[Federal Register Volume 79, Number 28 (Tuesday, February 11, 2014)]
[Notices]
[Pages 8226-8229]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-02934]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-71486; File No. SR-FINRA-2014-004]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change and
Amendment No. 1 Thereto Relating to Amendments to FINRA Rule 5110
(Corporate Financing Rule--Underwriting Terms and Arrangements)
February 5, 2014.
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 January 24, 2014, 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. On February
4, 2014, FINRA filed Amendment No. 1 to the proposed rule change.\3\
The Commission is publishing this notice to solicit comments on the
proposed rule change, as amended, from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In Amendment No. 1, FINRA: (1) modified Exhibit 5 to correct
a marking error; and (2) modified Form 19b-4 on page 4 and Exhibit 1
on page 17 to replace the language ``exchange-traded funds formed as
grantor or statutory trusts'' with the language ``collective
investment vehicles that are not registered as investment
companies.'' This Notice reflects the changes made by Amendment No.
1.
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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 5110 (Corporate Financing
Rule--Underwriting Terms and Arrangements) to expand the circumstances
in which termination fees and rights of first refusal are permissible;
exempt from the filing requirements certain collective investment
vehicles that are not registered as investment companies; and make
clarifying, non-substantive changes regarding documents filed through
FINRA's electronic filing system.\4\
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\4\ The effective date of the electronic filing requirements
under Rule 5110 was July 12, 2002. See Notice to Members 02-26.
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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 5110 (Corporate Financing Rule--Underwriting Terms and
Arrangements) (the ``Rule''), among other things, regulates
underwriting compensation, requires the filing of specified information
in connection with public offerings in which members will participate,
and prohibits unfair arrangements in connection with public offerings
of securities. FINRA proposes to amend the Rule's provisions regarding
unfair arrangements to: (1) Expand the circumstances under which
members and issuers may negotiate termination fees and rights of first
refusal (``ROFR''), with specified conditions; (2) exempt from the
filing requirements exchange-traded funds formed as grantor or
statutory trusts; and (3) codify the electronic filing requirement.
Termination Fees and Rights of First Refusal
Rule 5110(f) (Unreasonable Terms and Arrangements) sets forth terms
and arrangements that, when proposed in connection with a public
offering of securities, are considered unfair and unreasonable. Rule
5110(f)(2)(D) addresses fees in connection with a public offering of
securities that is not completed according to the terms of agreement
between the issuer and underwriter (``terminated offering'').
Specifically, paragraph (D) generally provides that it is unfair and
unreasonable for a member to arrange for the payment of any
compensation by an issuer in connection with a terminated offering
(``termination fee'' or ``tail fee''). Paragraph (D) further clarifies
that this prohibition does not include compensation negotiated and paid
in connection with a separate transaction that occurs in lieu of the
proposed offering, or reimbursement of out-of-pocket accountable
expenses actually incurred by the member.\5\
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\5\ Rule 5110(f)(2)(C) prohibits payment of commissions or
reimbursement of expenses to an underwriter prior to the
commencement of the sale of the securities being offered, except for
a reasonable advance against out-of-pocket accountable expenses
actually anticipated to be incurred by the underwriter. To the
extent such expenses are not actually incurred, any advance received
must be reimbursed to the issuer.
Paragraph (D) currently provides that the reimbursement of out-
of-pocket accountable expenses actually incurred by the member will
not be presumed to be unfair or unreasonable under normal
circumstances. The proposed amendment modifies paragraph (D) to
specify that out-of-pocket accountable expenses must be bona fide.
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Currently, paragraph (f)(2)(E) of Rule 5110 provides that, in the
event that an issuer terminates an offering with an underwriter and
subsequently consummates a similar transaction, a termination fee may
be permissible under certain circumstances. Historically, FINRA has
only considered permitting termination fee arrangements under this
provision where the subsequent transaction is an exchange offer or
similar offering where members provide substantial structuring or
advisory services (beyond that traditionally provided in connection
with a distribution of a public offering).\6\ In such cases, FINRA
believes that a
[[Page 8227]]
termination fee may be appropriate given the extent of the services
provided by the member to the issuer.
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\6\ See Notice to Members 97-82 (November 1997). Further, the
Rule provides that a tail fee may not have a duration of more than
two years from the date the member's services are terminated;
however, the Rule provides that a member may demonstrate on the
basis of information satisfactory to FINRA that an arrangement of
more than two years is not unfair or unreasonable under the
circumstances.
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FINRA has reevaluated its rules around termination fees and
believes it is appropriate to update the Rule to provide members with a
greater degree of flexibility and expand the circumstances under which
participating members and issuers may negotiate termination fee
arrangements. Specifically, FINRA is proposing to amend Rule 5110(f)(2)
(Prohibited Arrangements) to generally permit termination fees where:
(1) the agreement between the participating member and the issuer
specifies that the issuer has a right of ``termination for cause''
(i.e., where a member fails materially to perform the underwriting
services contemplated in the written agreement); \7\ (2) the agreement
specifies that an issuer's exercise of its right of ``termination for
cause'' eliminates any obligations with respect to the payment of any
termination fee; \8\ (3) the amount of any specified termination fee is
reasonable in relation to the services contemplated in the written
agreement; and (4) the agreement specifies that the issuer is not
responsible for paying the termination fee unless an offering or other
type of transaction is consummated by the issuer (without involvement
of the member) within two years of the date the engagement is
terminated with the member by the issuer. FINRA believes the proposal
provides members with a greater degree of flexibility in negotiating
the terms of their agreements for terminated offerings, while also
providing protection for issuers if a member fails materially to
perform the underwriting services contemplated in the written
agreement.
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\7\ The specific meaning of ``termination for cause'' would be
dictated by the agreement. For purposes of this proposal, a
``termination for cause'' would include a member's material failure
to perform the underwriting services contemplated in the written
agreement, but is not required to include events that are outside
the participating member's control.
\8\ Members would continue to be permitted to receive
reimbursement of out-of-pocket, bona fide, accountable expenses
actually incurred by the participating member in connection with a
terminated offering.
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Current Rule 5110(f)(2)(F) and (G) address ``ROFRs'', which provide
a member with the right to underwrite or participate in future public
offerings, private placements or other financings of the issuer. Rule
5110(f)(2)(F) deems as unfair and unreasonable any ROFR provided to a
member that: (1) Has a duration of more than three years from the date
of effectiveness or commencement of sales of the public offering, or
(2) provides more than one opportunity to waive or terminate the ROFR
in consideration of any payment or fee.\9\ Rule 5110(f)(2)(G) prohibits
any payment or fee to waive or terminate a ROFR regarding future public
offerings, private placements or other financings that exceed specified
values or that is not paid in cash.
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\9\ Historically, FINRA has interpreted the Rule to permit ROFRs
only in the case of successful offerings.
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FINRA also has reevaluated its rules around ROFRs and proposes
amendments to permit ROFRs in the case of both successful as well as
terminated offerings. FINRA proposes that ROFRs would be permissible
where: (1) The agreement between the participating member and issuer
specifies that the issuer has a right of termination for cause (i.e.,
where a member fails materially to perform the underwriting services
contemplated in the written agreement); (2) an issuer's exercise of its
right of ``termination for cause'' eliminates any obligations with
respect to the provision of any ROFR; and (3) any fees arising from
services provided under a ROFR are customary for those types of
services. As is currently the case, the Rule would continue to provide
that the duration of any ROFR may not be for more than three years from
the date of commencement of sales of the public offering (in the case
of a successful offering). In the case of a terminated offering, the
duration may not be for more than three years from the date the
engagement is terminated by the issuer. In both cases, the agreement
may not provide for more than one opportunity to waive or terminate the
ROFR in consideration of any payment or fee.\10\
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\10\ FINRA is proposing to redesignate Rule 5110(f)(2)(G) as
Rule 5110(f)(2)(F), which prohibits any payment or fee to waive or
terminate a ROFR regarding future public offerings, private
placements or other financings that exceed specified values or that
is not paid in cash.
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Filing Requirements for Certain Exchange-Traded Funds
Rule 5110(b)(8) (Exempt Offerings) generally provides an exemption
for investment companies from the filing requirements of the Rule.\11\
Due to this exemption, exchange-traded funds (``ETFs'') that are
structured as investment companies generally are exempt. However, this
exemption does not include certain other ETFs that are not investment
companies. FINRA believes it is appropriate to add an exemption for
these ETFs even if they do not fall under the definition of an
``investment company'' for the same reason that investment company ETFs
are exempted from the Rule. Specifically, the creation structure of
ETFs, whereby the component securities are deposited in return for
shares of the fund, is not a distribution model that Rule 5110 was
designed to address. Thus, FINRA is proposing to exempt offerings of
securities issued by a pooled investment vehicle, whether formed as a
trust, partnership, corporation, limited liability company or other
collective investment vehicle, that is not registered as an investment
company under the Investment Company Act and has a class of equity
securities listed for trading on a national securities exchange;
provided that such equity securities may be created or redeemed on any
business day at their net asset value per share.
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\11\ Rule 5110(b)(8)(C) exempts from the Rule's filing
requirements securities of ``open-end'' investment companies as
defined in Section 5(a)(1) of the Investment Company Act of 1940
(``Investment Company Act'') and securities of any ``closed-end''
investment company as defined in Section 5(a)(2) of the Investment
Company Act that: (1) makes periodic repurchase offers pursuant to
Rule 23c-3(b) under of the Investment Company Act; and (2) offers
its shares on a continuous basis pursuant to Rule 415(a)(1)(xi) of
SEC Regulation C.
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Electronic Filing
Rule 5110(b) (Filing Requirements) generally provides that no
member or person associated with a member shall participate in any
manner in a public offering of securities subject to Rules 2310, 5110
or 5121 unless the specified documents and information relating to the
offering have been filed with and reviewed by FINRA. FINRA proposes to
amend the Rule to make clarifying, non-substantive changes regarding
documents filed through FINRA's electronic filing system.\12\
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\12\ The effective date of the electronic filing requirements
under Rule 5110 was July 12, 2002. See Notice to Members 02-26.
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Industry Consultation
FINRA engaged in an extensive consultative process regarding the
proposed rule change, including through the issuance of a Regulatory
Notice soliciting comment on the termination fee and ROFR provisions,
the exemption for ETFs, and the codification of the electronic filings
requirement. Commenters generally supported the proposal as set forth
in the Notice, requesting certain clarifications and modifications. A
summary of the comments received in response to the Regulatory Notice
is discussed in Item 5 below.\13\
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\13\ The Commission notes that Item 5 is part of the rule filing
itself; it not part of this Notice.
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FINRA will announce the implementation date of the proposed rule
change in a Regulatory Notice to be published no later than 60 days
[[Page 8228]]
following Commission approval. The effective date of the proposed rule
change will be no later than 120 days following Commission approval.
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.
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\14\ 15 U.S.C. 78o-3(b)(6).
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The proposed rule change provides more flexibility to issuers and
participating members in the negotiation of termination fee and ROFR
terms and arrangements, while also promoting just and equitable
principles of trade by providing important protections for issuers who
terminate agreements with members for cause. Issuers can benefit from
the advice underwriters provide prior to raising capital, and may be
able to utilize more of an underwriter's resources if they can wait to
pay until they have the additional capital they plan to receive in a
public offering. This may be especially true for foreign issuers that
may need substantial advice and restructuring before accessing the U.S.
capital markets. Accordingly, issuers may want to enter into
termination fee or ROFR agreements if they provide an incentive to
underwriters to devote additional resources when the risk of not
receiving remuneration for those services is mitigated.
In addition, the proposed rule change provides an exemption for
certain other collective investment vehicles that are not registered as
investment companies, as exists for open-end and certain closed-end
investment companies. The proposed rule change also formalizes that
members must use FINRA's electronic filing system to file required
information and documents relating to offerings in which they
participate.
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. As discussed above, the
proposed rule change sets out consistent rules for all members entering
into agreements with issuers for the provision of services in
connection with a public offering of securities, and also enhances
competition among members that provide underwriting services to issuers
by broadening the types of compensation arrangements that firms can
negotiate with issuers. In addition, the amendments require that any
termination fee paid must be reasonable in relation to the underwriting
services contemplated and any ROFR fees paid must be customary in
relation to the services the member provides.
Further, the proposed rule change provides additional protections
to issuers that choose to enter into a termination fee agreement or
provide a right of first refusal by requiring that the agreement
provide issuers with a right to terminate for cause. Thus, under the
proposal, issuers would have no obligation to pay a termination fee or
be bound to a member by a ROFR if that member has failed materially to
provide the underwriting services contemplated in the agreement.
The proposed rule change also would promote competition by
eliminating disparate filing requirements for exchange-traded
collective investment vehicles not registered as investment companies
as compared to those that are structured as investment companies. FINRA
does not believe that the codification of the electronic filing
requirement or the other non-substantive and clarifying amendments
contained in the filing will impact competition. Therefore, 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.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
On June 6, 2012, FINRA published Regulatory Notice 12-27
(``Notice'' or ``Notice 12-27'') requesting comment on FINRA's proposal
to amend Rule 5110. A copy of the Notice is attached as Exhibit 2a.\15\
The comment period expired on July 23, 2012. FINRA received three
comments in response to the Notice.\16\ A list of the commenters in
response to the Notice is attached as Exhibit 2b, and copies of the
comment letters received in response to the Notice are attached as
Exhibit 2c. A summary of the comments and FINRA's response is provided
below.
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\15\ The Commission notes that Exhibits 2a, 2b, and 2c, are part
of the rule filing itself; they are not exhibits to this Notice.
\16\ See Letter from Bradley J. Swenson, Chief Compliance
Officer, ALPS Distributors, Inc., to Joseph E. Price, Senior Vice
President, FINRA, dated July 23, 2012 (``ALPS letter''); letter from
Sean Davy, Managing Director, Corporate Credit Markets Division,
Securities Industry and Financial Markets Association, to Marcia E.
Asquith, Corporate Secretary, FINRA, dated July 23, 2012 (``SIFMA
letter''); and letter from Jeffrey W. Rubin, Chair, Federal
Regulation of Securities Committee, Business Law Section of the
American Bar Association, to Marcia E. Asquith, Corporate Secretary,
FINRA, dated July 30, 2012 (``ABA letter'').
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In Notice 12-27, FINRA proposed amendments substantially similar to
the instant proposal. FINRA proposed to expand the circumstances under
which termination fees and ROFRs would be permissible while providing
protections for issuers that terminate arrangements with members for
cause. The Notice also proposed to eliminate the filing requirements
for exchange-traded funds that are structured as grantor or statutory
trusts.
Commenters generally supported the proposal as set forth in the
Notice and requested certain clarifications and modifications. With
respect to the ``termination for cause'' provision, two commenters
expressed concern that the provision would give an issuer broad
discretion regarding the circumstances in which it could avoid paying
an agreed upon termination fee to a member in the event of a terminated
offering.\17\ One commenter suggested limiting the circumstances under
which an issuer could exercise its right to terminate for cause to an
action or event that is ``within the direct control of the member'' and
results in a material failure on the part of the member to provide the
underwriting services.\18\ Commenters also suggested that the issuer's
termination for cause should take into account current market, economic
and political conditions.\19\ Another commenter suggested that the
issuer's termination for cause be limited to cases in which the issuer
requests the member to perform customary and reasonable services in
connection with the public offering and ``it is determined that the
member has materially failed to provide such services.'' \20\
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\17\ See ABA and SIFMA letters.
\18\ See ABA letter.
\19\ See ABA and SIFMA letters.
\20\ See SIFMA letter. SIFMA also suggested that the termination
for cause provision be operative as a function of the rule itself
and not be required to be included in the written agreement. FINRA
disagrees and believes it is important that the termination clause
be known to issuers and set forth in any written agreement regarding
the provision of underwriting services by a participating member in
connection with a public offering of securities.
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FINRA continues to believe that it is an important issuer
protection that members' arrangements include an issuer's right to
terminate an agreement for cause, but has modified the proposal to
provide that a ``termination for
[[Page 8229]]
cause'' shall include the participating member's material failure to
provide the underwriting services contemplated in the agreement, since
agreements may be drafted broadly to include services that are not
related to the member's role as an underwriter. FINRA also has
clarified in this filing that an issuer's termination of an agreement
due to events that are outside the member's control need not constitute
a ``termination for cause'' under the proposal.
One commenter suggested amending the ``termination for cause''
provision to allow related persons and affiliates of the issuer and
member to be parties to the written agreement noting that, in certain
cases, the provisions and associated obligations may be reflected in an
agreement between these persons.\21\ Rule 5110 defines the terms
``issuer'' and ``participating member'' broadly to include certain
related persons and affiliates. FINRA has revised the proposal to
reflect the term ``participating member'' when referencing the parties
to a member's written agreement with an issuer.
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\21\ See SIFMA letter.
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Notice 12-27 proposed that the agreement between the issuer and
member provide that any termination fee must be reasonable and any fee
arising from services provided under a ROFR be customary. Commenters
argued that requiring the inclusion of the reasonable and customary
language in a written agreement between the issuer and member is
unnecessary and suggested that FINRA require these standards in the
rule, but not require that they be expressed in the written
agreement.\22\ FINRA agrees and has reflected those changes in the
instant filing. One commenter also suggested that FINRA clarify whether
an issuer's payment of termination fees would be considered
underwriting compensation in connection with a subsequent public
offering that has been consummated within two years of the termination
of services.\23\
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\22\ See ABA and SIFMA letters. SIFMA stated that these
standards should be ``operative as a function of the rule itself and
should not be required to be set forth in a written agreement . . .
.''
\23\ See SIFMA letter. Under the Rule, items of value, such as
termination fees or fees paid for services rendered pursuant to a
ROFR are counted as compensation if they are received within 180
days prior to filing an offering or during the offering period. See
Rule 5110(c)(3)(A)(xiii).
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In Notice 12-27, FINRA proposed an exemption from the filing
requirements for ETFs formed as a grantor trust or statutory trust in
which the portfolio assets include commodities, currencies or other
assets that are not securities. Commenters supported this proposed
amendment and further suggested that FINRA modify the proposed rule
language to define the term ``ETF'' and broadly exempt from the Rule
all ETFs without regard to how they are structured and organized.\24\
FINRA has amended the language of the proposal to exempt offerings of
securities issued by a pooled investment vehicle, whether formed as a
trust, partnership, corporation, limited liability company or other
collective investment vehicle, that is not registered as an investment
company under the Investment Company Act and has a class of equity
securities listed for trading on a national securities exchange;
provided that such equity securities may be created or redeemed on any
business day at their net asset value per share. FINRA believes that
the current exemption for investment companies would capture virtually
all other ETFs.
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\24\ See ABA and ALPS letters.
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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 up to 90 days (i) as the
Commission may designate 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. 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-2014-004 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-2014-004. 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 20549-1090, on official business days between the hours
of 10:00 a.m. and 3:00 p.m. Copies of such filing also will be
available for inspection and copying at the principal offices 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-2014-
004, and should be submitted on or before March 4, 2014.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\25\
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\25\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-02934 Filed 2-10-14; 8:45 am]
BILLING CODE 8011-01-P