FINRA, the securities self-regulatory organization whose members are broker-dealers, recently simplified two rules that are critical in the public offering process.

FINRA’s Corporate Financing Rule generally regulates underwriting compensation and prohibits unfair arrangements in connection with the public offering of securities.  Among other provisions, the rule requires members to file information with FINRA about the securities offerings in which they “participate” and to disclose affiliations and other relationships that may indicate the existence of conflicts of interest.  The rule also imposes lock-up restrictions on certain securities acquired from the issuer by a member and restricts the receipt of certain items of value, such as termination or “tail” fees and rights of first refusal as to future transactions (ROFRs).  In addition, FINRA’s Conflict of Interest Rule prohibits FINRA members that have a “conflict of interest” from participating in a public offering of securities unless certain conditions are met.

These two FINRA rules have been revised to simplify member participation in offerings and associated reporting, while enabling members to negotiate more broadly for tail fees and ROFRs, as follows:

  1. Independent financial advisers not “participating” in offering – FINRA members who provide advisory or consulting services to the issuer are no longer deemed to be “participating” in the offering if they are neither engaged in, nor affiliated with any entity that is engaged in, the solicitation of orders for or distribution of securities in the offering.
  2. Securities received to prevent dilution not subject to lock-up – participating members who receive securities to prevent dilution are no longer required to enter into a special lock-up as to those securities for the period of 180 days immediately following the date of effectiveness or commencement of sales in the public offering.
  3. Affiliation disclosure only as to “participating” members – the FINRA filing under the Corporate Financing Rule no longer requires disclosure regarding whether the issuer’s officers, directors and certain beneficial owners have an affiliation or association with “any” FINRA member and instead only requires such disclosure as to “participating” FINRA members.
  4. Ownership of 10 percent or more of subordinated debt not deemed “control” – FINRA members are no longer deemed to “control” an issuer (which by definition creates a conflict of interest under the Conflict of Interest Rule) by virtue of holding 10 percent or more of the issuer’s subordinated debt.
  5. Tail fee arrangements permitted – FINRA members may now receive a tail fee in connection with public offerings if the fee is set forth in an agreement that permits the issuer to terminate the member for “cause” (including the member’s material failure to perform its underwriting services) without incurring any obligation to pay the fee, the amount of the fee is reasonable in relation to the services, and the issuer is not responsible for paying the termination fee unless the offering or other transaction is consummated (without involvement of the member) within two years from the member’s termination.
  6. ROFR arrangements permitted – FINRA members may now receive ROFRs to participate in future transactions if the arrangement is set forth in an agreement that permits the issuer to terminate the member for “cause” (including the member’s material failure to perform its underwriting services) without incurring any obligation with respect to the ROFR and any fees arising from services provided pursuant to the ROFR are customary for those types of services. As before, the duration of the ROFR may not exceed three years from the date of the offering or termination of the member’s engagement.
  7. ETFs need not make FINRA filings – a FINRA filing under the Corporate Financing Rule will not be required for securities issued by an exchange-traded fund (ETF) if it is a pooled investment vehicle that is not a registered investment company but has equity securities listed for trading on a national securities exchange that can be created or redeemed on any business day at their net asset value per share.

Action steps

In light of these rule changes, FINRA members and their counsel should update their compliance questionnaires, checklists and other FINRA filing process tools. They should also consider updating their forms of agreements to avoid receiving unnecessarily locked-up securities and consider updating their engagement letters and other agreements to take advantage of the new flexibility for tail fees and ROFR arrangements.

For more information on items 1-4 summarized above, see this FINRA release, and for more information on items 5-7 summarized above, see this FINRA release.