[Federal Register Volume 84, Number 149 (Friday, August 2, 2019)]
[Notices]
[Pages 37921-37931]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-16483]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-86509; File No. SR-FINRA-2019-012]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Instituting Proceedings To Determine Whether To 
Approve or Disapprove Proposed Rule Change To Amend FINRA Rule 5110 
(Corporate Financing Rule--Underwriting Terms and Arrangements) To Make 
Substantive, Organizational and Terminology Changes

July 29, 2019.

I. Introduction

    On April 11, 2019, 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 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend FINRA Rule 5110 
(Corporate Financing Rule--Underwriting Terms and Arrangements) 
(``Rule'' or Rule 5110) to make substantive, organizational and 
terminology changes to the Rule.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on May 1, 2019.\3\ On June 12, 2019, the Commission extended 
to July 30, 2019, the time period in which to approve the proposed rule 
change, disapprove the proposed rule change, or institute proceedings 
to determine whether to approve or disapprove the proposed rule 
change.\4\ The Commission received six comment letters on the 
proposal.\5\
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    \3\ See Securities Exchange Act Release No. 85715 (April 25, 
2019), 84 FR 18592 (May 1, 2019) (``Notice'').
    \4\ See Securities Exchange Act Release No. 34-86091 (June 12, 
2019), 84 FR 28371 (June 18, 2019).
    \5\ See Letter from Suzanne Rothwell, Managing Member, Rothwell 
Consulting LLC, to Secretary, Commission, dated May 14, 2019 
(``Rothwell''); letter from Stuart J. Kaswell, Esq., to Vanessa 
Countryman, Acting Director, Commission, dated May 17, 2019 
(``Kaswell''); letter from Eversheds Sutherland (US) LLP, on behalf 
of the Committee of Annuity Insurers, to Brent J. Fields, Secretary, 
Commission, dated May 21, 2019 (``CAI''); letter from Aseel Rabie, 
Managing Director and Associate General Counsel, Securities Industry 
and Financial Markets Association, to Vanessa Countryman, Acting 
Secretary, Commission, dated May 30, 2019 (``SIFMA''); letter from 
Robert E. Buckholz, Chair, Federal Regulation of Securities 
Committee, ABA Business Law Section, American Bar Association, to 
Vanessa Countryman, Acting Secretary, Commission, dated May 30, 2019 
(``ABA''); letter from Davis Polk & Wardwell LLP, to Vanessa 
Countryman, Acting Secretary, Commission, dated June 5, 2019 
(``Davis Polk'').
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    On July 11, 2019, FINRA responded to the comments and filed Partial 
Amendment No. 1 to the proposal.\6\ The Commission is publishing this 
notice and order to solicit comments on the proposal as modified by 
Partial Amendment No. 1 from interested persons and to institute 
proceedings pursuant to Exchange Act Section 19(b)(2)(B) \7\ to 
determine whether to approve or disapprove the proposed rule change, as 
modified by Partial Amendment No. 1.
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    \6\ See Letter from Jeanette Wingler, Associate General Counsel, 
FINRA, to Vanessa Countryman, Secretary, Commission, dated July 11, 
2019 (``FINRA Response''). Partial Amendment No. 1 and FINRA's 
response to comments received are available at https://www.finra.org/industry/rule-filings/sr-finra-2019-012. See also 
Section II.B infra.
    \7\ 15 U.S.C. 78s(b)(2)(B).
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    Institution of proceedings does not indicate that the Commission 
has reached any conclusions with respect to the proposed rule change, 
nor does it mean that the Commission will ultimately disapprove the 
proposed rule change. Rather, as discussed below, the Commission seeks 
additional input on the proposed rule change, as modified by Partial 
Amendment No. 1, and on the issues presented by the proposal.

II. Description of the Proposed Rule Change

A. Proposed Rule Change as Originally Filed

    The following is a summary of the proposed rule change as 
originally filed by FINRA.\8\
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    \8\ See Notice, supra note 3, for a complete description of the 
proposal as originally filed.
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    As described in more detail in the Notice, FINRA proposes to modify 
Rule 5110 in an effort to modernize, simplify, and streamline the Rule. 
Specifically, FINRA proposes changes to the following: (1) Filing 
requirements; (2) filing requirements for shelf offerings; (3) 
exemptions from filing and substantive requirements; (4) underwriting 
compensation; (5) venture capital exceptions; (6) treatment of non-
convertible or non-exchangeable debt securities and derivatives; (7) 
lock-up restrictions; (8) prohibited terms and arrangements; and (9) 
defined terms.\9\

[[Page 37922]]

FINRA believes that these changes should lessen the regulatory costs 
and burdens incurred when complying with the Rule.
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    \9\ As discussed below, the proposal retains the current 
approach to itemized disclosure of underwriting compensation, but 
makes explicit the existing practice of disclosing specified 
material terms and arrangements related to underwriting 
compensation, such as exercise terms, in the prospectus. In 
addition, the proposed rule change does not include any changes to 
current Rule 5110(h) (Non-Cash Compensation). According to FINRA, 
these provisions are the subject of a separate consolidated approach 
to non-cash compensation. See Regulatory Notice 16-29 (August 2016).
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Filing Requirements
    FINRA proposes to allow members more time to make the required 
filings with FINRA from one business day after filing with the SEC or a 
state securities commission or similar state regulatory authority to 
three business days.\10\
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    \10\ See proposed Rule 5110(a)(3)(A).
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    FINRA also proposes to clarify and reduce filing requirements by 
directing members to provide SEC document identification number if 
available.\11\ FINRA also proposes to require filing: (1) Industry-
standard master forms of agreement only if specifically requested to do 
so by FINRA; \12\ (2) amendments to previously filed documents only if 
there have been changes relating to the disclosures that impact the 
underwriting terms and arrangements for the public offering in those 
documents; \13\ (3) a representation as to whether any associated 
person or affiliate of a participating member is a beneficial owner of 
5% or more of ``equity and equity-linked securities''; \14\ and (4) an 
estimate of the maximum value for each item of underwriting 
compensation.\15\
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    \11\ See proposed Rule 5110(a)(4)(A).
    \12\ See proposed Rule 5110(a)(4)(A)(ii).
    \13\ See proposed Rule 5110(a)(4)(A)(iii).
    \14\ See proposed Rule 5110(a)(4)(B)(iii) and proposed Rule 
5110(j)(7).
    \15\ See proposed Rule 5110(a)(4)(B)(ii).
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    FINRA also proposes to make a number of other clarifications 
regarding filing requirements to FINRA and filing requirements of 
specific members participating in the public offering.\16\
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    \16\ See proposed Rule 5110(a)(3)(B), 5110(a)(2), 5110(a)(1)(C), 
and 5110(a)(1)(B). See also Notice, supra note 3, 84 FR at 18593.
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    FINRA proposes to adopt a new provision addressing terminated 
offerings, which provides that, when an offering is not completed 
according to the terms of an agreement entered into by the issuer and a 
member, but the member has received underwriting compensation, the 
member must give written notification to FINRA of all underwriting 
compensation received or to be received, including a copy of any 
agreement governing the arrangement.\17\
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    \17\ See proposed Rule 5110(a)(4)(C) and proposed Rule 
5110(g)(5).
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Filing Requirements for Shelf Offerings
    FINRA proposes to codify exemptions from the filing requirements 
for certain shelf offerings that have historically been exempt from 
Rule 5110 and to streamline the filing requirements for the remaining 
shelf offerings.\18\
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    \18\ See Notice, supra note 3, 84 FR at 189593-594.
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Public Offerings Exempt From the Filing Requirement
    FINRA proposes to expand and clarify the scope of the exemptions 
under current Rule 5110. For example, FINRA proposes to exempt from 
Rule 5110's filing requirement a public offering by an ``experienced 
issuer.'' \19\ Although the proposed rule change would continue to 
apply Rule 5110's filing requirement to shelf offerings by issuers that 
do not meet the ``experienced issuer'' standard, such issuer would only 
need to file the following: (1) The Securities Act of 1933 
(``Securities Act'') registration statement number; and (2) if 
specifically requested by FINRA, other documents and information set 
forth in Rule 5110(a)(4)(A) and (B).\20\ FINRA also proposes to clarify 
that securities of banks that have qualifying outstanding debt 
securities are exempt from the filing requirement.\21\
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    \19\ The proposed rule change would delete references to the 
pre-1992 standards for Form S-3 and standards approved in 1991 for 
Form F-10 and instead codify the requirement that the issuer have a 
36-month reporting history and at least $150 million aggregate 
market value of voting stock held by non-affiliates or alternatively 
the aggregate market value of voting stock held by non-affiliates is 
at least $100 million and the issuer has an annual trading volume of 
three million shares or more in the stock. See proposed Rule 
5110(j)(6) and Notice, supra note 3.
    \20\ See proposed Rule 5110(a)(4)(E).
    \21\ See proposed Rule 5110(h)(1)(A).
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    FINRA proposes to expand the current list of offerings that are 
exempt from both the filing requirements and substantive provisions of 
Rule 5110 to include public offerings of closed-end ``tender offer'' 
funds (i.e., closed-end funds that repurchase shares from shareholders 
pursuant to tender offers), insurance contracts and unit investment 
trusts.\22\ In addition, the proposed rule change reclassifies three 
items from the offerings exempt from filing and rule compliance to 
offerings excluded from the definition of public offering. The three 
items are: (1) Offerings exempt from registration with the SEC pursuant 
to Section 4(a)(1), (2) and (6) of the Securities Act; (2) offerings 
exempt from registration under specified Regulation D provisions; and 
(3) offerings of exempted securities as defined in Section 3(a)(12) of 
the Exchange Act.
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    \22\ See proposed Rule 5110(h)(2)(E), (K) and (L).
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Disclosure Requirements
    FINRA states that the proposed rule change would retain the current 
requirements for itemized disclosure of underwriting compensation and 
disclosing dollar amounts ascribed to each such item.\23\ FINRA also 
proposes to incorporate into proposed Supplementary Material .05 to 
Rule 5110 the requirements for disclosure of specified material terms 
and arrangements that it believes are consistent with current 
practice.\24\ Further, the proposal makes explicit the existing 
practice of disclosing specified material terms and arrangements 
related to underwriting compensation in the prospectus, and requires a 
description for: (1) Any right of first refusal (``ROFR'') granted to a 
participating member and its duration; and (2) the material terms and 
arrangements of the securities acquired by the participating member 
(e.g., exercise terms, demand rights, piggyback registration rights and 
lock-up periods).\25\
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    \23\ See proposed Rule 5110(b)(1) and Supplementary Material .05 
to Rule 5110. See also proposed Rule 5110(e)(1)(B) requiring 
disclosure of lock-ups.
    \24\ See proposed Supplementary Material .05 to Rule 5110.
    \25\ See proposed Supplementary Material .05 to Rule 5110.
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Underwriting Compensation
    FINRA proposes to define the term ``Underwriting Compensation'' in 
proposed Rule 5110 to mean ``any payment, right, interest, or benefit 
received or to be received by a participating member from any source 
for underwriting, allocation, distribution, advisory and other 
investment banking services in connection with a public offering. In 
addition, underwriting compensation shall include finder's fees, 
underwriter's counsel fees and securities.'' \26\
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    \26\ See proposed Rule 5110(j)(22).
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    Rule 5110 currently provides that all items of value received or to 
be received from any source are presumed to be underwriting 
compensation when received during the period commencing 180 days before 
the required filing date of the registration statement, and up to 90 
days following the effectiveness or commencement of sales of a public 
offering. FINRA states that, to better reflect the different types of 
offerings subject to the Rule, the proposed rule change would introduce 
the defined term ``review period'', and that the applicable time period 
would vary based on the type of offering. The proposed rule change 
would define the term ``review period'' to mean: (1) For a firm 
commitment offering, the 180-day period preceding the required filing 
date through the 60-day period following the effective date of the 
offering; (2) for a best efforts offering, the 180-day period preceding 
the required filing date through the 60-day period following the

[[Page 37923]]

final closing of the offering; and (3) for a firm commitment or best 
efforts takedown or any other continuous offering made pursuant to Rule 
415 of the Securities Act, the 180-day period preceding the required 
filing date of the takedown or continuous offering through the 60-day 
period following the final closing of the takedown or continuous 
offering.\27\
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    \27\ See proposed Rule 5110(j)(20). FINRA states that, in 
accordance with this proposal, payments and benefits received during 
the applicable review period would be considered in evaluating 
underwriting compensation.
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    The proposed rule change would continue to provide two non-
exhaustive lists of examples of payments or benefits that would and 
would not be considered underwriting compensation, with streamlining 
and clarifying modifications.\28\
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    \28\ See proposed Supplementary Material .01 to Rule 5110. See 
also Notice, supra note 3, for a full description of the proposal.
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    In addition, the proposed rule change would take a principles-based 
approach in considering whether issuer securities acquired from third 
parties or in directed sales programs may be excluded from underwriting 
compensation. Such approach would start with the presumption that the 
issuer securities received during the review period would be 
underwriting compensation. FINRA, however, would consider the following 
factors, as well as any other relevant factors and circumstances when 
considering whether securities of the issuer acquired from third 
parties may be excluded from underwriting compensation. Specifically, 
these include: (1) The nature of the relationship between the issuer 
and the third party, if any; (2) the nature of the transactions in 
which the securities were acquired, including, but not limited to, 
whether the transactions are engaged in as part of the participating 
member's ordinary course of business; and (3) any disparity between the 
price paid and the offering price or market price.
    With respect to issuer securities acquired in directed sales 
programs (commonly called friends and family programs), the proposed 
definition of ``participating member'' includes any FINRA member that 
is participating in a public offering, any affiliate or associated 
person of the member, and any immediate family of an associated person 
of the member, but does not include the issuer.\29\ Under proposed 
Supplementary Material .04 to Rule 5110, FINRA would consider the 
following factors, as well as any other relevant factors and 
circumstances when considering whether an acquisition of securities by 
a participating member pursuant to an issuer's directed sales program 
may be excluded from underwriting compensation: (1) The existence of a 
pre-existing relationship between the issuer and the person acquiring 
the securities; (2) the nature of the relationship; and (3) whether the 
securities were acquired on the same terms and at the same price as 
other similarly-situated persons participating in the directed sales 
program.
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    \29\ See proposed Rule 5110(j)(15).
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Venture Capital Exceptions
    FINRA states that the proposed rule change would modify, clarify 
and expand the venture capital exceptions.\30\ Specifically, the 
proposed rule change would no longer treat as underwriting compensation 
securities acquisitions covered by two of the current exceptions: (1) 
Securities acquisitions and conversions to prevent dilution; and (2) 
securities purchases based on a prior investment history. This 
treatment is conditioned on prior investments in the issuer occurring 
before the review period.\31\ When subsequent securities acquisitions 
take place (e.g., as a result of a stock split, a right of preemption, 
a securities conversion or when additional securities are acquired to 
prevent dilution of a long-standing interest in the issuer), the 
acquisition of the additional securities would not be treated as 
underwriting compensation under the proposed Rule.\32\
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    \30\ Rule 5110(d)(5) currently provides exceptions designed to 
distinguish securities acquired in bona fide venture capital 
transactions from those acquired as underwriting compensation (for 
brevity, referred to herein as the ``venture capital exceptions''). 
The proposed rule change would modify, clarify and expand the 
exceptions to further facilitate members' participation in bona fide 
venture capital transactions. FINRA states that the venture capital 
exceptions would include several restrictions to ensure the 
protection of other market participants and that the exceptions are 
not misused to circumvent the requirements of Rule 5110. See Notice, 
supra note 3.
    \31\ See proposed Supplementary Material .01(b)(14), (16-18).
    \32\ The proposed rule change would add these acquisitions to 
the list of examples of payments that are not underwriting 
compensation because they are based on a prior investment history 
and are subject to the terms of the original securities that were 
acquired before the review period. See proposed Supplementary 
Material .01(b)(14), (16-18).
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    FINRA also proposes to broaden two of the current venture capital 
exceptions regarding purchases and loans by certain affiliates, and 
investments in and loans to certain issuers, by removing a limitation 
on acquiring more than 25% of the issuer's total equity securities.\33\ 
These venture capital exceptions specify that the affiliate must be 
primarily in the business of making investments or loans. FINRA states 
that the proposed rule change expands the scope of these exceptions to 
include that the affiliate, directly or through a subsidiary it 
controls, must be in such business and further permits that the entity 
may be newly formed by such affiliate.
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    \33\ See proposed Rule 5110(d)(1) and (2).
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    With respect to the current venture capital exception relating to 
private placements with institutional investors, the proposal would 
require that the institutional investors participating in the offering 
are not affiliates of a FINRA member and must purchase at least 51% of 
the total number of securities sold in the private placement at the 
same time and on the same terms.\34\ In addition, the proposed rule 
change would raise the percent that participating members in the 
aggregate may acquire from 20% to 40% of the securities sold in the 
private placement.\35\ The proposed rule change would expand the scope 
of proposed FINRA Rule 5110(d)(3) to include providing services for a 
private placement (rather than just acting as a placement agent).\36\
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    \34\ See Notice, supra note 3, 84 FR at 18597.
    \35\ See proposed Rule 5110(d)(3)(C).
    \36\ See proposed Rule 5110(d)(3).
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    FINRA proposes to adopt a new venture capital exception where a 
highly regulated entity with significant disclosure requirements and 
independent directors who monitor investments is also making a 
significant co-investment in an issuer and is receiving securities at 
the same price and on the same terms as the participating member. The 
exception applies for securities acquired in a private placement before 
the required filing date of the public offering by a participating 
member if at least 15% of the total number of securities sold in the 
private placement were acquired, at the same time and on the same 
terms, by one or more entities that is an open-end investment company 
not traded on an exchange, and no such entity is an affiliate of a 
FINRA member participating in the offering.
    The proposed rule change would also provide some additional 
flexibility in the availability of the venture capital exceptions for 
securities acquired where the public offering has been significantly 
delayed. The proposed rule change would take a principles-based 
approach in considering whether it is appropriate to treat as 
underwriting compensation securities acquired by a member after the 
required filing date in a transaction that, except for the timing,

[[Page 37924]]

would otherwise meet the requirements of a venture capital 
exception.\37\
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    \37\ See Notice, supra note 3, 84 FR at 18597.
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Treatment of Non-Convertible or Non-Exchangeable Debt Securities and 
Derivatives
    The proposed rule change would expressly provide that non-
convertible or non-exchangeable debt securities and derivative 
instruments \38\ acquired in a transaction unrelated to a public 
offering would not be underwriting compensation.\39\ In contrast, for 
any non-convertible or non-exchangeable debt securities and derivative 
instruments acquired in a transaction related to the public offering, 
the proposed rule change would clarify that: (1) A description of those 
securities and derivative instruments must be filed with FINRA; and (2) 
this description must be accompanied by a representation that a 
registered principal or senior manager of the participating member has 
determined if the transaction was or will be entered into at a fair 
price.\40\
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    \38\ Consistent with the current Rule, the proposed rule change 
would define the term ``derivative instrument'' to mean any eligible 
OTC derivative instrument as defined in Rule 3b-13(a)(1), (2) and 
(3) of the Exchange Act. See proposed Supplementary Material .06(b) 
to Rule 5110.
    \39\ See proposed Supplementary Material .01(b)(19) to Rule 
5110.
    \40\ See proposed Rule 5110(a)(4)(B)(iv)(a). Generally 
consistent with current Rule 5110, the proposed rule change would 
define the term ``fair price'' to mean the participating members 
have priced a derivative instrument or non-convertible or non-
exchangeable debt security in good faith; on an arm's length, 
commercially reasonable basis; and in accordance with pricing 
methods and models and procedures used in the ordinary course of 
their business for pricing similar transactions. The proposed rule 
change would also clarify that a derivative instrument or other 
security received as compensation for providing services for the 
issuer, for providing or arranging a loan, credit facility, merger, 
acquisition or any other service, including underwriting services 
will not be deemed to be entered into or acquired at a fair price. 
See proposed Supplementary Material .06(b) to Rule 5110.
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    FINRA also proposes to clarify that non-convertible or non-
exchangeable debt securities and derivative instruments acquired in a 
transaction related to the public offering at a fair price would be 
considered underwriting compensation but would have no compensation 
value. In contrast, the proposed rule change would provide that non-
convertible or non-exchangeable debt securities and derivative 
instruments acquired in a transaction related to the public offering 
but not at a fair price would be considered underwriting compensation 
and subject to the normal valuation requirements of Rule 5110.\41\
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    \41\ See, e.g., proposed Supplementary Material .06(a) to Rule 
5110; proposed Rule 5110(c); Notice, supra note 3.
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Lock-Up Restrictions
    FINRA states that, subject to some exceptions, Rule 5110 requires 
in any public equity offering a 180-day lock-up restriction on 
securities that are considered underwriting compensation. The proposed 
rule change would provide that the lock-up period begins on the date of 
commencement of sales of the public equity offering (rather than the 
date of effectiveness of the prospectus).\42\
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    \42\ See proposed Rule 5110(e)(1)(A). The proposed rule change 
also would provide that the lock-up restriction must be disclosed in 
the section on distribution arrangements in the prospectus or 
similar document consistent with proposed Supplementary Material .05 
requiring disclosure of the material terms of any securities. See 
proposed Rule 5110(e)(1)(B).
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    FINRA proposes to add an exception from the lock-up restriction for 
securities acquired from an issuer that meets the registration 
requirements of Registration Forms S-3, F-3 or F-10.\43\ The proposed 
rule change would also add an exception from the lock-up restriction 
for securities that were acquired in a transaction meeting one of Rule 
5110's venture capital exceptions.\44\ The proposed rule change would 
also add an exception from the lock-up restriction for securities that 
were received as underwriting compensation and are registered and sold 
as part of a firm commitment offering.\45\
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    \43\ See proposed Rule 5110(e)(2)(A)(iii).
    \44\ See, e.g., proposed Rule 5110(e)(2)(A)(vi); Notice, supra 
note 3.
    \45\ See, e.g., proposed Rule 5110(e)(2)(A)(viii); Notice, supra 
note 3.
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    FINRA proposes to provide clarity about the treatment of non-
convertible or non-exchangeable debt securities and derivative 
instruments acquired in transactions related to a public offering and 
whether those securities are subject to the lock-up requirement.\46\
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    \46\ For a full description of this proposal, see Notice, supra 
note 3. See, also, proposed Rule 5110(e)(2)(A)(iv).
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    The proposed rule change would provide that the lock-up restriction 
does not apply to derivative instruments acquired in connection with a 
hedging transaction related to the public offering and at a fair 
price.\47\ In addition, FINRA proposes to add an exception to the lock-
up restriction to permit the transfer or sale of the security back to 
the issuer in a transaction exempt from registration with the SEC.\48\ 
FINRA also proposes to modify the lock-up exception in current Rule 
5110(g)(2)(A)(ii) to permit the transfer of any security to the 
member's registered persons or affiliates if all transferred securities 
remain subject to the restriction for the remainder of the lock-up 
period.\49\
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    \47\ See proposed Rule 5110(e)(2)(A)(v). Derivative instruments 
acquired in transactions related to the public offering that do not 
meet the requirements of the exception would continue to be subject 
to the lock-up restriction. See Notice, supra note 3.
    \48\ See proposed Rule 5110(e)(2)(B)(iii).
    \49\ See proposed Rule 5110(e)(2)(B)(i). The proposed rule 
change would retain the current exception to the lock up for the 
exercise or conversion of any security, if all such securities 
received remain subject to the lock-up restriction for the remainder 
of the 180-day lock-up period. See proposed Rule 5110(e)(2)(B)(ii).
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    Finally, because proposed Supplementary Material .01(b)(20) would 
provide that securities acquired subsequent to the issuer's IPO in a 
transaction exempt from registration under Rule 144A of Securities Act 
would not be underwriting compensation, FINRA states that the proposed 
rule change would correspondingly delete as unnecessary the current 
exception from the lock-up restriction for those securities.\50\
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    \50\ See current Rule 5110(g)(2)(A)(viii).
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Prohibited Terms and Arrangements
    FINRA proposes to clarify and amend the list of prohibited 
unreasonable terms and arrangements in connection with a public 
offering of securities.\51\ For example, the proposed rule change would 
clarify that it would be considered a prohibited arrangement for any 
underwriting compensation to be paid prior to the commencement of sales 
of public offering, except: (1) An advance against accountable expenses 
actually anticipated to be incurred, which must be reimbursed to the 
issuer to the extent not actually incurred; or (2) advisory or 
consulting fees for services provided in connection with the offering 
that subsequently is completed according to the terms of an agreement 
entered into by an issuer and a participating member.\52\
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    \51\ See proposed Rule 5110(g).
    \52\ See proposed Rule 5110(g)(4). For a complete description of 
the proposal with respect to prohibited terms and arrangements, see 
Notice, supra note 3, 84 FR at 18599-600, and Exhibit 5 as 
originally filed.
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Defined Terms
    The proposal would consolidate the defined terms in one location at 
the end of the Rule, which FINRA believes will simplify and clarify 
FINRA Rule 5110's defined terms.\53\ For example, FINRA proposes to 
consolidate the various provisions that address what constitutes

[[Page 37925]]

underwriting compensation into a single, new definition of 
``underwriting compensation.'' \54\ The proposed rule change also would 
eliminate the term ``underwriter and related persons'' and instead use 
the defined term ``participating member.'' \55\
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    \53\ For a complete description of the proposal with respect to 
defined terms, see Notice, supra note 3, 84 FR at 18600, and Exhibit 
5 as originally filed.
    \54\ See proposed Rule 5110(j)(22).
    \55\ FINRA states that, substantively consistent with the 
current Rule, the proposed rule change would define ``participating 
member'' to include any FINRA member that is participating in a 
public offering, any affiliate or associated person of the member, 
and any ``immediate family,'' but does not include the issuer. See 
proposed Rule 5110(j)(15). While not included in the ``participating 
member'' definition, the broad definition of underwriting 
compensation would include underwriter's counsel fees and expenses, 
financial consulting and advisory fees and finder's fees. As such, 
FINRA believes that the definition of ``underwriting compensation'' 
would ensure that the Rule addresses fees and expenses paid to 
persons previously covered by the term ``underwriter and related 
persons.'' In addition, the term ``immediate family'' is clarified 
for readability in proposed Rule 5110(j)(8) to mean the spouse or 
child of an associated person of a member and any relative who lives 
with, has a business relationship with, or provides to or receives 
support from an associated person of a member. See Notice, supra 
note 3, for a full description of the proposal as originally filed.
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Valuation of Securities
    The proposal would retain the current method for valuing options, 
warrants and other convertible securities received as underwriting 
compensation in the current Rule.\56\
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    \56\ See proposed Rule 5110(c).
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B. Notice of Partial Amendment No. 1

1. Introduction
    Set forth in Section II.B.2 below is the summary of Partial 
Amendment No. 1 to the proposed rule change, as prepared and submitted 
by FINRA to the Commission.\57\
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    \57\ The text of the proposed rule change, including Partial 
Amendment No. 1, is available on FINRA's website at http://www.finra.org/industry/rule-filings/sr-finra-2019-012.
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2. Self-Regulatory Organization's Statement of the Purpose of the 
Proposed Rule Change, as Modified by Partial Amendment No.1
    Partial Amendment No. 1 makes the following changes to the 
Proposal: (1) Modifies the requirement to file a description of any 
securities of the issuer acquired and beneficially owned by any 
participating member during the review period; (2) excepts ``actively-
traded'' securities from the lock-up restriction; (3) excludes from 
underwriting compensation in a revised public offering accountable 
expenses received pursuant to Rule 5110(g)(5)(A) in a prior offering; 
(4) exempts issuer self-tender offers from the filing and substantive 
requirements of the Rule; (5) clarifies the proposed investment grade 
debt exemption in Rule 5110(h)(1)(A); (6) modifies some proposed 
defined terms; and (7) clarifies when securities acquired would be 
deemed underwriting compensation pursuant to Rule 5110.
Filing a Description of Acquired Securities
    Commenters stated that proposed Rule 5110(a)(4)(B)(iv), which 
requires the filing of a ``description of any securities of the issuer 
acquired and beneficially owned by any participating member during the 
review period,'' should be limited to a description of any securities-
based underwriting compensation acquired during the review period by 
the participating member (i.e., no description for securities that do 
not constitute underwriting compensation).\58\ Commenters stated that 
the provision would impose significant additional costs and 
administrative burdens on members and, due to likely fluctuations in 
holdings over the review period, would present compliance challenges.
---------------------------------------------------------------------------

    \58\ See ABA, Davis Polk and SIFMA.
---------------------------------------------------------------------------

    A description of issuer securities acquired and beneficially owned 
by the participating member during the review period is needed to 
evaluate the underwriting terms and arrangements of the public offering 
and to ensure that there is no circumvention of the Rule. In response 
to the commenters' concerns and to reduce costs and administrative 
burdens on participating members, FINRA is proposing in this Partial 
Amendment No. 1 to revise Rule 5110(a)(4)(B)(iv) to not require filing 
a description of any securities acquired in accordance with 
Supplementary Material .01(b), which sets forth a non-exhaustive list 
of payments that generally would not be deemed to be underwriting 
compensation. This approach would reduce filing burdens for members 
regarding payments and benefits that would not be considered 
underwriting compensation, while ensuring that FINRA receives adequate 
information about other issuer securities acquired and beneficially 
owned by the participating member during the review period to fully 
evaluate the underwriting terms and arrangements of the public offering 
and to ensure that there is no circumvention of the Rule.\59\
---------------------------------------------------------------------------

    \59\ Specifically, Rule 5110(a)(4)(B)(iv) would be revised to: 
``(iv) a description of any securities of the issuer acquired and 
beneficially owned by any participating member during the review 
period, provided that: a. non-convertible or non-exchangeable debt 
securities and derivative instruments acquired in a transaction 
related to the public offering must be filed and also accompanied by 
a representation that a registered principal or senior manager of 
the participating member has determined if the transaction was or 
will be entered into at a fair price; [and] b. non-convertible or 
non-exchangeable debt securities and derivative instruments need not 
be filed if acquired in a transaction that is unrelated to the 
public offering[.]; and c. securities if acquired in accordance with 
Supplementary Material .01(b) need not be filed.''
---------------------------------------------------------------------------

Lock-Up Restriction
    SIFMA suggested eliminating the lock-up requirement for offerings 
of securities that are ``actively-traded'' (as defined in Rule 
101(c)(1) of SEC Regulation M). The Proposal would add exceptions from 
the lock-up restriction where other protections or market forces 
obviate the need for the restriction. Due to the existing public market 
for the securities, the Proposal included a proposed exception from the 
lock-up restriction for securities acquired from an issuer that meets 
the registration requirements of SEC Registration Forms S-3, F-3 or F-
10. The justification for this proposed exception also applies to 
securities that are ``actively-traded'' as defined in Rule 101(c)(1) of 
SEC Regulation M (i.e., securities that have an average daily trading 
volume value of at least $1 million and are issued by an issuer whose 
common equity securities have a public float value of at least $150 
million; provided, however, that such securities are not issued by the 
distribution participant or an affiliate of the distribution 
participant). Accordingly, FINRA is proposing in this Partial Amendment 
No. 1 to add Rule 5110(e)(2)(A)(ix) to provide that the lock-up 
restriction would not apply ``to a security that is `actively-traded' 
(as defined in Rule 101(c)(1) of SEC Regulation M).''
Revised Public Offerings
    Commenters stated that consideration of prior compensation received 
in a revised public offering is not appropriate, particularly if the 
compensation is received for services actually rendered or for out-of-
pocket expenses actually incurred in connection with the prior offering 
that was not completed in compliance with the requirements of proposed 
Rule 5110(g)(4) and (g)(5).\60\ Commenters stated that it is unclear: 
(1) What a ``revised public offering'' is; (2) whether the inclusion is 
limited solely to compensation received (or arrangements for 
compensation entered into) during

[[Page 37926]]

the review period for the revised public offering; and (3) how proposed 
Supplementary Material .01(a)(13) relates to proposed Rule 
5110(a)(4)(C) requiring notice to FINRA of compensation received for a 
prior offering that was not completed.
---------------------------------------------------------------------------

    \60\ See ABA, Davis Polk and SIFMA. SIFMA acknowledges that 
proposed Supplementary Material .01(a)(13), which provides that 
``underwriting compensation'' includes ``any compensation paid to 
any participating member in connection with a prior proposed public 
offering that was not completed, if the member firm participates in 
the revised public offering,'' is consistent with a similar 
provision in the current Rule. See Rule 5110(c)(3)(A)(xiii).
---------------------------------------------------------------------------

    As SIFMA acknowledges, Rule 5110 currently applies to underwriting 
compensation received in a prior public offering that was not completed 
when the participating member participates in the revised public 
offering. When assessing whether an offering is a revised public 
offering, FINRA looks at the facts and circumstances of the current 
offering and any relevant prior offering that was not completed with a 
focus on the material offering terms and underwriting terms and 
arrangements. When assessing a revised public offering, FINRA would 
consider securities and other compensation received as part of the 
prior offering that was not completed and during the review period for 
the revised public offering. Considering compensation received in the 
prior offering that was not completed is vital to preventing a 
participating member from being compensated twice for performing the 
same services for the issuer. Furthermore, the compensation received in 
a prior terminated offering would be considered underwriting 
compensation under Rule 5110 only if the member participates in the 
revised public offering.
    As the commenters noted, a participating member in a revised public 
offering may have received payment for accountable expenses in the 
prior offering that was not completed. FINRA believes that these 
expenses may be excluded from underwriting compensation in the revised 
public offering and, accordingly, FINRA is proposing in this Partial 
Amendment No. 1 to revise Supplementary Material .01(a)(13) to exclude 
from underwriting compensation accountable expenses received pursuant 
to Rule 5110(g)(5)(A).\61\
---------------------------------------------------------------------------

    \61\ Specifically, Supplementary Material .01(a)(13) would be 
revised to provide that underwriting compensation would include 
``any compensation paid to any participating member in connection 
with a prior proposed public offering that was not completed, if the 
member firm participates in the revised public offering, except that 
accountable expenses received pursuant to paragraph (g)(5)(A) shall 
not be deemed underwriting compensation.''
---------------------------------------------------------------------------

Issuer Self-Tender Offers
    With respect to the exemption in Rule 5110(h)(2)(G) for third-party 
tender offers, ABA suggested revising this exemption to also include 
tender offers by issuers for their own securities under the Exchange 
Act. ABA stated that there is little logic for excluding third-party 
tender offers, but not issuer self-tenders, when a FINRA member may act 
as dealer manager in connection with either type of transaction. FINRA 
is proposing in this Partial Amendment No. 1 to amend Rule 
5110(h)(2)(G) to apply to ``tender offers made pursuant to SEC 
Regulation 14D or Rule 13a-4 under the Exchange Act.'' Both third-party 
tender offers and issuer self-tender offers are subject to disclosure, 
filing and procedural requirements as set forth in the Exchange Act. 
Moreover, issuer self-tender offers have historically not been filed 
with FINRA for review pursuant to Rule 5110.
Investment Grade Debt Exemption
    With respect to the proposed investment grade debt exemption in 
Rule 5110(h)(1)(A), Rothwell opposed including public offerings where 
the issuer has securities in the same series that have equal rights and 
obligations as investment grade rated securities because doing so may 
allow an issuer to avoid filing a public offering of any type of 
securities with FINRA for review based on the issuer having only 
outstanding unrated non-convertible debt or preferred securities that 
the issuer deems to be in the same series as qualifying reacquired 
Treasury securities that were once rated investment grade. Rothwell 
suggested adding ``outstanding'' after ``has'' to ensure that an 
offering of debt or equity securities can rely only on the exemption at 
a time when the issuer has outstanding a qualifying issue of investment 
grade rated debt or preferred securities so that Treasury securities 
cannot qualify for this purpose.
    FINRA does not intend the exemption to apply where the issuer has 
only outstanding unrated non-convertible debt or preferred securities 
that the issuer deems to be in the same series as qualifying reacquired 
Treasury securities that were once rated investment grade. FINRA is 
proposing in this Partial Amendment No. 1 to revise proposed Rule 
5110(h)(1)(A) to exempt ``securities offered by a bank, corporate 
issuer, foreign government or foreign government agency that has 
outstanding unsecured non-convertible debt with a term of issue of at 
least four years or unsecured non-convertible preferred securities that 
are investment grade rated, as defined in Rule 5121(f)(8), or are 
outstanding securities in the same series that have equal rights and 
obligations as investment grade rated securities, provided that an 
initial public offering of equity is required to be filed.''
Defined Terms
    ABA suggested that the definition of ``bank'' expressly include 
U.S. branches and agencies of a foreign bank, which have been 
interpreted by the SEC to constitute U.S. banks for other purposes 
under the federal securities laws, including in connection with Rule 
15a-6 under the Exchange Act. ABA stated that the need for a ``foreign 
bank'' to apply to FINRA for an exemption under the Rule is 
unnecessarily burdensome, particularly in the context of reliance on 
the investment grade debt exemption set forth in Proposed Rule 
5110(h)(l)(A).
    FINRA is proposing in this Partial Amendment No. 1 to amend the 
proposed defined term bank in Rule 5110(j)(2) to mean ``a bank as 
defined in Section 3(a)(6) of the Exchange Act, a branch or agency in 
the United States of a foreign bank that is supervised and examined by 
a federal or state banking authority and otherwise meets the 
requirements of Section 3(a)(6) of the Exchange Act, or [is] a foreign 
bank that has been granted an exemption under this Rule and shall refer 
only to the regulated entity, not its subsidiaries or other 
affiliates.'' As the ABA noted, this approach is consistent with the 
SEC's interpretation of what is a bank for other purposes under the 
federal securities laws. For example, the SEC provided that for 
purposes of Rule 15a-6 under the Exchange Act, a foreign bank is 
excluded from the defined term ``bank'' except to the extent that the 
``foreign bank establishes a branch or agency in the United States that 
is supervised and examined by a federal or state banking authority and 
otherwise meets the requirements of section 3(a)(6).'' \62\
---------------------------------------------------------------------------

    \62\ See Securities Exchange Act Release No. 27017 (July 11, 
1989), 54 FR 30013 (July 18, 1989) (File No. S7-11-88, Registration 
Requirements for Foreign Broker-Dealers, note 16) and Frequently 
Asked Questions Regarding Rule 15a-6 and Foreign Broker-Dealers, 
footnote 3, (March 21, 2013) available at https://www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm.
---------------------------------------------------------------------------

    SIFMA supported carving out ``participating members'' from the 
defined term ``issuer'' and suggested a clarifying carve out to exclude 
any participating member that is the actual corporate issuer of the 
securities being offered or a selling security holder offering its own 
beneficially held securities to the public. FINRA is proposing in this 
Partial Amendment No. 1 to amend the defined term ``issuer'' to exclude 
a participating member, except where the participating member is 
offering its securities. Specifically, FINRA proposes to revise

[[Page 37927]]

proposed Rule 5110(j)(12) to define ``issuer'' to mean ``a registrant 
or other person that is offering its securities to the public, any 
selling security holder offering securities to the public, any 
affiliate of the registrant or such other person or selling security 
holder, and the officers or general partners, and directors thereof, 
but does not include a participating member unless the participating 
member is itself the registrant or a selling security holder offering 
its own beneficially held securities to the public.''
    The ABA suggested a technical change to the defined term ``public 
offering'' in proposed Rule 5110(j)(18)(A) to update the reference to 
offerings pursuant to Section 4(a)(6) of the Securities Act to Section 
4(a)(5) of the Securities Act. FINRA is proposing in this Partial 
Amendment No. 1 to amend the defined term's reference to these 
offerings as suggested by the commenter.
Underwriting Compensation
    Commenters asserted that participating members' purchases of 
securities in the public offering at the public offering should not be 
underwriting compensation subject to Rule 5110.\63\ FINRA would 
interpret the Proposal not to include as underwriting compensation non-
convertible securities purchased by the participating member in a 
public offering at the public offering price during the review period. 
FINRA is proposing in this Partial Amendment No. 1 to revise the 
Supplementary Material to expressly exclude securities purchased on 
these terms from being deemed underwriting compensation under the 
Proposal.\64\ FINRA has seen acquisitions of convertible securities by 
a participating member with negotiated or preferential terms prohibited 
under proposed Rule 5110(g)(8). FINRA would consider these securities 
to be underwriting compensation.
---------------------------------------------------------------------------

    \63\ See ABA, Davis Polk, Rothwell and SIFMA. Commenters noted 
questions raised by the inclusion as underwriting compensation of 
any equity securities acquired by a participating member during the 
review period under Supplementary Material .01(a)(7) and scope of 
the defined term ``review period'' in proposed Rule 5110(j)(20).
    \64\ Specifically, FINRA is proposing in this Partial Amendment 
No. 1 to amend proposed Supplementary Material .01(a)(7) to provide 
that underwriting compensation includes ``common or preferred stock, 
options, warrants, and other equity securities, including debt 
securities convertible to or exchangeable for equity securities, 
beneficially owned, as defined in Rule 5121 by the participating 
members the value of which is determined pursuant to this Rule, and 
acquired during the review period, as defined in this Rule, except 
that non-convertible securities purchased by a participating member 
in a public offering at the public offering price during the review 
period shall not be deemed underwriting compensation;''.
---------------------------------------------------------------------------

    As set forth in the Proposal, proposed Supplementary Material 
.01(b)(12) would provide that compensation received through any stock 
bonus, pension, or profit-sharing plan that qualifies under Section 401 
of the Internal Revenue Code or a similar plan is not underwriting 
compensation. ABA recommended revising the provision to expressly 
include securities received under a written compensatory benefit plan 
in an offering exempt from registration pursuant to Rule 701 under the 
Securities Act and any other ``employee benefit plan'' (as such term is 
defined in Securities Act Rule 405). Davis Polk requested confirmation 
that grants of equity compensation to immediate family of participating 
members, other than new employees of the issuer, in the ordinary course 
of business pursuant to bona fide equity compensation arrangements will 
not be deemed underwriting compensation.\65\
---------------------------------------------------------------------------

    \65\ Davis Polk also disagreed with the ABA that the exclusion 
from underwriting compensation only apply to equity grants made 
pursuant to Rule 701 under the Securities Act due to limitations on 
annual grants of equity compensation under Rule 701 that force 
reliance on Section 4(a)(2) of the Securities Act. However, it is 
not clear that the ABA intended to propose the exclusion as 
suggested by Davis Polk.
---------------------------------------------------------------------------

    To provide additional clarity, FINRA is proposing in this Partial 
Amendment No. 1 to revise Supplementary Material .01(b)(12) to refer to 
a written compensatory benefit plan in an offering exempt from 
registration pursuant to Rule 701 under the Securities Act and any 
other employee benefit plan (as defined in Securities Act Rule 405). As 
revised, Supplementary Material .01(b)(12) would exclude from 
underwriting compensation ``compensation received through any stock 
bonus, pension, employee benefit plan, or profit-sharing plan that 
qualifies under Section 401 of the Internal Revenue Code or a similar 
plan, including, but not limited to, an employee benefit plan as 
defined in Securities Act Rule 405 or a compensatory benefit plan or 
compensatory benefit contract exempt from registration pursuant to 
Securities Act Rule 701 . . .''

III. Summary of Comments and FINRA's Response 66
---------------------------------------------------------------------------

    \66\ See Notice, supra note 3, for full FINRA discussion of the 
original filing.
---------------------------------------------------------------------------

    The Commission received six comment letters on the filing as 
originally proposed.\67\ Subsequently, FINRA submitted Partial 
Amendment No. 1 and a response to the comments.\68\ The comments and 
FINRA's response are summarized below.
---------------------------------------------------------------------------

    \67\ See supra note 5 and accompanying text.
    \68\ See FINRA Response, supra note 6.
---------------------------------------------------------------------------

Overall Proposal
    Four commenters support FINRA's efforts to review, streamline and 
modernize the Rule for the benefit of market participants but offer 
suggested modifications to some aspects of the proposal.\69\ As 
discussed below, one commenter expresses support and suggests a 
modification of a proposed exemption, but otherwise does not comment on 
other aspects of the proposal.\70\ In response, FINRA proposes certain 
modifications to the initial proposal as described in detail below.
---------------------------------------------------------------------------

    \69\ See ABA, Davis Polk, Rothwell and SIFMA, supra note 5.
    \70\ See CAI, supra note 5.
---------------------------------------------------------------------------

    One commenter believes that excessive underwriting compensation 
should be addressed through disclosure to investors and states that 
FINRA Rule 5110 is inconsistent with the Exchange Act and the 
Securities Act.\71\ In response, FINRA states its belief that, while 
disclosure of underwriting compensation is an important component of 
Rule 5110, disclosure alone is not sufficient to prohibit unfair 
underwriting terms and arrangements that disadvantage issuers and 
investors in public offerings of securities.
---------------------------------------------------------------------------

    \71\ See Kaswell, supra note 5.
---------------------------------------------------------------------------

Filing Requirements
    Three commenters state that several of the proposed filing 
requirements are unnecessary.\72\ Namely, commenters argue that the 
following filing requirements should be eliminated: (1) Disclosure of 
holdings that are excluded from underwriting compensation; (2) M&A and 
private placement engagement letters; (3) a representation as to 
whether any officer or director of the issuer and any beneficial owner 
of 5% or more of any class of the issuer's equity and equity-linked 
securities is an associated person or affiliate of a participating 
member; (4) notification of underwriting compensation received in 
terminated or revised offerings; and (5) a description of securities 
acquired in bona fide venture capital transactions.\73\
---------------------------------------------------------------------------

    \72\ See ABA, Davis Polk and SIFMA, supra note 5.
    \73\ See id.
---------------------------------------------------------------------------

    In response to commenters' concerns, FINRA proposes in Partial 
Amendment No. 1 to revise FINRA Rule 5110(a)(4)(B)(iv) to not require 
filing a description of any securities acquired in accordance with 
Supplementary Material .01(b), which sets forth a non-

[[Page 37928]]

exhaustive list of payments that generally would not be deemed to be 
underwriting compensation.\74\ With respect to a revised public 
offering, as discussed in Partial Amendment No. 1, and in response to 
commenters' concerns, FINRA proposes to revise Supplementary Material 
.01(a)(13) to exclude from underwriting compensation accountable 
expenses received pursuant to Rule 5110(g)(5)(A).\75\
---------------------------------------------------------------------------

    \74\ See FINRA Response, supra note 6 at 3-4.
    \75\ Specifically, Supplementary Material .01(a)(13) would be 
revised to provide that underwriting compensation would include 
``any compensation paid to any participating member in connection 
with a prior proposed public offering that was not completed, if the 
member firm participates in the revised public offering, except that 
accountable expenses received pursuant to paragraph (g)(5)(A) shall 
not be deemed underwriting compensation.'' See also FINRA Response, 
supra note 6 at 6 n.10.
---------------------------------------------------------------------------

    FINRA, however, continues to believe that M&A and private placement 
engagement letters should be required to be filed with FINRA so that it 
may determine if they impact the underwriting terms and arrangements 
for the public offering.\76\ Likewise, FINRA continues to believe that 
beneficial owners of 5% or more must be disclosed.\77\ FINRA also 
continues to believe that underwriting compensation received or to be 
received in terminated offerings is relevant to FINRA's evaluation of 
compliance with Rule 5110.\78\
---------------------------------------------------------------------------

    \76\ See FINRA Response, supra note 6 at 3.
    \77\ See FINRA Response, supra note 6 at 4-5. See also ABA, 
Davis Polk and SIFMA, supra note 5. ABA and SIFMA suggest a 25% 
threshold, while Davis Polk suggests a 10% threshold.
    \78\ See FINRA Response, supra note 6 at 5.
---------------------------------------------------------------------------

    FINRA proposes to retain the requirement that a description be 
filed for any securities acquired in a bona fide venture capital 
transaction as set forth in proposed Rule 5110(d). FINRA believes that 
a description of the securities is needed for FINRA to assess whether 
the acquisition meets the requirements for a venture capital exception 
or whether the securities should instead be treated as underwriting 
compensation.\79\
---------------------------------------------------------------------------

    \79\ See FINRA Response, supra note 6 at 4.
---------------------------------------------------------------------------

    Although most commenters suggest scaling back the filing 
requirements, one commenter suggests that FINRA withdraw the proposed 
expansion of an exemption from such requirement. Specifically, the 
commenter proposes that the expansion of ``seasoned issuer'' filing 
exemption to an issuer's public offerings where the issuer has 
``securities in the same series that have equal rights and obligations 
as investment grade rated securities'' be removed.\80\ Moreover, this 
and another commenter requested additional clarification on the 
``seasoned issuer'' exemption.\81\ Namely, one commenter sought 
clarification regarding whether the issuer's qualifying debt or 
preferred securities for purposes of the exemption must be issued and 
outstanding.\82\ The other commenter requested clarification that the 
use of the term ``corporate issuer'' in the exemption is not meant to 
exclude issuers if they are not organized in ``corporate'' form.\83\ In 
response to commenters' concerns, FINRA proposes to further revise Rule 
5110(h)(1)(A) to exempt ``securities offered by a bank, corporate 
issuer, foreign government or foreign government agency that has 
outstanding unsecured non-convertible debt with a term of issue of at 
least four years or unsecured non-convertible preferred securities that 
are investment grade rated, as defined in Rule 5121(f)(8), or are 
outstanding securities in the same series that have equal rights and 
obligations as investment grade rated securities, provided that an 
initial public offering of equity is required to be filed'' (emphasis 
added). FINRA further clarifies that it does not intend the exemption 
to apply where the issuer has only outstanding, unrated non-convertible 
debt or preferred securities that the issuer deems to be in the same 
series as qualifying reacquired Treasury securities that were once 
rated investment grade. In addition, FINRA states that it would 
interpret ``corporate issuers'' to include, among other entities, 
limited partnerships and limited liability companies.\84\
---------------------------------------------------------------------------

    \80\ See Rothwell, supra note 5.
    \81\ See Rothwell and ABA, supra note 5.
    \82\ See Rothwell, supra note 5.
    \83\ See ABA, supra note 5.
    \84\ See FINRA Response, supra note 6 at 14.
---------------------------------------------------------------------------

Disclosure
    One commenter suggests adopting a de minimis exception for itemized 
disclosure under which participating members may disclose a maximum 
aggregate value for items of underwriting compensation.\85\ In 
response, FINRA notes that it previously considered the Rule's 
disclosure requirements in responding to comments received to the 
Notice 17-15 Proposal, and has decided to retain the current disclosure 
requirements.\86\
---------------------------------------------------------------------------

    \85\ See SIFMA, supra note 5.
    \86\ See FINRA Response, supra note 6 at 7.
---------------------------------------------------------------------------

Valuation
    Two commenters request clarification, as well as offer suggestions, 
on FINRA's proposal to modify Rule 5110's calculations for valuing 
convertible and non-convertible securities.\87\ Commenters request 
alternative valuation methodologies on a case-by-case basis \88\ and 
for unit securities.\89\ One commenter also requests, for purposes of 
clarification, express exclusion from valuation as underwriting 
compensation for options and other derivatives acquired at a fair 
price.\90\
---------------------------------------------------------------------------

    \87\ See SIFMA and Rothwell, supra note 5.
    \88\ See SIFMA, supra note 5 at 8.
    \89\ See Rothwell, supra note 5 at 12.
    \90\ See SIFMA, supra note 5 at 8.
---------------------------------------------------------------------------

    FINRA proposes to retain the methods in the current Rule for 
valuing options, warrants and other convertible securities received as 
underwriting compensation. FINRA states that exemptive relief may be 
available on a case-by-case basis pursuant to Rule 5110(i) for a member 
firm that seeks to use a single, consistently applied alternative 
valuation methodology.\91\ FINRA also notes that it has previously 
provided guidance for valuing unit securities.\92\ With respect to 
options and other derivatives acquired at a fair price, FINRA notes 
that the requested clarification is set forth in proposed Rule 
5110(c)(5), which states ``[a]ny non-convertible or non-exchangeable 
debt or derivative instrument acquired or entered into at a `fair 
price' as defined in Supplementary Material .06(b) and underwriting 
compensation received in or receivable in the settlement, exercise or 
other terms of such non-convertible or non-exchangeable debt or 
derivative instrument shall not have a compensation value for purposes 
of determining underwriting compensation.'' \93\
---------------------------------------------------------------------------

    \91\ See FINRA Response, supra note 6 at 8.
    \92\ See id.
    \93\ See FINRA, supra note 6 at 8.
---------------------------------------------------------------------------

Venture Capital Exceptions
    Commenters generally support the venture capital exceptions \94\ 
with one commenter requesting clarification on the definition of 
``institutional investor'' and suggesting that the exception be 
expanded to include other highly regulated entities.\95\ The commenter 
also suggests that the venture capital exceptions should be clarified 
to provide that a participating member could make the determination as 
to the availability of an exception at the time of the acquisition of 
the securities.\96\ In response, FINRA notes that it had previously 
considered these issues in responding to comments received to the 
Notice 17-15 Proposal \97\ and declines to make further changes. FINRA 
states that it will retain the definition of ``institutional investor'' 
as proposed and

[[Page 37929]]

also notes that whether an acquisition of the securities meets an 
exception must be determined before the required filing date.\98\
---------------------------------------------------------------------------

    \94\ See Rothwell and SIFMA, supra note 5.
    \95\ See SIFMA, supra note 5 at 4-5.
    \96\ See id.
    \97\ See FINRA Response, supra note 6 at 10.
    \98\ See id.
---------------------------------------------------------------------------

Lock-Up Restriction
    One commenter suggests several changes to FINRA's proposed lock-up 
restriction, such as eliminating the restriction for offerings of 
securities that are ``actively-traded,'' making consistent the lock-up 
period for participating members in a follow-on offering as the lock-up 
period for insiders, and allowing the sale or other disposition of 
locked-up securities by registered investment advisers who are 
participating members.\99\ In response, as discussed in Partial 
Amendment No. 1, FINRA proposes to add Rule 5110(e)(2)(A)(ix) to 
provide that the lock-up restriction will not apply ``to a security 
that is ``actively-traded'' (as defined in Rule 101(c)(1) of SEC 
Regulation M).'' \100\ FINRA also notes that it would consider any 
additional request for exemptive relief under Rule 5110 pursuant to 
Rule 5110(i).\101\
---------------------------------------------------------------------------

    \99\ See SIFMA, supra note 5 at 6.
    \100\ See FINRA Response, supra note 6 at 11.
    \101\ See id.
---------------------------------------------------------------------------

Non-Cash Compensation
    Two commenters request clarification that restrictions on non-cash 
compensation as set forth in the current Rule and proposed Rule 5110(f) 
are not intended to limit or otherwise be inconsistent with other 
provisions in the Rule that implicitly permit the receipt by 
participating members of non-cash compensation under appropriate 
circumstances.\102\ In response to the commenters' request for 
clarification, FINRA confirms the commenters' understanding regarding 
the restrictions on receipt of non-cash compensation.\103\
---------------------------------------------------------------------------

    \102\ See ABA, supra note 5 at 7; SIFMA, supra note 5 at 9.
    \103\ See FINRA Response, supra note 6 at 12.
---------------------------------------------------------------------------

Prohibited Terms and Arrangements
    One commenter, although generally supportive of the proposed 
changes relating to prohibited terms and arrangements in connection 
with a public offering of securities, offers two suggestions.\104\ The 
commenter suggests that payments allowed prior to the commencement of 
sales of a public offering also be permitted in respect of offerings 
that are not completed if the payments are for services actually 
provided and the issuer has not terminated the services of the 
participating member for cause.\105\ The commenter further suggests 
that Rule 5110(g)(11), which provides that a FINRA member may not 
``participate with an issuer in the public offering of securities if 
the issuer hires persons primarily for the purpose of solicitation, 
marketing, distribution or sales of the offering, except in compliance 
with Section 15(a) of the Exchange Act or [Exchange Act] Rule 3a4-1 and 
applicable state law,'' should be further modified to limit this 
prohibition to those instances in which the FINRA member knows, or 
reasonably should have known, that the issuer had hired persons absent 
compliance with applicable federal or state securities laws.\106\ FINRA 
believes that these specific modifications to proposed FINRA Rule 
5110(g) are not necessary.\107\
---------------------------------------------------------------------------

    \104\ See ABA, supra note 5.
    \105\ See ABA, supra note 5 at 7-8.
    \106\ See id.
    \107\ See FINRA Response, supra note 6 at 12-13.
---------------------------------------------------------------------------

Exemptions from Filing and Substantive Requirements
    Commenters are generally supportive of FINRA's proposal to exempt 
certain offerings from the filing requirements.\108\ One commenter, 
however, requests that FINRA expand the exemptions to include tender 
offers by issuers for their own securities under the Exchange Act.\109\ 
In response to comment, as discussed in Partial Amendment No. 1, FINRA 
proposes to amend Rule 5110(h)(2)(G) to include tender offers by 
issuers for their own securities.\110\ Accordingly, Proposed Rule 
5110(h)(2)(G) will apply to ``tender offers made pursuant to SEC 
Regulation 14D or Rule 13a-4 under the Exchange Act.'' \111\
---------------------------------------------------------------------------

    \108\ See Rothwell, CAI and ABA, supra note 5.
    \109\ See ABA, supra note 5 at 10.
    \110\ See FINRA Response, supra note 6 at 14.
    \111\ See FINRA Response, supra note 6 at 14.
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Defined Terms
    One commenter suggests that the definition of ``bank'' under 
proposed Rule 5110(j)(2) should also include the US branches and 
agencies of a foreign bank.\112\ In response, as discussed in the 
Partial Amendment No. 1, FINRA proposes to amend the proposed 
definition of bank in Rule 5110(j)(2) to mean ``a bank as defined in 
Section 3(a)(6) of the Exchange Act, a branch or agency in the United 
States of a foreign bank that is supervised and examined by a federal 
or state banking authority and otherwise meets the requirements of 
Section 3(a)(6) of the Exchange Act, or [is] a foreign bank that has 
been granted an exemption under this Rule and shall refer only to the 
regulated entity, not its subsidiaries or other affiliates.'' \113\
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    \112\ See ABA, supra note 5 at 10.
    \113\ See FINRA Response, supra note 6 at 15.
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    Three commenters express concern over the term ``experienced 
issuer'' in Rule 5110(j)(6) and suggested alternatives or requested 
clarification.\114\ For example, commenters express concern that the 
proposal would eliminate SEC and FINRA's past interpretive guidance 
relating to the term.\115\ FINRA, however, believes that the proposed 
definition of ``experienced issuer'' codifies standards currently in 
place and simplifies the analysis for the benefit of members.\116\ 
FINRA also believes that any guidance and interpretation issued by the 
SEC or FINRA relating to the term remain valid and illustrative.\117\
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    \114\ See ABA, Davis Polk and SIFMA, supra note 5.
    \115\ See id.
    \116\ See FINRA Response, supra note 6 at 16.
    \117\ See id.
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    One commenter requests to expand the defined term ``independent 
financial adviser'' in Rule 5110(j)(9) and revise proposed Rule 
5110(j)(16) to allow an independent financial adviser to provide 
ordinary services to an issuer and assist the issuer in preparing the 
offering document and other documents.\118\ In response, FINRA 
disagrees with the suggested expansion of services that may be provided 
by the independent financial adviser.\119\
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    \118\ See Rothwell, supra note 5 at 14-15.
    \119\ See FINRA Response, supra note 6 at 17.
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    Three commenters suggest a variety of changes to the proposed 
definitions of ``participate,'' ``issuer,'' and ``participating 
member.'' \120\ FINRA, however, does not agree with the commenters' 
suggestions to create additional carve-outs from the definitions.\121\ 
Nevertheless, in response to one commenter's concern,\122\ as discussed 
in the Partial Amendment No. 1, FINRA proposes to amend the defined 
term ``issuer'' to exclude a participating member, except where the 
participating member is offering its securities.\123\
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    \120\ See Rothwell, ABA, SIFMA and Davis Polk, supra note 5.
    \121\ See FINRA Response, supra note 6 at 18.
    \122\ See Rothwell, supra note 5.
    \123\ See FINRA Response, supra note 6 at 18.
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    One commenter suggest that the defined term ``public offering'' 
should expressly exclude securities offered or sold by a broker-dealer 
pursuant to Sections 4(a)(3) and 4(a)(4) of the Securities Act.\124\ 
FINRA, in response,

[[Page 37930]]

declines to make the suggested revision.\125\
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    \124\ See ABA, supra note 5 at 11. The ABA also suggests a 
technical change to update the reference in proposed Rule 
5110(j)(18)(A) to offerings pursuant to Section 4(a)(6) of the 
Securities Act to Section 4(a)(5) of the Securities Act. As 
discussed in the Partial Amendment No. 1, FINRA proposes to revise 
the public offering definition's reference to these offerings as 
suggested by the commenter. See id.
    \125\ See FINRA Response, supra note 6 at 18.
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    Four commenters assert that participating members' purchases of 
securities in a public offering at the public offering price should not 
be considered underwriting compensation subject to Rule 5110.\126\ 
Moreover, two commenters suggest that proposed Supplementary Material 
.04, which addresses securities acquired by a participating member's 
associated persons or their immediate family members in issuer directed 
sales programs, should be modified to focus only on securities acquired 
at a price lower than the public offering price.\127\ In response, 
FINRA provides that it would interpret the proposal not to include as 
underwriting compensation non-convertible securities purchased by a 
participating member in a public offering at the public offering price 
during the review period. As discussed in the Partial Amendment No. 1, 
FINRA proposes to revise the Supplementary Material to expressly 
exclude securities purchased on these terms from being deemed 
underwriting compensation.\128\
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    \126\ See ABA, Davis Polk, Rothwell and SIFMA, supra note 5.
    \127\ See ABA and SIFMA, supra note 5.
    \128\ See FINRA Response, supra note 6 at 19 n.27.
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    Two commenters request clarification as to whether certain 
compensated parties would be considered ``participating members'' and 
thus their compensation be deemed underwriting compensation.\129\ For 
example, one commenter requests confirmation that compensation received 
by a non-U.S. underwriter that is not itself a FINRA member or an 
affiliate of a participating FINRA member is not considered 
underwriting compensation.\130\ FINRA confirms that such compensation 
is not underwriting compensation for the purposes of Rule 5110.\131\
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    \129\ See SIFMA and Davis Polk, supra note 5.
    \130\ See SIFMA, supra note 5 at 7-8.
    \131\ See FINRA Response, supra note 6 at 19-20.
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    Another commenter requests confirmation that fees and other 
compensation paid by an issuer to a foreign broker-dealer affiliated 
with a participating member in connection with the foreign distribution 
of an offering occurring both in the U.S. and outside the U.S. 
simultaneously should not be deemed underwriting compensation under 
Rule 5110.\132\ In response, FINRA states that, if the participating 
members are able to divide underwriting compensation so as to 
separately allocate the underwriting compensation received by the non-
U.S. broker-dealer for the non-U.S. portion of the global offering, 
FINRA would consider that separately allocated underwriting 
compensation to be outside the scope of Rule 5110 and not subject to 
the requirements of Rule 5110.\133\
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    \132\ See Davis Polk, supra note 5 at 4.
    \133\ See FINRA Response, supra note 6 at 20.
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    Finally, another commenter notes that the inclusion of ``finder's 
fees, underwriter's counsel fees, and securities'' in the proposed 
``underwriting compensation'' definition in Rule 5110(j)(22) is 
confusing and unnecessary in light of the much clearer and more fulsome 
language contained in the Supplementary Material .01.\134\ In response, 
FINRA provides that it does not believe that the non-exhaustive 
examples in Supplementary Material .01 do not obviate the need for the 
defined term to capture the full scope of possible underwriting 
compensation.\135\
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    \134\ See ABA, supra note 5 at 4-5.
    \135\ See FINRA Response, supra note 6 at 20.
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Underwriting Compensation
    One commenter supports the changes in proposed Supplementary 
Material .01 of items that would or would not be underwriting 
compensation,\136\ while others requested that additional items be 
excluded from underwriting compensation.\137\ Specifically, commenters 
suggest the following be excluded: (1) The 1% valuation assigned to 
ROFRs; \138\ (2) nominal gifts and occasional entertainment; \139\ (3) 
fees for services performed by participating members in the ordinary 
course of business unrelated to the distribution of the offering; \140\ 
(4) bona fide market making activity; \141\ and (5) any cash 
compensation, securities or other benefit received by an associated 
person, immediate family or affiliate of a participating member if the 
FINRA member or its parent or other affiliate is issuing its own 
securities in the public offering.\142\ In response, FINRA disagrees 
with these suggestions and believes that such compensations should be 
reported to FINRA as underwriting compensation.\143\
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    \136\ See Rothwell, supra note 5 at 2.
    \137\ See ABA, Davis Polk and SIFMA, supra note 5.
    \138\ See SIFMA and ABA, supra note 5.
    \139\ See ABA, supra note 5.
    \140\ See Davis Polk, supra note 5.
    \141\ See ABA and Davis Polk, supra note 5.
    \142\ See SIFMA, supra note 5.
    \143\ See FINRA Response, supra note 6 at 20-23.
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    Two commenters suggests revising Supplementary Material .01(b)(14) 
to exclude securities acquired as the result of an ``exercise'' of 
securities that were originally acquired prior to the review 
period.\144\ In response, FINRA states that, pursuant to proposed 
Supplementary Material .01(b)(15), securities acquired as the result of 
an exercise of options or warrants that were originally acquired prior 
to the review period would not be underwriting compensation.\145\
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    \144\ See ABA and Davis Polk, supra note 5.
    \145\ See FINRA response, supra note 6 at 21-22.
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    Two commenters suggest that the exception in proposed Supplementary 
Material .01(b)(12) be expanded to include additional employee benefit 
plans.\146\ In response to commenters' suggestions,\147\ and as 
discussed in the Partial Amendment No. 1, FINRA proposes to revise 
Supplementary Material .01(b)(12) to refer to a written compensatory 
benefit plan in an offering exempt from registration pursuant to Rule 
701 under the Securities Act and any other employee benefit plan (as 
defined in Securities Act Rule 405).\148\
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    \146\ See ABA and Davis Polk, supra note 5
    \147\ See id.
    \148\ See FINRA Response, supra note 6 at 22.
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FINRA Rule 5121 (Public Offerings of Securities With Conflicts of 
Interest)
    Two commenters request clarification regarding the required 
participation by a QIU.\149\ In response, FINRA states that it has 
previously provided guidance regarding QIU participation pursuant to 
Rule 5121, and is willing to consider requests for additional guidance 
on Rule 5121 separate from the proposal.\150\
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    \149\ See, e.g., SIFMA, supra note 5 at 10, and ABA, supra note 
5 at 8-9.
    \150\ See FINRA Response, supra note 6 at 23-24.
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IV. Proceedings To Determine Whether To Approve or Disapprove SR-FINRA-
2019-012 and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Exchange Act to determine whether the proposed rule 
change should be approved or disapproved.\151\ Institution of 
proceedings appears appropriate at this time in view of the legal and 
policy issues raised by the proposal. As noted above, institution of 
proceedings does not indicate that the Commission has

[[Page 37931]]

reached any conclusions with respect to any of the issues involved. 
Rather, the Commission seeks and encourages interested persons to 
comment on the issues presented by the proposed rule change and provide 
the Commission with arguments to support the Commission's analysis as 
to whether to approve or disapprove the proposed rule change, as 
modified by Partial Amendment No. 1.
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    \151\ 15 U.S.C. 78s(b)(2). Exchange Act Section 19(b)(2)(B) 
provides that proceedings to determine whether to disapprove a 
proposed rule change must be concluded within 180 days of the date 
of publication of notice of the filing of the proposed rule change. 
The time for conclusion of the proceedings may be extended for up to 
an additional 60 days if the Commission finds good cause for such 
extension and publishes its reasons for so finding or if the self-
regulatory organization consents to the extension.
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    Pursuant to Section 19(b)(2)(B) of the Exchange,\152\ the 
Commission is providing notice of the grounds for disapproval under 
consideration. The Commission is instituting proceedings to allow for 
additional analysis of the proposal's consistency with Section 
15A(b)(9) of the Act,\153\ which requires that FINRA's rules be 
designed to, among other things, promote just and equitable principles 
of trade, 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. As summarized above, commenters 
raised, and sought clarification regarding, a number of issues. In 
response, FINRA recently submitted Partial Amendment No. 1 and response 
to comments. Accordingly, the Commission believes it is appropriate to 
institute proceedings to allow additional consideration and comments by 
both commenters and the Commission, and any potential response to 
comments or supplemental information by FINRA.
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    \152\ 15 U.S.C. 78s(b)(2)(B).
    \153\ 15 U.S.C. 78o-3(b)(6).
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V. Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
issues raised by the proposed rule change, as modified by Partial 
Amendment No. 1. In particular, the Commission invites the written 
views of interested persons on whether the proposed rule change, as 
modified by Partial Amendment No. 1, is inconsistent with Section 
15A(b)(6), or any other provision, of the Exchange Act, or the rules 
and regulations thereunder.
    Although there do not appear to be any issues relevant to approval 
or disapproval that would be facilitated by an oral presentation of 
views, data, and arguments, the Commission will consider, pursuant to 
Rule 19b-4, any request for an opportunity to make an oral 
presentation.\154\
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    \154\ Exchange Act Section 19(b)(2), as amended by the 
Securities Acts Amendments of 1975, Public Law 94-29, 89 Stat. 97 
(1975), grants the Commission flexibility to determine what type of 
proceedings--either oral or notice and opportunity for written 
comments--is appropriate for consideration of a particular proposal 
by a self-regulatory organization. See Securities Acts Amendments of 
1975, Report of the Senate Committee on Banking, Housing and Urban 
Affairs to Accompany S. 249, S. Rep. No. 75, 94th Cong., 1st Sess. 
30 (1975).
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    Interested persons are invited to submit written data, views, and 
arguments by August 23, 2019 concerning whether the proposed rule 
change should be approved or disapproved. Any person who wishes to file 
a rebuttal to any other person's submission must file that rebuttal by 
September 16, 2019. In light of the concerns raised by the proposed 
rule change, as modified by Partial Amendment No. 1, as discussed 
above, the Commission invites additional comment on the proposed rule 
change, as modified by Partial Amendment No. 1, as the Commission 
continues its analysis of whether the proposed rule change, as modified 
by Partial Amendment No. 1, is consistent with Section 15A(b)(6), or 
any other provision of the Exchange Act, or the rules and regulations 
thereunder.
    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-2019-012 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2019-012. 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 website (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 website 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-FINRA-2019-012 and 
should be submitted on or before August 23, 2019. If comments are 
received, any rebuttal comments should be submitted by September 16, 
2019.
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    \155\ 17 CFR 200.30-3(a)(12); 17 CFR 200.30-3(a)(57).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\155\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-16483 Filed 8-1-19; 8:45 am]
 BILLING CODE 8011-01-P


