
commenter requests confirmation that compensation received by a non-
U.S. underwriter that is not itself a FINRA member or an affiliate of a
participating FINRA member is not considered underwriting
compensation.\196\ Another commenter requests confirmation that fees
and other compensation paid by an issuer to a foreign broker-dealer
affiliated with a participating member in connection with a foreign
distribution of an offering occurring in the U.S. and outside the U.S.
simultaneously would not be deemed underwriting compensation under Rule
5110.\197\
---------------------------------------------------------------------------
\194\ See id.
\195\ See SIFMA Letter No. 1 and Davis Polk, supra note 5.
\196\ See SIFMA Letter No. 1, supra note 5 at 7-8.
\197\ See Davis Polk, supra note 5 at 4.
---------------------------------------------------------------------------
In response, FINRA confirms that compensation received by a non-
U.S. underwriter that is not itself a FINRA member or an affiliate of a
participating FINRA member is not considered underwriting
compensation.\198\ Further, FINRA provides that, if the participating
members are able to divide underwriting compensation so as to
separately allocate the underwriting compensation received by the non-
U.S. broker-dealer for the non-U.S. portion of the global offering,
FINRA would consider such separately allocated underwriting
compensation to be outside the scope of Rule 5110 and not subject to
the requirements of Rule 5110.\199\
---------------------------------------------------------------------------
\198\ See FINRA Response No. 1, supra note 6 at 19-20.
\199\ See FINRA Response No. 1, supra note 6 at 20.
---------------------------------------------------------------------------
Finally, another commenter notes that the inclusion of ``finder's
fees, underwriter's counsel fees, and securities'' in the proposed
``underwriting compensation'' definition in Rule 5110(j)(22) is
confusing and unnecessary in light of the much clearer and more fulsome
language contained in the Supplementary Material .01.\200\
---------------------------------------------------------------------------
\200\ See ABA, supra note 5 at 4-5.
---------------------------------------------------------------------------
In response, FINRA provides that the non-exhaustive examples in
Supplementary Material .01 do not obviate the need for the defined term
to capture the full scope of possible underwriting compensation.\201\
---------------------------------------------------------------------------
\201\ See FINRA Response No. 1, supra note 6 at 20.
---------------------------------------------------------------------------
Underwriting Compensation
One commenter supports the changes in proposed Supplementary
Material .01, which provides non-exhaustive lists of examples of
payments or benefits that would or would not be underwriting
compensation,\202\ while others request that additional items be
included to the list of items not deemed underwriting
compensation.\203\ Specifically, commenters suggest the following be
deemed not to constitute underwriting compensation: (1) The 1%
valuation assigned to ROFRs; \204\ (2) nominal gifts and occasional
entertainment; \205\ (3) fees for services performed by participating
members in the ordinary course of business unrelated to the
distribution of the offering; \206\ and (4) any cash compensation,
securities or other benefit received by an associated person, immediate
family, or affiliate of a participating member if the FINRA member or
its parent or other affiliate is issuing its own securities in the
public offering.\207\
---------------------------------------------------------------------------
\202\ See Rothwell, supra note 5 at 2.
\203\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
\204\ See SIFMA and ABA, supra note 5.
\205\ See ABA, supra note 5.
\206\ See Davis Polk, supra note 5. One commenter also requests
that FINRA delete the words ``to the issuer'' from Supplementary
Material .01(b)(4)-(6), given the construct of items in proposed
Supplementary Material .01(b) and the definition of underwriting
compensation in proposed Rule 5110(j)(22) covering payments from
``any source.'' See ABA, supra note 5.
\207\ See SIFMA Letter No. 1, supra note 5.
---------------------------------------------------------------------------
In response, FINRA disagrees with these suggestions and believes
that such compensations should be reported to FINRA as underwriting
compensation.\208\ With respect to 1% valuation assigned to ROFRs,
FINRA maintains that ROFRs are a valuable benefit that traditionally
have been used in combination with other forms of compensation to
reward underwriters and that this historical approach to valuing ROFRs
is reasonable. As for the suggestion pertaining to nominal gifts and
occasional entertainment, FINRA responds that given the Rule's
restrictions on the receipt of non-cash compensation, it expects such
compensation to be nominal in practice, but that disclosure of non-cash
compensation is needed for FINRA to have a complete understanding of
underwriting compensation. Further, FINRA notes that the examples
pertaining to payments or benefits received for services that may be
considered unrelated to the public offering were added at the request
of members for clarification and that the proposed scope of the
examples is appropriate. Finally, with respect to compensation related
to the issuance of one's own securities, FINRA states that, while rare,
FINRA has seen potential violations of Rule 5110 in such offerings.
Accordingly, FINRA declines to provide an exclusion of such instances
from underwriting compensation.
---------------------------------------------------------------------------
\208\ See FINRA Response No. 1, supra note 6 at 20-23.
---------------------------------------------------------------------------
In response to FINRA's proposal to expressly exclude non-
convertible securities purchased by the participating member in a
public offering at the public offering price during the review period
from being deemed underwriting compensation, and to consider
acquisitions of convertible securities by a participating member with
negotiated or preferential terms under proposed Rule 5110(g)(8) as
underwriting compensation,\209\ one commenter suggests modifying
Supplementary Material .01(a)(7) to provide that any securities
purchased during the review period by a participating member in a
public offering at the public offering price and without any
preferential terms shall not be deemed underwriting compensation.\210\
---------------------------------------------------------------------------
\209\ In Partial Amendment No. 1, FINRA proposed to revise the
Supplementary Material to expressly exclude non-convertible
securities purchased by the participating member in a public
offering at the public offering price during the review period from
being deemed underwriting compensation under the proposal. In
distinguishing between non-convertible and convertible securities,
FINRA noted that it would consider acquisitions of convertible
securities by a participating member with negotiated or preferential
terms prohibited under proposed Rule 5110(g)(8) as underwriting
compensation. See FINRA Response No. 2, supra note 11 at 10. See
also Order Instituting Proceedings, supra note 8, 84 FR at 37927.
\210\ See SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------
In response, FINRA states that it is appropriate to interpret
purchases of both convertible and non-convertible securities during the
review period by a participating member in a public offering at the
public offering price and on the same terms as all others that are not
participating members not be
[[Page 72408]]
underwriting compensation.\211\ FINRA thus proposes to adopt the
suggestion in substantive part, stating that the proposed amendment
would instead incorporate the concept of purchases at the same price
and with the same terms to provide objectivity and clarity.\212\ FINRA
explains that the concept of preferential treatment suggested by the
commenter would require weighing and considering all of the various
terms of a securities acquisition, which could be time consuming and
would introduce uncertainty into the evaluation.\213\
---------------------------------------------------------------------------
\211\ See FINRA Response No. 2, supra note 11 at 10. See also
Order Instituting Proceedings, supra note 8, 84 FR at 37927.
\212\ See FINRA Response No. 2, supra note 11 at 10.
\213\ See id. at 10-11.
---------------------------------------------------------------------------
Three commenters suggest revising proposed Supplementary Material
.01(b)(21) to expressly reference ``bona fide market making activity''
in the list of items not deemed as underwriting compensation under the
proposed rule.\214\ In response, as described above, FINRA proposes in
Partial Amendment No. 2 to amend proposed Supplementary Material
.01(b)(21) to expressly reference bona fide market making.\215\
---------------------------------------------------------------------------
\214\ See ABA and Davis Polk, supra note 5, and SIFMA Letter No.
2, supra note 9.
\215\ See FINRA Response No. 2, supra note 11 at 12.
Specifically, the provision would be revised to state that
underwriting compensation does not include ``securities acquired in
the secondary market by a participating member that is a broker-
dealer in connection with the performance of bona fide customer
facilitation activities and bona fide market making activities;
provided that securities acquired from the issuer will be considered
`underwriting compensation' if the securities were not acquired at a
fair price (taking into account, among other things customary
commissions, mark-downs and other charges) . . .'' See id.
---------------------------------------------------------------------------
Two commenters suggest revising Supplementary Material .01(b)(14)
to exclude from underwriting compensation securities acquired as the
result of an ``exercise'' of securities that were originally acquired
prior to the review period.\216\ In response, FINRA states that,
pursuant to proposed Supplementary Material .01(b)(15), such securities
would not be underwriting compensation.\217\
---------------------------------------------------------------------------
\216\ See ABA and Davis Polk, supra note 5.
\217\ See FINRA Response No. 1, supra note 6 at 21-22.
---------------------------------------------------------------------------
Two commenters suggest that the exception in proposed Supplementary
Material .01(b)(12) be expanded to include additional employee benefit
plans.\218\ In response to commenters' suggestions,\219\ and as
discussed in the Partial Amendment No. 1 and described above, FINRA
proposes to revise Supplementary Material .01(b)(12) accordingly.\220\
---------------------------------------------------------------------------
\218\ See ABA and Davis Polk, supra note 5.
\219\ See id.
\220\ See FINRA Response No. 1, supra note 6 at 22. See also
supra note 44.
---------------------------------------------------------------------------
FINRA Rule 5121 (Public Offerings of Securities With Conflicts of
Interest)
Two commenters request clarification regarding the required
participation by a qualified independent underwriter (``QIU'').\221\ In
response, FINRA states that it has previously provided guidance
regarding QIU participation pursuant to Rule 5121, and would be willing
to consider requests for additional guidance on Rule 5121 separate from
the proposal.\222\
---------------------------------------------------------------------------
\221\ See, e.g., SIFMA Letter No. 1, supra note 5 at 10, and
ABA, supra note 5 at 8-9.
\222\ See FINRA Response No. 1, supra note 6 at 23-24.
---------------------------------------------------------------------------
IV. Discussion and Commission Findings
After careful review of the proposed rule change, the comment
letters, and FINRA's response to the comments, the Commission finds
that the rule change, as modified by Partial Amendments Nos. 1 and 2,
is consistent with the requirements of the Exchange Act and the rules
and regulations thereunder that are applicable to a national securities
association.\223\ Specifically, the Commission finds that the rule
change is consistent with Section 15A(b)(6) of the Exchange Act,\224\
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.
---------------------------------------------------------------------------
\223\ In approving this rule change, the Commission has
considered the rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
\224\ 15 U.S.C. 78o-3(b)(6).
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FINRA states that the proposal seeks to modify Rule 5110 in an
effort to modernize the Rule by, among other things, improving the
administration of the Rule and simplifying the Rule's provisions while
maintaining important protections for market participants, including
issuers and investors participating in offerings. FINRA also provides
that it engaged in extensive consultation with the industry to
understand what aspects of the Rule needed to be modernized,
simplified, and clarified. In sum, FINRA believes that the changes it
proposes should lessen the regulatory costs and burdens incurred when
complying with the Rule.
The Commission has carefully considered the proposed rule change,
as modified by Partial Amendments Nos. 1 and 2, comment letters, and
FINRA's response to the comments, and believes that the Rule as amended
is reasonably designed to provide just and equitable principles of
trade, while providing for protection of investors and the public
interest consistent with Section 15A(b)(6) of the Exchange Act.\225\
Consequently, the Commission finds that the proposed rule change is
designed to promote capital formation and aid member compliance
efforts, while maintaining the integrity of the public offering process
and investor confidence in the capital market.
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\225\ Id.
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The Commission notes that a total of nine comments were received,
and FINRA made a number of clarifications and modifications to the
original proposal to address commenters' comments. The Commission notes
that commenters, in general, supported FINRA's effort to modernize and
streamline the Rule and recognized that the proposal would ``make the
Rule more efficient and provide members more certainty . . .'' \226\
The Commission also recognizes that two commenters challenge the
consistency of the Rule with the Exchange Act and the Securities
Act.\227\ These commenters believe excessive underwriting compensation
should be addressed through disclosure to investors and suggest
eliminating Rule 5110 in its entirety or amending it to require only
disclosure of underwriting compensation. Further, one commenter notes
that FINRA does not identify or justify the amount of fees it collects
under Rule 5110 and argues that ``[o]n this basis alone, it is unclear
how FINRA's Rule 5110 fees comply with the 1934 Act requirements that
fees be reasonable and not impose an undue burden on competition.''
\228\
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\226\ See Davis Polk, supra note 5.
\227\ See Kaswell Letter Nos. 1 and 2 and Callcott, supra notes
5, 9.
\228\ See Callcott, supra note 9.
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The Commission believes these comments are outside the scope of the
proposed rule change. FINRA in the proposal seeks only to amend the
Rule currently in place. Further, FINRA does not in this proposal seek
to amend the fees related to the Rule.\229\ Accordingly, the Commission
does not believe these comments can be appropriately addressed through
this proposal.
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\229\ See also FINRA's responses to these comments, supra notes
6 and 11.
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The Commission believes that FINRA gave due consideration to the
proposal and met the requirements of the Exchange Act. The Commission
also believes that the proposal modernizes and streamlines the Rule for
the benefit of the members subject to, and the
[[Page 72409]]
investors affected by, the Rule. For the reasons stated above, the
Commission finds that the proposed rule change is consistent with the
Exchange Act and the rules and regulations thereunder.
V. Accelerated Approval of Proposed Rule Change, as Modified by Partial
Amendments Nos. 1 and 2
The Commission finds good cause, pursuant to Section 19(b)(2) of
the Act, for approving the proposed rule change, as modified by Partial
Amendment Nos. 1 and 2 thereto, prior to the 30th day after publication
of Partial Amendment No. 2 in the Federal Register. Partial Amendment
No. 2 responds specifically to comments received in response to the
Order Instituting Proceedings and makes corresponding amendments to the
proposal. These revisions specifically respond to comments received,
add clarity to the proposal, and do not raise any novel regulatory
concerns. Accordingly, the Commission finds that good cause exists to
approve the proposal, as modified by Partial Amendment Nos. 1 and 2 on
an accelerated basis.
VI. Solicitation of Comments on Partial Amendment No. 2
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change, as amended by Partial Amendment Nos. 1 and 2, 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 email to [email protected]. Please include
File Number SR-FINRA-2019-012 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2019-012. This
file number should be included on the subject line if email 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 website (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 website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of FINRA. All comments received
will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-FINRA-2019-012 and should be submitted
on or before January 21, 2020.
VII. Conclusion
It is therefore ordered pursuant to Exchange Act Section 19(b)(2)
\53\ that the proposal (SR-FINRA-2019-012), as modified by Partial
Amendments Nos. 1 and 2, be, and it hereby is, approved on an
accelerated basis.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\230\
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\230\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-28216 Filed 12-30-19; 8:45 am]
BILLING CODE 8011-01-P