
[Federal Register Volume 79, Number 92 (Tuesday, May 13, 2014)]
[Notices]
[Pages 27355-27357]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-10895]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72114; File No. SR-FINRA-2014-004]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change Relating to 
Amendments to FINRA Rule 5110 (Corporate Financing Rule--Underwriting 
Terms and Arrangements) As Amended

May 7, 2014.
    On January 24, 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 to amend FINRA Rule 5110 (Corporate Financing 
Rule--Underwriting Terms and Arrangements). On February 4, 2014, FINRA 
filed Amendment No. 1 to the proposed rule change. The proposed rule 
change was published for comment in the Federal Register on February 
11, 2014.\3\ The Commission received one

[[Page 27356]]

comment letter on the proposal.\4\ On March 31, 2014, FINRA responded 
to the comment letter.\5\ This order approves the proposed rule change, 
as amended.
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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. 71486 (February 5, 
2014), 79 FR 8226 (SR-FINRA-2014-004) (``Notice'').
    \4\ See Letter from Stephen E. Roth and Susan S. Krawczyk, 
Sutherland Asbill & Brennan LLP, on behalf of the Committee of 
Annuity Insurers (``CAI''), Washington, District of Columbia to 
Elizabeth M. Murphy, Secretary, Commission, dated March 4, 2014 
(``CAI Letter'').
    \5\ See Letter from Kathryn M. Moore, Associate General Counsel, 
FINRA, to Kevin O'Neill, Deputy Secretary, Commission (``FINRA 
Letter'').
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I. Description of the Proposed Rule Change \6\
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    \6\ A more detailed description of the proposal is contained in 
the Notice. See supra note 4.
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    FINRA Rule 5110, among other things, regulates underwriting 
compensation, requires the filing of specified information in 
connection with public offerings in which members will participate, and 
prohibits unfair arrangements in connection with public offerings of 
securities. FINRA proposes to amend the Rule's provisions regarding 
unfair arrangements to: (1) Expand the circumstances under which 
members and issuers may negotiate termination fees and rights of first 
refusal (``ROFR''), with specified conditions; (2) exempt from the 
filing requirements exchange-traded funds formed as grantor or 
statutory trusts; and (3) codify the electronic filing requirement.
Termination Fees and Rights of First Refusal
    Rule 5110(f) (Unreasonable Terms and Arrangements) sets forth terms 
and arrangements that, when proposed in connection with a public 
offering of securities, are considered unfair and unreasonable. Rule 
5110(f)(2)(D) addresses fees in connection with a public offering of 
securities that is not completed according to the terms of the 
agreement between the issuer and underwriter (``terminated offering''). 
Specifically, Rule 5110(f)(2)(D) generally provides that it is unfair 
and unreasonable for a member to arrange for the payment of any 
compensation by an issuer in connection with a terminated offering 
(``termination fee'' or ``tail fee''). Rule 5110(f)(2)(D) further 
clarifies that this prohibition does not include compensation 
negotiated and paid in connection with a separate transaction that 
occurs in lieu of the proposed offering, or reimbursement of out-of-
pocket accountable expenses actually incurred by the member.\7\ 
Currently, Rule 5110(f)(2)(E) provides that, in the event an issuer 
terminates an offering with an underwriter and subsequently consummates 
a similar transaction, a termination fee may be permissible under 
certain circumstances.
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    \7\ Rule 5110(f)(2)(C) prohibits payment of commissions or 
reimbursement of expenses to an underwriter prior to the 
commencement of the sale of the securities being offered, except for 
a reasonable advance against out-of-pocket accountable expenses 
actually anticipated to be incurred by the underwriter. If the 
expenses are not actually incurred, any advance received must be 
returned to the issuer. Paragraph (D) currently provides that the 
reimbursement of out-of-pocket accountable expenses actually 
incurred by the member will not be presumed to be unfair or 
unreasonable under normal circumstances. The proposed amendment 
modifies paragraph (D) to specify that out-of-pocket accountable 
expenses must be bona fide.
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    FINRA is proposing to amend Rule 5110(f)(2) (Prohibited 
Arrangements) to generally permit termination fees where: (1) The 
agreement between the participating member and the issuer specifies 
that the issuer has a right of ``termination for cause'' (i.e., where a 
member fails materially to perform the underwriting services 
contemplated in the written agreement); \8\ (2) the agreement specifies 
that an issuer's exercise of its right of ``termination for cause'' 
eliminates any obligations with respect to the payment of any 
termination fee; \9\ (3) the amount of any specified termination fee is 
reasonable in relation to the services contemplated in the written 
agreement; and (4) the agreement specifies that the issuer is not 
responsible for paying the termination fee unless an offering or other 
type of transaction is consummated by the issuer (without involvement 
of the member) within two years of the date the issuer terminates the 
engagement with the member. FINRA indicated that the change to the rule 
would provide members with additional flexibility to negotiate 
termination fees.
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    \8\ The specific meaning of ``termination for cause'' would be 
dictated by the agreement. For purposes of this proposal, FINRA has 
defined a ``termination for cause'' to include a member's material 
failure to perform the underwriting services contemplated in the 
written agreement, but events that are outside the participating 
member's control are not required to be included in the definition.
    \9\ Members would continue to be permitted to receive 
reimbursement of out-of-pocket, bona fide, accountable expenses 
actually incurred by the participating member in connection with a 
terminated offering.
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    Current Rule 5110(f)(2)(F) and (G) addresses ROFRs, which provide a 
member with the right to underwrite or participate in future public 
offerings, private placements or other financings of the issuer. Rule 
5110(f)(2)(F) deems as unfair and unreasonable any ROFR provided to a 
member that: (1) Has a duration of more than three years from the date 
of effectiveness or commencement of sales of the public offering, or 
(2) provides more than one opportunity to waive or terminate the ROFR 
in consideration of any payment or fee.\10\ Rule 5110(f)(2)(G) 
prohibits any payment or fee to waive or terminate a ROFR regarding 
future public offerings, private placements or other financings that 
exceed specified values or that is not paid in cash.
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    \10\ Historically, FINRA has interpreted the Rule to permit 
ROFRs only in the case of successful offerings.
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    FINRA also proposes amendments to permit ROFRs in both successful 
and terminated offerings. ROFRs would be permissible where: (1) The 
agreement between the participating member and issuer specifies that 
the issuer has a right of termination for cause (i.e., where a member 
fails materially to perform the underwriting services contemplated in 
the written agreement); (2) an issuer's exercise of its right of 
termination for cause eliminates any obligations with respect to the 
provision of any ROFR; and (3) any fees arising from services provided 
under a ROFR are customary for those types of services. The Rule would 
continue to provide that the duration of any ROFR must be less than 
three years from the date of commencement of sales of the public 
offering (in the case of a successful offering). In the case of a 
terminated offering, the duration must be less than three years from 
the date the issuer terminates the engagement. The agreement may not 
provide for more than one opportunity to waive or terminate the ROFR in 
consideration of any payment or fee.\11\
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    \11\ FINRA is proposing to redesignate Rule 5110(f)(2)(G) as 
Rule 5110(f)(2)(F), which prohibits any payment or fee to waive or 
terminate a ROFR regarding future public offerings, private 
placements or other financings that exceed specified values or that 
is not paid in cash.
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Filing Requirements for Certain Exchange-Traded Funds
    Rule 5110(b)(8) (Exempt Offerings) generally provides an exemption 
for investment companies from the filing requirements of the Rule.\12\ 
Due to this exemption, exchange-traded funds (``ETFs'') that are 
structured as investment companies generally are exempt. However, this 
exemption does not include certain other ETFs that are not investment 
companies. FINRA

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proposes to add an exemption for these ETFs that are not included in 
the definition of an ``investment company'' because the creation 
structure of ETFs is not a distribution model that Rule 5110 was 
designed to address. Specifically, FINRA is proposing to exempt 
offerings of securities issued by a pooled investment vehicle, whether 
formed as a trust, partnership, corporation, limited liability company 
or other collective investment vehicle, that is not registered as an 
investment company under the Investment Company Act and has a class of 
equity securities listed for trading on a national securities exchange, 
provided that such equity securities may be created or redeemed on any 
business day at their net asset value per share.
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    \12\ Rule 5110(b)(8)(C) exempts from the Rule's filing 
requirements securities of ``open-end'' investment companies as 
defined in Section 5(a)(1) of the Investment Company Act of 1940 
(``Investment Company Act'') and securities of any ``closed-end'' 
investment company as defined in Section 5(a)(2) of the Investment 
Company Act that: (1) Make periodic repurchase offers pursuant to 
Rule 23c-3(b) under of the Investment Company Act; and (2) offer 
their shares on a continuous basis pursuant to Rule 415(a)(1)(xi) of 
SEC Regulation C.
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Electronic Filing
    Rule 5110(b) (Filing Requirements) generally provides that no 
member or person associated with a member shall participate in any 
manner in a public offering of securities subject to Rules 2310, 5110 
or 5121 unless the specified documents and information relating to the 
offering have been filed with and reviewed by FINRA. FINRA proposes to 
amend the Rule to make clarifying, non-substantive changes regarding 
documents filed through FINRA's electronic filing system.\13\
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    \13\ The effective date of the electronic filing requirements 
under Rule 5110 was July 12, 2002. See Notice supra note 4.
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II. Discussion of Comments and FINRA's Response

    In response to the Commission's request for comment on the proposed 
rule change,\14\ the Commission received one comment letter from the 
CAI.\15\ CAI stated that it has no objection to FINRA's proposed rule 
change, but CAI stated its belief that, consistent with the proposal to 
treat different types of ETFs the same, FINRA should also exempt 
different types of insurance contracts from the filing requirements of 
the Corporate Financing Rule.\16\ The commenter points out that in its 
current form, Rule 5110(b)(8) provides exemptions for only three types 
of insurance contracts,\17\ but not for other offerings of insurance 
contracts.\18\ Consequently, CAI proposes that ``FINRA also consider an 
additional `catch-all' exemption for offerings of insurance contracts 
not explicitly described in existing exemptions from the Corporate 
Financing Rule in order to clarify and confirm that offerings of 
insurance contracts are not subject to the filing requirements of the 
Corporate Financing Rule.'' \19\ CAI states that these presently non-
exempt contracts share a number of features with the contract types 
that are exempt from the Corporate Financing Rule.\20\ CAI therefore 
proposes that FINRA amend Rule 5110(b)(8) to exempt offerings of 
insurance premium funding programs and any other types of insurance 
contracts issued by an insurance company (not otherwise covered in an 
exemption above), except contracts which are exempt securities pursuant 
to Section 3(a)(8) of the Securities Act of 1933.\21\
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    \14\ See Notice supra note 4.
    \15\ See supra note 5.
    \16\ See supra note 5, at 2.
    \17\ See supra note 5, at 2-3. Specifically, these contracts 
are: exempted securities, as defined in Section 3(a)(12) of the Act; 
variable contracts, as defined in FINRA Rule 2320(b); and modified 
guaranteed annuity contracts and modified guaranteed life insurance 
policies. See id.
    \18\ Such insurance contracts could include annuity and life 
insurance contracts using an indexed method for crediting interest, 
synthetic guaranteed withdrawal benefit products (also known as 
contingent annuities), and combination long-term care insurance with 
cash value annuities and life insurance products. See supra note 5, 
at 3.
    \19\ See supra note 5, at 1-2.
    \20\ See supra note 5, at 4.
    \21\ See id.
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    In its response, FINRA stated that it appreciates CAI's comments, 
but considers the comments to be outside the scope of the proposal.\22\ 
FINRA stated that it will separately consider the comments and 
determine whether any future action is appropriate.\23\
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    \22\ See supra note 6, at 2.
    \23\ See id.
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III. Discussion and Commission Findings

    The Commission has carefully reviewed the proposed rule change, the 
comment letter, and FINRA's response to the comment letter, and 
believes that FINRA has adequately addressed the comment letter. 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.\24\ In particular, the Commission finds that 
the proposed rule change is consistent with Section 15A(b)(6) of the 
Act,\25\ 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 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.
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    \24\ 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).
    \25\ 15 U.S.C. 78o-3(b)(6).
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    As discussed above, FINRA proposes to amend Rule 5110(f) to expand 
the circumstances under which members and issuers may negotiate 
termination fees and ROFR. The Commission believes that the proposed 
rule change is reasonable because it may provide more flexibility to 
issuers and participating members in negotiating termination fees and 
terms and arrangements for ROFR, while also promoting the protection of 
issuers where a member fails materially to perform the underwriting 
services contemplated in the written agreement.
    Additionally, as discussed above, FINRA proposes to amend Rule 
5110(b) to extend the exemption from the filing requirements of Rule 
5110(b)(8) that is generally afforded to ETFs structured as investment 
companies to ETFs formed as grantor or statutory trusts. The Commission 
believes that extending this exemption to these ETFs is reasonable 
because it will ensure that similarly situated ETFs are treated the 
same under Rule 5110.
    Lastly, FINRA proposes amendments to Rule 5110 to codify the 
electronic filing requirement. The Commission believes that this 
amendment is reasonable because it will provide clarification regarding 
the manner by which documents are filed with FINRA.
    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,\26\ that the proposed rule change (SR-FINRA-2014-004) be, and it 
hereby is, approved.
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    \26\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\27\
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    \27\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-10895 Filed 5-12-14; 8:45 am]
BILLING CODE 8011-01-P


