[Federal Register Volume 78, Number 175 (Tuesday, September 10, 2013)]
[Notices]
[Pages 55322-55325]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-21930]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70312; File No. SR-FINRA-2013-037]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend 
FINRA Rule 5131 (New Issue Allocations and Distributions)

September 4, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 23, 2013, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend FINRA Rule 5131 (New Issue Allocations 
and Distributions) to provide a limited exception to allow members to 
rely on written representations from certain accounts to comply with 
Rule 5131(b).
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    FINRA Rule 5131 (New Issue Allocations and Distributions) (the 
``Rule'') addresses abuses in the allocation and distribution of ``new 
issues.'' \3\ Rule 5131(b) prohibits the practice of spinning, which 
refers to an underwriter's allocation of new issue shares to executive 
officers and directors of a company as an inducement to award the 
underwriter with investment banking business, or as consideration for 
investment banking business previously awarded (the ``spinning'' 
provision).
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    \3\ Rule 5131 provides that ``new issue'' shall have the same 
meaning as in Rule 5130(i)(9).
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    Specifically, the spinning provision provides that no member or 
person associated with a member may allocate shares of a new issue to 
any account in which an executive officer or director of a public 
company \4\ or a covered non-public company,\5\ or a person materially 
supported \6\ by such executive officer or director, has a beneficial 
interest: \7\
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    \4\ A ``public company'' is any company that is registered under 
Section 12 of the Exchange Act or files periodic reports pursuant to 
Section 15(d) thereof. See Rule 5131(e)(1).
    \5\ The Rule defines a ``covered non-public company'' as any 
non-public company satisfying the following criteria: (i) Income of 
at least $1 million in the last fiscal year or in two of the last 
three fiscal years and shareholders' equity of at least $15 million; 
(ii) shareholders' equity of at least $30 million and a two-year 
operating history; or (iii) total assets and total revenue of at 
least $75 million in the latest fiscal year or in two of the last 
three fiscal years. See Rule 5131(e)(3).
    \6\ ``Material support'' means directly or indirectly providing 
more than 25% of a person's income in the prior calendar year. 
Persons living in the same household are deemed to be providing each 
other with material support. See Rule 5131(e)(6).
    \7\ The Rule provides that the term ``beneficial interest'' 
shall have the same meaning as in Rule 5130(i)(1).
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     If the company is currently an investment banking services 
\8\ client of the member or the member has received compensation from 
the company for

[[Page 55323]]

investment banking services in the past 12 months;
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    \8\ ``Investment banking services'' include, without limitation, 
acting as an underwriter, participating in a selling group in an 
offering for the issuer or otherwise acting in furtherance of a 
public offering of the issuer; acting as a financial adviser in a 
merger, acquisition or other corporate reorganization; providing 
venture capital, equity lines of credit, private investment, public 
equity transactions (PIPEs) or similar investments or otherwise 
acting in furtherance of a private offering of the issuer; or 
serving as placement agent for the issuer. See Rule 5131(e)(5).
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     If the person responsible for making the allocation 
decision knows or has reason to know that the member intends to 
provide, or expects to be retained by the company for, investment 
banking services within the next three months; or
     On the express or implied condition that such executive 
officer or director, on behalf of the company, will retain the member 
for the performance of future investment banking services.
    Rule 5131.02 (Annual Representation) provides that, for the 
purposes of the spinning provision, a member may rely on a written 
representation obtained within the prior 12 months from the beneficial 
owner(s) of an account, or a person authorized to represent the 
beneficial owner(s), as to whether such beneficial owner(s) is an 
executive officer or director or person materially supported by an 
executive officer or director and if so, the company on whose behalf 
such executive officer or director serves. Therefore, to comply with 
the spinning provision, firms typically issue questionnaires to their 
customers to ascertain whether any of the persons covered by the 
spinning provision have a beneficial interest in the account.\9\
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    \9\ The spinning provision currently addresses operational 
burdens associated with some accounts with a large and diverse 
ownership base where the potential for spinning is minimal through a 
series of exemptions for purchasers such as mutual funds, insurance 
company general accounts and various employee benefit plans. See 
generally Rule 5130(c). Private funds, however, are not a category 
of purchasers for which a general exemption exists.
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    Rule 5131(b)(2) provides a de minimis exception for new issue 
allocations to any account in which the beneficial interests of 
executive officers and directors of a company subject to the rule, and 
persons materially supported by such executive officers and directors, 
do not exceed in the aggregate 25% of such account. FINRA understands 
that members (and their customers) have had difficulty obtaining, 
tracking and aggregating information from funds regarding indirect 
beneficial owners, such as participants in a fund of funds, for use in 
determining an account's eligibility for the de minimis exception and 
that this has resulted in compliance difficulties and restrictions, 
including in situations where the ability of an underwriter to confer 
any meaningful financial benefit to a particular investor by allocating 
new issue shares to the account is impracticable.\10\
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    \10\ For example, members have noted that broker-dealers 
normally do not know the identity of the beneficial owners of the 
fund of funds invested in the account.
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    FINRA believes that certain funds, owing to several mitigating 
factors including their size, lack of affiliation with the account 
directly receiving the allocation and layered (and often opaque) 
ownership structure, generally do not raise the concerns that the Rule 
is designed to address. Moreover, where the potential profits from a 
new issue allocation are spread across a large and diverse investor 
base, it is unlikely that the proportional benefit to any particular 
indirect investor would be of an amount that would further spinning 
(i.e., indirect fund ownership can be an impractical and ineffective 
means to receive any benefit from spinning). Therefore, FINRA is 
proposing a limited exception to the spinning provision in the fund of 
funds context that includes a set of conditions designed to ensure that 
the important protections of the Rule continue to be preserved, while 
offering meaningful relief for members and investors in situations 
where spinning abuse is not likely.
    Specifically, FINRA is proposing to provide that members may rely 
upon a written representation obtained within the prior 12 months from 
a person authorized to represent an account that does not look through 
to the indirect beneficial owners of a fund invested in the account, 
that such fund:
     Is a ``private fund'' as defined in the Investment 
Advisers Act of 1940; \11\
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    \11\ Section 202(a)(29) of the Investment Advisers Act of 1940 
defines the term ``private fund'' as an issuer that would be an 
investment company, as defined in Section 3 of the Investment 
Company Act of 1940 (15 U.S.C. 80a-3) (``Investment Company Act''), 
but for Section 3(c)(1) or 3(c)(7) of the Investment Company Act.
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     Is managed by an investment adviser;
     Has assets greater than $50 million;
     Owns less than 25% of the account and is not a fund in 
which a single investor has a beneficial interest of 25% or more;
     Does not have a beneficial owner that also is a control 
person of such fund's investment adviser;
     Is ``unaffiliated'' with the account in that the private 
fund's investment adviser does not have a control person in common with 
the account's investment adviser;\12\ and
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    \12\ A control person of an investment adviser is a person with 
direct or indirect ``control'' over the investment adviser; as that 
term is defined in Form ADV.
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     Was not formed for the specific purpose of investing in 
the account.
    FINRA believes that these conditions are reasonable to assure that 
a member's new issue allocation will not be in furtherance of spinning, 
while reducing the compliance burdens associated with the Rule. In 
addition, a member may rely upon a written representation by an account 
as to the availability of this proposed exception unless it believes, 
or has reason to believe, that such representation is inaccurate. 
Members availing themselves of the new supplementary material must 
maintain a copy of all records and information relating to whether an 
account is eligible to receive an allocation of the new issue under the 
spinning provision in its files for at least three years following the 
member's allocation to that account.
    FINRA discussed with FINRA committees, industry groups and member 
firms the logistical impracticalities, costs and other hurdles involved 
in attempting to track beneficial ownership. The comments are described 
in detail in Item 5 (sic) below. The proposal takes those discussions 
into account.
    FINRA has considered various alternatives to the current approach, 
including proposing an exception for all private funds meeting certain 
asset thresholds, providing an interpretation to the existing de 
minimis exception, or requiring alternative percentage caps for direct 
and indirect beneficial ownership in the account. In considering these 
and other alternatives, FINRA sought to balance preserving the 
protections the Rule was designed to provide with limiting the scope of 
the rule to situations that might reasonably result in the harms sought 
to be addressed. FINRA also sought to avoid increasing complexity in 
the Rule, with added compliance costs, where the concerns to be avoided 
were remote.
    As a result, FINRA determined that a wholesale exception for 
private funds was not appropriate.\13\ In addition, because a fund 
indirectly invested in the account could consist of a single investor--
potentially including covered persons--FINRA believes that a limit to 
both direct and indirect beneficial ownership is important in 
preserving the efficacy of the spinning provision. The proposed rule 
change is intended to balance the compliance concerns and burdens noted 
by the industry with FINRA's goal of assuring that the Rule continues 
to be designed to promote investor confidence and prevent fraudulent 
and manipulative behaviors.
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    \13\ See supra note 9.
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    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no later than 120 days 
following Commission approval.

[[Page 55324]]

2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\14\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed exception and 
required conditions will further these purposes by promoting capital 
formation and aiding member compliance efforts, while maintaining 
investor confidence in the capital markets.
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    \14\ 15 U.S.C. 78o-3(b)(6).
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    Specifically, the proposed condition that the fund be managed by an 
investment adviser that is unaffiliated with the account's investment 
adviser seeks to ensure the structural independence of the funds' 
respective advisers. This requirement, in addition to the proviso that 
the unaffiliated private fund must not have been formed for the 
specific purpose of investing in the account, seeks to mitigate the 
possibility of collusive conduct aimed at furthering spinning.
    In addition, the condition providing that the unaffiliated private 
fund may not have any beneficial owners who also are control persons of 
such fund's investment adviser seeks to eliminate the conflict that may 
exist where an adviser also is an investor in the fund and, therefore, 
may directly benefit from allocation decisions. The requirements 
regarding the minimum size of the private fund (over $50 million) and 
the percentage ownership thresholds (private fund must own less than 
25% of the account and not be a fund in which a single investor has a 
beneficial interest of 25% or more) seek to ensure that the 
proportional benefit of any new issue allocation to a single indirect 
beneficial owner would be insufficient to further spinning.

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act in that the proposed rule 
provides an exception to Rule 5131(b) for funds of funds that face 
special difficulties under the existing exemptions from the Rule, and 
thus the proposed exemption tries to reduce differential impacts of the 
Rule. FINRA also believes that it is reasonable to permit members to 
rely on written representations from the account regarding compliance 
with the conditions of the exception as a means of achieving compliance 
with the purposes of the Rule without imposing layered tracking and 
other requirements on members that could be costly and unduly hamper 
the accounts' access to new issue shares.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    FINRA received four letters regarding the issues addressed by the 
proposed rule change from three commenters,\15\ and engaged in 
additional discussions with industry groups and market participants 
regarding the operation of the spinning provision, the operation of the 
existing de minimis exception and members' difficulty in identifying 
indirect beneficial owners of an account. A list of the commenters is 
attached as Exhibit 2a. Copies of the comment letters received are 
attached as Exhibit 2b.
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    \15\ See Letters from Gregory J. Robbins, Senior Managing 
Director and General Counsel, Mesirow Advanced Strategies, Inc., to 
Gary L. Goldsholle, Vice President and Associate General Counsel, 
Office of the General Counsel, FINRA, dated June 10, 2011 
(``Mesirow''); Andrew Baker, Chief Executive Officer, Alternative 
Investment Management Association, to Richard G. Ketchum, Chairman 
and Chief Executive Officer, FINRA, dated August 3, 2011 (``AIMA''); 
Stuart J. Kaswell, Executive Vice President and Managing Director 
and General Counsel, Managed Funds Association, to Marc Menchel, 
Executive Vice President and General Counsel, FINRA, dated August 
19, 2011 (``MFA 1''); and Stuart J. Kaswell, Executive Vice 
President and Managing Director and General Counsel, Managed Funds 
Association, to Marc Menchel, Executive Vice President and General 
Counsel, FINRA, dated October 4, 2011 (``MFA 2'').
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    Commenters sought either interpretive guidance regarding the 
existing de minimis exception to increase its scope or a new amendment 
to address difficulties in allocating to investment funds, particularly 
in the fund of funds context. Commenters argued that investment funds 
are not an effective tool for a broker-dealer to convey a meaningful 
benefit to a particular covered person.\16\ One commenter stated that 
the funds of funds it offers have investments in anywhere from 25 to 70 
unaffiliated portfolio funds.\17\ The commenter further noted that 
investors in a fund of funds, including any potential covered persons, 
cannot direct which broker a portfolio fund uses or will use, and may 
not know in which portfolio funds the fund of funds is invested.\18\
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    \16\ See AIMA, Mesirow, MFA 1 and MFA 2.
    \17\ See Mesirow.
    \18\ See Mesirow.
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    Commenters also discussed the logistical impracticalities and other 
hurdles involved in attempting to track beneficial ownership.\19\ A 
commenter stated that, as currently structured, the spinning provisions 
potentially would require significant amounts of time and money to 
implement.\20\ In addition, another commenter generally stated that 
funds of funds may (and often do) have several hundred investors, each 
of which themselves may have hundreds of beneficial owners; thus, the 
operational hurdles and cost of obtaining the relevant representations 
from all of the ultimate beneficial owners would be substantial.\21\ 
The commenter further stated that obtaining beneficial ownership 
information is not always possible due to confidentiality and investor 
privacy concerns.\22\
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    \19\ See e.g., AIMA, MFA 1 and MFA 2.
    \20\ See AIMA.
    \21\ See MFA 2.
    \22\ See MFA 1.
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    FINRA has carefully considered the comments received and has 
considered the various alternatives suggested in crafting the current 
proposal and believes that the proposed rule change strikes the 
appropriate balance by simplifying the operation of the Rule while 
maintaining the protections the spinning provision is designed to 
provide, as discussed above.\23\
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    \23\ One commenter suggested, among other things, that the 
existing 25% de minimis exception be interpreted to apply separately 
to each public company or covered non-public company. However, the 
rule clearly states that the calculation is to be applied in the 
aggregate for all covered companies and the proposal would not 
change that requirement. See AIMA.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act.

[[Page 55325]]

Comments may be submitted by any of the following methods:

Electronic Comments

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

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2013-037. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2013-037 and should be 
submitted on or before October 1, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-21930 Filed 9-9-13; 8:45 am]
BILLING CODE 8011-01-P