US: Amendments to FINRA Rules 5130 and 5131 Provide Greater Flexibility

Background

FINRA Rule 5130 generally restricts, among other things, broker-dealers (or persons associated with them) from selling shares of a new issue, to an account in which a restricted person has a beneficial interest. Rule 5131 restricts (so called “spinning”) brokers from selling new issues to accounts that are beneficially owned by persons that are executive officers or directors of public companies having specified relationships with the broker-dealer (and persons materially supported by such persons) (“Covered Persons”). Since FINRA Rules 5130 and 5131 look to the beneficial owners of an account, persons responsible for making investments in new issues for accounts with multiple beneficial owners, such as managers of private investment funds, need to determine whether the beneficial owners of such accounts are Restricted Persons or Covered Persons. For purposes of these rules beneficial interest can take the form of almost any economic interest such as a right to share in the profits or losses.

Revisions

FINRA’s update to these rules clarifies many historically obscure points and provides greater flexibility for investors:

Non-U.S. Investment Companies

Non-U.S. Offerings and Independent Allocations by Non-U.S. Non-Member Broker-Dealers

Sovereign Entities

Sovereign entities are now excluded from the category of restricted persons covering owners of brokerdealers. FINRA has newly defined a “sovereign entity” to be a sovereign nation or a pool of capital or an investment fund owned or controlled by a sovereign nation and created for the purpose of making investments on behalf of the sovereign nation. Additionally, a “sovereign nation” is defined as a sovereign nation or its political subdivisions agencies or instrumentalities. The exclusion does not extend; however, to affiliates of sovereign entities that are otherwise restricted. By way of example, the broker owned by the sovereign entity would continue to be restricted while the sovereign entity would not.

Non-U.S. Employee Retirement Benefit Plans

Rule 5130(c)(8) now provides an exemption for an employee retirement benefit plan organized under, and governed by, either U.S. or non-U.S. laws, provided that such plan or family of plans: (1) has, in aggregate, at least 10,000 plan participants and beneficiaries and $10 billion in assets, (2) is operated in a nondiscriminatory manner, insofar as a wide range of employees regardless of income or position, may participate (3) is administered by trustees or managers that have a fiduciary obligation to the participants and beneficiaries, and (4) is not sponsored solely by a broker-dealer.

Issuer-Directed Securities

Rules 5130(d) and 5131.01 provide exemptions for issuer-directed allocations of securities, subject to specified conditions. For consistency with Rule 5131.01, FINRA has amended paragraph (d) of Rule 5130 to apply the exemptions to securities directed by affiliates and selling shareholders of the issuer and to clarify that the exemptions apply to securities directed in writing. FINRA has clarified that certain exemptions also apply to securities that are directed by a single affiliate or selling shareholder of the issuer. In addition, FINRA has amended Rule 5130(d)(1)(B) to permit issuer-directed allocations of securities to employees and directors of franchisees.

SPACs

FINRA has excluded special purpose acquisition companies (“SPACs”) from the definition of “new issue,” citing that like registered closed-end investment companies, business development companies and real estate investment trusts SPACs typically commence trading at the public offering price with little potential for trading at a premium given that their assets at the time the IPO trades consist of the capital they have raised through the offering process. Moreover, if there is a premium, it is generally small.

Family Investment Vehicles

Historically FINRA has defined a “family investment vehicle” as a legal entity that is beneficially owned solely by immediate family members (largely these are a person’s parents, mother-in-law or father-in-law, spouse, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children, and any other individual to whom the person provides material support³). A person with the authority to buy or sell securities for such a family investment vehicle has not been considered a portfolio manager based solely on this investment authority and, therefore was not considered a restricted person under Rule 5130. The amendments broaden what constitutes a family investment vehicle to more closely align with the definition of a family office under the Investment Advisers Act of 1940.

Lock-Up Agreements

Rule 5131(d)(2) requires lock-up agreements applicable to the officers and directors of an issuer entered into in connection with the new issue stipulate certain notification procedures be followed informing the issuer and general public of the impending release or waiver of such lock-up agreement’s transfer restrictions. The exemption for transfers not involving compensation that are to persons agreeing to be bound by the same lock-up terms, has been modified to include immediate family members as defined in Rule 5130(i)(5) provided that the transferee agree in writing to be bound by the same lock-up agreement terms in place for the transferor. Finally, the amendment modified Rule 5131.03 to include the disclosure of a release in a publicly filed registration statement in connection with a secondary offering within the definition of announcement through a major news service.

Unaffiliated Charitable Organizations

The amendment excludes unaffiliated charitable organizations from the definition of a “covered non-public company” for the purposes of the “spinning” prohibition under Rule 5131, effectively allowing allocation of new issues to executive officers and directors of these charitable organizations even if they have a current or potential investment banking relationship.

Addition of Anti-Dilution Provision