United States: FINRA Proposes Substantive And Organizational Amendments To Corporate Financing Rule

On April 25, 2019, the Financial Industry Regulatory Authority, Inc. ("FINRA") filed proposed amendments to FINRA Rule 5110 ("FINRA Rule 5110" or "the Rule"), commonly referred to as the "Corporate Financing Rule", with the U.S. Securities and Exchange Commission ("SEC").1 If approved by the SEC, the amendment would constitute the first comprehensive overhaul of the Corporate Financing Rule since 2004, and would impact a number of aspects of the Rule, including: (i) available exemptions from filing under the Rule as well as the substantive filing requirements of the Rule, (ii) the definition of "underwriting compensation", (iii) the addition of exceptions to the definition of "underwriting compensation" for venture capital firms, (iv) treatment of non-convertible or non-exchangeable debt securities and derivatives, (v) lock-up restrictions; and (vi) prohibited terms and arrangements.

All comments regarding the proposed amendments (the "Proposed Rule") must be received by May 22, 2019. The text of the Proposed Rule is attached hereto as Exhibit A.

Background: The Corporate Financing Rule

FINRA Rule 5110 regulates the terms and conditions of the participation of FINRA member broker-dealers in public offerings.2 The Rule prohibits underwriting arrangements in connection with the public offering of securities if those underwriting terms and conditions are deemed under the Rule to be "unfair" or "unreasonable." The Rule regulates underwriters' compensation in three ways: (i) by aggregating all "items of value" received by underwriters and other related persons in connection with the public offering, deeming such items of value to be "compensation in connection with the public offering" and limiting that compensation; (ii) placing a prohibition on the receipt of certain items of value in connection with participation in a public offering; and (iii) requiring disclosure of all items of value that are deemed to be compensation to the underwriters in connection with the public offering in filings to FINRA.

The Proposed Amendments

The Proposed Rule would result in a wide array of changes to FINRA Rule 5110, including to the following areas:

  • Administrative matters;
  • Time Period for filing requirements;
  • Filing requirements for shelf offerings;
  • Exemptions from the filing and substantive requirements of FINRA Rule 5110;
  • Regulation of "underwriting compensation;"
  • Definition of "underwriting compensation;"
  • "Venture capital" exceptions;
  • Treatment of non-convertible or non-exchangeable debt securities and derivatives;
  • Lock-up restrictions relating to securities deemed to be underwriting compensation; and 
  • Prohibited terms and arrangements.

FINRA Rule 5110 was last revised in 2004, modernizing it to better reflect the various financial activities of multi-service members.3 Following this and subsequent narrower amendments that addressed industry practices regarding particular underwriting terms and arrangements, FINRA issued an initial proposal, found at Regulatory Notice 17-15 ("Notice 17-15").4 Many of the initial proposals in Notice 17-15 were incorporated in the Proposed Rule. 
The below provides a brief summary of each of the proposed amendments.

Extending the Time Period for Making Required FINRA Filings

Currently, a FINRA filing must be made within one business day after filing with the SEC. The Proposed Rule would extend the period for filing to three business days.

Streamlining Filing Requirements for Shelf Offerings

The Proposed Rule codifies the historical standards for public offerings that are exempt from the FINRA Rule 5110 filing requirement and seeks to streamline the filing requirements for shelf offerings that remain subject to the filing requirement:

The current rule does not require the filing or review of offerings by issuers that qualify to offer securities on Form F-3 or S-3, as those forms existed before October 21, 1992 (the "pre-1992 standards"). In general, the Rule does not require filings or review by an issuer with a 36-month reporting history and at least $150 million in public float 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.5 The Proposed Rule exempts from the filing requirement a public offering by an "experienced issuer" and deletes references to the pre-1992 standards for Form-3 and standards approved in 1991 for Form F-10. This again raises the concern that certain issuers will be excluded due to the narrower filing requirements.6

For shelf offerings that continue to be subject to a FINRA filing, the filing requirements are streamlined to only require the Securities Act registration statement number, and other specified documents and information set forth under the proposed rule, if expressly requested by FINRA. Any streamlining of the shelf offering review process will be a welcome development by the industry and by issuers.

Expanding Exemptions from FINRA Filing and Substantive Rule Compliance Requirements

The Proposed Rule expands the offerings that are exempt from the filing or substantive compliance requirements of Rule 5110 to include the following:

  • Securities of banks that have qualifying outstanding debt securities, as defined by the Rule, are exempt from the filing requirements, but still subject to substantive rule compliance requirements;7
  • 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 will be added to the list of offerings that are exempt from both the filing and substantive rule compliance requirements.

Clarifying the Definition of "Underwriting Compensation"

The proposed rule clarifies what is considered underwriting compensation for purposes of Rule 5110, by eliminating the concept of "items of value" (i.e., the non-exhaustive list of payments and benefits currently included in the underwriting compensation calculation), in favor of a single, new definition: "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." Underwriting compensation would also include "finder's fees, underwriter's counsel fees and securities.8

In addition, as was the case in the Notice 17-15 proposal, the amendments would revise the "review period to include the time period commencing 180 days prior to the initial filing of the applicable offering, and ending 60 days following the termination of the offering. All payments and benefits received during this applicable review period would be considered in evaluating total underwriting compensation.9

Expansion of Venture Capital Exceptions to Underwriting Compensation Definition

In order to facilitate the participation of broker-dealers in bona fide venture capital transactions, the proposed rule no longer treats as underwriting compensation the following securities acquisitions: (i) securities acquisitions and conversions to prevent dilutions; and (ii) securities purchases based on a prior investment history, which is defined as two years preceding the required filing date. The amendments also broaden current venture capital exceptions regarding purchases and loans by certain affiliates, and loans to certain issuers, by removing a limitation on acquiring more than 25 percent of the issuer's total equity securities.

Clarifying the Treatment of Non-Convertible or Non-Exchangeable Debt Securities and Derivatives

The proposed rule clarifies the treatment of non-convertible or non-exchangeable debt securities and derivatives by expressly providing that non-convertible or non-exchangeable debt securities and derivative instruments acquired in a transaction unrelated to a public offering would not be underwriting compensation. The proposed rule also clarifies that for that non-convertible or non-exchangeable debt securities and derivative instruments acquired in a transaction related to a public offering, the filing must include (i) a description of those securities and derivative instruments and (ii) 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.

Prior guidance under NASD Rule 2710(c)(3)(B)(vi) and (vii) made definitional changes to "items of value," excluding non-convertible or non-exchangeable debt securities and derivatives acquired or entered into: (i) for a fair price; (ii) in the ordinary course of business; and (iii) in transactions unrelated to the public offering. This also had the effect of excluding these securities from the lock-up requirements under the prior rule.10 Under the Proposed Rule, as non-convertible or non-exchangeable debt securities and derivative instruments acquired in a transaction unrelated to a public offering would not be underwriting compensation, the lock-up restrictions would not apply.

Modification of Lock-Up Restrictions

The Proposed Rule amends the 180-day lock-up restriction on securities that are deemed to be underwriting compensation to begin on the date of commencement of sales, rather than the date of effectiveness of the prospectus. Additionally, the Proposed Rule adds certain exceptions from the lock-restriction. For example, securities acquired from an issuer that meets the registration requirements of SEC Registration Forms S-3, F-3 or F-10 are excepted from the lock-up restriction. The amendment also adds 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.11

Clarification of Prohibited Terms and Arrangements

The Proposed Rule clarifies the list of prohibited terms and arrangements currently in Rule 5110(f) by identifying the scope of relevant activities deemed to be related to the public offering and referring to the commencement of sales of the public offering, rather than date of effectiveness, as the reference date for counting whether any unregistered security is considered to be an item of underwriting compensation.12 The amendments 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 in the following circumstances: (i) an advance against accountable expenses actually anticipated to be incurred, which must be reimbursed to the issuer to the extend not actually incurred; or (ii) 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.


Although the Proposed Rule reflects a comprehensive effort by FINRA to modernize, clarify and streamline the requirements of FINRA Rule 5110, it still falls short in fully reflecting current economic practice. For example, the Proposed Rule does not tie "experienced issuer" status to S-3 eligibility in general. As a result, issuers who may not fall within the "experienced issuer" definition under FINRA Rule 5110, but may nonetheless be S-3 eligible under the Securities Act (including under the standards for that form as it existed in 1992), would nonetheless remain subject to the filing requirements of FINRA Rule 5110. Accordingly, although the Proposed Rule does make certain welcome concessions to developments in the corporate financing landscape, there remains significant areas where the Rule could be further modernized in order to better reflect current practice and also in order to better facilitate the participation of U.S. broker-dealers in capital raising activities.


1 The text of the proposed rule is available at https://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2019-012.pdf.

2 Our full range of publications relating to the Corporate Financing Rule is available at https://brokerdealer.shearman.com/home?newstype=538&practiceID=3688.

3 Securities Exchange Act Release No. 48989 (December 23, 2003), 68 FR 75684 (December 31, 2003) (Order Approving File No. SR–NASD–2000–04). See also Notice to Members 04–13 (February 2004).

4 For information on Notice 17-15, see our prior client note at https://www.shearman.com/perspectives/2017/04/finra-amndts-to-corporate-financing-rule.

5 "Public float" is defined as the portion of a company's outstanding shares that is in the hands of public investors, as opposed to company officers, directors or stockholders that hold controlling interests. These are the shares that are available for trading. The float is calculated by subtracting restricted shares from outstanding shares.

6 See Comment Letter, p.6, Securities Industry Association, File No. SR-NASD-2004-22 Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to the Corporate Financing Rule and Shelf Offerings of Securities, February 1, 2015, https://www.sec.gov/rules/sro/nasd/nasd2004022/sia020105.pdf. In general, the concern is that Forms S-3 and F-3 allow offerings by certain persons other than the issuer itself, i.e., guaranteed subsidiaries. Under the proposed definition of "experienced issuer," no exception would be available for guaranteed subsidiaries.

7 Defined in Proposed Rule 5110(h)(1)(A) as "securities offered by a bank, corporate issuer, foreign government or foreign government agency that has 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 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.

8 The Proposed Rule continues to exempt fees for advisory or consulting services provided to the issuer by an "independent financial adviser," so long as they are neither engaged in, nor affiliated or associated with any entity that is engaged in, the solicitation or distribution of the offering. A further non-exhaustive list of examples has been provided to clarify payments or benefits that may be considered underwriting compensation. See Proposed Rule 5110(j)(9), (15), and (20); see also Supplementary Material .01.

9 See Proposed Rule 5110(j)(20).

10 See 68 Fed. Reg. 75684, 79697; Release No. 34–48989; File No. SR–NASD–00–04.

11 The Proposed Rule will include the following eight exceptions to the lock-up restrictions: (i) if the security is required to be transferred by operation of law or by reason of reorganization of the issuer; (ii) if the aggregate amount of securities of the issuer beneficially owned by a participating member does not exceed 1% of the securities being offered; (iii) to a security of an issuer that meets the registration requirements of SEC Registration Forms S-3, F-3 or F-10; (iv) to a non-convertible or non-exchangeable debt security acquired in a transaction related to the public offering; (v) to a derivative instrument acquired in connection with a hedging transaction related to the public offering and at a fair price; (vi) if the security was acquired in a transaction that met the requirements of paragraph (d); (vii) if the security is beneficially owned on a pro-rata basis by all equity owners of an investment fund, provided that no participating member manages or otherwise directs investments by the fund, and participating members in the aggregate do not own more than 10% of the equity in the fund; or (viii) if the security was received as underwriting compensation, and is registered and sold as part of a firm commitment offering. See Proposed Rule 5110(e)(2).

12 Specifically, to clarify the scope, the Proposed Rule 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.

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.

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