United States: FINRA Files With SEC To Amend Rule On "Spinning" New Issues

Last Updated: September 20 2013
Article by Amy Natterson Kroll and Laura E. Flores

FINRA has filed with the Securities and Exchange Commission ("SEC") a proposed rule change to amend FINRA Rule 5131 (the "Rule")1 to except from compliance with the Rule's "spinning provision"2 certain private funds of funds that satisfy a group of proposed preconditions.

Rule 5131 is intended to curb abuses by FINRA members ("Members") and their associated persons in the allocation and distribution of "new issues."3 The spinning provision is specifically designed to prevent the allocation and distribution of new issues to accounts in which executive officers and directors of investment banking clients, and persons materially supported by such executive officers and directors, have a beneficial interest in exchange for investment banking business.4 

In its current form, the spinning provision excepts allocations of new issues to (1) accounts in which the aggregate beneficial interests of executive officers, directors and persons materially supported by such executive officers and directors do not exceed 25% of such account and (2) certain types of accounts that typically have large and diverse investor bases, such as registered investment companies.5 Private funds are not currently an excepted account type unless they are eligible for one of the articulated exceptions. Private funds therefore go to great lengths to gather information about their beneficial owners, in order to demonstrate that they are eligible to receive new issue allocations. Gathering that information is particularly difficult, if not impossible, for many funds of funds.

The Rule provides that a Member may rely on a written representation from the beneficial owners of an account, or a person authorized to represent such beneficial owners, to determine whether the beneficial owners, and thus the account, are within the scope of the spinning provision.6 The use of a written representation was intended to help facilitate Members' compliance with the spinning provision; however, it has become apparent that identifying and aggregating indirect beneficial ownership information for private funds of funds presents a significant obstacle to Member compliance because often a fund of funds does not have the ability to gather information about the beneficial owners of the funds in the fund of funds.

To ameliorate this obstacle, FINRA is proposing to expand the account types excepted from the spinning provision to include accounts that do not look through to the indirect beneficial owners of a fund, such as funds of funds, and satisfy certain conditions. The conditions, set forth below, are designed to capture funds that pose minimal risk of spinning.

To rely on the exception, a fund must:

  • be a "private fund" as defined in the Investment Advisers Act of 1940;
  • be managed by an investment adviser;
  • have assets greater than $50 million;
  • own less than 25% of the account and not have a single investor with a beneficial interest of 25% or more;
  • not have a beneficial owner that also is a control person of the fund's investment adviser;
  • be "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
  • not have been formed for the specific purpose of investing in the account.

Members would be permitted to rely on a written representation that an account satisfies the foregoing conditions and could rely on the proposed exception, unless the Member believes, or has reason to believe, that such representation is inaccurate.7 

In its Notice of Proposed Rulemaking, FINRA noted that it considered several alternative approaches to address the obstacle, including an exception available to all private funds with certain asset thresholds, but ultimately determined that the proposed exception struck the right balance of preserving the protections of the Rule and limiting the availability of the exception to situations that are not vulnerable to spinning.

While the purpose of the proposed rule change is commendable, and would help a limited number of fund of funds, certain of the proposed conditions appear to be unnecessarily restrictive and threaten to overshadow the intended benefit of the proposed exception. In particular, the fifth condition would prevent a fund that is invested in a fund of funds from availing itself of the proposed exception if its fund manager owns an interest in the fund and is a control person, as that term is defined in Form ADV, of the fund's investment adviser — a scenario that is not uncommon. This would be the result even if the fund manager owned a single share of the fund and despite the fact that the fund has a less than 25% interest in the fund of funds in compliance with the fourth condition and is unaffiliated with the investment adviser to the fund of funds in compliance with the sixth condition. It seems unlikely that the "proportional benefit to [the fund manager in this scenario] would be of an amount that would further spinning."8 Nonetheless, the proposed exception would operate to exclude the fund and fund of funds in this scenario from benefitting from the proposed exception to allow their participation in new issue allocations. The contemplated result seems anomalous to FINRA's intent, in light of the fact that an account in which executive officers and directors of investment banking clients, and persons materially supported by such officers and directors, beneficially own in the aggregate 25%, is eligible to receive new issue allocations in reliance on the Rule's existing de minimis exception. Arguably there is a greater opportunity for spinning in the latter scenario. Furthermore, given the Rule's existing de minimis exception, it is curious that FINRA did not include a similar 25% beneficial ownership threshold in the fifth condition. The inclusion of such a threshold could adequately address FINRA's balancing concerns.

To ensure that FINRA is aware of these flaws to its proposed rule change, we encourage fund advisers and other investment advisers, as well as Members, to comment on the proposed rule change. Submissions of comment letters should refer to File Number SR-FINRA-2013-037 and should be submitted on or before October 1, 2013.

Footnotes

1 The text of the Proposed Rule Change can be viewed here: http://www.finra.org/web/groups/industry/@ip/@reg/@rulfil/documents/rulefilings/p329146.pdf.

2 FINRA Rule 5131(b), the spinning provision, prohibits a member or person associated with a member from allocating shares of a new issue to any account in which an executive officer or director of a public company or a covered non-public company, or a person materially supported by such executive officer or director, has a beneficial interest: (1) if the company is currently an investment banking services client of the member or the member has received compensation from the company for investment banking services in the past 12 months; (B) 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 3 months; or (C) 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. 

3 "New issues" is defined in FINRA Rule 5130(i)(9).

4 FINRA explained that "such persons are often in a position to hire members on behalf of the companies they serve, allocating new issues to such persons creates the appearance of impropriety and has the potential to divide the loyalty of the agents of the company (i.e., the executive officers and directors) from the principal (i.e., the company) on whose behalf they must act." FINRA Regulatory Notice 10-60, Approval of New Issue Rule, November 2010, available at http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p122490.pdf.

5 The excepted account types are set forth in FINRA Rule 5130(c)(1) through (3) and (5) through (10).

6 Supplementary Material .02 provides that "for purposes of paragraph (b), a member may rely on a written representation obtained within the prior 12 months from the beneficial owner(s) of the account, or a person authorized to represent the beneficial owner(s) of the account, 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(ies) on whose behalf such executive officer or director serves." 

7 Members that avail themselves of the proposed exception must comply with the recordkeeping requirements set forth in Supplementary Material .02.

8 Proposed Rule Change at 7.

www.bingham.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.