Document ID: SEC-2019-1997-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2019-12-31T05:00Z

[Federal Register Volume 84, Number 250 (Tuesday, December 31, 2019)]
[Notices]
[Pages 72396-72409]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-28216]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87855; File No. SR-FINRA-2019-012]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Partial Amendment No. 2 and Order 
Granting Accelerated Approval of the Proposed Rule Change To Amend 
FINRA Rule 5110 (Corporate Financing Rule--Underwriting Terms and 
Arrangements) To Make Substantive, Organizational, and Terminology 
Changes, as Modified by Partial Amendment No. 1 and Partial Amendment 
No. 2

December 23, 2019.

I. Introduction

    On April 11, 2019, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (the 
``Commission'' or ``SEC''), 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\ On July 11, 2019, FINRA responded to the comments and 
filed Partial Amendment No. 1 to the proposal.\6\ On July 29, 2019, the 
Commission published Partial Amendment No. 1 for notice and comment and 
instituted proceedings pursuant to Section 19(b)(2)(B) of the Exchange 
Act \7\ to determine whether to approve or disapprove the proposed rule 
change, as modified by Partial Amendment No. 1.\8\ The Commission 
received three comment letters in response to the Order Instituting 
Proceedings.\9\ On October 28, 2019, the

[[Page 72397]]

Commission extended the time period in which the Commission must 
approve or disapprove the proposed rule change, as amended by Partial 
Amendment No. 1.\10\ On November 8, 2019, FINRA responded to the 
comments and filed Partial Amendment No. 2 to the proposal.\11\ This 
order provides notice of filing of Partial Amendment No. 2 and approves 
the proposal, as modified by Partial Amendments No. 1 and No. 2, on an 
accelerated basis.
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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. 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 No. 1''); 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 No. 1''); 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'').
    \6\ See letter from Jeanette Wingler, Associate General Counsel, 
FINRA, to Vanessa Countryman, Secretary, Commission, dated July 11, 
2019 (``FINRA Response No. 1''). Partial Amendment No. 1 is 
available at https://www.finra.org/industry/rule-filings/sr-finra-2019-012. See also Order Instituting Proceedings, infra note 8.
    \7\ 15 U.S.C. 78s(b)(2)(B).
    \8\ See Securities Exchange Act Release No. 8650977391 (July 29, 
2019), 84 FR 37921 (August 2, 2019) (``Order Instituting 
Proceedings'').
    \9\ See letter from Hardy Callcott and Joseph McLaughlin, to 
Vanessa Countryman, Secretary, Commission, dated August 14, 2019 
(``Callcott''); letter from Stuart J. Kaswell, Law Office of Stuart 
J. Kaswell, LLC, to Jill M. Peterson, Assistant Secretary, 
Commission, dated August 16, 2019 (``Kaswell Letter No. 2''); and 
letter from Aseel Rabie, Managing Director and Associate General 
Counsel, Securities Industry and Financial Markets Association, to 
Vanessa Countryman, Secretary, Commission, dated August 23, 2019 
(``SIFMA Letter No. 2'').
    \10\ See Securities Exchange Act Release No. 87407 (October 28, 
2019), 84 FR 58794 (November 1, 2019).
    \11\ See letter from Jeanette Wingler, Associate General 
Counsel, FINRA, to Vanessa Countryman, Secretary, Commission, dated 
November 8, 2019 (``FINRA Response No. 2''). Partial Amendment No. 2 
is available at https://www.finra.org/industry/rule-filings/sr-finra-2019-012. See also Section II.B infra.
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II. Description of the Proposed Rule Change

    Below is a description of FINRA's proposal as modified by Partial 
Amendment No. 1, followed by a description of Partial Amendment No. 2.

A. Proposed Rule Change as Modified by Partial Amendment No. 1 
12
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    \12\ For a more detailed description of the proposed rule change 
as modified by Partial Amendment No. 1, see Notice, supra note 3, 
and Order Instituting Proceedings, supra note 8. See also Partial 
Amendment No. 1 available at https://www.finra.org/sites/default/files/2019-07/sr-finra-2019-012-amendment-no1.pdf.
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    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. FINRA states that these 
changes should lessen the regulatory costs and burdens incurred when 
complying with the Rule.
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.\13\
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    \13\ 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.\14\ FINRA proposes to require filing: (1) Industry-standard 
master forms of agreement only if specifically requested to do so by 
FINRA; \15\ (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; \16\ (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''; \17\ and (4) an 
estimate of the maximum value for each item of underwriting 
compensation.\18\
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    \14\ See proposed Rule 5110(a)(4)(A).
    \15\ See proposed Rule 5110(a)(4)(A)(ii).
    \16\ See proposed Rule 5110(a)(4)(A)(iii).
    \17\ See proposed Rule 5110(a)(4)(B)(iii) and proposed Rule 
5110(j)(7).
    \18\ See proposed Rule 5110(a)(4)(B)(ii).
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    Proposed Rule 5110(a)(4)(B)(iv) would 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.\19\
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    \19\ See Order Instituting Proceedings, supra note 8, 84 FR at 
37927-28, and Partial Amendment No. 1, supra note 6.
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    FINRA also proposes to make a number of other clarifications 
regarding filing requirements to FINRA.\20\ For example, the proposed 
rule change would clarify that a member participating in an offering is 
not required to file with FINRA if the filing has been made by another 
member participating in the offering.\21\ In addition, rather than 
providing a non-exhaustive list of types of public offerings that are 
required to be filed, the proposed rule change would instead state that 
a public offering in which a member participates must be filed for 
review unless exempted by the Rule.\22\ The proposed rule change, 
moreover, would clarify the general standard that no member may engage 
in the distribution or sale of securities unless FINRA has provided an 
opinion that it has no objection to the proposed underwriting terms and 
arrangements.\23\ The proposed rule change also would clarify that any 
member acting as a managing underwriter or in a similar capacity must 
notify the other members participating in the public offering if 
informed of an opinion by FINRA that the underwriting terms and 
arrangements are unfair and unreasonable and the proposed terms and 
arrangements have not been appropriately modified.\24\
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    \20\ 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.
    \21\ See proposed Rule 5110(a)(3)(B). Participating members are 
responsible for filing public offerings with FINRA. While an issuer 
may file an offering with FINRA if a participating member has not 
yet been engaged, a participating member must assume filing 
responsibilities once it has been engaged.
    \22\ See proposed Rule 5110(a)(2).
    \23\ See proposed Rule 5110(a)(1)(C).
    \24\ See proposed Rule 5110(a)(1)(B).
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    Further, 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.\25\
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    \25\ 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.\26\
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    \26\ See Notice, supra note 3, 84 FR at 18593-594.
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Public Offerings Exempt From Substantive and/or 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.'' \27\ And 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

[[Page 72398]]

information set forth in Rule 5110(a)(4)(A) and (B).\28\
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    \27\ 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), 5110(h)(1)(C), and Notice, supra note 3, 84 FR at 18593-
594.
    \28\ See proposed Rule 5110(a)(4)(E).
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    Moreover, in proposed Rule 5110(h)(1)(A), FINRA proposes to clarify 
that securities of banks that have qualifying outstanding debt 
securities are exempt from the filing requirement.\29\ Further, in the 
same provision, FINRA proposes to clarify that Treasury securities 
would not qualify for an exemption. Accordingly, FINRA proposes to make 
clear that the exemption applies to ``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).\30\
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    \29\ See proposed Rule 5110(h)(1)(A).
    \30\ See Order Instituting Proceedings, supra note 8, 84 FR at 
37926.
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    FINRA also proposes to expand the current list of offerings that 
are exempt from both the filing requirements and substantive provisions 
of Rule 5110. Specifically, FINRA proposes to include from such 
exemptions 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.\31\ In 
addition, FINRA would also include in such exemptions tender offers by 
issuers for their own securities made pursuant to Rule 13e-4 under the 
Exchange Act.\32\
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    \31\ See proposed Rule 5110(h)(2)(E), (K) and (L).
    \32\ See Order Instituting Proceedings, supra note 8, 84 FR at 
37926, and Partial Amendment No. 1, supra note 6.
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    In addition, FINRA proposes to reclassify three items from the 
offerings exempt from filing and rule compliance to offerings excluded 
from the definition of public offering. These include: (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.\33\
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    \33\ See proposed Rule 5110(j)(18) and Order Instituting 
Proceedings, supra note 8, 84 FR at 37922.
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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 
for disclosing dollar amounts ascribed to each such item.\34\ 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 securities 
acquired by the participating member (e.g., exercise terms, demand 
rights, piggyback registration rights, and lock-up periods).\35\
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    \34\ 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.
    \35\ 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.'' \36\
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    \36\ See proposed Rule 5110(j)(22).
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    Further, FINRA provides that payments and benefits received during 
the applicable review period would be considered in evaluating 
underwriting compensation. According to FINRA, 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 or similar document, 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. Accordingly, 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 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.\37\
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    \37\ 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 modification.\38\ According to FINRA, the proposed 
examples of payments or benefits that would be underwriting 
compensation are comparable to the list of items of value in the 
current Rule with some additional clarifying changes. For example, the 
proposed rule change would expand the current item of value related to 
reimbursement of expenses to provide that fees and expenses paid or 
reimbursed to, or paid on behalf of, the participating members, 
including but not limited to road show fees and expenses and due 
diligence expenses, would be underwriting compensation.\39\ Consistent 
with current practice, the proposed rule change would also include in 
underwriting compensation non-cash compensation.\40\
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    \38\ See proposed Supplementary Material .01 to Rule 5110.
    \39\ See proposed Supplementary Material .01(a)(2) to Rule 5110. 
See also proposed Supplementary Material .01(a)(3) and (4) to Rule 
5110 which includes fees and expenses of participating members' 
counsel and finder's fees paid or reimbursed to, or paid on behalf 
of, the participating members (except for reimbursement of ``blue 
sky'' fees) as underwriting compensation.
    \40\ See proposed Supplementary Material .01(a)(14) to Rule 
5110.
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    According to FINRA, the proposed examples of payments or benefits 
that would not be underwriting compensation include several new 
examples to provide greater clarity and to address questions raised by 
members. For instance, the proposed rule change would clarify that the 
following would not be considered underwriting compensation: (1) 
Payments for records management and advisory services received by 
members in connection with some corporate reorganizations; \41\ (2) 
payment or reimbursement of legal costs resulting from a contractual 
breach

[[Page 72399]]

or misrepresentation by the issuer; \42\ (3) securities acquired 
pursuant to a governmental or court approved proceeding or plan of 
reorganization as a result of action by the government or court (e.g., 
bankruptcy or tax court proceeding); \43\ (4) non-convertible 
securities purchased by the participating member in a public offering 
at the public offering price during the review period; \44\ (5) 
accountable expenses received pursuant to Rule 5110(g)(5)(A); \45\ and 
(6) compensation received through an employee benefit plan that 
qualifies under Section 401 of the Internal Revenue Code or a similar 
plan.\46\
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    \41\ See proposed Supplementary Material .01(b)(3) to Rule 5110.
    \42\ See proposed Supplementary Material .01(b)(4) to Rule 5110.
    \43\ See proposed Supplementary Material .01(b)(22) to Rule 
5110.
    \44\ Specifically, FINRA proposes in 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 . . .'' See 
FINRA Response No. 1, supra note 6, at 19 n. 27.
    \45\ 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 Order Instituting 
Proceedings, supra note 8, 84 FR at 37926 n.61 and Partial Amendment 
No. 1, supra note 6.
    \46\ Specifically, 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 . . .'' See 
Order Instituting Proceedings, supra note 8, 84 FR at 37927, and 
Partial Amendment No. 1, supra note 6.
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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, 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.\47\
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    \47\ See proposed Supplementary Material .04 to Rule 5110.
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Venture Capital Exceptions
    FINRA states that the proposed rule change would modify, clarify, 
and expand the venture capital exceptions.\48\ 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.\49\ 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.\50\
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    \48\ 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''). 
See Notice, supra note 3.
    \49\ See proposed Supplementary Material .01(b)(14) and (16-18).
    \50\ 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) and (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.\51\ 
Further, FINRA proposes to condition the availability of these 
exceptions to require that the affiliate, directly or through a 
subsidiary it controls, be in the business of making investments or 
loans or is an entity that has been newly formed by such affiliate.\52\
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    \51\ See proposed Rule 5110(d)(1) and (2).
    \52\ Id.
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    With respect to the current venture capital exception relating to 
private placements with institutional investors, the proposal would now 
clarify that the exception is available where the institutional 
investors participating in the offering are not affiliates of a FINRA 
member and purchase at least 51% of the total number of securities sold 
in the private placement at the same time and on the same terms.\53\ In 
addition, the proposed rule change would raise the percentage that 
participating members in the aggregate may acquire from 20% to 40% of 
the securities sold in the private placement.\54\ Further, the proposed 
rule change would expand the scope of the exception to include 
providing services for a private placement (rather than just acting as 
a placement agent).\55\
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    \53\ See Notice, supra note 3, 84 FR at 18596-597.
    \54\ See proposed Rule 5110(d)(3)(C).
    \55\ 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

[[Page 72400]]

affiliate of a FINRA member participating in the offering.\56\
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    \56\ See proposed Rule 5110(d)(4).
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    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, 
would otherwise meet the requirements of a venture capital 
exception.\57\ FINRA would consider the factors in proposed 
Supplementary Material .02 in determining whether securities acquired 
in a transaction that occurs after the required filing date, but 
otherwise meets the requirements of a venture capital exception, may be 
excluded from underwriting compensation. Specifically, FINRA would 
consider the following factors, as well as any other relevant factors 
and circumstances: (1) The length of time between the date of filing of 
the registration statement or similar document and the date of the 
transaction in which securities were acquired; (2) the length of time 
between the date of the transaction in which the securities were 
acquired and the anticipated commencement of the public offering; and 
(3) the nature of the funding provided, including, but not limited to 
the issuer's need for funding before the public offering.\58\
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    \57\ See Notice, supra note 3, 84 FR at 18597.
    \58\ See proposed Supplementary Material .02(a)-(c) to Rule 
5110.
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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 \59\ acquired in a transaction unrelated to a public 
offering would not be underwriting compensation.\60\ 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.\61\
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    \59\ 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.
    \60\ See proposed Supplementary Material .01(b)(19) to Rule 
5110.
    \61\ See proposed Rule 5110(a)(4)(B)(iv)(a). FINRA states that, 
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.
---------------------------------------------------------------------------

    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.\62\
---------------------------------------------------------------------------

    \62\ See, e.g., proposed Supplementary Material .06(a) to Rule 
5110, proposed Rule 5110(c), and Notice, supra note 3.
---------------------------------------------------------------------------

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).\63\ 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 and arrangements of any acquisition of 
securities by a participating member.\64\
---------------------------------------------------------------------------

    \63\ See proposed Rule 5110(e)(1)(A).
    \64\ See proposed Rule 5110(e)(1)(B).
---------------------------------------------------------------------------

    FINRA proposes to add an 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.\65\ Further, 
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.\66\ FINRA provides that, 
while these securities would not be considered underwriting 
compensation and, thus, not subject to the lock-up restriction, the 
exception would provide additional clarity with respect to these 
securities. Moreover, the proposed rule change would 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.\67\
---------------------------------------------------------------------------

    \65\ See proposed Rule 5110(e)(2)(A)(iii).
    \66\ See proposed Rule 5110(e)(2)(A)(vi).
    \67\ See proposed Rule 5110(e)(2)(A)(viii).
---------------------------------------------------------------------------

    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.\68\ 
Specifically, FINRA proposes that the lock-up restriction would not 
apply to derivative instruments acquired in connection with a hedging 
transaction related to the public offering and at a fair price.\69\ 
Moreover, 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).'' \70\ In addition, the transfer or sale of a security back to the 
issuer in a transaction exempt from registration with the SEC would not 
be subject to the lockup restriction.\71\ Further, current Rule 
5110(g)(2)(A)(ii) would be modified 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.\72\
---------------------------------------------------------------------------

    \68\ See proposed Rule 5110(e)(2)(A)(iv).
    \69\ 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.
    \70\ See proposed Rule 5110(e)(2)(A)(ix). See also Order 
Instituting Proceedings, supra note 8, 84 FR at 37925, and Partial 
Amendment No. 1, supra note 6.
    \71\ See proposed Rule 5110(e)(2)(B)(iii).
    \72\ 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).
---------------------------------------------------------------------------

    Finally, because proposed Supplementary Material .01(b)(20)

[[Page 72401]]

would provide that securities acquired subsequent to the issuer's IPO 
in a transaction exempt from registration under Rule 144A of the 
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.\73\
---------------------------------------------------------------------------

    \73\ See current Rule 5110(g)(2)(A)(viii).
---------------------------------------------------------------------------

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.\74\ For example, the proposed rule change would 
clarify the scope of relevant activities that would be deemed related 
to the public offering \75\ and refer to the commencement of sales of 
the public offering (rather than the date of effectiveness) in relation 
to the receipt of underwriting compensation consisting of any option, 
warrant or convertible security with specified terms.\76\ The proposal 
would also 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.\77\ Finally, the 
proposed rule change would also simplify a provision that relates to 
payments made by an issuer to waive or terminate a ROFR to participate 
in a future capital-raising transaction.\78\ The proposed rule change 
would, however, retain the prohibition on any non-cash payment or fee 
to waive or terminate a ROFR.\79\
---------------------------------------------------------------------------

    \74\ See proposed Rule 5110(g).
    \75\ See proposed Rule 5110(g)(11). Specifically, to clarify the 
scope, the proposed rule change would refer to ``solicitation, 
marketing, distribution or sales of the offering'' rather than the 
current ``distribution or assisting in the distribution of the 
issue, or for the purpose of assisting in any way in connection with 
the underwriting.'' See Notice, supra note 3, 84 FR at 18599 n. 63.
    \76\ See proposed Rule 5110(g)(8).
    \77\ See proposed Rule 5110(g)(4).
    \78\ See current Rule 5110(f)(2)(F)(i).
    \79\ See proposed Rule 5110(g)(7).
---------------------------------------------------------------------------

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 
Rule 5110's defined terms. For example, FINRA proposes to consolidate 
the various provisions that address what constitutes underwriting 
compensation into a single, new definition of ``underwriting 
compensation.'' \80\ The proposed rule change also would eliminate the 
term ``underwriter and related persons'' and instead use the defined 
term ``participating member.'' \81\ Further, the proposed rule change 
would move the definition of ``public offering'' from Rule 5121 to Rule 
5110 \82\ and would modify the definition to add ``made in whole or in 
part in the United States'' to clarify the jurisdictional scope of the 
definition.\83\ The proposed rule change would also move, without 
modification, the definition of ``Net Offering Proceeds'' from Rule 
5110 to Rule 5121.\84\
---------------------------------------------------------------------------

    \80\ See proposed Rule 5110(j)(22). FINRA proposes to define the 
term ``underwriting compensation'' 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.'' 
See id.
    \81\ 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, according to FINRA, 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 states its belief 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, according to 
FINRA, 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.
    \82\ See proposed Rule 5110(j)(18). Rule 5121 would incorporate 
the definition in Rule 5110 by reference. See Rule 5121(f).
    \83\ See proposed Rule 5110(j)(18). FINRA is also proposing to 
amend the defined term ``public offering'' in proposed Rule 
5110(j)(18)(A) to update the reference to offerings pursuant to 
``Section 4(6)'' of the Securities Act to refer instead to Section 
4(a)(5) of the Securities Act. See Order Instituting Proceedings, 
supra note 8, 84 FR at 37927.
    \84\ See proposed Rule 5121(f)(9).
---------------------------------------------------------------------------

    In addition, the proposed rule change would modernize Rule 5110's 
language (e.g., by replacing references to specific securities 
exchanges to instead reference the definition of ``national securities 
exchange'' in the Exchange Act). Furthermore, according to FINRA, the 
proposed rule change would include new defined terms to provide greater 
predictability for members in applying the Rule (e.g., ``experienced 
issuer,'' \85\ ``equity-linked securities,'' \86\ ``overallotment 
option'' \87\ and ``review period'' \88\).
---------------------------------------------------------------------------

    \85\ As discussed supra, 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. (Alternatively, $100 million or more aggregate market 
value of voting stock held by non-affiliates and an annual trading 
volume of at least three million shares). Issuers meeting this 
standard would be defined as ``experienced issuers'' and their 
public offerings would be exempt from filing, but subject to the 
substantive provisions of Rule 5110. See proposed Rule 5110(j)(6).
    \86\ See proposed Rule 5110(j)(7).
    \87\ See proposed Rule 5110(j)(14).
    \88\ See proposed Rule 5110(j)(20).
---------------------------------------------------------------------------

    The proposed rule change, moreover, would incorporate the 
definition of ``associated person'' \89\ in Article I, Section (rr) of 
the FINRA By-Laws. Also, the proposed rule change would provide that a 
bank is ``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.'' \90\ In addition, the proposed rule 
change would revise the issuer definition 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.'' \91\
---------------------------------------------------------------------------

    \89\ See proposed Rule 5110(j)(1).
    \90\ See proposed Rule 5110(j)(2).
    \91\ See proposed Rule 5110(j)(12).
---------------------------------------------------------------------------

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.\92\
---------------------------------------------------------------------------

    \92\ See proposed Rule 5110(c). See also Notice, supra note 3, 
84 FR at 18600.

---------------------------------------------------------------------------

[[Page 72402]]

B. Partial Amendment No. 2 93
---------------------------------------------------------------------------

    \93\ The description in this Item II.B is based on Partial 
Amendment No. 2, as filed by FINRA. See supra note 11.
---------------------------------------------------------------------------

    In response to comments received in response to the Order 
Instituting Proceedings, FINRA filed Partial Amendment No. 2 to the 
proposed rule change, as modified by Partial Amendment No. 1.\94\ 
Partial Amendment No. 2 would modify the proposed rule change, as 
modified by Amendment No. 1, as follows:
---------------------------------------------------------------------------

    \94\ See id.
---------------------------------------------------------------------------

Filing Requirements
    In Partial Amendment No. 2, FINRA proposes to change the beneficial 
ownership threshold with respect to the representation requirement in 
proposed Rule 5110(a)(4)(B)(iii) from 5% to 10%. Specifically, as 
modified by Partial Amendment No. 2, proposed Rule 5110(a)(4)(B)(iii) 
would now require the filing of ``a representation as to whether any 
officer or director of the issuer and any beneficial owner of 10% or 
more of any class of the issuer's equity and equity-linked securities 
is an associated person or affiliate of a participating member''.
Venture Capital Exception
    In Partial Amendment No. 2, FINRA proposes new Supplementary 
Material .07 to Rule 5110 to expressly provide its interpretation that 
the determination of whether a securities acquisition may qualify for a 
venture capital exception from underwriting compensation is to be made 
at the time of the securities acquisition.\95\
---------------------------------------------------------------------------

    \95\ Specifically, as proposed in Partial Amendment No. 2, 
proposed new Supplementary Material .07 to Rule 5110 would state 
``[t]he determination of whether a securities acquisition may be 
excluded from underwriting compensation pursuant to paragraph (d) is 
to be made at the time of the securities acquisition.'' See Partial 
Amendment No. 2, supra note 11.
---------------------------------------------------------------------------

Investment Grade Debt Exemption
    FINRA proposes to revise proposed Rule 5110(h)(1)(A) to add the 
term ``foreign bank'' to the list of entities that may rely on the 
investment grade exemption.
Definition of ``Participate''
    FINRA proposes to revise proposed Rule 5110(j)(16)(B) to delete the 
words ``provided that another member or members is participating in the 
public offering.''
Underwriting Compensation
    FINRA proposes to revise proposed Supplementary Material .01(a)(7) 
to provide that purchases of both convertible and non-convertible 
securities during the review period by a participating member in a 
public offering at the public offering price and on the same terms as 
all others that are not participating members not be underwriting 
compensation.\96\
---------------------------------------------------------------------------

    \96\ Specifically, Supplementary Material .01(a)(7) would now 
provide that ``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 any such securities 
purchased during the review period by a participating member in a 
public offering at the public offering price and on the same terms 
as all others purchasing in the public offering that are not 
participating members shall not be deemed underwriting 
compensation.''
---------------------------------------------------------------------------

    Further, FINRA proposes to revise proposed Supplementary Material 
.01(b)(21) to provide that securities acquired by a member firm acting 
as a bona fide market maker would not constitute underwriting 
compensation.\97\
---------------------------------------------------------------------------

    \97\ Specifically, Supplementary Material .01(a)(7) would now 
provide that underwriting compensation does not include ``securities 
acquired in the secondary market by a participating member that is a 
broker-dealer in connection with the performance of bona fide 
customer facilitation activities and bona fide market making 
activities . . .''
---------------------------------------------------------------------------

III. Discussion of Comments Received on the Proposed Rule Change and 
FINRA's Response

    The Commission received a total of nine comments in response to the 
proposed rule change.\98\ Six comment letters were received in response 
to the filing as originally proposed.\99\ Subsequently, FINRA filed 
Partial Amendment No. 1 and a response to those comments.\100\ The 
Commission thereafter received three comments in response to the Order 
Instituting Proceedings.\101\ FINRA subsequently filed Partial 
Amendment No. 2 and a response to comments received in response to the 
Order Instituting Proceedings.\102\ Significant comments received and 
FINRA's responses are summarized below.
---------------------------------------------------------------------------

    \98\ See supra notes 5 and 9.
    \99\ See supra note 5.
    \100\ See FINRA Response No. 1, supra note 6.
    \101\ See supra note 9.
    \102\ See supra note 11.
---------------------------------------------------------------------------

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.\103\ As 
discussed below, one commenter expresses support of a proposed 
exemption, but otherwise does not comment on other aspects of the 
proposal.\104\ In response, FINRA has proposed certain modifications to 
the initial proposal as described in detail below.
---------------------------------------------------------------------------

    \103\ See ABA, Davis Polk, Rothwell, and SIFMA Letter No. 1, 
supra note 5.
    \104\ See CAI, supra note 5.
---------------------------------------------------------------------------

    Two commenters believe excessive underwriting compensation should 
be addressed through disclosure to investors and that Rule 5110 is 
inconsistent with the Exchange Act and the Securities Act.\105\ These 
commenters suggest eliminating Rule 5110 in its entirety, or amending 
it to require only disclosure of underwriting compensation. In 
response, FINRA states, among other things, 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.\106\
---------------------------------------------------------------------------

    \105\ See Kaswell Letter Nos. 1 and 2, and Callcott, supra notes 
5, 9.
    \106\ See FINRA Response No. 1, supra note 6 at 2, and FINRA 
Response No. 2, supra note 11 at 5-6.
---------------------------------------------------------------------------

Filing Requirements
    Three commenters state that several of the proposed filing 
requirements are unnecessary.\107\ Namely, commenters argue that the 
following filing requirements should be eliminated or modified: (1) 
Disclosure of holdings that are excluded from underwriting 
compensation; \108\ (2) M&A and private placement engagement letters; 
\109\ (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; \110\ (4) notification of 
underwriting compensation received in terminated or revised offerings; 
\111\ and (5) a description of securities acquired in bona fide venture 
capital transactions.\112\
---------------------------------------------------------------------------

    \107\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
    \108\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
    \109\ See ABA, supra note 5. See also SIFMA Letter No. 2, supra 
note 9.
    \110\ See ABA and SIFMA Letter No. 1, supra note 5, and SIFMA 
Letter No. 2, supra note 9.
    \111\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
    \112\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
---------------------------------------------------------------------------

    In response to commenters' concerns regarding disclosure of 
holdings that are excluded from underwriting compensation, FINRA 
proposes in Partial Amendment No. 1 to revise Rule 5110(a)(4)(B)(iv) to 
not require filing a

[[Page 72403]]

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.\113\
---------------------------------------------------------------------------

    \113\ See FINRA Response No. 1, supra note 6 at 3-4.
---------------------------------------------------------------------------

    With respect to M&A and private placement engagement letters, FINRA 
states that it continues to believe that such 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.\114\ 
Further, in response to one commenter's concern that FINRA's Public 
Offering System does not mirror the requirements of the proposed Rule 
and requires filing of stand-alone M&A and private placement engagement 
letters otherwise not required by the Rule,\115\ FINRA responds by 
stating that proposed Rule 5110(a)(4)(A)(ii) requires filing an 
engagement letter with FINRA for review only when the engagement letter 
contains terms relevant to the underwriting terms and arrangements. 
FINRA states that engagement letters that do not contain terms relevant 
to the underwriting terms and arrangements would therefore not be 
required.\116\ FINRA further states that, if the proposed rule change 
is approved, FINRA's Public Offering System would be revised and 
administered consistent with proposed Rule 5110(a)(4)(A)(ii).\117\
---------------------------------------------------------------------------

    \114\ See FINRA Response No. 1, supra note 6 at 3.
    \115\ See SIFMA Letter No. 2, supra note 9 at 3-5.
    \116\ See FINRA Response No. 2, supra note 11 at 2-3.
    \117\ See id.
---------------------------------------------------------------------------

    In response to comments with respect to the representation 
requirement in proposed Rule 5110(a)(4)(B)(iii),\118\ FINRA proposes to 
increase the disclosure threshold of beneficial ownership from 5% to 
10% or more of an entity's common or preferred equity.\119\ 
Specifically, in Partial Amendment No. 2, FINRA proposes to revise 
proposed Rule 5110(a)(4)(B)(iii) to require filing ``a representation 
as to whether any officer or director of the issuer and any beneficial 
owner of 10% or more of any class of the issuer's equity and equity-
linked securities is an associated person or affiliate of a 
participating member.'' FINRA states that this proposed amendment would 
provide greater flexibility to participating members in relation to 
beneficial ownership information while still requiring that 
participating members provide information needed to identify potential 
conflicts of interest.\120\
---------------------------------------------------------------------------

    \118\ See FINRA Response No. 1, supra note 6 at 4-5. See also 
ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5. ABA and SIFMA 
suggest a 25% threshold, while Davis Polk suggests a 10% threshold. 
See also SIFMA Letter No. 2, supra note 9.
    \119\ See FINRA Response No. 2, supra note 11 at 3.
    \120\ See FINRA Response No. 2, supra note 11 at 3.
---------------------------------------------------------------------------

    Further, with respect to compensation received relating to revised 
or terminated public offerings, FINRA states that such underwriting 
compensation is relevant for purposes of evaluating compliance with 
Rule 5110 and for preventing a member from being compensated twice for 
the same services.\121\ In addition, 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).\122\
---------------------------------------------------------------------------

    \121\ See FINRA Response No. 1, supra note 6 at 6.
    \122\ Specifically, Supplementary Material .01(a)(13) would 
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 
No. 1, supra note 6 at 6 n.10.
---------------------------------------------------------------------------

    In response to comments regarding description of securities 
acquired in bona fide venture capital transactions, FINRA proposes to 
retain the requirement. 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.\123\
---------------------------------------------------------------------------

    \123\ See FINRA Response No. 1, supra note 6 at 4.
---------------------------------------------------------------------------

    Although most commenters suggest scaling back the filing 
requirements, one commenter suggests that FINRA withdraw a proposed 
exception from the filing requirement.\124\ Specifically, the commenter 
proposes that the expansion of the ``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.\125\ Moreover, this and another 
commenter request additional clarification on the ``seasoned issuer'' 
exemption.\126\ Specifically, one commenter seeks clarification 
regarding whether the issuer's qualifying debt or preferred securities 
for purposes of the exemption must be issued and outstanding.\127\ The 
other commenter requests clarification that the term ``corporate 
issuer'' in the exemption is not meant to exclude issuers if they are 
not organized in ``corporate'' form.\128\
---------------------------------------------------------------------------

    \124\ See Rothwell, supra note 5.
    \125\ See id.
    \126\ See Rothwell and ABA, supra note 5.
    \127\ See Rothwell, supra note 5.
    \128\ See ABA, supra note 5.
---------------------------------------------------------------------------

    In response to commenters' concerns, FINRA 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. Accordingly, 
FINRA proposes to 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). In addition, FINRA states that 
it would interpret ``corporate issuers'' to include, among other 
entities, limited partnerships and limited liability companies.\129\
---------------------------------------------------------------------------

    \129\ See FINRA Response No. 1, 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 that do not 
individually or in the aggregate exceed the lesser of: (1) $50,000; and 
(2) 0.1% of the dollar amount of securities offered in the public 
offering.\130\ The same commenter also suggests that nominal gifts and 
occasional meals or other business entertainment that are provided in 
accordance with the limits set forth in proposed Rule 5110(f)(2)(A) and 
(B) should not be required to be separately itemized and disclosed as 
underwriting compensation because the administrative costs and burdens 
would outweigh the benefits.\131\
---------------------------------------------------------------------------

    \130\ See SIFMA Letter No. 1, supra note 5, and SIFMA Letter No. 
2, supra note 9.
    \131\ See SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------

    In response, FINRA notes that it previously considered the Rule's 
disclosure requirements and continues to believe that the current 
itemized

[[Page 72404]]

approach to disclosure is appropriate.\132\ FINRA further states that a 
de minimis exception would inherently involve a participating member 
categorizing different forms of underwriting compensation and 
determining whether the specific category exceeds the de minimis 
threshold.\133\
---------------------------------------------------------------------------

    \132\ See FINRA Response No. 1, supra note 6 at 7. See also 
FINRA Response No. 2, supra note 11 at 4-5.
    \133\ See FINRA Response No. 2, supra note 11 at 4-5.
---------------------------------------------------------------------------

    FINRA also declines to revise its Rule per commenter's suggestion 
regarding nominal gifts and occasional meals or other business 
entertainment. FINRA states that the suggested change would not alter 
the current requirements for disclosing non-cash compensation because 
non-cash compensation in connection with a public offering has long 
been considered underwriting compensation under Rule 5110 and is 
disclosed to FINRA via a question in FINRA's electronic filing system 
for public offerings.\134\
---------------------------------------------------------------------------

    \134\ See id. at 5.
---------------------------------------------------------------------------

Valuation
    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.\135\ Commenters request 
alternative valuation methodologies on a case-by-case basis \136\ and 
for unit securities.\137\ 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.\138\
---------------------------------------------------------------------------

    \135\ See SIFMA Letter No. 1 and Rothwell, supra note 5.
    \136\ See SIFMA Letter No. 1, supra note 5 at 8.
    \137\ See Rothwell, supra note 5 at 12.
    \138\ See SIFMA Letter No. 1, supra note 5 at 8.
---------------------------------------------------------------------------

    In response, FINRA states that it 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.\139\ FINRA also notes that 
it has previously provided guidance for valuing unit securities.\140\ 
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.'' \141\
---------------------------------------------------------------------------

    \139\ See FINRA Response No. 1, supra note 6 at 8.
    \140\ See id.
    \141\ See id.
---------------------------------------------------------------------------

Venture Capital Exceptions
    Commenters generally support the venture capital exceptions.\142\ 
One commenter, however, contends that the definition of ``institutional 
investor'' \143\ renders the venture capital exception unworkable.\144\ 
The commenter suggests that the definition should focus instead on 
whether a participating member manages the investor's investments or 
otherwise controls or directs the investment decisions of the investor. 
Alternatively, the commenter suggests that the scope of those subject 
to the equity interest calculation be limited to the participating 
FINRA member firm and its affiliates (i.e., the calculation should not 
include associated persons that are not otherwise ``affiliates'' of the 
member firm or immediate family of such associated persons). Further, 
the commenter suggests that the co-investment exception \145\ be 
expanded to include other highly regulated entities that purchase in 
the private offering under the same conditions, provided that, in each 
case, no participating member manages the entity's investments or 
otherwise controls or directs the management or policies of the 
entity.\146\ Finally, 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 the 
exception at the time of the acquisition of the securities.\147\
---------------------------------------------------------------------------

    \142\ See Rothwell and SIFMA Letter No. 1, supra note 5.
    \143\ Proposed Rule 5110(j)(10) defines the term ``institutional 
investor'' to mean ``any person that has an aggregate of at least 
$50 million invested in securities in its portfolio or under 
management, including investments held by its wholly owned 
subsidiaries; provided that no participating members manage the 
institutional investor's investments or have an equity interest in 
the institutional investor, either individually or in the aggregate, 
that exceeds 5% for a publicly owned entity or 1% for a nonpublic 
entity.
    \144\ See SIFMA Letter No. 1, supra note 5.
    \145\ According to FINRA, co-investment exception is a type of 
venture capital exception that applies to 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. See proposed Rule 5110(d)(4). See also Notice, supra note 
3, 84 FR at 18612.
    \146\ See SIFMA Letter No. 1, supra note 5.
    \147\ See id. See also SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------

    In response, FINRA declines to revise the definition of 
``institutional investor''. FINRA believes that revising the definition 
as suggested to focus on controlling or directing investment decisions 
would insert uncertainty and subjectivity into the definition and that 
the current definition is more objective.\148\ Moreover, because Rule 
5110's venture capital exceptions are relied upon by members, FINRA 
does not agree that the institutional investor definition makes the 
venture capital exceptions unworkable.
---------------------------------------------------------------------------

    \148\ See FINRA Response No. 1, supra note 6 at 9-10.
---------------------------------------------------------------------------

    As for the comment regarding expanding the venture capital 
exception to other highly regulated entities, FINRA states that it will 
assess how the exception is operating in practice and may in the future 
consider extending the exception to include co-investments with other 
highly regulated entities on comparable terms.\149\ In response to the 
request that the determination as to the availability of a venture 
capital exception be made at the time of the acquisition of the 
securities and based on the participating member's knowledge at that 
time, FINRA proposes new Supplementary Material .07 to Rule 5110, which 
would provide that ``[t]he determination of whether a securities 
acquisition may be excluded from underwriting compensation pursuant to 
paragraph (d) is to be made at the time of the securities 
acquisition.'' \150\
---------------------------------------------------------------------------

    \149\ See FINRA Response No. 1, supra note 6 at 9.
    \150\ See FINRA Response No. 2, supra note 11 at 6-7. FINRA 
points out that a securities acquisition must be made prior to the 
required filing date to qualify for the venture capital exceptions; 
accordingly, proposed Rule 5110(d)(1)-(4) would retain the language 
``before the required filing date of the public offering'' in the 
rule text to continue to require that the securities acquisition be 
made prior to the required filing date to qualify for a venture 
capital exception. See id. at 7.
---------------------------------------------------------------------------

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

[[Page 72405]]

investment advisers who are participating members.\151\
---------------------------------------------------------------------------

    \151\ See SIFMA Letter No. 1, supra note 5 at 6.
---------------------------------------------------------------------------

    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).'' \152\ Due to 
conflicting views on the issue of follow-on offerings, however, FINRA 
states that it will retain the historical approach of a 180-day lock-up 
period for both initial and follow-on public offerings.\153\ FINRA 
notes that certain follow-on public offerings may qualify for other 
exemptions.\154\ FINRA also notes that, with respect to registered 
investment advisers who are participating members, it would consider 
requests for exemptive relief from the lock-up restriction pursuant to 
Rule 5110(i).\155\
---------------------------------------------------------------------------

    \152\ See FINRA Response No. 1, supra note 6 at 11.
    \153\ See id.
    \154\ See id.
    \155\ 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.\156\
---------------------------------------------------------------------------

    \156\ See ABA, supra note 5 at 7, and SIFMA Letter No. 1, supra 
note 5 at 9.
---------------------------------------------------------------------------

    In response to the commenters' request for clarification, FINRA 
confirms the commenters' understanding regarding the restrictions on 
receipt of non-cash compensation.\157\
---------------------------------------------------------------------------

    \157\ See FINRA Response No. 1, 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.\158\ 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.\159\ 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.\160\
---------------------------------------------------------------------------

    \158\ See ABA, supra note 5.
    \159\ See ABA, supra note 5 at 7-8.
    \160\ See id.
---------------------------------------------------------------------------

    In response, FINRA declines to modify the Rule pursuant to the 
commenter's suggestions.\161\ FINRA believes that receiving advisory or 
consulting fees for services provided in connection with a public 
offering that is not completed and, therefore, results in no capital 
being raised is an unreasonable term and arrangement for purposes of 
Rule 5110. It notes, however, that participating members may receive 
termination fees or a ROFR related to an offering that is not completed 
consistent with Rule 5110(g)(5).
---------------------------------------------------------------------------

    \161\ See FINRA Response No. 1, supra note 6 at 12-13.
---------------------------------------------------------------------------

    Further, FINRA believes that reasonable due diligence by a 
participating member would generally detect whether an issuer who has 
hired persons primarily for the purpose of solicitation, marketing, 
distribution, or sales of the offering was not in compliance with 
Section 15(a) of the Exchange Act or Rule 3a4-1 under the Exchange Act 
and applicable state law. According to FINRA, however, it would 
consider whether the participating member knew, or reasonably should 
have known, that the issuer had hired such persons absent compliance 
with applicable federal or state securities laws in assessing any 
violation of Rule 5110(g)(11).
Exemptions From Filing and Substantive Requirements
    Commenters are generally supportive of FINRA's proposal to exempt 
certain offerings from the filing requirements.\162\ One commenter, 
however, requests that FINRA expand the exemptions to include tender 
offers by issuers for their own securities under the Exchange Act.\163\ 
In response to the comment, as discussed in Partial Amendment No. 1 and 
described above, FINRA proposes to amend Rule 5110(h)(2)(G) to include 
tender offers by issuers for their own securities.\164\
---------------------------------------------------------------------------

    \162\ See Rothwell, CAI, and ABA, supra note 5.
    \163\ See ABA, supra note 5 at 10.
    \164\ See FINRA Response No. 1, supra note 6 at 13-14.
---------------------------------------------------------------------------

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.\165\ In response, as discussed in the 
Partial Amendment No. 1 and described above, FINRA proposes to amend 
the proposed definition of bank in Rule 5110(j)(2) to include ``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.'' \166\
---------------------------------------------------------------------------

    \165\ See ABA, supra note 5 at 10.
    \166\ See FINRA Response No. 1, supra note 6 at 15.
---------------------------------------------------------------------------

    In response to the Order Instituting Proceedings, one commenter 
states that it agrees with the proposed modification to the definition 
of bank, but further suggests that proposed Rule 5110(h)(1)(A) also be 
amended to include ``foreign bank'' to avoid creating a new and 
burdensome requirement that foreign banks must apply to FINRA for an 
exemption before relying on the investment grade debt exemption from 
filing.\167\ In response, FINRA proposes to revise Rule 5110(h)(1)(A) 
to add ``foreign bank'' to the list of entities that may rely on the 
exemption.\168\
---------------------------------------------------------------------------

    \167\ See SIFMA Letter No. 2, supra note 9 at 2.
    \168\ See FINRA Response No. 2, supra note 11 at 7-8.
---------------------------------------------------------------------------

    Four commenters express concern over the term ``experienced 
issuer'' in Rule 5110(j)(6) and suggested alternatives or requested 
clarification.\169\ For example, commenters express concern that the 
proposal would eliminate SEC and FINRA's past interpretive guidance 
relating to the term.\170\ Further, one commenter specifically requests 
clarification regarding the extent to which member firms can rely on 
prior SEC and FINRA guidance and interpretation associated with the 
Form S-3 and F-10 eligibility requirements, including those related to 
determining aggregate market value and public float.\171\ Yet another 
commenter suggests revising the definition of ``experienced issuer'' to 
``explain the requirements that must be met to satisfy the `reporting 
history' requirement.'' \172\
---------------------------------------------------------------------------

    \169\ See ABA, Davis Polk, SIFMA Letter No. 1, and Rothwell, 
supra note 5.
    \170\ See id.
    \171\ See SIFMA Letter No. 2, supra note 9 at 6-7.
    \172\ See Rothwell, supra note 5 at 14.
---------------------------------------------------------------------------

    In response, FINRA states that it believes that the proposed 
definition of

[[Page 72406]]

``experienced issuer'' codifies standards currently in place and 
simplifies the analysis for the benefit of members.\173\ FINRA also 
notes that any guidance and interpretation issued by the SEC or FINRA 
relating to the term remain valid and illustrative,\174\ including any 
guidance and interpretation on determining aggregate market value and 
public float issued by the SEC or FINRA at adoption of, or issued 
thereafter in connection with, the pre-1992 standards for Forms S-3 and 
F-3 and standards approved in 1991 for Form F-10.\175\ Finally, FINRA 
states that ``reporting history is commonly understood to mean that the 
issuer has filed all material required to be filed for the relevant 
period immediately preceding the filing of the registration 
statement.'' \176\
---------------------------------------------------------------------------

    \173\ See FINRA Response No. 1, supra note 6 at 16.
    \174\ See id.
    \175\ FINRA further states that the proposed defined term is 
intended for simplification only, and incorporation of the standards 
into the proposed defined term would not alter the scope of public 
offerings subject to Rule 5110. See FINRA Response No. 2, supra note 
11 at 8.
    \176\ See FINRA Response No. 1, supra note 6 at 15.
---------------------------------------------------------------------------

    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 
offering and other documents.\177\
---------------------------------------------------------------------------

    \177\ See Rothwell, supra note 5 at 14-15.
---------------------------------------------------------------------------

    In response, FINRA disagrees with the suggested expansion of 
services that may be provided by the independent financial 
adviser.\178\ According to FINRA, the commenter's suggestion would 
represent a significant expansion on the scope of services that may be 
provided by an independent financial adviser. Moreover, if adopted, 
compensation for these expanded services would not be underwriting 
compensation under the Rule. FINRA notes that it had previously 
concluded that that the advisory or consulting services that an 
independent financial adviser may provide minimizes the risk of the 
imposition of unfair or unreasonable terms and arrangements on issuers.
---------------------------------------------------------------------------

    \178\ See FINRA Response No. 1, supra note 6 at 17.
---------------------------------------------------------------------------

    Four commenters seek clarification and/or suggest a variety of 
changes to the proposed definitions of ``participate,'' ``issuer,'' and 
``participating member'' \179\ Specifically, two commenters seek 
clarification on the extent of the ``issuer'' carve out from the 
definition of ``participating member.'' \180\ One commenter suggests 
amending the proposed defined term ``participate'' to include 
additional detail on activities that are considered involvement in the 
distribution of an offering by adding ``including solicitation, 
marketing, distribution or sales of the offering.'' \181\ Additionally, 
two commenters suggest excluding certain broker activities from the 
definition of ``participate,'' such as acting as a broker for a selling 
shareholder in return for compensation consisting of customary 
brokerage commissions and under circumstances in which the broker does 
not use special selling efforts and selling methods.\182\ Finally, one 
commenter states that it does not believe that an independent financial 
adviser that is not engaged in the solicitation or distribution of the 
offering should be deemed to be ``participating'' in a public 
offering--and thereby subject to the Rule's filing and other 
requirements--solely because no other FINRA member is participating in 
the offering.\183\
---------------------------------------------------------------------------

    \179\ See Rothwell, ABA, SIFMA Letter No. 1, and Davis Polk, 
supra note 5.
    \180\ See Rothwell and SIFMA Letter No. 1, supra note 5.
    \181\ See Rothwell, supra note 5.
    \182\ See ABA and Davis Polk, supra note 5.
    \183\ See SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------

    In response, FINRA states that the addition of ``but does not 
include the issuer'' to the definition of participating member is 
``intended to make clear that the `issuer' as defined in proposed Rule 
5110(j)(12) is entirely excluded from the proposed `participating 
member' definition.'' \184\ Moreover, in Partial Amendment No. 1 and as 
described above, FINRA proposes to amend the defined term ``issuer'' to 
exclude a participating member, except where the participating member 
is offering its securities.
---------------------------------------------------------------------------

    \184\ See FINRA Response No. 1, supra note 6 at 18.
---------------------------------------------------------------------------

    With respect to the term ``participate,'' while FINRA concedes that 
adding ``including solicitation, marketing, distribution or sales of 
the offering'' is illustrative, FINRA proposes to retain the current 
approach in the definition to accommodate a broad range of activities 
that may constitute participating in an offering.\185\ Moreover, FINRA 
states that it does not agree with the commenters' suggestion to create 
additional carve-outs from the definition of ``participate'' for 
certain brokerage activities, but notes that a participating members' 
compensation for some activities may not be deemed underwriting 
compensation.\186\
---------------------------------------------------------------------------

    \185\ See FINRA Response No. 1, supra note 6 at 17.
    \186\ See id.
---------------------------------------------------------------------------

    Finally, with respect to the suggested changes related to 
independent financial advisers, FINRA proposes to revise Rule 
5110(j)(16)(B) to delete the words ``provided that another member or 
members is participating in the public offering.'' FINRA states that 
current Rule 5110 does not include this provision and that, 
accordingly, deleting the language will make the approach consistent 
with the current Rule.\187\
---------------------------------------------------------------------------

    \187\ See FINRA Response No. 2, supra note 11 at 9.
---------------------------------------------------------------------------

    Two commenters suggest that the defined term ``public offering'' in 
proposed Rule 5110(j)(18) 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.\188\ FINRA declines to make the suggested revision, 
stating that members have not previously filed these offerings with 
FINRA and, consequently, FINRA has not received information on these 
offerings.\189\
---------------------------------------------------------------------------

    \188\ See ABA, supra note 5 at 11, and SIFMA Letter No. 2, supra 
note 9 at 8-9. 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 and 
described above, FINRA proposes to revise the public offering 
definition's reference to these offerings as suggested by the 
commenter. See supra note 81.
    \189\ See FINRA Response No. 1, supra note 6 at 18.
---------------------------------------------------------------------------

    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.\190\
---------------------------------------------------------------------------

    \190\ See ABA, Davis Polk, Rothwell, and SIFMA Letter No. 1, 
supra note 5.
---------------------------------------------------------------------------

    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.\191\
---------------------------------------------------------------------------

    \191\ See FINRA Response No. 1, supra note 6 at 19 n.27.
---------------------------------------------------------------------------

    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.\192\ One 
commenter is concerned that the proposed definition of ``review 
period'' expands the scope of the Rule and

[[Page 72407]]

suggests that FINRA withdraw Supplementary Material .04.\193\
---------------------------------------------------------------------------

    \192\ See ABA and SIFMA Letter No. 1, supra note 5.
    \193\ See Rothwell, supra note 5 at 1.
---------------------------------------------------------------------------

    In response to concerns regarding proposed Supplementary Material 
.04, FINRA states that proposed Supplementary Material .04 takes into 
account the price at which the securities are acquired. FINRA notes 
that, pursuant to proposed Supplementary Material .04, FINRA would 
consider, among other factors, 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.\194\ Two 
commenters request clarification as to whether certain compensated 
parties would be considered ``participating members'' and thus their 
compensation be deemed underwriting compensation.\195\ 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.\196\ 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 a foreign 
distribution of an offering occurring in the U.S. and outside the U.S. 
simultaneously would not be deemed underwriting compensation under Rule 
5110.\197\
---------------------------------------------------------------------------

    \194\ See id.
    \195\ See SIFMA Letter No. 1 and Davis Polk, supra note 5.
    \196\ See SIFMA Letter No. 1, supra note 5 at 7-8.
    \197\ See Davis Polk, supra note 5 at 4.
---------------------------------------------------------------------------

    In response, FINRA confirms 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.\198\ Further, FINRA provides 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 such separately allocated underwriting 
compensation to be outside the scope of Rule 5110 and not subject to 
the requirements of Rule 5110.\199\
---------------------------------------------------------------------------

    \198\ See FINRA Response No. 1, supra note 6 at 19-20.
    \199\ See FINRA Response No. 1, supra note 6 at 20.
---------------------------------------------------------------------------

    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.\200\
---------------------------------------------------------------------------

    \200\ See ABA, supra note 5 at 4-5.
---------------------------------------------------------------------------

    In response, FINRA provides 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.\201\
---------------------------------------------------------------------------

    \201\ See FINRA Response No. 1, supra note 6 at 20.
---------------------------------------------------------------------------

Underwriting Compensation
    One commenter supports the changes in proposed Supplementary 
Material .01, which provides non-exhaustive lists of examples of 
payments or benefits that would or would not be underwriting 
compensation,\202\ while others request that additional items be 
included to the list of items not deemed underwriting 
compensation.\203\ Specifically, commenters suggest the following be 
deemed not to constitute underwriting compensation: (1) The 1% 
valuation assigned to ROFRs; \204\ (2) nominal gifts and occasional 
entertainment; \205\ (3) fees for services performed by participating 
members in the ordinary course of business unrelated to the 
distribution of the offering; \206\ and (4) 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.\207\
---------------------------------------------------------------------------

    \202\ See Rothwell, supra note 5 at 2.
    \203\ See ABA, Davis Polk, and SIFMA Letter No. 1, supra note 5.
    \204\ See SIFMA and ABA, supra note 5.
    \205\ See ABA, supra note 5.
    \206\ See Davis Polk, supra note 5. One commenter also requests 
that FINRA delete the words ``to the issuer'' from Supplementary 
Material .01(b)(4)-(6), given the construct of items in proposed 
Supplementary Material .01(b) and the definition of underwriting 
compensation in proposed Rule 5110(j)(22) covering payments from 
``any source.'' See ABA, supra note 5.
    \207\ See SIFMA Letter No. 1, supra note 5.
---------------------------------------------------------------------------

    In response, FINRA disagrees with these suggestions and believes 
that such compensations should be reported to FINRA as underwriting 
compensation.\208\ With respect to 1% valuation assigned to ROFRs, 
FINRA maintains that ROFRs are a valuable benefit that traditionally 
have been used in combination with other forms of compensation to 
reward underwriters and that this historical approach to valuing ROFRs 
is reasonable. As for the suggestion pertaining to nominal gifts and 
occasional entertainment, FINRA responds that given the Rule's 
restrictions on the receipt of non-cash compensation, it expects such 
compensation to be nominal in practice, but that disclosure of non-cash 
compensation is needed for FINRA to have a complete understanding of 
underwriting compensation. Further, FINRA notes that the examples 
pertaining to payments or benefits received for services that may be 
considered unrelated to the public offering were added at the request 
of members for clarification and that the proposed scope of the 
examples is appropriate. Finally, with respect to compensation related 
to the issuance of one's own securities, FINRA states that, while rare, 
FINRA has seen potential violations of Rule 5110 in such offerings. 
Accordingly, FINRA declines to provide an exclusion of such instances 
from underwriting compensation.
---------------------------------------------------------------------------

    \208\ See FINRA Response No. 1, supra note 6 at 20-23.
---------------------------------------------------------------------------

    In response to FINRA's proposal to expressly exclude non-
convertible securities purchased by the participating member in a 
public offering at the public offering price during the review period 
from being deemed underwriting compensation, and to consider 
acquisitions of convertible securities by a participating member with 
negotiated or preferential terms under proposed Rule 5110(g)(8) as 
underwriting compensation,\209\ one commenter suggests modifying 
Supplementary Material .01(a)(7) to provide that any securities 
purchased during the review period by a participating member in a 
public offering at the public offering price and without any 
preferential terms shall not be deemed underwriting compensation.\210\
---------------------------------------------------------------------------

    \209\ In Partial Amendment No. 1, FINRA proposed to revise the 
Supplementary Material to expressly exclude non-convertible 
securities purchased by the participating member in a public 
offering at the public offering price during the review period from 
being deemed underwriting compensation under the proposal. In 
distinguishing between non-convertible and convertible securities, 
FINRA noted that it would consider acquisitions of convertible 
securities by a participating member with negotiated or preferential 
terms prohibited under proposed Rule 5110(g)(8) as underwriting 
compensation. See FINRA Response No. 2, supra note 11 at 10. See 
also Order Instituting Proceedings, supra note 8, 84 FR at 37927.
    \210\ See SIFMA Letter No. 2, supra note 9.
---------------------------------------------------------------------------

    In response, FINRA states that it is appropriate to interpret 
purchases of both convertible and non-convertible securities during the 
review period by a participating member in a public offering at the 
public offering price and on the same terms as all others that are not 
participating members not be

[[Page 72408]]

underwriting compensation.\211\ FINRA thus proposes to adopt the 
suggestion in substantive part, stating that the proposed amendment 
would instead incorporate the concept of purchases at the same price 
and with the same terms to provide objectivity and clarity.\212\ FINRA 
explains that the concept of preferential treatment suggested by the 
commenter would require weighing and considering all of the various 
terms of a securities acquisition, which could be time consuming and 
would introduce uncertainty into the evaluation.\213\
---------------------------------------------------------------------------

    \211\ See FINRA Response No. 2, supra note 11 at 10. See also 
Order Instituting Proceedings, supra note 8, 84 FR at 37927.
    \212\ See FINRA Response No. 2, supra note 11 at 10.
    \213\ See id. at 10-11.
---------------------------------------------------------------------------

    Three commenters suggest revising proposed Supplementary Material 
.01(b)(21) to expressly reference ``bona fide market making activity'' 
in the list of items not deemed as underwriting compensation under the 
proposed rule.\214\ In response, as described above, FINRA proposes in 
Partial Amendment No. 2 to amend proposed Supplementary Material 
.01(b)(21) to expressly reference bona fide market making.\215\
---------------------------------------------------------------------------

    \214\ See ABA and Davis Polk, supra note 5, and SIFMA Letter No. 
2, supra note 9.
    \215\ See FINRA Response No. 2, supra note 11 at 12. 
Specifically, the provision would be revised to state that 
underwriting compensation does not include ``securities acquired in 
the secondary market by a participating member that is a broker-
dealer in connection with the performance of bona fide customer 
facilitation activities and bona fide market making activities; 
provided that securities acquired from the issuer will be considered 
`underwriting compensation' if the securities were not acquired at a 
fair price (taking into account, among other things customary 
commissions, mark-downs and other charges) . . .'' See id.
---------------------------------------------------------------------------

    Two commenters suggest revising Supplementary Material .01(b)(14) 
to exclude from underwriting compensation securities acquired as the 
result of an ``exercise'' of securities that were originally acquired 
prior to the review period.\216\ In response, FINRA states that, 
pursuant to proposed Supplementary Material .01(b)(15), such securities 
would not be underwriting compensation.\217\
---------------------------------------------------------------------------

    \216\ See ABA and Davis Polk, supra note 5.
    \217\ See FINRA Response No. 1, supra note 6 at 21-22.
---------------------------------------------------------------------------

    Two commenters suggest that the exception in proposed Supplementary 
Material .01(b)(12) be expanded to include additional employee benefit 
plans.\218\ In response to commenters' suggestions,\219\ and as 
discussed in the Partial Amendment No. 1 and described above, FINRA 
proposes to revise Supplementary Material .01(b)(12) accordingly.\220\
---------------------------------------------------------------------------

    \218\ See ABA and Davis Polk, supra note 5.
    \219\ See id.
    \220\ See FINRA Response No. 1, supra note 6 at 22. See also 
supra note 44.
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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 qualified independent underwriter (``QIU'').\221\ In 
response, FINRA states that it has previously provided guidance 
regarding QIU participation pursuant to Rule 5121, and would be willing 
to consider requests for additional guidance on Rule 5121 separate from 
the proposal.\222\
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    \221\ See, e.g., SIFMA Letter No. 1, supra note 5 at 10, and 
ABA, supra note 5 at 8-9.
    \222\ See FINRA Response No. 1, supra note 6 at 23-24.
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IV. Discussion and Commission Findings

    After careful review of the proposed rule change, the comment 
letters, and FINRA's response to the comments, the Commission finds 
that the rule change, as modified by Partial Amendments Nos. 1 and 2, 
is consistent with the requirements of the Exchange Act and the rules 
and regulations thereunder that are applicable to a national securities 
association.\223\ Specifically, the Commission finds that the rule 
change is consistent with Section 15A(b)(6) of the Exchange Act,\224\ 
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.
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    \223\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \224\ 15 U.S.C. 78o-3(b)(6).
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    FINRA states that the proposal seeks to modify Rule 5110 in an 
effort to modernize the Rule by, among other things, improving the 
administration of the Rule and simplifying the Rule's provisions while 
maintaining important protections for market participants, including 
issuers and investors participating in offerings. FINRA also provides 
that it engaged in extensive consultation with the industry to 
understand what aspects of the Rule needed to be modernized, 
simplified, and clarified. In sum, FINRA believes that the changes it 
proposes should lessen the regulatory costs and burdens incurred when 
complying with the Rule.
    The Commission has carefully considered the proposed rule change, 
as modified by Partial Amendments Nos. 1 and 2, comment letters, and 
FINRA's response to the comments, and believes that the Rule as amended 
is reasonably designed to provide just and equitable principles of 
trade, while providing for protection of investors and the public 
interest consistent with Section 15A(b)(6) of the Exchange Act.\225\ 
Consequently, the Commission finds that the proposed rule change is 
designed to promote capital formation and aid member compliance 
efforts, while maintaining the integrity of the public offering process 
and investor confidence in the capital market.
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    \225\ Id.
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    The Commission notes that a total of nine comments were received, 
and FINRA made a number of clarifications and modifications to the 
original proposal to address commenters' comments. The Commission notes 
that commenters, in general, supported FINRA's effort to modernize and 
streamline the Rule and recognized that the proposal would ``make the 
Rule more efficient and provide members more certainty . . .'' \226\ 
The Commission also recognizes that two commenters challenge the 
consistency of the Rule with the Exchange Act and the Securities 
Act.\227\ These commenters believe excessive underwriting compensation 
should be addressed through disclosure to investors and suggest 
eliminating Rule 5110 in its entirety or amending it to require only 
disclosure of underwriting compensation. Further, one commenter notes 
that FINRA does not identify or justify the amount of fees it collects 
under Rule 5110 and argues that ``[o]n this basis alone, it is unclear 
how FINRA's Rule 5110 fees comply with the 1934 Act requirements that 
fees be reasonable and not impose an undue burden on competition.'' 
\228\
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    \226\ See Davis Polk, supra note 5.
    \227\ See Kaswell Letter Nos. 1 and 2 and Callcott, supra notes 
5, 9.
    \228\ See Callcott, supra note 9.
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    The Commission believes these comments are outside the scope of the 
proposed rule change. FINRA in the proposal seeks only to amend the 
Rule currently in place. Further, FINRA does not in this proposal seek 
to amend the fees related to the Rule.\229\ Accordingly, the Commission 
does not believe these comments can be appropriately addressed through 
this proposal.
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    \229\ See also FINRA's responses to these comments, supra notes 
6 and 11.
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    The Commission believes that FINRA gave due consideration to the 
proposal and met the requirements of the Exchange Act. The Commission 
also believes that the proposal modernizes and streamlines the Rule for 
the benefit of the members subject to, and the

[[Page 72409]]

investors affected by, the Rule. For the reasons stated above, the 
Commission finds that the proposed rule change is consistent with the 
Exchange Act and the rules and regulations thereunder.

V. Accelerated Approval of Proposed Rule Change, as Modified by Partial 
Amendments Nos. 1 and 2

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Act, for approving the proposed rule change, as modified by Partial 
Amendment Nos. 1 and 2 thereto, prior to the 30th day after publication 
of Partial Amendment No. 2 in the Federal Register. Partial Amendment 
No. 2 responds specifically to comments received in response to the 
Order Instituting Proceedings and makes corresponding amendments to the 
proposal. These revisions specifically respond to comments received, 
add clarity to the proposal, and do not raise any novel regulatory 
concerns. Accordingly, the Commission finds that good cause exists to 
approve the proposal, as modified by Partial Amendment Nos. 1 and 2 on 
an accelerated basis.

VI. Solicitation of Comments on Partial Amendment No. 2

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended by Partial Amendment Nos. 1 and 2, 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 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 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of FINRA. All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment 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 January 21, 2020.

VII. Conclusion

    It is therefore ordered pursuant to Exchange Act Section 19(b)(2) 
\53\ that the proposal (SR-FINRA-2019-012), as modified by Partial 
Amendments Nos. 1 and 2, be, and it hereby is, approved on an 
accelerated basis.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\230\
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    \230\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-28216 Filed 12-30-19; 8:45 am]
BILLING CODE 8011-01-P