[Federal Register Volume 78, Number 233 (Wednesday, December 4, 2013)]
[Notices]
[Pages 72946-72949]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-28975]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70957; File No. SR-FINRA-2013-037]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting
Accelerated Approval of a Proposed Rule Change, as Modified by
Amendment No. 1, To Amend FINRA Rule 5131 (New Issue Allocations and
Distributions)
November 27, 2013.
I. Introduction
On August 23, 2013, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to amend FINRA Rule 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 proposed rule change was published for comment in the
Federal Register on September 10, 2013.\3\ The Commission received two
comment letters in response to the proposed rule change.\4\ On November
22, 2013, FINRA filed Amendment No. 1 with the Commission to respond to
the comment letters and to propose a clarifying modification to the
proposed exception regarding the eligibility of an unaffiliated private
fund where a control person of the fund's investment adviser also is a
beneficial owner in the fund. The Commission is publishing this notice
and order to solicit comments on Amendment No. 1 and to approve the
proposed rule change, as modified by Amendment No. 1, on an accelerated
basis.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 70312 (Sept. 4,
2013), 78 FR 55322 (Sept. 10, 2013) (Notice of Filing of SR-FINRA-
2013-037) (``Original Proposal''). The comment period ended on
October 1, 2013.
\4\ See letter to Elizabeth M. Murphy, Secretary, Commission,
from William G. Mulligan, CEO, Cordium US., dated Oct. 1, 2013
(``Cordium letter''); and letter to Elizabeth M. Murphy, Secretary,
Commission, from Stuart J. Kaswell, Executive Vice President &
Managing Director, Managed Funds Association, dated Sept. 30, 2013
(``MFA letter''). The letters are available on the Commission's Web
site at http://www.sec.gov/comments/sr-finra-2013-037/finra2013037.shtml.
---------------------------------------------------------------------------
II. Description of Proposal
On August 23, 2013, FINRA filed the Original Proposal to amend
FINRA Rule 5131 to provide a limited exception to allow members to rely
on written representations from certain accounts in complying with
FINRA Rule 5131(b) (the ``spinning provision'').\5\
---------------------------------------------------------------------------
\5\ See supra note 3.
---------------------------------------------------------------------------
FINRA Rule 5131 addresses abuses in the allocation and distribution
of ``new issues,'' \6\ and paragraph (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.
---------------------------------------------------------------------------
\6\ The term ``new issue'' has the same meaning as in Rule
5130(i)(9). See Rule 5130(i)(9).
---------------------------------------------------------------------------
The spinning provision generally 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
\7\ or a covered non-public company,\8\ or a person materially
[[Page 72947]]
supported \9\ by such executive officer or director, has a beneficial
interest \10\ if such public company or covered non-public company has
certain current, recent or anticipated investment banking relationships
with the member.
---------------------------------------------------------------------------
\7\ A ``public company'' is any company that is registered under
Section 12 of the Act or files periodic reports pursuant to Section
15(d) thereof. See Rule 5131(e)(1).
\8\ The term ``covered non-public company'' means 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).
\9\ ``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).
\10\ The term ``beneficial interest'' has the same meaning as in
Rule 5130(i)(1). See Rule 5130(i)(1).
---------------------------------------------------------------------------
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 has a beneficial interest in the account.
Under the spinning provision, whether an account in which an
executive officer or director of a company (or person materially
supported by such executive officer or director) has a beneficial
interest will be eligible to purchase shares of a new issue will depend
upon whether the company is a current, recent or prospective investment
banking client of the firm, as set forth in the rule. Where an
executive officer or director of a company (or a person materially
supported by such executive officer or director) has a beneficial
interest in an account, a member must also be able to identify the
company on whose behalf such executive officer or director serves to
determine whether the company is a current, recent or prospective
investment banking client of the firm under the rule; if the member is
unable to obtain such information, it has to resort to restricting all
new issue allocations to such account, which is not the intended
purpose of the rule.
The spinning provision went into effect on September 26, 2011. and,
since then, FINRA has received feedback from industry participants that
obtaining the information necessary to ensure compliance with the rule,
and eligibility for the de minimis exception, has proved difficult.\11\
In particular, 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 (``FOF''), 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.\12\
---------------------------------------------------------------------------
\11\ Among other exceptions, 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.
\12\ 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.
---------------------------------------------------------------------------
Thus, in the Original Proposal, FINRA proposed a limited exception
from the spinning provision, subject to a set of conditions, designed
to ensure the important protections of Rule 5131(b) continue to be
preserved, while offering meaningful relief for members and investors
in situations where spinning abuse is not likely. Specifically, the
Original Proposal provided 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
beneficial owners of a fund invested in the account, provided that such
fund:
Is a ``private fund'' as defined in the Investment
Advisers Act of 1940;
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;
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; and
was not formed for the specific purpose of investing in
the account.
The Original Proposal also required that, to be eligible for the
exception, the unaffiliated private fund may not have a beneficial
owner that also is a control person of such fund's investment adviser.
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.
III. Summary of Comments, FINRA's Response and Amendment No. 1
As stated above, the Commission received two comment letters in
response to the Original Proposal.\13\ Both commenters strongly support
the adoption of the proposed amendment and stated that the proposed
rule would ease the tracking burden for allocations to accounts that do
not raise the concerns the spinning rule is designed to address, while
also preserving the efficacy of the rule.\14\ However, the commenters
also suggest certain modifications that they believe improve the
usefulness of the proposed exception without compromising the
objectives of the rule.\15\
---------------------------------------------------------------------------
\13\ See supra note 4.
\14\ See Cordium letter and MFA letter.
\15\ Id.
---------------------------------------------------------------------------
Both commenters asked that FINRA eliminate the proposed condition
that the unaffiliated private fund must not have a beneficial owner
that also is a control person of such fund's investment adviser.\16\
The commenters noted that it is not uncommon for an FOF to have an
investor that is both a beneficial owner of the FOF and a control
person of such fund's investment adviser.\17\ One commenter noted that
investment in the fund by a control person serves the purpose of
aligning the interests of a control person with the interests of the
fund's investors and, therefore, is a practice that institutional
investors often require from fund managers.\18\ The other commenter
stated that this condition does not further the purposes of the
spinning rule and recommended eliminating this aspect of the
proposal.\19\
---------------------------------------------------------------------------
\16\ Id.
\17\ Id.
\18\ See MFA letter.
\19\ See Cordium letter.
---------------------------------------------------------------------------
As an alternative, one commenter recommended that, rather than
excluding funds with a beneficial owner that also is a control person
of the investment adviser, the proposal instead should be amended to
provide that a member 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 beneficial owners of a fund
invested in the account (other than a beneficial owner that is a
control person of the investment adviser to such private fund), subject
to the other
[[Page 72948]]
proposed conditions.\20\ FINRA agrees with this comment and, therefore,
proposed a clarifying amendment to delete the proposed condition that
the unaffiliated private fund must not have a beneficial owner that
also is a control person of such fund's investment adviser and,
instead, to include language substantially similar to that suggested by
the commenter.\21\
---------------------------------------------------------------------------
\20\ See MFA letter.
\21\ See MFA letter.
---------------------------------------------------------------------------
Therefore, where a beneficial owner also is a control person of the
FOF's adviser, a member must ascertain whether such person is a covered
person based upon the standards set forth in Rule 5131(b). If a member
obtains a written representation from an account that a beneficial
owner in an unaffiliated private fund is a control person of such
fund's investment adviser, but is not a covered person under the
spinning provision, an allocation to such account would still be
eligible for the proposed exception, if the conditions, as amended, are
met. If a beneficial owner in an unaffiliated private fund is both a
control person and a covered person under the spinning provision, a new
issue allocation to such covered persons would be impermissible, unless
such allocation is permitted under another exception (e.g., the de
minimis exception).\22\
---------------------------------------------------------------------------
\22\ See supra note 11.
---------------------------------------------------------------------------
As stated above, the commenters noted that it is not uncommon for
an FOF to have an investor that is both a beneficial owner of the FOF
and a control person of such fund's investment adviser. Therefore, the
Original Proposal would not have provided the intended relief for
members in many cases where the efficacy of the spinning provision
would still be preserved. Thus, instead of eliminating eligibility for
the exception for any FOF with a beneficial owner that also is a
control person of such fund's investment adviser, the revised proposal
would permit a member to avail itself of the exception with respect to
other beneficial owners (that are not also control persons of the FOF's
investment adviser). FINRA believes that this revision to the proposal
strikes the proper balance between members' concerns regarding the
difficulty of identifying indirect beneficial owners of an account and
preserving the important protections of Rule 5131(b).
One commenter also recommended that FINRA either reduce or
eliminate the proposal's condition that, to be eligible under the
exception, the unaffiliated private fund must have assets greater than
$50 million.\23\ This commenter believes that the percentage ownership
threshold conditions, which require that the unaffiliated private fund
own less than 25% of the account and does not have a single investor
with a beneficial interest of 25% or more, along with the other
conditions, are sufficient to ensure that spinning would be
unlikely.\24\
---------------------------------------------------------------------------
\23\ See Cordium letter.
\24\ See Cordium letter.
---------------------------------------------------------------------------
FINRA is of the view that the percentage ownership threshold
conditions alone are not sufficient to ensure that the protections of
the spinning rule are preserved and, therefore, continues to believe
that the ``assets greater than $50 million'' component is an
appropriate additional safeguard. Specifically, FINRA believes that
this requirement helps ensure a sufficient degree of dilution that
would reduce the economic meaningfulness to a potentially covered
person of any single IPO allocation, and therefore, does not propose
eliminating or reducing this condition at this time.
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.
IV. Commission Findings
After carefully considering the proposed rule change, as modified
by Amendment No. 1, the comments submitted, and FINRA's responses to
the comments, the Commission finds that the proposed rule change, as
modified by Amendment No. 1, is consistent with the requirements of the
Act and the rules and regulations thereunder applicable to a national
securities association.\25\ In particular, the Commission finds that
the proposed rule change, as modified by Amendment No. 1, is consistent
with Section 15A(b)(6) of the Act,\26\ which requires, among other
things, that FINRA rules 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.
---------------------------------------------------------------------------
\25\ In approving this proposed rule change, the Commission has
considered the proposed rule change's impact on efficiency,
competition, and capital formation. See 15 U.S.C. 78c(f).
\26\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------
Specifically, the Commission believes that the proposed exception
and required conditions, as amended, are consistent with the provisions
of the Act noted above by promoting capital formation and aiding member
compliance efforts, while maintaining investor confidence in the
capital markets. In simplifying and clarifying the operation of the
proposed exception for FINRA members and other industry participants,
the Commission believes that the proposed rule change, as modified by
Amendment No. 1, reasonably balances the compliance concerns and the
burdens noted by the industry while preserving the efficacy of the
spinning provision and FINRA's goal of assuring that the rule continues
to be designed to promote capital formation and investor confidence and
prevent fraudulent and manipulative behaviors.
In addition, the Commission does not believe that the proposed rule
change, as modified by Amendment No. 1, 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 change provides an
exception to Rule 5131(b) for accounts with unaffiliated private fund
investors that face special difficulties under the existing exceptions
from the rule, and thus reduces differential impacts of the rule
without compromising the objectives of the spinning provision.
The Commission believes that FINRA adequately addressed the
comments raised in response to FINRA's notice.
V. Accelerated Approval
The Commission finds good cause, pursuant to Section 19(b)(2) of
the Act,\27\ for approving the proposed rule change, as modified by
Amendment No. 1 thereto, prior to the 30th day after publication of
Amendment No. 1 in the Federal Register. The changes proposed in
Amendment No. 1 respond to the comment letters received by the
Commission in response to the Original Proposal and further simplify
the operation of the spinning provision for members and other industry
participants.\28\ In addition, accelerating approval of this proposed
rule change, as modified by Amendment No. 1, should benefit FINRA
members by aiding member compliance efforts while preserving the
efficacy of the spinning provision and should benefit investors by
maintaining investor protection in the capital markets.
---------------------------------------------------------------------------
\27\ 15 U.S.C. 78s(b)(2).
\28\ See MFA letter. See also Cordium letter.
---------------------------------------------------------------------------
VI. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Amendment No.
[[Page 72949]]
1, is consistent with the Act. Comments may be submitted by any of the
following methods:
Electronic Comments
Use the Commission's Internet comment form (http://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
person 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 December 26, 2013.
VII. Conclusion
It is therefore ordered pursuant to Section 19(b)(2) of the
Act,\29\ that the proposed rule change (SR-FINRA-2013-037), as modified
by Amendment No. 1, be and hereby is approved on an accelerated basis.
---------------------------------------------------------------------------
\29\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\30\
---------------------------------------------------------------------------
\30\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-28975 Filed 12-3-13; 8:45 am]
BILLING CODE 8011-01-P