
[Federal Register Volume 79, Number 19 (Wednesday, January 29, 2014)]
[Notices]
[Pages 4793-4796]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-01656]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71372; File No. SR-FINRA-2014-003]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend 
FINRA's Corporate Financing Rules To Simplify and Refine the Scope of 
the Rules

January 23, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on January 9, 2014, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of the 
Substance of the Proposed Rule Change

    FINRA is proposing to amend FINRA's corporate financing rules to 
simplify and refine the scope of the rules.
    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.

[[Page 4794]]

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    FINRA proposes to amend Rules 5110 (Corporate Financing Rule--
Underwriting Terms and Arrangements) and 5121 (Public Offerings of 
Securities with Conflicts of Interest). Rule 5110 generally regulates 
underwriting compensation and prohibits unfair arrangements in 
connection with the public offering of securities. Among other 
provisions, Rule 5110 requires members to file with FINRA information 
about the securities offerings in which they participate and to 
disclose affiliations and other relationships that may indicate the 
presence of conflicts of interest. Rule 5121 generally provides that 
members with a conflict of interest may not participate in a public 
offering unless the member complies with certain prescribed disclosures 
or other protections.
    FINRA is proposing amendments to Rule 5110 to: (1) Narrow the scope 
of the definition of ``participation or participating in a public 
offering;'' (2) modify the lock-up restrictions to exclude certain 
securities acquired or converted to prevent dilution; and (3) clarify 
that the information requirements apply only to relationships with a 
``participating'' member. FINRA also is proposing amendments to Rule 
5121 to narrow the scope of the definition of ``control.''
Participation in a Public Offering
    As noted above, Rule 5110 generally regulates underwriting 
compensation and prohibits unfair arrangements in connection with the 
public offering of securities. The protections of the rule apply to 
members that are ``participating'' in the public offering of an 
issuer's securities. Rule 5110(a)(5) defines ``participating in a 
public offering'' to include ``participation in the distribution of the 
offering on an underwritten, non-underwritten, or any other basis'' and 
the ``furnishing of customer and/or broker lists for solicitation.'' 
Due to the importance of the role such members serve in the capital 
raising process and the degree to which issuers must rely on them, 
those members may be in a position to extract unreasonable underwriting 
terms, arrangements or compensation from issuers.
    However, also included within the definition of ``participating in 
a public offering'' is participation in ``any advisory or consulting 
capacity related to the offering.'' Unlike in cases where a member is 
involved in distribution and solicitation activities, a member that 
solely provides advisory or consulting services typically would not 
have a significant degree of leverage over an issuer. Consequently, 
FINRA does not believe that the harms sought to be prevented by Rule 
5110 are likely to occur in such cases.
    Thus, FINRA is proposing to amend the definition of ``participating 
in a public offering'' to provide that an ``independent financial 
adviser'' that provides advisory or consulting services to an issuer 
would not be deemed to be ``participating'' in the public offering of 
an issuer's securities. The amendments would define ``independent 
financial adviser'' as a member that provides advisory or consulting 
services to the issuer and that is neither engaged in, nor affiliated 
with any entity that is engaged in, the solicitation or distribution of 
the offering. To the extent a member engages in solicitation or 
distribution activities in addition to providing advisory or consulting 
services, this exclusion would not be available and all of the 
compensation received by that member in connection with the offering 
would be included in the compensation limitations of Rule 5110. Rule 
5110(a)(5)'s definition of ``participating member'' also includes 
affiliates of the member. Thus, if a member provides distribution or 
solicitation services and its affiliate provides advisory or consulting 
services, all of the compensation received by the member and its 
affiliate would be included in the compensation limitations of Rule 
5110.
    FINRA believes this proposed modification preserves the protections 
of the rule while also removing a possible obstacle to the ability of 
issuers to obtain advisory or consulting services from members not 
participating in the offering, since today the rule would include the 
compensation for such services in the limits on overall underwriting 
compensation. Thus, under the proposed approach, issuers would be free 
to seek the benefit of consulting services or advice from a member that 
is not engaged in the distribution or sale of its securities regarding 
such matters as the options for financing that may be available to the 
issuer, the benefits and disadvantages of a public offering and the 
terms proposed by the underwriters.
Lock-Up Restrictions
    Rule 5110(d)(1) generally includes as underwriting compensation all 
items of value, which may include unregistered securities, that are 
acquired (or arranged to be acquired) within 180 days prior to the 
filing of the registration statement (``180-day review period''). Rule 
5110(d)(5) (Exceptions from Underwriting Compensation) provides five 
exceptions that permit participating members to acquire securities of 
the issuer during the 180-day review period without the securities 
being deemed to be underwriting compensation.
    The provisions of paragraph (d)(5)(D) of Rule 5110 (Acquisitions 
and Conversions to Prevent Dilution) exclude from underwriting 
compensation the receipt of additional securities to prevent dilution 
of the investor's investment (e.g., securities acquired as a result of 
a stock-split or a pro-rata rights or similar offering) where such 
additional securities are received during the 180-day review period or 
subsequent to the filing of the public offering, but where the original 
securities were acquired prior to the 180-day review period or 
otherwise were not deemed by FINRA to be underwriting compensation, as 
described in Rule 5110(d)(5)(D). Among other things, the exception 
requires that the right or opportunity to receive the additional 
securities was provided to all similarly situated security holders and 
the receipt of the additional securities does not increase the 
recipient's percentage ownership of the same class.
    The exception is available when securities are acquired as a result 
of a stock split or pro-rata rights or similar offering, a stock 
conversion of securities that have not been deemed by FINRA to be 
underwriting compensation or certain rights of preemption. With respect 
to a right of preemption, the exception is only available if the right 
was granted in connection with securities purchased either: (i) In a 
private placement so long as the securities acquired in the private 
placement are not deemed to be underwriting compensation (i.e., the 
private placement did not occur within the 180-day review period); or 
(ii) from a public offering or the public market.

[[Page 4795]]

    While these acquisitions and conversions to prevent dilution are 
excepted from underwriting compensation, they currently continue to be 
subject to the lock-up restrictions of paragraph (g)(1).\3\ For 
example, if common shares were acquired before the 180-day review 
period, they are not considered ``items of value'' and are not subject 
to the compensation limitations or lock-up restrictions. However, 
shares received as a result of the preexisting ownership of the common 
shares during the 180-day review period (e.g., resulting from a stock-
split) are not subject to the compensation limitations, but continue to 
be locked up pursuant to paragraph (g)(1). Subjecting securities 
acquired or converted to prevent dilution during the 180-day review 
period to the lock-up restrictions even where they are not considered 
``items of value'' under Rule 5110(c)(3) may not provide any useful 
protection, and this requirement may impose unnecessary burdens on 
firms to track and monitor compliance with the lock-up provisions. 
Therefore, FINRA proposes to treat shares received in an acquisition or 
conversion to prevent dilution during the 180-day review period 
consistent with the treatment provided for the securities on which 
their acquisition or conversion was based, thereby eliminating the 
lock-up restrictions for these securities.
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    \3\ Paragraph (g)(1) of Rule 5110 generally provides that such 
securities received as a result of an acquisition or conversion to 
prevent dilution must not be sold during the offering, or sold, 
transferred, assigned, pledged, or hypothecated, or be the subject 
of any hedging, short sale, derivative, put, or call transaction 
that would result in the effective economic disposition of the 
securities by any person for a period of 180 days immediately 
following the date of effectiveness or commencement of sales of the 
public offering (``lock-up restrictions'').
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Information Requirements
    Subject to certain exceptions, Rule 5110(b)(6)(A)(iii) requires 
filers to disclose to FINRA information about the affiliation or 
association with any member of the officers, directors, and certain 
owners of the issuer. FINRA is proposing to amend Rule 
5110(b)(6)(A)(iii) to reduce the scope of this provision from requiring 
disclosure about the affiliation or association of the specified 
parties with ``any member'' to ``any participating member.'' The 
compensation limitations and other provisions of Rule 5110 and Rule 
5121 apply only to members that participate in a public offering. 
Consequently, affiliations of non-participating members would not 
present the type of concerns that the rule is designed to address, and 
requiring that information about these other members be filed with 
FINRA is unnecessary.
Definition of ``Control''
    FINRA proposes to revise the scope of the definition of ``control'' 
in Rule 5121(f)(6) to exclude beneficial ownership of 10 percent or 
more of the outstanding subordinated debt of an entity. The scope of 
the definition of ``control'' is related to the determination of 
whether a member and an issuer are deemed to be affiliated \4\ for 
purposes of the conflicts provisions of Rule 5121 (Public Offerings of 
Securities With Conflicts of Interest) \5\ and for certain 
informational requirements of Rule 5110.\6\ However, ownership of 10 
percent or more of the outstanding subordinated debt of an entity is 
not a meaningful measure of control or affiliation for purposes of 
Rules 5121 and 5110. The proposed amendment thus would reduce the scope 
of the information required to be reported by members.
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    \4\ Rule 5121(f)(1) provides that the term ``affiliate'' means 
an entity that controls, is controlled by or is under common control 
with a member.
    \5\ Rule 5121 defines ``conflict of interest'' to include 
situations where the issuer ``controls, is controlled by or is under 
common control with the member or the member's associated persons.''
    \6\ See Rule 5110(b)(6)(A)(iii).
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    FINRA staff discussed the proposal with industry groups and 
advisory committees in developing its approach, and these parties were 
supportive of the proposal. FINRA received one comment from an advisory 
committee member regarding the proposed reduction of the scope of the 
Rule 5110's provisions to only ``participating'' members. Specifically, 
the committee member suggested that FINRA retain the information 
requirement for issuer relationships with any financial adviser that 
owns 5 percent or more of any class of the issuer's securities--even 
where such financial adviser is not affiliated with a participating 
member. However, FINRA believes it is more appropriate to limit the 
information requirement to members that are ``participating'' in the 
offering and their affiliates, which would capture advisers who are 
affiliates of participating members (but would exclude an independent 
financial advisor). The effective date of the proposed rule change will 
be 30 days following Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\7\ which requires, among 
other things, that FINRA rules must 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.
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    \7\ 15 U.S.C. 78o-3(b)(6).
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    FINRA believes that the proposed rule change meets these 
requirements in that it eliminates burdensome provisions that are not 
justified by the regulatory purposes of the rules, while continuing to 
preserve important protections addressing abusive arrangements and 
minimizing the opportunity for abusive practices by members in 
connection with their participation in public offerings of securities. 
For example, the proposed amendments to Rule 5110(a)(5) to revise the 
definition of ``participation'' to exclude from the definition's scope 
advisory or consulting services provided to the issuer by an 
independent financial adviser supports [sic] capital formation without 
compromising investor protection. Specifically, FINRA believes that 
provision of such services by an independent party, wholly uninvolved 
with the solicitation or distribution of the offering, is not likely to 
present the harms sought to be prevented by Rule 5110.
    Similarly, the proposed amendments to the provision subjecting 
securities acquired as a result of an acquisition or conversion to 
prevent dilution--notwithstanding that the acquisition of the such 
securities is not deemed underwriting compensation pursuant to Rule 
5110(d)(5)--maintains [sic] the goals of preventing fraudulent and 
manipulative acts and practices as well as protecting investors and the 
public interest. Since the effective date of the Rule 5110(d)(5)(D) on 
March 22, 2004,\8\ FINRA has not observed abuse in connection with 
securities acquired prior to the 180-day review period where those 
securities ultimately split within the 180-day period (or otherwise 
qualify for the (d)(5)(D) exception). Thus, in addition to the current 
exception for securities acquisitions or conversion to prevent dilution 
from the underwriting compensation provisions, FINRA believes it also 
is appropriate to except these acquisitions or conversions to prevent 
dilution from the lock-up restrictions of paragraph (g) given the 
continued application of the protections described in paragraph 
(d)(5)(D)(ii), (iii) and (iv).
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    \8\ See Securities Exchange Act Release No. 48989 (December 23, 
2003), 68 FR 75684 (December 31, 2003) (Order Approving File No. SR-
NASD-00-04).
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    The proposed amendment to limit the scope of the disclosure 
provision of 5110(b)(6)(A)(iii) to issuer relationships with ``any 
participating member'' (rather

[[Page 4796]]

than ``any member'') reduces the burden on members to report to FINRA 
items of information that FINRA does not believe are necessary. The 
current requirement to obtain information regarding the acquisition of 
the issuer's unregistered equity securities by any member regardless of 
whether the member is participating in the offering may facilitate 
filing when members are moving in and out of a syndicate or selling 
group prior to an offering. Information regarding members that are not 
participating in the offering, however, is not useful for purposes of 
the rule's compensation limits and other requirements. Accordingly, the 
burden of acquiring this unnecessary information is not justified by a 
regulatory benefit.
    Finally, in proposing amendments to the scope of the definition of 
``control'' in Rule 5121(f)(6), as discussed above, FINRA believes that 
ownership of 10 percent or more of the outstanding subordinated debt of 
an entity should be excluded from the scope of the definition of 
``control'' because it is not a meaningful measure of control or 
affiliation between a member and an issuer for purposes of Rules 5121 
and 5110 and, thus, eliminating this aspect of the definition would 
reduce the information required to be reported to FINRA by members 
without reducing the rule's efficacy, consistent with the purposes of 
the Act.

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. As discussed above, the 
proposal makes simplifying and streamlining amendments to Rules 5110 
and 5121 and would reduce the burden of compliance. The proposed 
amendments also would provide these benefits to any affected members 
engaging in activity subject to Rules 5110 and 5121.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2014-003 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-FINRA-2014-003. This 
file number should be included on the subject line if email 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 on 
official business days between the hours of 10:00 a.m. and 3:00 p.m. 
Copies of such filing also will be available for inspection and copying 
at the principal offices 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-FINRA-2014-003, and should be submitted on or before 
February 19, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\9\
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    \9\ 17 CFR 200.30-3(a)(12).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2014-01656 Filed 1-28-14; 8:45 am]
BILLING CODE 8011-01-P


