Daily Rules, Proposed Rules, and Notices of the Federal Government
FINRA is proposing Amendment No. 3 to SR-NASD-2003-140, a proposed rule change to further and more specifically prohibit certain abuses in the allocation and distribution of shares in initial public offerings ("IPOs"). The text of the proposed rule change in Amendment No. 3 replaces and supersedes the text in the original rule filing and Amendment Nos. 1 and 2 thereto.
The text of the proposed rule change is available on FINRA's Web site at
In its filing with the Commission, FINRA included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. FINRA has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.
On September 15, 2003, NASD (n/k/a FINRA) filed with the SEC SR-NASD-2003-140, a proposed rule change to adopt new FINRA Rule 5131 (originally proposed as NASD Rule 2712) to address disclosure and management of conflicts of interests that may adversely affect the allocation and distribution of IPOs. The proposed rule change also is intended to sustain public confidence in the IPO process, which is critical to the continued success of the capital markets. The SEC published the proposed rule change for notice and comment on December 20, 2004 and received twelve comment letters.
FINRA is filing this Amendment No. 3 to address the substantive issues raised by commenters and to clarify and streamline the proposed rule. Among other things, the revisions simplify the spinning provision, clarify the scope of the lock-up disclosure and returned shares provisions and propose several new defined terms.
FINRA is eliminating the presumption that any allocation within the prior six months of the receipt of investment banking business would violate the spinning provision. Instead, FINRA is proposing an outright prohibition on allocations in certain specified situations where a client relationship exists, where compensation has been received or where a member intends to provide or expects to be retained for investment banking services. Specifically, FINRA is proposing amendments to clarify that the spinning prohibition would apply to allocations to the account of an executive officer or director of a current investment banking client of the member in addition to companies from which the member has received investment banking compensation during the past twelve months. Further, FINRA is proposing to narrow the forward-looking window to three months in order to capture circumstances during such period where the member intends to provide, or expects to be retained by the company for, investment banking services within the next three months.
FINRA is adding Supplementary Material .01 to provide that the spinning prohibition would not apply to allocations of securities that are directed in writing by the issuer, its affiliates or selling shareholders, so long as the member has no involvement or influence, directly or indirectly, in the allocation decisions of the issuer, its affiliates or selling shareholders with respect to such issuer-directed securities. In addition, to clarify the scope of the types of accounts to which the spinning restrictions would apply, FINRA is proposing a new defined term "account of an executive officer or director." The proposed definition would mean any account in which an executive officer or director of a company, or a person materially supported by such executive officer or director, has a financial interest or over which such executive officer, director,
FINRA is proposing to exempt from the notice and disclosure requirements releases and waivers effected solely to permit transfers of securities that are not for consideration where the transferee has agreed in writing to be bound by the same lock-up agreement terms in place for the transferor. FINRA believes that, where the transfer is not for consideration and the transferee is bound by the same terms, the concerns that generally would prompt the need for disclosure under the proposal are mitigated.
In addition, FINRA is proposing to amend the provision addressing the agreement among underwriters, which provides that the agreement between the book-running lead manager(s) and other syndicate members must require that any shares returned by a purchaser to a syndicate member after secondary market trading commences be used to: (a) Offset the existing syndicate short position, or (b) if no syndicate short position exists, the member must offer returned shares at the public offering price to unfilled customers' orders pursuant to a random allocation methodology. Because the allocation concerns underlying the proposed rule only exist where the market price of the returned shares is above the IPO price, FINRA is proposing to amend the proposed rule to provide that the returned shares provision would only be applicable where such shares are trading at a premium to their IPO price. In addition, because a reallocation of returned shares may extend the distribution of the securities for the purposes of SEC Regulation M, FINRA reminds members of their responsibility to undertake reallocations under the proposal in a manner that also is not inconsistent with SEC Regulation M.
FINRA also is proposing to limit the prohibition on the acceptance of market orders to the period prior to the commencement of secondary market trading in the IPO. Therefore, once a trading price on the secondary market has been established, members may accept market orders from customers, even on the first day of trading. FINRA believes that this revised approach strikes an appropriate balance by helping to avoid inadvertent purchases at prices that do not reflect an investor's true investment decision nor reasonable expectations, while limiting the scope and duration of the prohibition to address the pre-open entry of market orders occurring prior to the availability of last trade price information.
FINRA is proposing to add a definition of "investment banking services" substantially similar to that found in the research rules. The proposed definition of "investment banking services" would include "acting as an underwriter, participating in a selling group in an offering for the issuer or otherwise acting in furtherance of a public offering of the issuer; acting as a financial adviser in a merger, acquisition or other corporate reorganization; providing venture capital, equity lines of credit, private investment, public equity transactions (PIPEs) or similar investments or otherwise acting in furtherance of a private offering of the issuer; or serving as placement agent for the issuer."
FINRA also is proposing a definition of "IPO" to mean the "initial public offering of an issuer's equity securities, which offering is registered under the Securities Act of 1933 and as a result of which the issuer becomes a public company." The proposed definition of "public company" means "any company that is registered under Section 12 of the Securities Exchange Act of 1934 or files periodic reports pursuant to Section 15(d) thereof."
FINRA will announce the effective date of the proposed rule change in a
FINRA believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,
FINRA does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.
The SEC published the proposed rule change for notice and comment on December 20, 2004 and received twelve comment letters.
Proposed Rule 5131(a) (originally proposed as NASD Rule 2712(a)) would
For example, one commenter requested that the proposal be limited to compensation that is "clearly excessive."
Commenters also requested that FINRA provide additional guidance to clarify that, in determining whether or not compensation is excessive, all the facts and circumstances surrounding the services provided will be considered including, among other things, the risk and effort involved in the transaction.
FINRA agrees that an assessment of whether compensation is excessive will be based upon all of the relevant facts and circumstances including, where applicable, the level of risk and effort involved in the transaction and the rates generally charged for such services. Likewise, given that a determination of what is "excessive" compensation will involve a consideration of all the relevant facts and circumstances, FINRA cannot clarify whether or not compensation for a particular wash sale transaction will be deemed excessive. While NASD (n/k/a FINRA) has stated in the Proposing Release that trading activity that serves no economic purpose other than to generate compensation for the member (such as certain wash sales) would be considered excessive, if a wash sale has an economic purpose, that factor will be considered in assessing whether the transaction has an economic purpose, and in turn whether the trading fees for such sales are excessive.
Proposed Rule 5131(b) (originally proposed as NASD Rule 2712(b)) would prohibit the allocation of IPO shares to an executive officer or director of a company, or to persons materially supported by such person, if the member received compensation from the company for investment banking services in the past 12 months or expects to receive or intends to seek investment banking business from the company in the next 6 months. The proposal included a rebuttable presumption that, where a firm allocates IPO shares to an executive officer or director of a company and then subsequently receives investment banking business from that company, the allocations would be deemed to have been made with the expectation or intent to receive such business. Finally, the proposed provision would prohibit allocations made on the express or implied condition that the executive officer or director, on behalf of the company, would direct future investment banking business to the member.
Commenters generally supported the adoption of a rule that would address the practice of spinning, but expressed concern that the proposal is overbroad and would lead to compliance difficulties.
FINRA is proposing to narrow the forward-looking window to prohibit allocations in cases where the member intends to provide, or expects to be retained by the company for, investment banking services over the next three months. FINRA believes that a three-month window, combined with the prohibition on allocations based on the express or implied condition that the member will be retained for future investment banking business as set forth in paragraph 5131(b)(3), will sufficiently addresses this conflict of interest.
In addition, FINRA has eliminated the presumption that all allocations within the prior specified period are violations of the rule. Where an executive officer or director receives an IPO allocation and the investment bank is subsequently retained for the performance of investment banking services within the three-month window by such executive officer or director's employing firm, FINRA will investigate what particular information about the business relationship was known by the firm, including a review of the communications between the broker-dealer and the investment banking client as well as the member's systems for logging and managing prospective and current client and transaction information.
FINRA also is proposing revisions to clarify that the spinning prohibition would apply to allocations to an executive officer or director of a current investment banking client of the member (in addition to companies from which the member has received investment banking compensation during the past twelve months). FINRA believes that, in all cases, allocations to executive officers and directors of existing clients should be prohibited, and that allocations should not be permitted due to the compensation schedule between the client and the member where the business relationship falls within the specified windows.
Commenters also raised concerns regarding the provision prohibiting the allocation of IPO shares to an executive officer or director on the "express or implied" condition that such executive officer or director, on behalf of the company, will retain the member for the performance of future investment banking services.
Several commenters requested an exemption from the spinning provision for allocations to executive officers and directors that were directed by the issuer ("issuer-directed shares").
FINRA believes that so long as the member has no involvement or influence, directly or indirectly, in the allocation decisions of an issuer, its affiliates or selling shareholders, allocations directed by such parties should fall outside of the spinning prohibitions. Accordingly, FINRA is adding Supplementary Material .01 to provide that the spinning prohibition would not apply to allocations of securities that are directed in writing by the issuer, its affiliates or selling shareholders, so long as the member has no involvement or influence, directly or indirectly, in the allocation decisions of the issuer, its affiliates or selling shareholders with respect to such issuer-directed shares.
Along with the carve-out for issuer-directed sharers, commenters also requested an exemption for allocations made by a separately organized investment adviser.
To comply with the proposed spinning provision, members would be required to determine whether an account is an "account of an executive officer or director" prior to making an allocation of IPO shares in order to avoid violating the rule. Commenters expressed concern regarding the compliance burden of tracking executive officers and directors and those materially supported by them, and requested that the rule be limited to apply only to the officers and directors themselves and immediate family members living in the same household.
Commenters also stated that the rule should be limited to officers and directors of a U.S. public company or where the securities of the officer or director's company are principally traded in the U.S.
In addition, in order to clarify the scope of the types of accounts to which the spinning restrictions would apply, FINRA is proposing a new defined term "account of an executive officer or director." The proposed definition would mean any account in which an executive officer or director of a company, or a person materially supported by such executive officer or director, has a financial interest or over which such executive officer, director, or materially supported person has discretion or control, other than (A) an investment company registered under the Investment Company Act of 1940 and (B) any other investment fund over which neither an executive officer, director, or materially supported person has discretion or control, provided that executive officers, directors, and materially supported persons collectively own interests representing no more than 25% of the assets of such fund. FINRA believes that the proposed exceptions for registered investment companies and any other fund in which covered persons' collective interests are limited to 25% of the fund's assets will prevent firms from indirectly allocating IPOs to executive officers and directors.
Commenters generally supported the proposals related to IPO Pricing and Trading Practices; however some commenters expressed concern regarding certain provisions. Commenters argued that the notice and public disclosure requirements relating to lock-up agreements would result in a flood of meaningless information and that, therefore, at a minimum, only the release of a significant amount of shares should be required to be disclosed.
FINRA continues to believe that public disclosure should be required for releases and waivers permitting the transfer of securities subject to a lock-up agreement, and that such disclosure should be made two business days prior to the impending release. However, FINRA is proposing to exempt from the notice and disclosure requirements releases and waivers effected solely to permit a transfer of securities that are not for consideration and where the transferee has agreed in writing to be bound by the same lock-up agreement terms in place for the transferor. Where the transfer is not for consideration and the transferee is bound by the same terms, the concerns that generally would prompt the need for disclosure under the proposal are mitigated.
Commenters requested that FINRA permit the disclosure of the required information through any method permitted under SEC Regulation FD.
FINRA believes that any news service used by issuers for providing public disclosure of material information pursuant to SEC Regulation FD would satisfy the proposed rule's requirement that public disclosure be made "through a major news service." FINRA also agrees that notice and public disclosure is not necessary for the natural expiration of a lock-up already disclosed in the prospectus. However, FINRA does not believe that it is necessary to make these clarifications in the rule text.
One commenter requested that FINRA clarify that the notice requirement would be fulfilled by providing an announcement to a major news organization irrespective of whether the news organization ultimately publishes the announcement.
Commenters also expressed concern regarding the proposed requirements applicable to returned shares.
Commenters further requested clarification regarding the requirements for returned shares. Commenters argued that certain scenarios should be exempted from the rule, including where the securities returned were the subject of a bona fide sale but the investor failed to pay for the securities.
Commenters also raised concern that the reallocation of shares subsequent to the commencement of aftermarket trading may be considered to be new sales of securities that continue the distribution of the IPO shares with the result that members' market-making purchases in the aftermarket may be deemed to be in violation of SEC Regulation M.
The proposed rule change also provides that no member may accept a market order for the purchase of IPO shares during the first day that the IPO shares commence trading on the secondary market. Commenters expressed concern that this provision would increase volatility in secondary market trading and also would be technologically cumbersome and costly for members to implement.
FINRA notes that technological advancements since the time of the initial filing have resulted in improved access to real-time price information, making it less likely that a customer's market order would result in the purchase of a security at a price that is unrelated to the customer's expectations. Thus, FINRA proposes to modify the prohibition on the acceptance of market orders to apply only to orders entered prior to the commencement of secondary market trading in an IPO. FINRA believes that this revision more precisely focuses the rule to the time posing greatest potential for investor harm.
Commenters requested several amendments to the definitional section with respect to certain terms used in the proposal. Commenters requested that a definition of "investment banking services" be added and that such definition be based on the research analyst rules.
One commenter requested that, if a definition of "investment banking services" were adopted, it should be limited to U.S. registered offerings.
Commenters supported the addition of definitions for the terms "initial public offering" and "public company."
Within 35 days of the date of publication of this notice in the
(A) By order approve such proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule change should be disapproved.
We seek specific comment on whether there are any alternatives to the proposed rule change that FINRA should consider, such as whether proposed new Rule 5131(b)'s spinning provision should be modified to include a mandatory ban prohibiting members from seeking or providing investment banking services to a company for a period of 12 months following any allocation of IPO shares to an account of an executive officer or director of such company and whether such a ban would facilitate compliance.
Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods:
* Use the Commission's Internet comment form (
* Send an e-mail to
* Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-NASD-2003-140. This file number should be included on the subject line if e-mail 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 Web site (