SEC Approves FINRA Amendments to Rules 5130 and 5131

Morgan Lewis

Morgan Lewis

The US Securities and Exchange Commission (SEC) recently approved amendments to FINRA Rules 5130 and 5131 (the Rules).[1] The Rules are intended to promote fairness in the allocation of new issues of equity securities by prohibiting allocations to broker-dealers and persons who, among other things, own or control, directly or indirectly, more than 10% of a broker-dealer or who are portfolio managers (Restricted Persons).[2] The amendments to the Rules, among other things, update the Rules’ general exemptions, the definition of “Restricted Person,” and the definition of “new issue.” FINRA has not yet announced an effective date, but we believe the Rules will be effective relatively soon. FINRA member firms and others should begin evaluating account opening and other documents that collect information to facilitate compliance with the Rules, such as private fund subscription agreements, to determine whether they should be amended to incorporate the forthcoming changes to the Rules.

General Exemptions

  • US and Employee Retirement Benefit Plans: Rule 5130, as amended, includes a new general exemption from Rule 5130 for US and foreign retirement benefit plans that (i) have at least 10,000 participants and beneficiaries and $10 billion in assets, (ii) are operated such that a wide range of employees, regardless of income or position, can participate, (iii) are managed by fiduciaries acting in the best interest of the participants and beneficiaries, and (iv) are not sponsored by a broker-dealer.[3] This amendment results in a corresponding exemption in Rule 5131 as well.[4]
  • Foreign Investment Companies: Rule 5130, as amended, expands the ways that a foreign investment company can fall within the current general exemption from application of Rule 5130. Prior to the amendments, foreign investment companies were exempt from applicability of the Rule 5130 if they met the threshold criteria of (1) being organized outside the United States and authorized for sale to the public or traded on a foreign securities exchange, and (2) have no more than 5% of owners who are Restricted Persons. The amendments expand this exemption to provide an alternative to the 5% threshold of Restricted Persons, for foreign investment companies that have at least 100 direct investors or at least 1,000 indirect investors. A foreign investment company relying on this newly expanded exemption cannot have been formed for the specific purposes of permitting Restricted Persons to invest in new issues. This amendment also results in a corresponding exemption under Rule 5131.

Restricted Person (and Control Person) Exemption

  • Sovereign Wealth Funds: The amendments to Rule 5130 exclude from Restricted Persons sovereign entities, which include sovereign nations, pools of capital or funds owned or controlled by sovereign nations and any other vehicles owned or controlled by a sovereign nation created for the purpose of making investments on behalf of, or for the benefit of, the sovereign nation. This amendment addresses the situation in which a sovereign entity makes an investment that would otherwise cause the sovereign entity to be a “person owning a broker-dealer” and therefore a Restricted Person.
  • Family Investment Vehicle Advisers: The definition of Restricted Persons in Rule 5130 includes “portfolio managers,” but not portfolio managers that are advisers to family investment vehicles (often referred to as “family offices”). The amendments make the definition of family investment vehicles consistent with the concept of family offices set forth in the Investment Advisers Act of 1940. The changes expand the definition of family investment vehicles to include those that invest on behalf of multiple generations and also those that include as beneficiaries key employees, including advisers from the family office. As a result, advisers to these family investment vehicles are no longer treated as “portfolio managers” for purposes of Rule 5130 and therefore are no longer Restricted Persons.

New Issues Exclusions

  • Regulation S and Other Non-US Offerings of Securities: The amendments exclude from “new issues” offerings made under Regulation S or otherwise made outside the United States or its territories. However, the amendments also limit this exclusion so that it does not cover Regulation S and other non-US offerings made as part of a global offering part of which is registered in the United States, unless the offerings are made by a foreign nonmember broker-dealer that is participating in the underwriting syndicate for the global offering and is independently allocating the securities to non-US persons.
  • SPACs: The amendments approved by the SEC add special purpose acquisition companies (SPACs) to the list of products excluded from the definition of “new issue,” along with the currently excluded business development companies, direct participation programs and real estate investment trusts (REITs).

Other Changes

  • Unaffiliated Charitable Organizations”[5]: Rule 5131 is amended to exclude from “covered non-public companies” those charitable organizations that would otherwise, based on asset size, fall within the definition of “covered non-public company.” This exclusion is limited to 501(c)(3) organizations.
  • Issuer Directed Securities: Rule 5130 and Supplementary Material .01 to Rule 5131 are amended to allow one or more affiliates and selling shareholders to direct allocations of securities in compliance with the other conditions of the Rules.
  • Anti-Dilution Provisions: Rule 5131 is amended to add supplemental materials with anti-dilution provisions, similar to those already in Rule 5130. Supplementary Material .04 provides that if an executive officer or director of a public company or covered non-public company or a person materially supported by such a person has a beneficial interest in an account with an equity interest in an issuer or company acquired by the issuer in the year prior to the offering, the account can receive an allocation of the new issuer if the allocation would not increase the account’s equity ownership percentage above its level three months prior to the filing of the registration statement for the offering, there are no special terms, and securities acquired pursuant to the Supplementary Material .04 are essentially restricted for three months following the effective date of the offering.

Next Steps

Although comments are invited on these amendments, the amendments have been approved and will be effective on a date to be announced by FINRA. We believe that FINRA will make the amendments effective quickly and therefore we encourage affected firms to turn to their onboarding materials and begin amending materials to gather information both with regard to current investors and going forward with regard to new investors.


[1] Self Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Partial Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Partial Amendment No. 1, To Amend FINRA Rule 5130 (Restrictions on the purchase and Sale of initial Equity Public Offerings) and FINRA Rule 5131 (New Issue Allocations and Distributions), 84 Fed. Reg. 61102 (November 12, 2019).

[2] The complete definition of “restricted person” is found in Rule 5130(i)(10).

[3] FINRA had granted specific relief from Rule 5130 for foreign employee retirement benefit plans that have demonstrated that through their structure they could not serve as conduits for restricted persons to purchase new issues, and these letters informed the amendments now approved. See Letter from Gary L. Goldsholle, FINRA, to Edward A. Kwalwasser, Proskauer Rose LLP, dated December 7, 2010; Letter from Afshin Atabaki, FINRA, to Christopher M. Wells, Proskauer Rose LLP, dated November 2, 2012; Letter from Meredith Cordisco, FINRA, to Amy Natterson Kroll, Morgan, Lewis & Bockius LLP, dated July 23, 2015; and Letter from Meredith Cordisco, FINRA, to Amy Natterson Kroll, Morgan, Lewis & Bockius LLP, dated April 16, 2018.

[4] This amendment remedies a disparity in treatment due to the differences in exemptive authority in Rule 5130 and Rule 5131. Although FINRA Rule 5130(h) permits “the staff, for good cause shown [to] exempt any person, security or transaction,” FINRA Rule 5131(f) only permits exemptions “in exceptional and unusual circumstances.” As a result, FINRA has issued a number of individual exemptive letters under Rule 5130 to foreign employee retirement benefit plans, but has not been able to do the same under Rule 5131.
[5] An “‘unaffiliated charitable organization’ is a tax-exempt entity organized under Section 501(c)(3) of the Internal Revenue Code that is not affiliated with the member and for which no executive officer or director of the member, or person materially supported by such executive officer or director, is an individual listed or required to be listed on Part VII of Internal Revenue Service Form 990 (i.e., officers, directors, trustees, key employees, highest compensated employees and certain independent contractors).” FINRA Rule 5131(e)(9).

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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