FINRA recently simplified two rules that are critical in the public offering process. FINRA’s Corporate Financing Rule generally regulates underwriting compensation and prohibits unfair arrangements in connection with the public offering of securities. Among other provisions, the rule requires members to file information with FINRA about the securities offerings in which they “participate” and to disclose affiliations and other relationships that may indicate the existence of conflicts of interest. The rule also imposes lock-up restrictions on certain securities acquired from the issuer and restricts the receipt of certain items of value, such as termination, or “tail,” fees and rights of first refusal as to future transactions (ROFRs). In addition, FINRA’s Conflict of Interest Rule prohibits FINRA members that have a conflict of interest from participating in a public offering of securities unless certain conditions are met.
FINRA recently revised these rules to simplify member participation in offerings and associated reporting, while enabling members to negotiate more broadly for tail fees and ROFRs:
1. Independent financial advisers not “participating” in offering - FINRA members who provide advisory or consulting services are no longer be deemed to be “participating” in the offering if they are neither engaged in, nor affiliated with any entity that is engaged in, the solicitation or distribution of the offering.
2. Securities received to prevent dilution not subject to lock-up - participating members who receive securities to prevent dilution are no longer be required to lock up those securities for the period of 180 days immediately following the date of effectiveness or commencement of sales of the public offering.
3. Affiliation disclosure only as to “participating” members - the FINRA filing no longer requires disclosure regarding whether the issuer’s officers, directors, and certain beneficial owners have an affiliation or association with “any” FINRA member and instead only requires such disclosure as to “participating” FINRA members.
4. Ownership of 10 percent or more of subordinated debt not deemed “control” - FINRA members are no longer be deemed to “control” an issuer (which by definition creates a conflict of interest) by virtue of holding 10 percent or more of the issuer’s subordinated debt.
5. Tail fee arrangements permitted - FINRA members may now receive a tail fee in connection with public offerings if the fee is set forth in an agreement that permits the issuer to terminate the member for “cause” (including the member’s material failure to perform its underwriting services) without facing any obligation to pay the fees, the amount of the fee is reasonable in relation to the services, and the issuer consummates an offering or other transaction within two years from the member’s termination.
6. ROFR arrangements permitted - FINRA members may now receive ROFRs to participate in future transactions if the arrangement is set forth in an agreement that permits the issuer to terminate the member for “cause” (including the member’s material failure to perform its underwriting services) without facing any obligation with respect to the ROFR and the amount of any fees arising from services provided pursuant to the ROFR are customary for those types of services.
7. ETFs need not make FINRA filings - a FINRA filing will not be required for securities issued by an exchange-traded fund (ETF) if it is a pooled investment vehicle that is not a registered investment company but has equity securities listed for trading on a national securities exchange that can be created or redeemed on any business day at their net asset value per share.
In light of these rule changes, FINRA members should update their compliance questionnaires, checklists and other FINRA filing process tools. They should also consider updating their forms of agreements to avoid receiving unnecessarily locked up securities, and consider updating their engagement letters and other agreements to take advantage of the new flexibility for tail fees and ROFR arrangements. We have a number of attorneys here at DLA Piper who can assist you with those updates.