The Securities and Exchange Commission approved amendments to the Financial Industry Regulatory Authority New Issue Rule (Rule 5130) and Anti-Spinning Rule (Rule 5131) (collectively, Rules) on November 5, 2019 (Amendments).1 FINRA will shortly publish a Regulatory Notice announcing that the Amendments will become effective no later than January 31, 2020.
Absent an exemption, FINRA Rule 5130 prohibits securities industry insiders – such as broker-dealers, registered representatives, owners of broker-dealers, portfolio managers and finders and fiduciaries (collectively within Rule 5130’s definition of “restricted persons”) – from purchasing new issues (IPO shares) through any account in which they have a “beneficial interest.” FINRA Rule 5131 prohibits the allocation of new issues to accounts in which executive officers or directors of a public company or a “covered non-public company” have a beneficial interest. For further background on the Rules and the proposed amendments, please refer to Dechert OnPoint, FINRA Proposes Amendments to Rules 5130 and 5131 Governing Purchase and Sale of Initial Equity Public Offerings and New Issue Allocations.
Originally published for comment in the Federal Register on August 8, 2019, several commenters expressed concern about whether certain proposed amendments were unduly restrictive or failed to address important issues consistent with changes in the law, investment practices, and SEC views. To address commenters’ concerns, the Amendments, as approved by the SEC, expand exemptions and exclusions provided under the Rules relating to: family investment vehicles; U.S. and foreign employee retirement benefits plans; sovereign wealth funds that are owners of broker-dealers; foreign investment companies; foreign offerings; issuer-directed securities; special purpose acquisition companies (SPACs); and lock-up agreements (including in the context of anti-dilution).
Family Offices and Family Investment Vehicles
FINRA proposed exempting from Rule 5130 family investment vehicles beneficially owned by “family clients,” provided that if such beneficial owners include key employees who are not family members, the person with sole investment authority must be an “immediate family member” as defined in the Rule. Dechert filed comment letters on behalf of two clients urging FINRA to expand the definition to conform to the SEC’s Family Office Rule under the Investment Advisers Act of 1940. FINRA agreed, and revised the proposed amendments to remove the limitation with respect to immediate family members. Accordingly, amended Rule 5130 permits a family investment vehicle to purchase new issues where investment authority is exercised by a non-family member investment professional who is a key employee.
U.S. and Foreign Employee Retirement Benefits Plans
The Amendments add an exemption for foreign retirement plans similar to the Rule 5130 exemption for ERISA retirement plans. The exemption covers all foreign retirement plans, provided such plans: have at least 10,000 participants and $10 billion in assets; are open to employees regardless of income or position; are administered by trustees or managers that have a fiduciary obligation to administer the plan in the interests of participants and beneficiaries; and are not sponsored by a broker-dealer.
Sovereign Wealth Funds
The Amendments exclude “sovereign entities” (which term includes a pool of capital or investment fund owned or controlled by a sovereign nation) from the scope of owners of a broker-dealer that is restricted under Rule 5130. In response to a comment on the proposed amendments, FINRA expanded the scope of this exclusion to encompass other types of sovereign investment vehicles. Accordingly, amended Rule 5130 will permit a sovereign wealth fund, vehicle, or other pool of capital owned or controlled by a sovereign nation (including political subdivisions, agencies or instrumentalities thereof) to invest in new issues without regard to direct or indirect ownership by a broker-dealer.
Foreign Investment Companies
The Amendments add alternative tests to the current Rule 5130 exemption for foreign investment companies to include those that have 100 or more direct owners or 1,000 or more indirect owners. In response to a comment, FINRA narrowed the exemption to cover only foreign investment companies that were not formed for the specific purpose of permitting restricted persons to invest in new issues.
The Amendments exclude from the definition of “new issue” in both Rules a foreign offering made in accordance with Regulation S or otherwise made outside the United States that is not concurrently registered for sale in the United States. In response to comments on the proposed amendments, FINRA amended the exclusion by adding supplementary material clarifying that “while shares in a foreign offering that are concurrently registered for sale in the United States would not be categorically excluded from the definition of ‘new issue’ under Rules 5130 and 5131, the rules are not intended to restrict new issue allocations to non-U.S. persons by foreign nonmember broker-dealers participating in an underwriting syndicate, provided that such allocation decisions are not made at the direction or request of a member or an associated person of a member [broker-dealer].” All such allocations must be made independently by a foreign non-member broker-dealer participating in an underwriting syndicate.
The Amendments expand the exclusions from Rule 5130 for issuer-directed securities (i.e., securities as to which the issuer, its affiliates, or selling shareholders direct the allocation by underwriters). In response to comments on the proposed amendments, FINRA clarified that the exclusions apply to securities directed by a single affiliate or a single selling shareholder. FINRA further clarified that issuer-directed allocations to broker-dealer personnel, or members of their immediate family, who are employees or directors of the issuer or certain affiliated entities (i.e., the issuer’s parent, or a subsidiary of the issuer or the issuer’s parent) expressly includes employees and directors of franchisees.
Currently, FINRA Rule 5130 excludes from the definition of “new issue” the offerings of business development companies, direct participant programs and real estate investment trusts. In response to a comment on the proposed amendments, FINRA included SPACs in the exclusion.
The Amendments add an anti-dilution provision to FINRA Rule 5131, which is similar to the anti-dilution provision in FINRA Rule 5130 that permits allocation of new issues to executive officers and directors, enabling them to maintain their existing equity ownership positions. In response to comments that requested elimination of the lock-up provisions in both Rule 5130 and the proposed amendments to Rule 5131, FINRA asserted that the lock-up provisions are necessary to prevent non-bona fide investors from circumventing the provisions of the Rules.
Rule 5131(d)(2), which relates to lock-up agreements entered into by officers and directors of an issuer in connection with a new issue, requires releases or waivers of lock-ups to be publicly announced. In response to a commenter, FINRA excluded transfers to immediate family members from the Rule 5131 public announcement requirement.