
[Federal Register: October 5, 2010 (Volume 75, Number 192)]
[Notices]               
[Page 61541-61547]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05oc10-151]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63010; File No. SR-NASD-2003-140]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 4 and Order Granting 
Accelerated Approval of a Proposed Rule Change, as Modified by 
Amendment Nos. 1 Through 4, Relating to the Prohibition of Certain 
Abuses in the Allocation and Distribution of Shares in Initial Public 
Offerings (``IPOs'')

September 29, 2010.

I. Introduction

    On September 15, 2003, the National Association of Securities 
Dealers, Inc. (``NASD'') (n/k/a the Financial Industry Regulatory 
Authority, Inc. (``FINRA'')) filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt new FINRA Rule 5131 
(originally proposed as NASD Rule 2712) to further and more 
specifically prohibit certain abuses in the allocation and distribution 
of shares in initial public offerings (``IPOs''). NASD amended the 
proposed rule change on December 9, 2003 and August 4, 2004. On 
February 10, 2010, FINRA filed with the Commission Amendment No. 3 to 
SR-NASD-2003-140.\3\ The Commission published the proposed rule change, 
as modified by Amendment No. 3, for comment in the Federal Register on 
March 18, 2010.\4\ The Commission received three comment letters in 
response to the proposed rule change.\5\ On July 30, 2010, FINRA 
responded to the comment letters and filed Amendment No. 4 to the 
proposed rule change. The Commission is publishing this notice and 
order to solicit comments on Amendment No. 4, and to approve the 
proposed rule change, as modified by Amendment Nos. 1 through 4, on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 50896 (Dec. 20, 
2004), 69 FR 77804 (Dec. 28, 2004).
    \4\ See Securities Exchange Act Release No. 61690 (March 11, 
2010), 75 FR 13176 (March 18, 2010) (``Amendment No. 3'').
    \5\ See Letter from Jeffrey W. Rubin, Chair, Committee on 
Federal Regulation of Securities, Business Law Section, American Bar 
Association (``ABA''), to Elizabeth M. Murphy, Secretary, SEC, dated 
April 6, 2010; Letter from Sean Davy, Managing Director, Corporate 
Credit Markets Division, Securities Industry Financial Markets 
Association (``SIFMA''), to Elizabeth M. Murphy, Secretary, SEC, 
dated April 8, 2010; and Letter from Ross M. Langill, Chairman & 
CEO, Regal Bay Investment Group LLC (``Regal''), to Elizabeth M. 
Murphy, Secretary, SEC, dated April 8, 2010.
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II. Description of Proposal

a. Quid Pro Quo Allocations

    Proposed FINRA Rule 5131(a) would prohibit any member or person 
associated with a member from offering or threatening to withhold 
shares it allocates of a new issue as consideration or inducement for 
the receipt of compensation that is excessive in relation to the 
services provided by the member.

b. Prohibition on Spinning

    Proposed FINRA Rule 5131(b) would prohibit the allocation of new 
issue shares to the account of an executive officer or director of a 
company (1) if the company is currently an investment banking services 
client of the member or the member has received compensation from the 
company for investment banking services in the past 12 months; (2) if 
the member intends to provide, or expects to be retained by the company 
for, investment banking services within the next 3 months; or (3) on 
the express or implied condition that such executive officer or 
director, on behalf of the company, will retain the member for the 
performance of future investment banking services.
    FINRA also proposes that members establish, maintain and enforce 
policies and procedures reasonably designed to ensure that investment 
banking personnel have no involvement or influence, directly or 
indirectly, in the new issue allocation decisions of the member. The 
spinning provision would apply to any account in which an executive 
officer or director of a public company or a ``covered non-public 
company,'' or a person materially supported by such executive officer 
or director, has a beneficial interest. The term ``covered non-public 
company'' would mean any non-public company satisfying the following 
criteria: (i) Income of at least $1 million in the last fiscal year or 
in two of the last three fiscal years and shareholders' equity of at 
least $15 million; (ii) shareholders' equity of at least $30 million 
and a two-year operating history; or (iii) total assets and total 
revenue of at least $75 million in the latest fiscal year or in two of 
the last three fiscal years.\6\ FINRA also proposes to prohibit new 
issue allocations only where the person responsible for making the 
allocation decision ``knows or has reason to know that the member 
intends to provide, or expects to be retained by the company for, 
investment banking services within the next 3 months.''
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    \6\ These criteria are based on quantitative initial listing 
standards for a national securities exchange, which FINRA believes 
is a suitable proxy for the types of companies that are likely to be 
targeted by members for investment banking services. In this case, 
FINRA has determined that the applicable standards should be no less 
than those required for initial listing on the NASDAQ Global Market. 
FINRA further believes that, in modifying the scope of companies 
covered by the spinning provisions, it is unnecessary to create a de 
minimis standard for investment banking services compensation as 
urged by ABA. Moreover, FINRA also believes that a de minimis 
standard would pose additional compliance burdens and would be 
susceptible to abuse by those seeking to avoid application of the 
proposed rule.
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    In addition, to facilitate compliance with the spinning provisions 
as requested by commenters, proposed new Supplementary Material .02 
would expressly permit members to rely on written representations 
obtained within

[[Page 61542]]

the prior 12 months from the beneficial owner(s) of the account (or a 
person authorized to represent the beneficial owner(s)) as to whether 
such beneficial owner(s) is an executive officer or director (or person 
materially supported by an executive officer or director) and if so, 
the company(ies) on whose behalf such executive officer or director 
serves. FINRA requires that the initial representation be an 
affirmative representation, but will permit such representation to be 
updated annually through the use of negative consent letters. Finally, 
a member would be required to maintain a copy of all records and 
information relating to whether an account is eligible to receive an 
allocation of the new issue for at least three years following the 
member's allocation to that account.
    FINRA also proposes to include a limitation in the spinning rule 
providing that the spinning prohibitions would not apply to allocations 
made to any account described in FINRA Rule 5130(c)(1) through (3) and 
(5) through (10), or to any other account in which the beneficial 
interests of executive officers and directors of the company and 
persons materially supported by such executive officers and directors 
in the aggregate do not exceed 25% of such account.\7\ FINRA also 
proposes to add a new definition of ``beneficial interest,'' which 
would have the same meaning as FINRA Rule 5130.\8\
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    \7\ One commenter asked that hedge funds clearly be included in 
the proposal. See Regal. FINRA notes that hedge funds would be 
included where the beneficial interest of executive officers and 
directors of a particular company (and materially supported persons) 
in the aggregate exceed 25%. FINRA continues to believe that the 25% 
threshold is most appropriate and therefore will not increase the 
standard to 50% as requested by one commenter. See ABA.
    \8\ FINRA Rule 5130(i)(1) defines ``beneficial interest'' to 
mean any economic interest, such as the right to share in gains or 
losses. The receipt of a management or performance based fee for 
operating a collective investment account, or other fees for acting 
in a fiduciary capacity, shall not be considered a beneficial 
interest in the account.
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    FINRA proposes to use the term ``new issue'' throughout the 
proposed rule and to use the same definition provided in FINRA Rule 
5130(i)(9). Thus, the proposed rule, as amended, would apply to ``new 
issues,'' meaning ``any initial public offering of an equity security 
as defined in Section 3(a)(11) of the Act, made pursuant to a 
registration statement or offering circular.'' As such, the proposed 
definition of ``new issue'' would exclude:
     Offerings made pursuant to an exemption under Section 
4(1), 4(2) or 4(6) of the Securities Act of 1933 (``Securities Act''), 
or Securities Act Rule 504 if the securities are ``restricted 
securities'' under Securities Act Rule 144(a)(3), or Rule 144A or Rule 
505 or Rule 506 adopted thereunder;
     Offerings of exempted securities as defined in Section 
3(a)(12) of the Act, and rules promulgated thereunder;
     Offerings of securities of a commodity pool operated by a 
commodity pool operator as defined under Section 1a(5) of the Commodity 
Exchange Act;
     Rights offerings, exchange offers, or offerings made 
pursuant to a merger or acquisition;
     Offerings of investment grade asset-backed securities;
     Offerings of convertible securities;
     Offerings of preferred securities;
     Offerings of an investment company registered under the 
Investment Company Act of 1940 (``Investment Company Act'');
     Offerings of securities (in ordinary share form or ADRs 
registered on Form F-6) that have a pre-existing market outside of the 
United States; and
     Offerings of a business development company as defined in 
Section 2(a)(48) of the Investment Company Act, a direct participation 
program as defined in Rule 2310(a) or a real estate investment trust as 
defined in Section 856 of the Internal Revenue Code.

c. Policies Concerning Flipping

    Proposed FINRA Rule 5131(c)(1) would prohibit members or persons 
associated with a member from directly or indirectly recouping, or 
attempting to recoup, any portion of a commission or credit paid or 
awarded to an associated person for selling shares of a new issue that 
are subsequently flipped by a customer, unless the managing underwriter 
has assessed a penalty bid on the entire syndicate. Moreover, proposed 
FINRA Rule 5131(c)(2) would require, in addition to any obligation to 
maintain records relating to penalty bids under SEA Rule 17a-2(c)(1), 
that members promptly record and maintain information regarding any 
penalties or disincentives assessed on its associated persons in 
connection with a penalty bid.

d. IPO Pricing and Trading Practices

(1) Indications of Interest
    Proposed FINRA Rule 5131(d)(1) would require, in a new issue, the 
book-running lead manager to provide to the issuer's pricing committee 
(or, if the issuer has no pricing committee, its board of directors): 
(1) A regular report of indications of interest, including the names of 
interested institutional investors and the number of shares indicated 
by each, as reflected in the book-running lead manager's book of 
potential institutional orders, and a report of aggregate demand from 
retail investors; and (2) after the settlement date of the new issue, a 
report of the final allocation of shares to institutional investors as 
reflected in the books and records of the book-running lead manager 
including the names of purchasers and the number of shares purchased by 
each, and aggregate sales to retail investors.
(2) Lock-Up Agreements
    Proposed FINRA Rule 5131(d)(2) would require that any lock-up 
agreement or other restriction on the transfer of the issuer's shares 
by officers and directors of the issuer entered into in connection with 
a new issue must provide that such restrictions will apply to their 
issuer-directed shares. It also must provide that, at least two 
business days before the release or waiver of any lock-up or other 
restriction on the transfer of the issuer's shares, the book-running 
lead manager will notify the issuer of the impending release or waiver 
and announce the impending release or waiver through a major news 
service. The exceptions to this notification requirement are where the 
release or waiver is effected solely to permit a transfer of securities 
that is not for consideration and where the transferee has agreed in 
writing to be bound by the same lock-up agreement terms in place for 
the transferor.
    FINRA also is proposing new Supplementary Material .03 to provide 
that the required announcement also may be made by another member or 
the issuer (although it remains the responsibility of the book-running 
lead manager to ensure that the impending release or waiver is properly 
announced in compliance with this Rule).
(3) Returned Shares
    Proposed FINRA Rule 5131(d)(3) would require that the agreement 
between the book-running lead manager and other syndicate members must 
require, to the extent not inconsistent with SEC Regulation M, that any 
shares trading at a premium to the public offering price that are 
returned by a purchaser to a syndicate member after secondary market 
trading commences be used to offset the existing syndicate short 
position. If no syndicate short position exists, proposed FINRA Rule 
5131(d)(3)(B) would require the member to either: (1) Offer returned 
shares at the public offering price to unfilled customers' orders 
pursuant to a random allocation methodology; or (2) sell returned 
shares on the secondary market and donate profits from the sale to an

[[Page 61543]]

``unaffiliated charitable organization'' with the condition that the 
donation be treated as an anonymous donation to avoid any reputational 
benefit to the member. Proposed FINRA Rule 5131 would establish a new 
definition of ``unaffiliated charitable organization'' to prevent such 
charitable donations from benefiting the member or executive officers 
and directors of the member (and persons they materially support).\9\ 
The definition of ``unaffiliated charitable organization'' is closely 
tied to specific information charities are required to file with the 
Internal Revenue Service.
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    \9\ Proposed FINRA Rule 5131(e)(9) defines ``unaffiliated 
charatable organization'' as a tax-exempt entity organized under 
Section 501(c)(3) of the Internal Revenue Code that is not 
affiliated with the member and for which no executive officer or 
director of the member, or person materially supported by such 
executive officer or director, is an individual listed or required 
to be listed on Part VII of the Internal Revenue Service Form 990 
(i.e., officers, directors, trustees, key employees, highest 
compensated employees and certain independent contractors).
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(4) Market Orders
    Proposed FINRA Rule 5131(d)(4) would require that no member may 
accept a market order for the purchase of shares of a new issue in the 
secondary market prior to the commencement of trading of such shares in 
the secondary market.

e. Definitions

    Proposed FINRA Rule 5131(d) would provide the following 
definitions. The term ``public company'' would mean any company that is 
registered under Section 12 of the Exchange Act or files periodic 
reports pursuant to Section 15(d) thereof. The term ``beneficial 
interest'' would have the same meaning as defined in FINRA Rule 
5130(i)(1). The term ``covered security'' would mean any non-public 
company satisfying the following criteria: (i) Income of at least $1 
million in the last fiscal year or in two of the last three fiscal 
years and shareholders' equity of at least $15 million; (ii) 
shareholders' equity of at least $30 million and a two-year operating 
history; or (iii) total assets and total revenue of at least $75 
million in the latest fiscal year or in two of the last three fiscal 
years. The term ``flipped'' would mean the initial sale of new issue 
shares purchased in an offering within 30 days following the offering 
date of such offering.
    In addition, proposed FINRA Rule 5131(d) would define the term 
``investment banking services'' to include, without limitation, acting 
as an underwriter, participating in a selling group in an offering for 
an issuer or otherwise acting in furtherance of a public offering of 
the issuer; acting as a financial adviser in a merger, acquisition or 
other corporate reorganization; providing venture capital, equity lines 
of credit, private investment, public equity transactions (PIPEs) or 
similar investments or otherwise acting in furtherance of a private 
offering of the issuer; or serving as placement agent for the issuer. 
Under the proposed rule, the term ``material support'' would mean 
directly or indirectly providing more than 25% of a person's income in 
the prior calendar year. Persons living in the same household are 
deemed to be providing each other with material support. The term ``new 
issue'' would have the same meaning as in Rule 5130(i)(9). In addition, 
the term ``penalty bid'' would mean an arrangement that permits the 
managing underwriter to reclaim a selling concession from a syndicate 
member in connection with an offering when the securities originally 
sold by the syndicate member are purchased in syndicate covering 
transactions. The term ``unaffiliated charitable organization'' would 
mean a tax-exempt entity organized under Section 501(c)(3) of the 
Internal Revenue Code that is not affiliated with the member and for 
which no executive officer or director of the member, or person 
materially supported by such executive officer or director, is an 
individual listed or required to be listed on Part VII of the Internal 
Revenue Service Form 990 (i.e., officers, directors, trustees, key 
employees, highest compensated employees and certain independent 
contractors).
Supplementary Material
    Proposed FINRA Rule 5131 would also include supplementary material 
regarding issuer directed allocations, in paragraph .01, which would 
provide that the prohibitions of paragraph (b) of the rule would not 
apply to securities that are directed in writing by the issuer, its 
affiliates, or selling shareholders, so long as the member has no 
involvement or influence, directly or indirectly, in the allocation 
decisions of the issuer, its affiliates, or selling shareholders with 
respect to such issuer-directed shares. Proposed FINRA Rule 5131 would 
also provide supplementary material regarding annual representation, in 
paragraph .02, which would provide that for purposes of paragraph (b) 
of the rule, a member may rely on a written representation obtained 
within the prior 12 months within the parameters set forth in paragraph 
.02. The proposed rule would also provide supplementary material 
regarding lock-up announcements, in paragraph .03, stating that the 
requirement that the book-running lead manager announce the impending 
release or waiver of a lock-up or other restriction on the transfer of 
the issuer's shares shall be deemed satisfied where such announcement 
is made by the book-running manager, another member or the issuer, so 
long as such announcement otherwise complies with the requirements of 
paragraph (d)(2) of Rule 5131.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA, and at 
the Commission's Public Reference Room.

III. Summary of Comments and Amendment No. 4

Prohibition on Spinning

    Proposed FINRA Rule 5131(b) would prohibit the allocation of IPO 
shares to the account of an executive officer or director of a company 
(1) if the company is currently an investment banking services client 
of the member or the member has received compensation from the company 
for investment banking services in the past 12 months; (2) if the 
member intends to provide, or expects to be retained by the company 
for, investment banking services within the next 3 months; or (3) on 
the express or implied condition that such executive officer or 
director, on behalf of the company, will retain the member for the 
performance of future investment banking services.
    Commenters generally supported the proposed changes to the spinning 
rule but requested additional modifications.\10\ Commenters' concerns 
included that it would be difficult to identify the universe of 
officers and directors subject to the rule and asked that members be 
permitted to rely on annual negative consent letters.\11\ One commenter 
expressed particular concern regarding the applicability of the rule to 
officers and directors of non-public companies.\12\
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    \10\ See SIFMA.
    \11\ See ABA and SIFMA.
    \12\ See SIFMA.
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    In response to commenters' concerns, FINRA is proposing several 
changes to the spinning provisions. First, FINRA proposes that members 
establish, maintain and enforce policies and procedures reasonably 
designed to ensure that investment banking personnel have no 
involvement or influence, directly or indirectly, in the new issue 
allocation decisions of the member. FINRA believes that such procedures 
are essential to managing conflicts of interest between investment

[[Page 61544]]

banking and syndicate activities. FINRA understands that these 
procedures are customary at members today, and wants to ensure that 
such policies and procedures remain in force.
    In addition, in response to comments, FINRA proposes to narrow the 
scope of the non-public companies covered by the spinning provision to 
focus the rule and firms' compliance efforts on those allocations that 
have the greatest potential for abuse. Specifically, the spinning 
provision would apply to any account in which an executive officer or 
director of a public company or a ``covered non-public company,'' or a 
person materially supported by such executive officer or director, has 
a beneficial interest. The term ``covered non-public company'' means 
any non-public company satisfying the following criteria: (i) Income of 
at least $1 million in the last fiscal year or in two of the last three 
fiscal years and shareholders' equity of at least $15 million; (ii) 
shareholders' equity of at least $30 million and a two-year operating 
history; or (iii) total assets and total revenue of at least $75 
million in the latest fiscal year or in two of the last three fiscal 
years.\13\
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    \13\ These criteria are based on quantitative initial listing 
standards for a national securities exchange, which FINRA believes 
is a suitable proxy for the types of companies that are likely to be 
targeted by members for investment banking services. In this case, 
FINRA has determined that the applicable standards should be no less 
than those required for initial listing on the NASDAQ Global Market. 
FINRA further believes that, in modifying the scope of companies 
covered by the spinning provisions, it is unnecessary to create a de 
minimis standard for investment banking services compensation as 
urged by ABA. Moreover, FINRA believe that a de minimis standard 
would pose additional compliance burdens and would be susceptible to 
abuse by those seeking to avoid application of the proposed rule.
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    One commenter stated that it may be difficult to determine when the 
member ``intends to provide'' investment banking services and asked 
that the member be permitted to rely on policies and procedures 
reasonably designed to determine whether an entity is a current or 
prospective investment banking client, or whether the member intends to 
provide investment banking services to a prospective client, on the 
basis of reasonable criteria (which criteria may limit the 
identification of current clients to those relationships that are more 
than aspirational or passing, or for which the firm has a reasonable 
expectation of an active near-term relationship).\14\ FINRA does not 
believe that the spinning provision should be recast solely as a 
``policies and procedures'' rule. However, in response to commenters' 
concerns and in light of the provision explicitly requiring policies 
and procedures excluding investment banking personnel input into new 
issue allocation decisions, FINRA proposes to modify the three month 
forward looking provision to prohibit new issue allocations only where 
the person responsible for making the allocation decision ``knows or 
has reason to know that the member intends to provide, or expects to be 
retained by the company for, investment banking services within the 
next 3 months.'' FINRA believes that this change strikes an appropriate 
balance in addressing the potential that new issue allocations will 
influence future business with the member while not unnecessarily 
impacting the capital formation process.\15\ However, according to 
FINRA, if a member maintains effective information barriers between the 
investment banking and syndicate departments and the persons 
responsible for making new issue allocation decisions neither know nor 
have reason to know of the prospective business relationship, the 
forward-looking provision will not be violated.
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    \14\ See SIFMA.
    \15\ If an executive officer or director receives an allocation 
and the investment bank subsequently is retained for the performance 
of investment banking services within the three month window by such 
executive officer or director's employing firm, FINRA will 
investigate the particular information about the business 
relationship that was known (and by whom) at the time of the 
allocation, including a review of the communications between the 
broker-dealer and the investment banking client, and between the 
investment banking and syndicate departments, as well as the 
member's systems for logging and managing prospective and current 
client and transaction information.
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    To facilitate compliance with the spinning provisions as requested 
by commenters, proposed new Supplementary Material .02 expressly 
permits members to rely on written representations obtained within the 
prior 12 months from the beneficial owner(s) of the account (or a 
person authorized to represent the beneficial owner(s)) as to whether 
such beneficial owner(s) is an executive officer or director (or person 
materially supported by an executive officer or director) and if so, 
the company(ies) on whose behalf such executive officer or director 
serves. Consistent with current practice under FINRA Rule 5130, FINRA 
requires that the initial representation be an affirmative 
representation, but will permit such representation to be updated 
annually through the use of negative consent letters. Members are 
reminded that a member may not rely upon any representation it 
believes, or has reason to believe, is inaccurate. Finally, a member 
would be required to maintain a copy of all records and information 
relating to whether an account is eligible to receive an allocation of 
the new issue for at least three years following the member's 
allocation to that account.
    FINRA notes that members should understand that the representation 
in the spinning context differs from that in FINRA Rule 5130 because, 
in the spinning case, the information obtained from the customer is 
not, by itself, sufficient to make a determination of whether a 
customer is eligible to purchase a new issue. Members also must 
determine whether each account considered for a new issue allocation 
involves an executive officer or director (or materially supported 
person) of a current or prospective client that falls within the scope 
of paragraph (b). Members may choose to adopt a more restrictive 
internal policy prohibiting allocations to all executive officers, 
directors and materially supported persons; however, FINRA notes that 
this is not required under the proposed rule change.\16\
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    \16\ FINRA notes that the Voluntary Initiative more broadly 
prohibited allocations to the account of any executive officer or 
director of a U.S. public company or a public company for which a 
U.S. market is the principal equity trading market with respect to 
all hot IPOs. Voluntary Initiative Regarding Allocations of 
Securities in ``Hot'' Initial Public Offerings to Corporate 
Executives and Directors, http://www.sec.gov/news/press/
globalvolinit.htm (Apr. 28, 2003).
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    Commenters also asked that the definition of ``account of an 
executive officer or director'' be amended to apply to accounts in 
which an executive officer, director or materially supported person has 
a ``beneficial interest'' rather than a ``financial interest.'' \17\ 
Commenters asked that the rule exclude accounts over which executive 
officers, directors or materially supported persons have ``discretion 
or control'' as this may unduly impact allocations to certain 
funds.\18\ Commenters further argued that the definition of ``account 
of an executive officer or director'' should be modified to exclude 
certain other entities (such as foreign investment companies) 
consistent with FINRA Rule 5130(c).\19\
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    \17\ See ABA. Commenters generally favored the use of defined 
terms in proposed FINRA Rule 5131 that are consistent with the terms 
used in Rule 5130. See ABA and Regal.
    \18\ See ABA.
    \19\ See ABA.
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    In response to comments, FINRA proposes to delete the definition of 
``account of an executive officer or director'' and to instead include 
a new limitation in the spinning rule providing that the spinning 
prohibitions would not apply to allocations made to any account 
described in FINRA Rule 5130(c)(1) through (3) and (5) through

[[Page 61545]]

(10), or to any other account in which the beneficial interests of 
executive officers and directors of the company and persons materially 
supported by such executive officers and directors in the aggregate do 
not exceed 25% of such account.\20\ As requested by commenters, FINRA 
also proposes to add a new definition of ``beneficial interest,'' which 
will have the same meaning as FINRA Rule 5130.\21\ FINRA believes 
deleting the term ``account of an executive officer or director'' and 
modifying the scope of the rule to generally exclude those accounts 
excepted from FINRA Rule 5130(c) is appropriate in that allocations to 
such accounts are not likely to result in the type of abuse the 
spinning prohibition is geared toward. FINRA believes that the 
proposal, as amended, continues to meet the goals of the rule while 
avoiding an unnecessary impact on capital formation. In addition, by 
replacing references to ``financial interest'' with ``beneficial 
interest'' and deleting the reference to accounts in which officers and 
directors exercise ``discretion or control,'' FINRA believes that the 
rule more properly focuses on accounts in which relevant parties have 
an economic interest.
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    \20\ One commenter asked that hedge funds clearly be included in 
the proposal. See Regal. FINRA notes that hedge funds would be 
included where the beneficial interest of executive officers and 
directors of a particular company (and materially supported persons) 
in the aggregate exceed 25%. FINRA continues to believe that the 25% 
threshold is most appropriate and therefore will not increase the 
standard to 50% as requested by one commenter. See ABA.
    \21\ FINRA Rule 5130(i)(1) defines ``beneficial interest'' to 
mean any economic interest, such as the right to share in gains or 
losses. FINRA notes that the receipt of a management or performance 
based fee for operating a collective investment account, or other 
fees for acting in a fiduciary capacity, shall not be considered a 
beneficial interest in the account.
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    Commenters argued that the spinning rule should apply only to ``hot 
IPOs'' and should exclude the types of offerings excepted under FINRA 
Rule 5130(i)(9).\22\ FINRA does not agree that the rule should apply 
only to ``hot IPOs.'' FINRA believes that the proposed rule change 
should not be limited to hot IPOs for the same reasons that FINRA Rule 
5130 is not limited to hot IPOs.\23\ Specifically, the operation of a 
rule based on an unknown future event--the opening price--creates 
compliance difficulties and potentially may exacerbate spinning 
problems and may harm capital formation by necessitating members to 
cancel allocations and reallocate shares to another customer. FINRA 
does, however, agree that certain types of offerings that are not 
likely to trade at a premium in the aftermarket should be excluded from 
the rule. Therefore, FINRA proposes to replace the defined term 
``initial public offering'' or ``IPO'' with the term ``new issue'' 
throughout the proposed rule and to use the same definition provided in 
FINRA Rule 5130(i)(9). In developing the definition of ``new issue'' in 
FINRA Rule 5130, FINRA carefully considered the extent to which such 
offerings may be hot issues. Thus, the proposed rule, as amended, 
applies to ``new issues,'' meaning ``any initial public offering of an 
equity security as defined in Section 3(a)(11) of the Act, made 
pursuant to a registration statement or offering circular.''
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    \22\ See ABA.
    \23\ While earlier proposed versions of the IPO Rule would have 
applied only to ``hot issues,'' FINRA, then NASD, revised the 
proposal to cover the purchase and sale of all initial equity public 
offerings, not just those that open above a designated premium, 
because FINRA believed the revised approach would be easier to 
understand and would avoid many of the complexities associated with 
the cancellation provision. See Securities Exchange Act Release No. 
48701 (October 24, 2003), 68 FR 62126 (October 31, 2003) (Order 
Approving File No. SR-NASD-99-60). (Proposed rule change relating to 
restrictions on the purchases and sales of initial public offerings 
of equity securities).
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IPO Pricing and Trading Practices
    Commenters generally supported the amended proposal related to IPO 
Pricing and Trading Practices.\24\ However, one commenter asked that 
FINRA include clarifying language that the lock-up provision would only 
apply to lock-ups entered into in connection with the IPO, and not with 
respect to other lock-up agreements.\25\ FINRA confirms that this 
provision applies only to lock-up agreements entered into in connection 
with a new issue and has modified the rule text to reflect this.\26\ 
This commenter also asked that FINRA clarify that the required notice 
of an impending release or waiver of a lock-up may be announced either 
by the issuer or the applicable member(s).\27\ FINRA agrees that, so 
long as the announcement is made through a major news service at least 
two days before the release or waiver of any lock-up or other 
restriction on the transfer of the issuer's shares, the requirement is 
satisfied irrespective of whether such announcement is made by the 
book-running lead manager, another member or by the issuer. Thus, FINRA 
is proposing new Supplementary Material .03 in response to comments to 
provide that the required announcement also may be made by another 
member or the issuer. However, FINRA notes that it remains the 
responsibility of the book-running lead manager to ensure that the 
impending release or waiver is properly announced in compliance with 
this Rule.
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    \24\ See SIFMA.
    \25\ See SIFMA.
    \26\ Proposed Rule 5131(d)(2), as amended, provides that ``[a]ny 
lock-up agreement or other restriction on the transfer of the 
issuer's shares by officers and directors of the issuer entered into 
in connection with a new issue shall provide that * * *'' (new 
language emphasized).
    \27\ See SIFMA.
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    One commenter argued that the rule should be changed to permit the 
syndicate to retain discretion to either use returned shares to reduce 
the syndicate position or toward unfilled customer orders.\28\ FINRA 
does not agree that this change is appropriate. FINRA expects that when 
shares trade at a premium to the public offering price, the incidence 
of returned shares should be minimal so as not to affect the ability of 
syndicate members to stabilize the market for such shares to the extent 
stabilization activities are even necessary. Further, FINRA believes 
that the complexity of addressing this alternative would unnecessarily 
complicate the proposed rule change.\29\ However, in response to 
comments, FINRA is amending the rule to provide members with additional 
flexibility in the handling of returned shares. The amended proposal 
continues to require that, to the extent not inconsistent with SEC 
Regulation M, the agreement between the book-running lead manager and 
other syndicate members must require that any shares trading at a 
premium to the public offering price returned by a purchaser to a 
syndicate member after secondary market trading commences be used to 
offset the existing syndicate short position.\30\ However, where no 
syndicate short position exists, the proposed rule

[[Page 61546]]

change would provide the member with the option, provided that it is in 
accordance with SEC Regulation M, to either: (1) Offer returned shares 
at the public offering price to unfilled customers' orders pursuant to 
a random allocation methodology or (2) sell returned shares on the 
secondary market and donate profits from the sale to an ``unaffiliated 
charitable organization'' with the condition that the donation be 
treated as an anonymous donation to avoid any reputational benefit to 
the member.\31\ Proposed FINRA Rule 5131 establishes a new definition 
of ``unaffiliated charitable organization'' to prevent such charitable 
donations from benefiting the member or executive officers and 
directors of the member (and persons they materially support). FINRA 
believes that charitable donations funded by returned shares should not 
provide any reputational benefit to the member. The definition of 
``unaffiliated charitable organization'' is closely tied to specific 
information charities are required to file with the Internal Revenue 
Service.
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    \28\ See SIFMA.
    \29\ SIFMA also asked FINRA to clarify that anonymous, ordinary 
course sales on a national securities exchange or ATS at market 
prices will be considered a ``random allocation'' for the purposes 
of the rule. FINRA disagrees. The provision, as previously proposed 
would have required that, where no syndicate short position exists, 
the member must offer the returned shares to unfilled customer 
orders at the public offering price, not the market price. Moreover, 
FINRA notes that, if the shares are trading at a premium to the 
public offering price, then sales by the member at market prices 
would result in the premium inuring to the benefit of the member, 
which is inconsistent with the purpose of the provision and a 
member's obligations under FINRA Rule 5130.
    \30\ One commenter asked for confirmation that the appropriate 
time for determining whether returned shares are trading at a 
premium to their IPO price is at the time such securities are 
returned. FINRA agrees. See SIFMA. Another commenter argued that the 
requirement that members use a random allocation methodology to 
reallocate returned shares was inadequate. See Regal. FINRA 
disagrees and notes that this standard is already used successfully 
in other FINRA rules. See FINRA Rule 2360 (Allocation of Exercise 
Assignment Notices).
    \31\ Proposed FINRA Rule 5131(e)(9) defines ``unaffiliated 
charitable organization'' as a tax-exempt entity organized under 
Section 501(c)(3) of the Internal Revenue Code that is not 
affiliated with the member and for which no executive officer or 
director of the member, or person materially supported by such 
executive officer or director, is an individual listed or required 
to be listed on Part VII of Internal Revenue Service Form 990 (i.e., 
officers, directors, trustees, key employees, highest compensated 
employees and certain independent contractors).
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    The proposed rule change, as amended, prohibits the acceptance of 
market orders for the purchase of IPO shares prior to the commencement 
of trading on the secondary market. A commenter supported the proposed 
amendment but offered alternative rule text.\32\ FINRA favors its 
existing rule text but proposes a slight modification in response to 
comments to further clarify the provision such that the relevant text 
will now state that ``no member may accept a market order for the 
purchase of shares of a new issue in the secondary market prior to the 
commencement of trading of such shares in the secondary market.''
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    \32\ See SIFMA.
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Other Issues
    Commenters reiterated certain concerns regarding FINRA's proposed 
provision relating to abusive allocation arrangements. Proposed FINRA 
Rule 5131(a) prohibits a member from offering or threatening to 
withhold shares it allocates in an IPO as consideration or inducement 
for the receipt of compensation that is excessive in relation to the 
services provided by the member (i.e., quid pro quo allocations). 
Commenters generally supported this proposed provision but reiterated 
earlier concerns that the term ``excessive'' is subject to 
uncertainty.\33\ One commenter requested that FINRA clarify that any 
services provided for a ``fair price'' as provided by FINRA's Corporate 
Financing Rule (Rule 5110(a)(9)) would not be deemed excessive.\34\ 
This commenter also requested guidance that any services provided by a 
member paid for using ``soft dollars'' in conformity with Section 28(e) 
of the Act also would not be deemed excessive.\35\ Another commenter 
asked that clarifying language be added to the rule to provide that an 
assessment of whether compensation is excessive would be based on the 
relevant facts and circumstances including, where applicable, the level 
of risk and effort involved in the transaction and the rates generally 
charged for such services.\36\
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    \33\ See ABA and SIFMA.
    \34\ See ABA.
    \35\ See ABA.
    \36\ See SIFMA.
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    As stated in Amendment No. 3, FINRA agrees that an assessment of 
whether or not compensation is excessive would be based upon all of the 
relevant facts and circumstances including, where applicable, the level 
of risk and effort involved in the transaction and the rates generally 
charged for such services.\37\ However, FINRA continues to believe that 
the proposed language, which refers to ``compensation that is excessive 
in relation to the services provided,'' is most appropriate in that it 
affords FINRA the necessary flexibility in addressing the range of 
potential quid pro quo arrangements that may arise. As stated in 
Amendment No. 3, FINRA does not believe it is necessary to include rule 
text stating that an assessment of whether compensation is 
``excessive'' will be based upon all of the relevant facts and 
circumstances.\38\ Likewise, FINRA does not believe it is appropriate 
to provide blanket guidance regarding payments made in conformity with 
Section 28(e) of the Act or FINRA Rule 5110(a)(9).
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    \37\ See Amendment No. 3.
    \38\ See Amendment No. 3.
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    Finally, one commenter raised concerns regarding FINRA's proposed 
flipping provision.\39\ This commenter argued that, instead of defining 
the flipping period to mean the initial sale of new issue shares within 
30 days following the offering date, the flipping provision should be 
based on the sale of shares prior to the book manager lifting the 
penalty bid, making the time period under the rule subject to the 
discretion of the managing underwriter.\40\ FINRA does not agree that 
the suggested alternative represents an improvement to the proposed 
provision. FINRA believes that the certainty and finality of the 
proposed approach, including the 30-day window, is the appropriate 
duration for prohibiting members from recouping commissions from 
associated persons whose customers sell in cases where a penalty bid 
has not been assessed on the entire syndicate.
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    \39\ See Regal.
    \40\ See Regal.
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    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no less than 90 and no 
more than 180 days following publication of the Regulatory Notice 
announcing Commission approval.

IV. Discussion and Commission Findings

    After carefully considering the proposal, the comments submitted, 
and FINRA's response to the comments, the Commission finds that the 
proposed rule change, as modified by Amendment Nos. 1 through 4, is 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\41\ In particular, the Commission finds that the proposed 
rule change, as amended, is consistent with Section 15A(b)(6) of the 
Act,\42\ which requires, among other things, that FINRA rules be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. In particular, the 
Commission believes that the proposed rule change is a reasonable step 
to enhance members' avoidance of unacceptable conduct when they engage 
in the allocation and distribution of new issue shares. The Commission 
also believes that the proposed rule change is a reasonable step to 
enhance public confidence in the distribution of new issues.
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    \41\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \42\ 15 U.S.C. 78o-3(b)(6).
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    In addition, the Commission sought specific comment in Amendment 
No. 3 on whether there are any alternatives to the proposed rule change 
that FINRA should consider, such as whether proposed Rule 5131(b)'s 
spinning provisions should be modified to

[[Page 61547]]

include a mandatory ban prohibiting members from seeking or providing 
investment banking services to a company for a period of 12 months 
following any allocation of IPO shares to an account of an executive 
officer or director of such company and whether such a ban would 
facilitate compliance. One commenter strongly supported a 12-month 
prohibition.\43\ However, another commenter opposed such a prohibition, 
saying that it ``would--by rule--impose an automatic sanction for even 
inadvertent allocations of IPO securities'' and ``would, in all cases, 
be financially disproportionate to the value of the securities involved 
in any violation, would not take into account the specific facts of 
each situation, deprive the FINRA member of its statutory right to a 
fair hearing before the imposition of any disciplinary sanction, and 
would unfairly deprive the company of the right to select the services 
of the FINRA member.'' \44\ According to this commenter, in each case, 
the imposition of a mandatory ban, as suggested by the Commission, 
would be an excessive penalty in light of the facts and circumstances 
underlying the potential violation of the proposed rule.\45\ 
Nevertheless, this commenter noted that the 12-month prohibition 
``should not in any event be approved without an opportunity for review 
of and comment on the text of the proposed rule,'' with commenter 
requesting that the Commission republish for comment any proposal to 
adopt such a mandatory ban on investment banking services with a sixty-
day comment period. In light of these comments, the Commission will 
continue to consider the commenters' recommendations and concerns in 
considering whether any future action is warranted. However, the 
Commission does not believe this issue should preclude approval of the 
proposal.
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    \43\ See Regal.
    \44\ See ABA.
    \45\ See id.
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V. Accelerated Approval

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Act,\46\ for approving the proposed rule change, as modified by 
Amendment Nos. 1 through 4 thereto, prior to the 30th day after the 
date or publication of Amendment No. 4 in the Federal Register. The 
changes proposed in Amendment No. 4 respond to specific concerns 
raised. Moreover, accelerating approval of this proposal should benefit 
FINRA members by aiding them in avoiding misconduct in new issue 
distributions and should benefit investors by taking a step to enhance 
investor protection in the capital raising process.
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    \46\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Amendment No. 4, is consistent with the Act. 
Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-NASD-2003-140 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASD-2003-140. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/
sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASD-2003-140 and should be 
submitted on or before October 26, 2010.

VII. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASD-2003-140), as modified by 
Amendment Nos. 1 through 4, be, and hereby is, approved on an 
accelerated basis.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\47\
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    \47\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-24899 Filed 10-4-10; 8:45 am]
BILLING CODE 8010-01-P

