FINRA Amends Its Rule 5131 to Ease "New Issues" Compliance Related to Certain Funds-of-Funds

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  • FINRA, the Financial Industry Regulatory Authority, has amended Rule 5131, which addresses new issue allocations and accommodations, to provide certain compliance accommodations related to certain fund-of-funds.
  • In the amendment, FINRA provides a limited exception to the "anti-spinning" provision of Rule 5131 by allowing its members to rely, subject to certain conditions, on written representations from a private fund account that does not look through to the underlying beneficial owners of a fund-of-funds invested in such private fund.

Background

FINRA has amended Rule 5131, which addresses new issue allocations and accommodations, to provide certain compliance accommodations related to certain fund-of-funds (the "Amendment").

The Amendment provides a limited exception to the "anti-spinning" provision of Rule 5131 by allowing FINRA members to rely, subject to certain conditions, on written representations from a private fund account that does not look through to the underlying beneficial owners of a fund-of-funds invested in such private fund. In essence, the Amendment allows private funds to certify Rule 5131 compliance to FINRA members when seeking new issue allocations, even though the private fund (e.g., a hedge fund) does not look through certain of its investors (e.g., a fund-of-funds invested in such hedge fund) to its underlying beneficial owners (e.g., investors of a fund-of-funds) to determine whether any such investors are public company officers or otherwise covered by Rule 5131.

(For a discussion of Rule 5131 in general and its initial passage in 2011, please refer to our May 2011 client alert, "FINRA and SEC Approve New FINRA Rule 5131 re: "Spinning.")

The Amendment

Specifically, under Rule 5131, a FINRA member may rely upon a written representation obtained within the prior 12 months from a person authorized to represent an account (e.g., a hedge fund that invests in securities, such as new issues, directly) that does not look through to the beneficial owners of any unaffiliated private fund (e.g., a fund-of-funds) invested in the account, except for beneficial owners that are control persons of the investment adviser to such private fund (such as the general partner and/or principals of a fund-of-funds).

Such representation must say that the unaffiliated private fund (e.g., a fund-of-funds invested in such private fund/account): (1) is managed by an investment adviser; (2) has assets greater than $50 million; (3) owns less than 25 percent of the account; (4) is not a fund in which a single investor has a beneficial interest of 25 percent or more; and (5) was not formed for the specific purpose of investing in the account.

Conclusion

The Amendment benefits both direct investment hedge funds and funds-of-funds. Direct investment hedge funds do not need to determine Rule 5131 compliance of its funds-of-funds investors (or their beneficial owners) if such funds-of-funds can represent items 1 through 5 (above) to any such underlying hedge funds. Funds-of-funds, if they do not invest in new issues directly and only have exposures thereto indirectly by way of investment in other hedge funds, do not need lengthy Rule 5131 representations in their subscription agreements (provided that such funds-of-funds make Rule 5131 compliance inquiries to any control persons of its general partner and/or investment adviser).

Topics:  Compliance, FINRA, Investment Funds, Private Funds

Published In: Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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