
[Federal Register Volume 79, Number 84 (Thursday, May 1, 2014)]
[Notices]
[Pages 24802-24805]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-09972]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72033; File No. SR-FINRA-2014-003]


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

April 28, 2014.
    On January 9, 2014, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``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 proposing to amend FINRA Rules 5110 (Corporate 
Financing Rule--Underwriting Terms and Arrangements) and 5121 (Public 
Offerings of Securities with Conflicts of Interest) in several respects 
in order to simplify and refine the scope of the rules. The proposed 
rule change was published for comment in the Federal Register on 
January 29, 2014.\3\ The Commission received two comment letters on the 
proposal.\4\ On April 16, 2014, FINRA responded to the comment 
letters.\5\ On March 4, 2014, the Commission extended the time period 
for Commission action to April 28, 2014.\6\ This order approves the 
proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 71372 (January 23, 
2014), 79 FR 4793 (SR-FINRA-2014-003) (``Notice'').
    \4\ See Letter from Suzanne Rothwell (``Rothwell''), Managing 
Member, Rothwell Consulting LLC, to Elizabeth M. Murphy, Secretary, 
Commission, dated February 10, 2014 (``Rothwell Letter''); Letter 
from Sean Davy, Managing Director, Corporate Credits Market 
Division, Securities Industries and Financial Markets Association 
(``SIFMA''), to Elizabeth M. Murphy, Secretary, Commission, dated 
February 18, 2014 (``SIFMA Letter'').
    \5\ See Letter from Kathryn M. Moore, Associate General Counsel, 
FINRA, to Kevin O'Neill, Deputy Secretary, Commission, dated April 
16, 2014 (``FINRA Letter'').
    \6\ See Securities Exchange Act Release No. 71642 (March 4, 
2014), 79 FR 13364 (SR-FINRA-2014-003).
---------------------------------------------------------------------------

I. Description of the Proposed Rule Change \7\

    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 existence of conflicts of interest. 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 states that this change preserves the protections of the 
rule and will enable issuers to seek advice from a member that is not 
involved in the distribution or sale of the issuer's securities.
---------------------------------------------------------------------------

    \7\ A more detailed description of the proposal is contained in 
the Notice. See supra note 3.
---------------------------------------------------------------------------

Participation in a Public Offering

    Rule 5110(a)(5) defines ``participating in a public offering'' to 
include participation in ``any advisory or consulting capacity to the 
issuer related to the offering.'' FINRA proposes to amend Rule 
5110(a)(5) to provide that an ``independent financial adviser'' that 
provides advisory or consulting services to the issuer would not meet 
the definition of ``participation in a public offering'' as defined in 
Rule 5110(a)(5) and would therefore not be subject to the compensation 
limitations of Rule 5110. The proposal defines an independent financial 
adviser as ``a member that provides advisory or consulting services to 
the issuer and is neither engaged in, nor affiliated with any entity 
that is engaged in, the solicitation or distribution of the offering.''

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 the 180 day period 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, including 
excluding 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 before 
the 180-day review period or otherwise were not deemed by FINRA to be 
underwriting compensation, as described in Rule 5110(d)(5)(D).
    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 Rule 5110(g)(1). FINRA proposes 
to eliminate the lock-up restrictions for these securities in order to 
treat shares received in an acquisition or conversion to prevent 
dilution during the 180-day review period in a manner consistent with 
the treatment provided for the securities on which their acquisition or 
conversion was based.

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. The compensation limitations and other provisions 
of Rule 5110 and Rule 5121 apply only to members that participate in a 
public offering. Correspondingly, FINRA is proposing to amend Rule 
5110(b)(6)(A)(iii) to narrow the scope of this provision to require 
disclosure about the affiliation or association of the

[[Page 24803]]

specified parties with ``any participating member.''

Rule 5121--Definition of ``Control''

    Under Rule 5121, the scope of the definition of ``control'' is 
considered in determining whether a member and an issuer are deemed to 
be affiliated \8\ for purposes of the conflicts provisions of Rule 5121 
\9\ and for certain requirements to provide information to FINRA in 
Rule 5110. FINRA is proposing amendments to Rule 5121 to narrow the 
scope of the definition of ``control'' by eliminating Rule 
5121(f)(6)(iii), thereby excluding from the definition of control the 
following: ``beneficial ownership of 10 percent or more of the 
outstanding subordinated debt of an entity, including any right to 
receive such subordinated debt within 60 days of the member's 
participation in the public offering.''
---------------------------------------------------------------------------

    \8\ 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.
    \9\ 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.''
---------------------------------------------------------------------------

II. Discussion of Comments and FINRA's Response

    On January 29, 2014, the Commission published in the Federal 
Register FINRA's proposed rule change to amend its corporate financing 
rules.\10\ The Commission received the two comment letters listed 
above.\11\ SIFMA stated that it fully supports the substance of the 
proposed rule change and further stated that it believed that the 
modifications will benefit all offering participants by reducing 
unnecessary costs and burdens, while continuing to preserve important 
investor protection standards.\12\
---------------------------------------------------------------------------

    \10\ See supra note 3.
    \11\ See supra note 4.
    \12\ See SIFMA Letter supra note 4, at 2.
---------------------------------------------------------------------------

    Generally speaking, Rothwell expressed support for the proposed 
rule change's modifications to Rules 5110 and 5121, with the exception 
of the carve out in Rule 5110(a)(5) for independent financial advisers 
(``Adviser Proposal'').\13\ Rothwell stated that modifying Rule 
5110(a)(5) to exempt independent financial advisers from the definition 
of ``participation'' would result in independent financial advisers 
also being exempt from the definition of ``underwriter and related 
persons'' found in Rule 5110(a)(6).\14\ Rothwell stated that FINRA 
should clarify that the Adviser Proposal would operate to exclude an 
independent financial adviser from compliance with the provisions of 
Rule 5110, Rule 5121 and Rule 2310.\15\
---------------------------------------------------------------------------

    \13\ See Rothwell Letter supra note 4, at 2.
    \14\ See Rothwell Letter supra note 4, at 3.
    \15\ See id. Rothwell provides examples of eight specific 
provisions of FINRA's rules from which an independent financial 
adviser might be exempt. See id.
---------------------------------------------------------------------------

    Rothwell agreed with FINRA that a member-consultant that meets the 
definition of independent financial adviser is generally less able in 
comparison to the underwriters to negotiate an unfair arrangement with 
an issuer.\16\ Rothwell states, however, that this belief is also 
rooted in FINRA's experience that those issuers that hire FINRA members 
to provide independent advice on a potential IPO are major companies 
with significant negotiating power and consequently are able to avoid 
unfair and unreasonable terms under Rule 5110.\17\ But Rothwell 
believes in the case of medium or small-sized companies, the issuer may 
not have sufficient economic power to be dominant when negotiating 
arrangements with a consultant.\18\ Consequently, Rothwell recommends 
that the Adviser Proposal be revised and applied to independent 
financial advisers, which recommendations are summarized briefly 
here.\19\
---------------------------------------------------------------------------

    \16\ See Rothwell Letter supra note 4, at 4.
    \17\ See id.
    \18\ See id.
    \19\ See Rothwell Letter supra note 4, at 5-6.
---------------------------------------------------------------------------

     Because an independent financial adviser would be excluded 
from the definition of ``participation,'' the underwriter would not be 
required under Rule 5110(b)(6) to file with FINRA information on the 
consulting agreement, any acquisitions of securities by the 
``independent financial adviser'' within the 180-day review period, and 
any conflict of interest between the consultant and the issuer.\20\ 
Rothwell recommends that independent financial advisers comply with the 
information filing requirements of Rule 5110(b)(6) or that the Adviser 
Proposal be revised to require that the information described above be 
filed with FINRA.\21\
---------------------------------------------------------------------------

    \20\ See Rothwell Letter supra note 4, at 5.
    \21\ See id.
---------------------------------------------------------------------------

     Rothwell also recommends that FINRA clarify whether it 
would exercise its historical authority under Rule 5110 to conclude 
that a consulting arrangement with an ``independent financial adviser'' 
is unfair and unreasonable, despite the availability of the exemption, 
in the limited circumstance where FINRA staff determine that the 
consulting arrangement does not conform to ``high standards of 
commercial honor and just and equitable principles of trade'' under 
FINRA Rule 2010.\22\
---------------------------------------------------------------------------

    \22\ See id.
---------------------------------------------------------------------------

     Rothwell believes that potential investors should be 
provided information regarding the independent financial adviser's 
consulting arrangement, acquisition of securities and any conflict of 
interest. Consequently, Rothwell recommends that the Adviser Proposal 
be amended to include a condition requiring that a separate paragraph 
in the ``Plan of Distribution'' section of the prospectus under Rule 
5110(c)(2)(C) and Rule 5121(a)(1) disclose certain specific 
information.\23\
---------------------------------------------------------------------------

    \23\ See Rothwell Letter supra note 4, at 5-6. Specifically, the 
information that Rothwell states should be included in the 
prospectus are: (1) The identity of the consultant; (2) an 
explanation of the consulting arrangement, including the form (cash 
and securities or other arrangement) and amount of any compensation, 
and any terms providing for liquidated damages or a right of first 
refusal; (3) the acquisition of any securities of the issuer by the 
consultant during the 180-day review period in addition to those 
disclosed under (2) above; and (4) any ``conflict of interest'' with 
the issuer as defined in Rule 5121(f)(5).
---------------------------------------------------------------------------

     Lastly, Rothwell recommends that the Adviser Proposal be 
amended to include a condition requiring that an ``independent 
financial consultant'' comply with the 180-day lock-up restriction in 
Rule 5110(g) with respect to any securities of the issuer acquired 
pursuant to the consulting agreement or otherwise during the 180-day 
review period.\24\ Rothwell also recommends that FINRA require that any 
option, warrant or convertible security acquired by the ``independent 
financial adviser'' during the 180-day review period comply with the 
restriction of Rule 5110(f)(2)(H) (with the exception of Rule 
5110(f)(2)(H)(ii)) on the terms of such securities.\25\
---------------------------------------------------------------------------

    \24\ See Rothwell Letter supra note 4, at 6.
    \25\ See id.
---------------------------------------------------------------------------

    Rothwell also is concerned that the ordinary advisory services 
enumerated by FINRA and any other services provided by an ``independent 
financial consultant'' may be difficult to distinguish from, and may 
merge into, those activities that would bring such a consultant within 
the definitions of ``underwriter and related persons'' and 
``participation.'' \26\ Consequently, Rothwell requests that FINRA 
assist members in complying with the Adviser Proposal exemption by 
enumerating permissible consulting activities for an ``independent 
financial adviser'' and providing (where possible) guidance with 
respect to the types of activities that the consultant should not 
engage in (which is further discussed in the next section).\27\
---------------------------------------------------------------------------

    \26\ See Rothwell Letter supra note 4, at 7.
    \27\ See id.
---------------------------------------------------------------------------

    Additionally, Rothwell expressed concern that an independent 
financial

[[Page 24804]]

consultant, in the course of providing advice on the options for 
financing and the terms proposed by underwriters, among other possible 
advice requested by an issuer, would be considered to be engaged in the 
``solicitation or distribution of the offering,'' as prohibited by the 
Adviser Proposal, or to be a ``finder'' under the definition of 
``underwriter and related persons'' by assisting an issuer in 
identifying potential FINRA members or registered investment advisers 
that could serve as distribution channels and even contacting and 
arranging introductions to such persons.\28\ Consequently, Rothwell 
also requests that FINRA clarify the scope of the prohibition on 
``solicitation or distribution of the offering'' and of acting as a 
finder to assist FINRA members to comply with the exemption provided by 
the Adviser Proposal.\29\
---------------------------------------------------------------------------

    \28\ See id.
    \29\ See Rothwell Letter supra note 4, at 7-8.
---------------------------------------------------------------------------

    With respect to the proposed rule change to Rule 5110(g)(1) 
(related to the lock-up restriction) and Rule 5121(f)(6) (narrowing the 
scope of the conflict of interest rule), Rothwell supports FINRA's 
proposed modifications.\30\ And to the extent that FINRA does not adopt 
some form of Rothwell's recommendation to continue to require the 
filing of information relevant to a FINRA member that claims to be an 
independent financial adviser,\31\ Rothwell is opposed to the proposed 
modification to Rule 5110(b)(6)(A)(iii).\32\ However, Rothwell stated 
that if FINRA does modify its proposal in line with Rothwell's 
recommendation, Rothwell supports narrowing the information filing 
requirement.\33\
---------------------------------------------------------------------------

    \30\ See Rothwell Letter supra note 4, at 8-9.
    \31\ See supra notes 20-21 and accompanying text.
    \32\ See Rothwell Letter supra note 4, at 8.
    \33\ See id.
---------------------------------------------------------------------------

    FINRA responded to the comments in a letter dated April 16, 
2014.\34\ FINRA stated that in filing this proposed rule change, it 
concluded that the potential for abuse by independent financial 
advisers of issuers is minimized when a financial adviser is not 
engaged in, or affiliated with any entity that is engaged in, the 
solicitation or distribution of the offering.\35\ FINRA further stated 
that the purpose of the corporate financing rules--to prohibit the 
imposition of unfair and unreasonable underwriting terms and 
arrangements on issuers by members participating in a public offering--
is served and the risk of unfairness and unreasonableness is minimized 
when a member provides only advisory or consulting services.\36\ 
Indeed, FINRA stated that its review of public offerings filed under 
Rule 5110 in the last decade did not identify abusive underwriting 
terms and arrangements associated with firms that would fall under the 
proposed definition of independent financial adviser.\37\
---------------------------------------------------------------------------

    \34\ See supra note 5.
    \35\ See FINRA Letter supra note 5, at 3.
    \36\ See id.
    \37\ See FINRA Letter supra note 5, at 3. The proposal defined 
an independent financial adviser as ``a member that provides 
advisory or consulting services to the issuer and is neither engaged 
in, nor affiliated with any entity that is engaged in, the 
solicitation or distribution of the offering.'' See Notice supra 
note 3.
---------------------------------------------------------------------------

    In response to Rothwell's request to clarify the intended scope of 
the modifications in light of the Adviser Proposal,\38\ FINRA confirmed 
that the proposed rule change would exclude an independent financial 
adviser, acting solely in that capacity, from the requirements of Rule 
5110, Rule 5121 and Rule 2310.\39\
---------------------------------------------------------------------------

    \38\ See supra note 15 and accompanying text.
    \39\ See FINRA Letter supra note 5, at 3.
---------------------------------------------------------------------------

    In addition, FINRA stated that Rothwell's concerns stemming from 
the filing requirements of Rule 5110(b)(6) \40\ and the disclosure 
requirements of Rule 5110(c)(2)(C) \41\ are irrelevant to the rules 
that regulate the underwriting terms and arrangements in public 
offerings--the purpose of the corporate financing rules.\42\
---------------------------------------------------------------------------

    \40\ See supra notes 20-21 and accompanying text.
    \41\ See supra note 23 and accompanying text.
    \42\ See FINRA Letter supra note 5, at 3-4.
---------------------------------------------------------------------------

    In response to Rothwell's recommendation that the filing and 
disclosure requirements of Rule 5110(b)(6)(A)(iii) continue to apply to 
independent financial advisers,\43\ FINRA stated that the facts and its 
experience support the elimination of these requirements for 
independent financial advisers and do not justify burdening independent 
financial advisers with these requirements.\44\ In particular, FINRA 
stated that although the information sought by the filing and 
disclosure requirements of Rule 5110(b)(6)(A)(iii) from an underwriter 
is useful to assist investors in understanding potential conflicts 
raised by the underwriter's financial interests in the issuer, this 
conflict is unlikely to arise because an independent financial adviser 
is not engaged in underwriting the offering or otherwise participating 
in its solicitation and distribution.\45\
---------------------------------------------------------------------------

    \43\ See supra notes 20-21 and 32 and accompanying text.
    \44\ See FINRA Letter supra note 5, at 4.
    \45\ See id. FINRA also stated that it believes that targeted 
filing and disclosure requirements that focus squarely on 
underwriting compensation and arrangements would enhance the 
effectiveness of these provisions in Rule 5110(b)(6)(A)(iii). See 
id.
---------------------------------------------------------------------------

    FINRA also did not agree with Rothwell's recommendation \46\ that 
independent financial advisers that acquire securities during the 180-
day review period should be subject to the compensation requirements of 
Rule 5110(g) and Rule 5110(f)(2)(H).\47\ FINRA pointed out that 
although Rule 5110 is intended to impose requirements on underwriters 
and their affiliates to address potential conflicts, FINRA believes 
that independent financial advisers who lack leverage and influence 
over pricing and other terms of an offering are not subject to those 
types of conflicts.\48\
---------------------------------------------------------------------------

    \46\ See supra notes 24-25 and accompanying text.
    \47\ See FINRA Letter supra note 5, at 4-5.
    \48\ See FINRA Letter supra note 5, at 4.
---------------------------------------------------------------------------

    Finally, FINRA provided clarification \49\ on the types of 
activities that would be permitted and prohibited for an independent 
financial adviser, particularly with respect to the meaning of 
``solicitation or distribution of the offering,'' as requested by 
Rothwell.\50\ FINRA stated the existing definition of ``participation 
or participating in a public offering'' in Rule 5110(a)(5) presently 
includes ``participation in the distribution'' and furnishing of 
customer or broker lists ``for solicitation.'' \51\ FINRA also 
emphasized that it is prepared to address factual questions specific to 
a particular filing and offer its interpretation of the permissible 
services of independent financial advisers.\52\
---------------------------------------------------------------------------

    \49\ See FINRA Letter supra note 5, at 5.
    \50\ See supra notes 28-29 and accompanying text.
    \51\ See FINRA Letter supra note 5, at 5.
    \52\ See id.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    The Commission has carefully reviewed the proposed rule change, the 
comments received, and FINRA's response to the comments, and believes 
that FINRA has responded adequately to the comments. The Commission 
finds that the proposed rule change is consistent with the Act and the 
rules and regulations thereunder applicable to a national securities 
association.\53\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 15A(b)(6) of the Act,\54\ which, 
among other things, requires that FINRA rules be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged

[[Page 24805]]

in facilitating transactions in securities, to remove impediments to 
and perfect the mechanism of a free and open market and a national 
market system, and, in general, to protect investors and the public 
interest.
---------------------------------------------------------------------------

    \53\ 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).
    \54\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    As discussed above, FINRA proposed to amend 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. The Commission believes 
that this revision will reduce the burden on independent financial 
advisers while not compromising investor protection, as the harms 
sought to be prevented by Rule 5110 are not implicated where advisory 
or consulting services are being carried out by an independent party 
such as an independent financial adviser.
    With regard to FINRA's proposal to eliminate the lock-up 
restrictions for certain securities, the Commission believes that it is 
appropriate to treat shares received in an acquisition or conversion to 
prevent dilution during the 180-day review period consistently with the 
securities on which their acquisition or conversion was based. The 
amendment should further the goal of preventing fraudulent and 
manipulative acts and practices and protecting investors and the public 
interest, especially in light of the continued application of the 
protections described in Rule 5110(d)(5)(D)(ii)-(iv).
    With regard to FINRA's proposal to limit the scope of the 
disclosure requirement contained in Rule 5110(b)(6)(A)(iii) by 
specifying that the rule applies to ``any participating member,'' 
rather than simply ``any member,'' the Commission believes that this 
proposal should reduce the burden on members not participating in an 
offering who were required to report information regarding the 
acquisition of the issuer's unregistered equity securities to FINRA.
    In addition, the Commission believes that FINRA's proposal to amend 
the scope of the definition of ``control'' in Rule 5121(f)(6) is 
appropriate because it tailors the requirement to report information to 
eliminate an unnecessary burden on members while also maintaining the 
rule's efficacy.
    The Commission further believes that FINRA, through its response, 
has adequately addressed the concerns expressed in Rothwell's letter by 
providing additional guidance and clarification on its proposed changes 
to Rules 5110 and 5121 and further explaining the interaction of this 
proposal with other FINRA Rules.
    For the reasons stated above, the Commission finds that the rule 
change is consistent with the Act and the rules and regulations 
thereunder.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\55\ that the proposed rule change (SR-FINRA-2014-003) be, and it 
hereby is, approved.
---------------------------------------------------------------------------

    \55\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\56\
---------------------------------------------------------------------------

    \56\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-09972 Filed 4-30-14; 8:45 am]
BILLING CODE 8011-01-P


