On July 21, 2010, the Securities and Exchange Commission (the “SEC”) signed an order approving the Financial Industry Regulatory Authority, Inc.’s (“FINRA”) proposed Rule 5141, “Sale of Securities in a Fixed Price Offering” (the “Rule”). The Rule is intended to protect the integrity of fixed price offerings by ensuring that securities are sold to the public at the stated public offering price, and not at an undisclosed better price. The Rule was proposed as part of the development of a consolidated FINRA rulebook after FINRA replaced the National Association of Securities Dealers (the “NASD”). In addition to replacing NASD rules 0120(h), 2730, 2740 and 2750 (known as the Papilsky rules), and associated interpretive materials, the Rule eliminates provisions, such as recordkeeping requirements, that are addressed elsewhere in the consolidated FINRA rulebook, and adds additional provisions to clarify ambiguities in the predecessor NASD rules and related interpretative materials.

The Rule prohibits the grant of certain preferences, such as selling concessions, discounts and other allowances, in connection with fixed price offerings of securities. For purposes of the Rule, fixed priced offerings include securities offerings in the United States or any territory thereof, whether or not registered under the Securities Act of 1933, as amended, but specifically exclude “exempted securities” or “municipal securities” as such terms are defined under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Rule continues to apply to selling syndicate or selling group members, and clarifies that it is also applicable to single underwriters. The prohibition on granting certain preferences applies until the termination of the offering or until a member, or single underwriter, having made a “bona fide” public offering of the securities, is unable to continue selling such securities at the stated public offering price. This addresses “sticky deals.”

The Rule eliminates the general prohibition on transactions with related persons set forth in former NASD rule 2750. Section 5141(a) of the Rule permits a member of a selling syndicate or selling group, or a member that acts as a single underwriter, to sell securities in a fixed price offering to an affiliated person subject to the restrictions set forth in FINRA rule 5130. FINRA rule 5130 restricts the purchase and sale of initial equity public offerings and generally prohibits sales to and purchases by a broker-dealer and accounts in which a broker-dealer has a beneficial interest. Section 5141(b) clarifies that nothing in the Rule prohibits the purchase and sale of securities in a fixed price offering between members of the selling syndicate or selling group to ensure preservation of the underwriting process.

In addition, the Rule addresses certain ambiguities in the former NASD rules by adding new provisions under 5141.01, 5141.02, 5141.03, 5141.04 and 5141.05.

  • Provision 5141.01 provides a definition of a “reduced price” and provides greater certainty as to which economic equivalents, such as overtrading and improper underwriting recapture, are prohibited by the Rule. A reduced price includes a reduction of an advisory fee.
  • Provision 5141.02 clarifies that a member or person associated with a member that participates in a syndicate or selling group, or that acts as a single underwriter, is permitted to sell securities in the offering to a person or account to which it has provided or will provide research, provided that the person or account pays the state public offering price and the research is provided pursuant to Exchange Act Section 28(e).
  • 5141.03 clarifies that transactions between a member of a selling syndicate or selling group, or between a single underwriter and an affiliated person that are part of the normal and ordinary course of business and are unrelated to the sale or purchase of securities in a fixed price offering will not be deemed to confer a reduced price under the Rule.
  • Provision 5141.04 incorporates the NASD rule definition of “fixed price offering” with minor comments to bring the definition in line with the terms of the consolidated FINRA rulebook. Provision 5141.05 clarifies that a member who is an investment adviser may exempt securities that are purchased as part of a fixed price offering from the calculation of annual or periodic asset-based fees that the member charges a customer, provided that the exemption is part of the member’s normal and ordinary course of business with the customer and not solely in connection with the offering.

The Rule streamlines the regulatory process, reduces duplicative requirements already addressed in the consolidated FINRA rulebook generally, and clarifies certain definitions that should make it easier for members to determine which activities fall within the scope of the Rule. To the extent that underwriting agreements require members to make certain filings or maintain certain records in accordance with NASD rules, such agreements should be reviewed and revised to reflect the requirements under the general FINRA consolidated rulebook and existing SEC rules. For issuers who offer discounts for high-volume trades, the references to Notice to Members 81-3 in the Rule’s release and the decision not to repudiate this notice suggest that this practice is still permitted under the Rule provided that it meets the existing standard that the discount is not granted in a surreptitious manner and that it does not result in unfair discrimination vis-à-vis select investors. This position is further supported by the Rule’s definition of “fixed price offering” which does not explicitly prohibit multiple price offerings, provided that the different fixed prices are adequately disclosed. With respect to issuers who sell fixed offering price securities to investment advisers who onsell to their customers, the Rule clarifies when a different fixed price may be offered. Although 5141.05 expressly permits such practice, provided that it is part of the member’s normal and ordinary course of business with the customer, the Rule does not address the typical practice employed by members where two fixed price public offering prices are disclosed in the offering materials, one for general purchases and one for purchases made by persons who already pay fees to their investment advisers. The fact that this common practice is not expressly prohibited by the Rule suggests that it is still permitted. In either case, the issuer should disclose such arrangements in the offering documents.

The effective date has not been announced as of this writing.