Document ID: SEC-2013-2062-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2013-12-04T05:00Z

[Federal Register Volume 78, Number 233 (Wednesday, December 4, 2013)]
[Notices]
[Pages 72946-72949]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-28975]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70957; File No. SR-FINRA-2013-037]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting 
Accelerated Approval of a Proposed Rule Change, as Modified by 
Amendment No. 1, To Amend FINRA Rule 5131 (New Issue Allocations and 
Distributions)

November 27, 2013.

I. Introduction

    On August 23, 2013, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to amend FINRA Rule 5131 (New Issue Allocations 
and Distributions) to provide a limited exception to allow members to 
rely on written representations from certain accounts to comply with 
Rule 5131(b). The proposed rule change was published for comment in the 
Federal Register on September 10, 2013.\3\ The Commission received two 
comment letters in response to the proposed rule change.\4\ On November 
22, 2013, FINRA filed Amendment No. 1 with the Commission to respond to 
the comment letters and to propose a clarifying modification to the 
proposed exception regarding the eligibility of an unaffiliated private 
fund where a control person of the fund's investment adviser also is a 
beneficial owner in the fund. The Commission is publishing this notice 
and order to solicit comments on Amendment No. 1 and to approve the 
proposed rule change, as modified by Amendment No. 1, on an accelerated 
basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 70312 (Sept. 4, 
2013), 78 FR 55322 (Sept. 10, 2013) (Notice of Filing of SR-FINRA-
2013-037) (``Original Proposal''). The comment period ended on 
October 1, 2013.
    \4\ See letter to Elizabeth M. Murphy, Secretary, Commission, 
from William G. Mulligan, CEO, Cordium US., dated Oct. 1, 2013 
(``Cordium letter''); and letter to Elizabeth M. Murphy, Secretary, 
Commission, from Stuart J. Kaswell, Executive Vice President & 
Managing Director, Managed Funds Association, dated Sept. 30, 2013 
(``MFA letter''). The letters are available on the Commission's Web 
site at http://www.sec.gov/comments/sr-finra-2013-037/finra2013037.shtml.
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II. Description of Proposal

    On August 23, 2013, FINRA filed the Original Proposal to amend 
FINRA Rule 5131 to provide a limited exception to allow members to rely 
on written representations from certain accounts in complying with 
FINRA Rule 5131(b) (the ``spinning provision'').\5\
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    \5\ See supra note 3.
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    FINRA Rule 5131 addresses abuses in the allocation and distribution 
of ``new issues,'' \6\ and paragraph (b) prohibits the practice of 
``spinning,'' which refers to an underwriter's allocation of new issue 
shares to executive officers and directors of a company as an 
inducement to award the underwriter with investment banking business, 
or as consideration for investment banking business previously awarded.
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    \6\ The term ``new issue'' has the same meaning as in Rule 
5130(i)(9). See Rule 5130(i)(9).
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    The spinning provision generally provides that no member or person 
associated with a member may allocate shares of a new issue to any 
account in which an executive officer or director of a public company 
\7\ or a covered non-public company,\8\ or a person materially

[[Page 72947]]

supported \9\ by such executive officer or director, has a beneficial 
interest \10\ if such public company or covered non-public company has 
certain current, recent or anticipated investment banking relationships 
with the member.
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    \7\ A ``public company'' is any company that is registered under 
Section 12 of the Act or files periodic reports pursuant to Section 
15(d) thereof. See Rule 5131(e)(1).
    \8\ The term ``covered non-public company'' means any non-public 
company satisfying the following criteria: (i) Income of at least $1 
million in the last fiscal year or in two of the last three fiscal 
years and shareholders' equity of at least $15 million; (ii) 
shareholders' equity of at least $30 million and a two-year 
operating history; or (iii) total assets and total revenue of at 
least $75 million in the latest fiscal year or in two of the last 
three fiscal years. See Rule 5131(e)(3).
    \9\ ``Material support'' means directly or indirectly providing 
more than 25% of a person's income in the prior calendar year. 
Persons living in the same household are deemed to be providing each 
other with material support. See Rule 5131(e)(6).
    \10\ The term ``beneficial interest'' has the same meaning as in 
Rule 5130(i)(1). See Rule 5130(i)(1).
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    Rule 5131.02 (Annual Representation) provides that, for the 
purposes of the spinning provision, a member may rely on a written 
representation obtained within the prior 12 months from the beneficial 
owner(s) of an account, or a person authorized to represent the 
beneficial owner(s), as to whether such beneficial owner(s) is an 
executive officer or director or person materially supported by an 
executive officer or director and if so, the company on whose behalf 
such executive officer or director serves. Therefore, to comply with 
the spinning provision, firms typically issue questionnaires to their 
customers to ascertain whether any of the persons covered by the 
spinning provision has a beneficial interest in the account.
    Under the spinning provision, whether an account in which an 
executive officer or director of a company (or person materially 
supported by such executive officer or director) has a beneficial 
interest will be eligible to purchase shares of a new issue will depend 
upon whether the company is a current, recent or prospective investment 
banking client of the firm, as set forth in the rule. Where an 
executive officer or director of a company (or a person materially 
supported by such executive officer or director) has a beneficial 
interest in an account, a member must also be able to identify the 
company on whose behalf such executive officer or director serves to 
determine whether the company is a current, recent or prospective 
investment banking client of the firm under the rule; if the member is 
unable to obtain such information, it has to resort to restricting all 
new issue allocations to such account, which is not the intended 
purpose of the rule.
    The spinning provision went into effect on September 26, 2011. and, 
since then, FINRA has received feedback from industry participants that 
obtaining the information necessary to ensure compliance with the rule, 
and eligibility for the de minimis exception, has proved difficult.\11\ 
In particular, FINRA understands that members (and their customers) 
have had difficulty obtaining, tracking and aggregating information 
from funds regarding indirect beneficial owners, such as participants 
in a fund of funds (``FOF''), for use in determining an account's 
eligibility for the de minimis exception and that this has resulted in 
compliance difficulties and restrictions, including in situations where 
the ability of an underwriter to confer any meaningful financial 
benefit to a particular investor by allocating new issue shares to the 
account is impracticable.\12\
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    \11\ Among other exceptions, Rule 5131(b)(2) provides a de 
minimis exception for new issue allocations to any account in which 
the beneficial interests of executive officers and directors of a 
company subject to the rule, and persons materially supported by 
such executive officers and directors, do not exceed in the 
aggregate 25% of such account.
    \12\ For example, members have noted that broker-dealers 
normally do not know the identity of the beneficial owners of the 
fund of funds invested in the account.
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    Thus, in the Original Proposal, FINRA proposed a limited exception 
from the spinning provision, subject to a set of conditions, designed 
to ensure the important protections of Rule 5131(b) continue to be 
preserved, while offering meaningful relief for members and investors 
in situations where spinning abuse is not likely. Specifically, the 
Original Proposal provided that members may rely upon a written 
representation obtained within the prior 12 months from a person 
authorized to represent an account that does not look through to the 
beneficial owners of a fund invested in the account, provided that such 
fund:
     Is a ``private fund'' as defined in the Investment 
Advisers Act of 1940;
     is managed by an investment adviser;
     has assets greater than $50 million;
     owns less than 25% of the account and is not a fund in 
which a single investor has a beneficial interest of 25% or more;
     is ``unaffiliated'' with the account in that the private 
fund's investment adviser does not have a control person in common with 
the account's investment adviser; and
     was not formed for the specific purpose of investing in 
the account.
    The Original Proposal also required that, to be eligible for the 
exception, the unaffiliated private fund may not have a beneficial 
owner that also is a control person of such fund's investment adviser.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA, and at 
the Commission's Public Reference Room.

III. Summary of Comments, FINRA's Response and Amendment No. 1

    As stated above, the Commission received two comment letters in 
response to the Original Proposal.\13\ Both commenters strongly support 
the adoption of the proposed amendment and stated that the proposed 
rule would ease the tracking burden for allocations to accounts that do 
not raise the concerns the spinning rule is designed to address, while 
also preserving the efficacy of the rule.\14\ However, the commenters 
also suggest certain modifications that they believe improve the 
usefulness of the proposed exception without compromising the 
objectives of the rule.\15\
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    \13\ See supra note 4.
    \14\ See Cordium letter and MFA letter.
    \15\ Id.
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    Both commenters asked that FINRA eliminate the proposed condition 
that the unaffiliated private fund must not have a beneficial owner 
that also is a control person of such fund's investment adviser.\16\ 
The commenters noted that it is not uncommon for an FOF to have an 
investor that is both a beneficial owner of the FOF and a control 
person of such fund's investment adviser.\17\ One commenter noted that 
investment in the fund by a control person serves the purpose of 
aligning the interests of a control person with the interests of the 
fund's investors and, therefore, is a practice that institutional 
investors often require from fund managers.\18\ The other commenter 
stated that this condition does not further the purposes of the 
spinning rule and recommended eliminating this aspect of the 
proposal.\19\
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    \16\ Id.
    \17\ Id.
    \18\ See MFA letter.
    \19\ See Cordium letter.
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    As an alternative, one commenter recommended that, rather than 
excluding funds with a beneficial owner that also is a control person 
of the investment adviser, the proposal instead should be amended to 
provide that a member may rely upon a written representation obtained 
within the prior 12 months from a person authorized to represent an 
account that does not look through to the beneficial owners of a fund 
invested in the account (other than a beneficial owner that is a 
control person of the investment adviser to such private fund), subject 
to the other

[[Page 72948]]

proposed conditions.\20\ FINRA agrees with this comment and, therefore, 
proposed a clarifying amendment to delete the proposed condition that 
the unaffiliated private fund must not have a beneficial owner that 
also is a control person of such fund's investment adviser and, 
instead, to include language substantially similar to that suggested by 
the commenter.\21\
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    \20\ See MFA letter.
    \21\ See MFA letter.
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    Therefore, where a beneficial owner also is a control person of the 
FOF's adviser, a member must ascertain whether such person is a covered 
person based upon the standards set forth in Rule 5131(b). If a member 
obtains a written representation from an account that a beneficial 
owner in an unaffiliated private fund is a control person of such 
fund's investment adviser, but is not a covered person under the 
spinning provision, an allocation to such account would still be 
eligible for the proposed exception, if the conditions, as amended, are 
met. If a beneficial owner in an unaffiliated private fund is both a 
control person and a covered person under the spinning provision, a new 
issue allocation to such covered persons would be impermissible, unless 
such allocation is permitted under another exception (e.g., the de 
minimis exception).\22\
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    \22\ See supra note 11.
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    As stated above, the commenters noted that it is not uncommon for 
an FOF to have an investor that is both a beneficial owner of the FOF 
and a control person of such fund's investment adviser. Therefore, the 
Original Proposal would not have provided the intended relief for 
members in many cases where the efficacy of the spinning provision 
would still be preserved. Thus, instead of eliminating eligibility for 
the exception for any FOF with a beneficial owner that also is a 
control person of such fund's investment adviser, the revised proposal 
would permit a member to avail itself of the exception with respect to 
other beneficial owners (that are not also control persons of the FOF's 
investment adviser). FINRA believes that this revision to the proposal 
strikes the proper balance between members' concerns regarding the 
difficulty of identifying indirect beneficial owners of an account and 
preserving the important protections of Rule 5131(b).
    One commenter also recommended that FINRA either reduce or 
eliminate the proposal's condition that, to be eligible under the 
exception, the unaffiliated private fund must have assets greater than 
$50 million.\23\ This commenter believes that the percentage ownership 
threshold conditions, which require that the unaffiliated private fund 
own less than 25% of the account and does not have a single investor 
with a beneficial interest of 25% or more, along with the other 
conditions, are sufficient to ensure that spinning would be 
unlikely.\24\
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    \23\ See Cordium letter.
    \24\ See Cordium letter.
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    FINRA is of the view that the percentage ownership threshold 
conditions alone are not sufficient to ensure that the protections of 
the spinning rule are preserved and, therefore, continues to believe 
that the ``assets greater than $50 million'' component is an 
appropriate additional safeguard. Specifically, FINRA believes that 
this requirement helps ensure a sufficient degree of dilution that 
would reduce the economic meaningfulness to a potentially covered 
person of any single IPO allocation, and therefore, does not propose 
eliminating or reducing this condition at this time.
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no later than 120 days 
following Commission approval.

IV. Commission Findings

    After carefully considering the proposed rule change, as modified 
by Amendment No. 1, the comments submitted, and FINRA's responses to 
the comments, the Commission finds that the proposed rule change, as 
modified by Amendment No. 1, is consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to a national 
securities association.\25\ In particular, the Commission finds that 
the proposed rule change, as modified by Amendment No. 1, is consistent 
with Section 15A(b)(6) of the Act,\26\ which requires, among other 
things, that FINRA rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest.
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    \25\ In approving this proposed rule change, the Commission has 
considered the proposed rule change's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \26\ 15 U.S.C. 78o-3(b)(6).
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    Specifically, the Commission believes that the proposed exception 
and required conditions, as amended, are consistent with the provisions 
of the Act noted above by promoting capital formation and aiding member 
compliance efforts, while maintaining investor confidence in the 
capital markets. In simplifying and clarifying the operation of the 
proposed exception for FINRA members and other industry participants, 
the Commission believes that the proposed rule change, as modified by 
Amendment No. 1, reasonably balances the compliance concerns and the 
burdens noted by the industry while preserving the efficacy of the 
spinning provision and FINRA's goal of assuring that the rule continues 
to be designed to promote capital formation and investor confidence and 
prevent fraudulent and manipulative behaviors.
    In addition, the Commission does not believe that the proposed rule 
change, as modified by Amendment No. 1, will result in any burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Act in that the proposed rule change provides an 
exception to Rule 5131(b) for accounts with unaffiliated private fund 
investors that face special difficulties under the existing exceptions 
from the rule, and thus reduces differential impacts of the rule 
without compromising the objectives of the spinning provision.
    The Commission believes that FINRA adequately addressed the 
comments raised in response to FINRA's notice.

 V. Accelerated Approval

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Act,\27\ for approving the proposed rule change, as modified by 
Amendment No. 1 thereto, prior to the 30th day after publication of 
Amendment No. 1 in the Federal Register. The changes proposed in 
Amendment No. 1 respond to the comment letters received by the 
Commission in response to the Original Proposal and further simplify 
the operation of the spinning provision for members and other industry 
participants.\28\ In addition, accelerating approval of this proposed 
rule change, as modified by Amendment No. 1, should benefit FINRA 
members by aiding member compliance efforts while preserving the 
efficacy of the spinning provision and should benefit investors by 
maintaining investor protection in the capital markets.
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    \27\ 15 U.S.C. 78s(b)(2).
    \28\ See MFA letter. See also Cordium letter.
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VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Amendment No.

[[Page 72949]]

1, is consistent with the Act. Comments may be submitted by any of the 
following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2013-037 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2013-037. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
person identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-FINRA-2013-037 and should be submitted 
on or before December 26, 2013.

VII. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the 
Act,\29\ that the proposed rule change (SR-FINRA-2013-037), as modified 
by Amendment No. 1, be and hereby is approved on an accelerated basis.
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    \29\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\30\
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    \30\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-28975 Filed 12-3-13; 8:45 am]
BILLING CODE 8011-01-P