FINRA Files Proposed Amendments to Rule 5110 and Rule 5121 Narrowing the Scope of Required Information and Lock-Up Restrictions in Public Offerings


On January 9, 2014, FINRA made a filing with the SEC (SR-2014-003) that proposes to amend Rule 5110 to: (1) narrow the scope of the definition of “participation or participating in a public offering;” (2) modify the lock-up restrictions to exclude certain securities acquired or converted to prevent dilution; and (3) clarify that the information requirements apply only to relationships with a “participating” member.  FINRA also proposed to amend Rule 5121 to narrow the scope of the definition of “control.”  The language in the current rules is broad and places restrictions and requirements on FINRA members in public offerings that FINRA finds are beyond the rules’ intended purpose.  The proposed changes, which are summarized below, would simplify the rules and clarify what actions and circumstances related to FINRA members are permissible in public offerings.

Participation in a Public Offering.  Rule 5110 regulates underwriting compensation and arrangements, which include items of value and other arrangements with FINRA members that are “participating” in the public offering of an issuer’s securities.  FINRA is proposing to amend the definition of “participation or participating in a public offering” to exclude any member that “provides advisory or consulting services to the issuer and is neither engaged in, nor affiliated with any entity that is engaged in, the solicitation or distribution of the offering.”  In its filing, FINRA explained that this would allow FINRA members to advise issuers on topics such as financing options, benefits and disadvantages of a public offering and offering terms being proposed by an underwriter.  However, if a FINRA member engages in any solicitation or distribution activities, then all compensation paid to that member, including for any advisory or consulting services, would be subject to the compensation limitations of Rule 5110.

Lock-Up Restrictions.  Rule 5110(g) places a 180-day lock-up restriction on underwriters barring them from selling securities acquired in the period beginning 180 days before the initial filing with FINRA, including securities that are excluded from underwriter compensation pursuant to Rule 5110(d)(5).  The proposed amendments would remove the lock-up restriction from the category of securities owned by a FINRA member due to “acquisitions and conversions to prevent dilution.”  FINRA notes that Rule 5110(d)(5) requires as a condition to the exclusion that the securities have been provided to all similarly situated security holders, and that the receipt of these additional securities did not increase the recipient’s percentage ownership of the same class.  FINRA explains that locking up such securities thus does not provide any useful protection, and that it is proposing to remove the lock-up restrictions on securities received in a transaction excluded by Rule 5110(d)(5) in order to remove unnecessary burdens on firms to track and monitor compliance with the lock-up provisions, among other reasons.

Information Requirements.  FINRA is proposing to amend Rule 5110(b)(6)(A)(iii) to require disclosure of affiliations or associations that officers, directors or certain owners of the issuer have with only “participating members” and not “members” in general.  FINRA recognizes that affiliations with non-participating members does not present the concerns that Rule 5110 is meant to address, including whether members are in a position to extract unreasonable underwriting terms.

Definition of “Control.”  FINRA is proposing to revise the definition of “control” in Rule 5121(f)(6) to exclude from it beneficial ownership of 10 percent or more of the outstanding subordinated debt of an entity.  FINRA explains that ownership of 10 percent or more of the outstanding subordinated debt of an issuer is not a meaningful measure of control or affiliation, and the proposed amendment would reduce the scope of information required to be reported by members.

Public Comment.  Comments are due 21 days after publication of the proposal in the Federal Register.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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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