[Federal Register Volume 78, Number 175 (Tuesday, September 10, 2013)]
[Notices]
[Pages 55322-55325]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-21930]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70312; File No. SR-FINRA-2013-037]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend
FINRA Rule 5131 (New Issue Allocations and Distributions)
September 4, 2013.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on August 23, 2013, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to amend FINRA Rule 5131 (New Issue Allocations
and Distributions) to provide a limited exception to allow members to
rely on written representations from certain accounts to comply with
Rule 5131(b).
The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
FINRA Rule 5131 (New Issue Allocations and Distributions) (the
``Rule'') addresses abuses in the allocation and distribution of ``new
issues.'' \3\ Rule 5131(b) prohibits the practice of spinning, which
refers to an underwriter's allocation of new issue shares to executive
officers and directors of a company as an inducement to award the
underwriter with investment banking business, or as consideration for
investment banking business previously awarded (the ``spinning''
provision).
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\3\ Rule 5131 provides that ``new issue'' shall have the same
meaning as in Rule 5130(i)(9).
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Specifically, the spinning provision provides that no member or
person associated with a member may allocate shares of a new issue to
any account in which an executive officer or director of a public
company \4\ or a covered non-public company,\5\ or a person materially
supported \6\ by such executive officer or director, has a beneficial
interest: \7\
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\4\ A ``public company'' is any company that is registered under
Section 12 of the Exchange Act or files periodic reports pursuant to
Section 15(d) thereof. See Rule 5131(e)(1).
\5\ The Rule defines a ``covered non-public company'' as any
non-public company satisfying the following criteria: (i) Income of
at least $1 million in the last fiscal year or in two of the last
three fiscal years and shareholders' equity of at least $15 million;
(ii) shareholders' equity of at least $30 million and a two-year
operating history; or (iii) total assets and total revenue of at
least $75 million in the latest fiscal year or in two of the last
three fiscal years. See Rule 5131(e)(3).
\6\ ``Material support'' means directly or indirectly providing
more than 25% of a person's income in the prior calendar year.
Persons living in the same household are deemed to be providing each
other with material support. See Rule 5131(e)(6).
\7\ The Rule provides that the term ``beneficial interest''
shall have the same meaning as in Rule 5130(i)(1).
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If the company is currently an investment banking services
\8\ client of the member or the member has received compensation from
the company for
[[Page 55323]]
investment banking services in the past 12 months;
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\8\ ``Investment banking services'' include, without limitation,
acting as an underwriter, participating in a selling group in an
offering for the issuer or otherwise acting in furtherance of a
public offering of the issuer; acting as a financial adviser in a
merger, acquisition or other corporate reorganization; providing
venture capital, equity lines of credit, private investment, public
equity transactions (PIPEs) or similar investments or otherwise
acting in furtherance of a private offering of the issuer; or
serving as placement agent for the issuer. See Rule 5131(e)(5).
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If the person responsible for making the allocation
decision knows or has reason to know that the member intends to
provide, or expects to be retained by the company for, investment
banking services within the next three months; or
On the express or implied condition that such executive
officer or director, on behalf of the company, will retain the member
for the performance of future investment banking services.
Rule 5131.02 (Annual Representation) provides that, for the
purposes of the spinning provision, a member may rely on a written
representation obtained within the prior 12 months from the beneficial
owner(s) of an account, or a person authorized to represent the
beneficial owner(s), as to whether such beneficial owner(s) is an
executive officer or director or person materially supported by an
executive officer or director and if so, the company on whose behalf
such executive officer or director serves. Therefore, to comply with
the spinning provision, firms typically issue questionnaires to their
customers to ascertain whether any of the persons covered by the
spinning provision have a beneficial interest in the account.\9\
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\9\ The spinning provision currently addresses operational
burdens associated with some accounts with a large and diverse
ownership base where the potential for spinning is minimal through a
series of exemptions for purchasers such as mutual funds, insurance
company general accounts and various employee benefit plans. See
generally Rule 5130(c). Private funds, however, are not a category
of purchasers for which a general exemption exists.
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Rule 5131(b)(2) provides a de minimis exception for new issue
allocations to any account in which the beneficial interests of
executive officers and directors of a company subject to the rule, and
persons materially supported by such executive officers and directors,
do not exceed in the aggregate 25% of such account. FINRA understands
that members (and their customers) have had difficulty obtaining,
tracking and aggregating information from funds regarding indirect
beneficial owners, such as participants in a fund of funds, for use in
determining an account's eligibility for the de minimis exception and
that this has resulted in compliance difficulties and restrictions,
including in situations where the ability of an underwriter to confer
any meaningful financial benefit to a particular investor by allocating
new issue shares to the account is impracticable.\10\
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\10\ For example, members have noted that broker-dealers
normally do not know the identity of the beneficial owners of the
fund of funds invested in the account.
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FINRA believes that certain funds, owing to several mitigating
factors including their size, lack of affiliation with the account
directly receiving the allocation and layered (and often opaque)
ownership structure, generally do not raise the concerns that the Rule
is designed to address. Moreover, where the potential profits from a
new issue allocation are spread across a large and diverse investor
base, it is unlikely that the proportional benefit to any particular
indirect investor would be of an amount that would further spinning
(i.e., indirect fund ownership can be an impractical and ineffective
means to receive any benefit from spinning). Therefore, FINRA is
proposing a limited exception to the spinning provision in the fund of
funds context that includes a set of conditions designed to ensure that
the important protections of the Rule continue to be preserved, while
offering meaningful relief for members and investors in situations
where spinning abuse is not likely.
Specifically, FINRA is proposing to provide that members may rely
upon a written representation obtained within the prior 12 months from
a person authorized to represent an account that does not look through
to the indirect beneficial owners of a fund invested in the account,
that such fund:
Is a ``private fund'' as defined in the Investment
Advisers Act of 1940; \11\
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\11\ Section 202(a)(29) of the Investment Advisers Act of 1940
defines the term ``private fund'' as an issuer that would be an
investment company, as defined in Section 3 of the Investment
Company Act of 1940 (15 U.S.C. 80a-3) (``Investment Company Act''),
but for Section 3(c)(1) or 3(c)(7) of the Investment Company Act.
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Is managed by an investment adviser;
Has assets greater than $50 million;
Owns less than 25% of the account and is not a fund in
which a single investor has a beneficial interest of 25% or more;
Does not have a beneficial owner that also is a control
person of such fund's investment adviser;
Is ``unaffiliated'' with the account in that the private
fund's investment adviser does not have a control person in common with
the account's investment adviser;\12\ and
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\12\ A control person of an investment adviser is a person with
direct or indirect ``control'' over the investment adviser; as that
term is defined in Form ADV.
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Was not formed for the specific purpose of investing in
the account.
FINRA believes that these conditions are reasonable to assure that
a member's new issue allocation will not be in furtherance of spinning,
while reducing the compliance burdens associated with the Rule. In
addition, a member may rely upon a written representation by an account
as to the availability of this proposed exception unless it believes,
or has reason to believe, that such representation is inaccurate.
Members availing themselves of the new supplementary material must
maintain a copy of all records and information relating to whether an
account is eligible to receive an allocation of the new issue under the
spinning provision in its files for at least three years following the
member's allocation to that account.
FINRA discussed with FINRA committees, industry groups and member
firms the logistical impracticalities, costs and other hurdles involved
in attempting to track beneficial ownership. The comments are described
in detail in Item 5 (sic) below. The proposal takes those discussions
into account.
FINRA has considered various alternatives to the current approach,
including proposing an exception for all private funds meeting certain
asset thresholds, providing an interpretation to the existing de
minimis exception, or requiring alternative percentage caps for direct
and indirect beneficial ownership in the account. In considering these
and other alternatives, FINRA sought to balance preserving the
protections the Rule was designed to provide with limiting the scope of
the rule to situations that might reasonably result in the harms sought
to be addressed. FINRA also sought to avoid increasing complexity in
the Rule, with added compliance costs, where the concerns to be avoided
were remote.
As a result, FINRA determined that a wholesale exception for
private funds was not appropriate.\13\ In addition, because a fund
indirectly invested in the account could consist of a single investor--
potentially including covered persons--FINRA believes that a limit to
both direct and indirect beneficial ownership is important in
preserving the efficacy of the spinning provision. The proposed rule
change is intended to balance the compliance concerns and burdens noted
by the industry with FINRA's goal of assuring that the Rule continues
to be designed to promote investor confidence and prevent fraudulent
and manipulative behaviors.
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\13\ See supra note 9.
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FINRA will announce the effective date of the proposed rule change
in a Regulatory Notice to be published no later than 60 days following
Commission approval. The effective date will be no later than 120 days
following Commission approval.
[[Page 55324]]
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\14\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. FINRA believes that the proposed exception and
required conditions will further these purposes by promoting capital
formation and aiding member compliance efforts, while maintaining
investor confidence in the capital markets.
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\14\ 15 U.S.C. 78o-3(b)(6).
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Specifically, the proposed condition that the fund be managed by an
investment adviser that is unaffiliated with the account's investment
adviser seeks to ensure the structural independence of the funds'
respective advisers. This requirement, in addition to the proviso that
the unaffiliated private fund must not have been formed for the
specific purpose of investing in the account, seeks to mitigate the
possibility of collusive conduct aimed at furthering spinning.
In addition, the condition providing that the unaffiliated private
fund may not have any beneficial owners who also are control persons of
such fund's investment adviser seeks to eliminate the conflict that may
exist where an adviser also is an investor in the fund and, therefore,
may directly benefit from allocation decisions. The requirements
regarding the minimum size of the private fund (over $50 million) and
the percentage ownership thresholds (private fund must own less than
25% of the account and not be a fund in which a single investor has a
beneficial interest of 25% or more) seek to ensure that the
proportional benefit of any new issue allocation to a single indirect
beneficial owner would be insufficient to further spinning.
B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act in that the proposed rule
provides an exception to Rule 5131(b) for funds of funds that face
special difficulties under the existing exemptions from the Rule, and
thus the proposed exemption tries to reduce differential impacts of the
Rule. FINRA also believes that it is reasonable to permit members to
rely on written representations from the account regarding compliance
with the conditions of the exception as a means of achieving compliance
with the purposes of the Rule without imposing layered tracking and
other requirements on members that could be costly and unduly hamper
the accounts' access to new issue shares.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
FINRA received four letters regarding the issues addressed by the
proposed rule change from three commenters,\15\ and engaged in
additional discussions with industry groups and market participants
regarding the operation of the spinning provision, the operation of the
existing de minimis exception and members' difficulty in identifying
indirect beneficial owners of an account. A list of the commenters is
attached as Exhibit 2a. Copies of the comment letters received are
attached as Exhibit 2b.
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\15\ See Letters from Gregory J. Robbins, Senior Managing
Director and General Counsel, Mesirow Advanced Strategies, Inc., to
Gary L. Goldsholle, Vice President and Associate General Counsel,
Office of the General Counsel, FINRA, dated June 10, 2011
(``Mesirow''); Andrew Baker, Chief Executive Officer, Alternative
Investment Management Association, to Richard G. Ketchum, Chairman
and Chief Executive Officer, FINRA, dated August 3, 2011 (``AIMA'');
Stuart J. Kaswell, Executive Vice President and Managing Director
and General Counsel, Managed Funds Association, to Marc Menchel,
Executive Vice President and General Counsel, FINRA, dated August
19, 2011 (``MFA 1''); and Stuart J. Kaswell, Executive Vice
President and Managing Director and General Counsel, Managed Funds
Association, to Marc Menchel, Executive Vice President and General
Counsel, FINRA, dated October 4, 2011 (``MFA 2'').
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Commenters sought either interpretive guidance regarding the
existing de minimis exception to increase its scope or a new amendment
to address difficulties in allocating to investment funds, particularly
in the fund of funds context. Commenters argued that investment funds
are not an effective tool for a broker-dealer to convey a meaningful
benefit to a particular covered person.\16\ One commenter stated that
the funds of funds it offers have investments in anywhere from 25 to 70
unaffiliated portfolio funds.\17\ The commenter further noted that
investors in a fund of funds, including any potential covered persons,
cannot direct which broker a portfolio fund uses or will use, and may
not know in which portfolio funds the fund of funds is invested.\18\
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\16\ See AIMA, Mesirow, MFA 1 and MFA 2.
\17\ See Mesirow.
\18\ See Mesirow.
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Commenters also discussed the logistical impracticalities and other
hurdles involved in attempting to track beneficial ownership.\19\ A
commenter stated that, as currently structured, the spinning provisions
potentially would require significant amounts of time and money to
implement.\20\ In addition, another commenter generally stated that
funds of funds may (and often do) have several hundred investors, each
of which themselves may have hundreds of beneficial owners; thus, the
operational hurdles and cost of obtaining the relevant representations
from all of the ultimate beneficial owners would be substantial.\21\
The commenter further stated that obtaining beneficial ownership
information is not always possible due to confidentiality and investor
privacy concerns.\22\
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\19\ See e.g., AIMA, MFA 1 and MFA 2.
\20\ See AIMA.
\21\ See MFA 2.
\22\ See MFA 1.
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FINRA has carefully considered the comments received and has
considered the various alternatives suggested in crafting the current
proposal and believes that the proposed rule change strikes the
appropriate balance by simplifying the operation of the Rule while
maintaining the protections the spinning provision is designed to
provide, as discussed above.\23\
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\23\ One commenter suggested, among other things, that the
existing 25% de minimis exception be interpreted to apply separately
to each public company or covered non-public company. However, the
rule clearly states that the calculation is to be applied in the
aggregate for all covered companies and the proposal would not
change that requirement. See AIMA.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) by order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act.
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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 [email protected]. Please include
File Number SR-FINRA-2013-037 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2013-037. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 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-2013-037 and should be
submitted on or before October 1, 2013.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\24\
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\24\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-21930 Filed 9-9-13; 8:45 am]
BILLING CODE 8011-01-P