FINRA, the largest independent regulator for all securities firms doing business in the United States, has released a set of FAQs relating to its review of public securities offerings filed on its Public Offering Filing System, which replaced FINRA’s COBRA Desk online filing system in June of 2012.

FINRA’s Corporate Financing Department reviews public offering filings and provides firms with regulatory guidance with respect to underwriting arrangements. The SEC defers to FINRA to establish reasonable levels of underwriting compensation and adequate disclosure of the underwriting terms and conflicts,1 and the staff of the SEC typically will not declare an issuer’s registration statement to be effective unless the filer has received a “no objections” letter from FINRA.

The recently released FAQs address a number of topics relating to FINRA’s corporate financing rules, including: exemptions to lock-up requirements; calculating underwriter compensation; disclosure requirements regarding underwriter’s counsel fees and expenses; conflicts of interest; dividend reinvestment programs (DRIPs), unlisted real estate investment trusts (REITs) and direct participation programs (DPPs); and filling fees and other process related issues. 

This legal update highlights some of the more salient FAQs, all of which can be read here:

Lock-up Requirements and Exemptions

  • All items of value received by underwriters during the 180-day period preceding a public offering are deemed to be underwriting compensation, unless they meet one of five exceptions provided in Rule 5110(d)(5). Unregistered securities acquired by underwriters during the 180-day review period that are excepted from such rule are subject to a 180-day lock-up following commencement of a public offering. However, in certain cases, FINRA has provided exemptive relief from such lock-up requirements. The FAQs set forth some facts and circumstances that FINRA staff has considered when determining whether to grant exemptive relief, in particular, whether:
    • the acquisition of the securities was required in order to restructure the issuer’s capitalization for certain specified purposes;
    • the securities were registered and included as part of the underwritten public offering; and
    • the securities were acquired under an arrangement that was designed to benefit the issuer and was not proposed by the FINRA member firm.

Underwriting Compensation

  • A Right of First Refusal (ROFR) granted to an underwriter is an item of value (worth the dollar amount the issuer has agreed to pay the underwriter to waive or terminate the ROFR, or, if no dollar amount has been agreed upon, 1% of the offering proceeds) required to be included in the underwriter compensation calculations, provided such ROFR is granted during the 180-day period prior to the commencement of a public offering.

Disclosure Requirements

  • If an underwriter’s counsel fees and expenses are paid or reimbursed by an issuer in connection with the distribution of a public offering, they must be included as underwriting compensation.  However they need not be separately itemized.   
  • When an underwriter receives compensation consisting of an option, warrant or convertible security, the specific terms of such instrument do not need to be disclosed in the prospectus. Rather, FINRA will review the instrument to determine whether its terms would violate Rule 5110(f)(2)(H).

Conflicts of Interest

  • FINRA has granted a limited exemption from compliance with the filing requirements of Rule 5110 and Rule 5121 for the public offerings of government sponsored enterprise issuers (GSE) when a conflict of interest exists because an affiliate of the underwriter owns more than 10% of the GSE. 
  • A FINRA member firm making a filing in connection with the offering of its own securities is required to engage a Qualified Independent Underwriter (QIU). In light of the fact that FINRA discontinued a program that required QIUs to file information annually to demonstrate that it met the Rule 5121(f)(12) standards, FINRA member firms are now required to represent in the Public Offering System that the QIU meets such qualification requirements.

DPPs and REITs

  • Rule 2310 prohibits unlisted REITs from charging a sales load or commission on securities that are purchased through the reinvestment of dividends.
  • The determination of whether a closed-end fund is a direct participation program (DPP) subject to Rule 2310 depends upon whether it receives flow-through tax treatment under the Internal Revenue Code, not on its legal structure.
  • FINRA has granted a limited exemption from the non-cash provision of Rule 2310 when an unlisted REIT hosts a training and education (T&E) meeting  with an affiliated unlisted REIT at or near a representative asset of the affiliated REIT, when the REIT and the affiliated REIT:
    • split the costs of the T&E meeting;
    • were managed by the same sponsor;
    • had selling agreements with the same broker-dealers; and
    • otherwise complied with the non-cash compensation requirements in Rule 2310.