FINRA Amendment to Proposed Rule 5131

MEMORANDUM

Re: FINRA Amendment to Proposed Rule 5131

Date: 4/26/2010

By: Lawrence Metelitsa

On September 15, 2003, NASD now the Financial Industry Regulatory Authority ("FINRA") filed a proposed rule change to adopt new FINRA Rule 5131 (originally proposed as NASD Rule 2712) to deal with disclosure and management of conflicts of interests that may adversely affect the allocation and distribution of IPOs. The proposed rule change was meant to create greater public confidence in the IPO process, which is vital to the continued growth and success of the capital markets. The NASD amended the proposed rule change on December 9, 2003 and August 4, 2004. The most recent amendment was proposed by FINRA on February 17, 2010. This latest Amendment seeks to regulate member firms by implementing the following rules:

Quid Pro Quo Allocations: The Amendment to this rule means that members, or those persons associated with members, may not withhold or threaten to withhold, any allocated shares from an I.P.O in order to collect excessive fees relative to the services provided by the member. 

Spinning: In investment banking the act of "Spinning" refers to the allocating of shares of a hot initial offering by a securities firm to the personal account of a corporate executive in anticipation of gaining future business from the executive's firm. The Amendment to 5131 prevents members, or persons associated with members, from Spinning in the following circumstances: :

(i) 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;

(ii) if the member intends to provide, or expects to be retained by the

company for, investment banking services within the next 3 months; or

(iii) 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.

Policies Concerning Flipping: The practice of flipping refers to that no member, or person associated with a member, may directly or indirectly recover, or attempt to recover, any portion of a commission or credit paid or awarded to an associated person for selling shares in an IPO that are subsequently flipped by a customer, unless the managing underwriter has assessed a penalty bid on the entire syndicate. Furthermore, any obligation to maintain records relating to penalty bids falls under SEA Rule 17a-2(c)(1), a member shall promptly record and maintain information regarding any penalties or disincentives assessed on its associated persons in connection with a penalty bid.

IPO Pricing and Trading Practices.  In an equity I.P.O. The book-running lead manager must provide to the issuer’s pricing committee (or, its board of directors if no pricing committee exists) a "Regular Report of Indications of Interest", which is to include the names of interested institutional investors and the number of shares indicated by each, as reflected in the book-running lead manager’s book of potential institutional orders, and a report of aggregate demand from retail investors. In addition, after the settlement date of the IPO, a report of the final allocation of shares to institutional investors, as reflected in the books and records of the book-running lead manager, including the names of purchasers and the number of shares purchased by each, and aggregate sales to retail investors must also be provided to the issuer’s pricing committee (or, its board of directors if no pricing committee exists).


Lock-Up Agreements.  A "Lock- Up" Agreement is a legally binding contract between the underwriters and insiders of a company prohibiting these individuals from selling any shares of stock for a specified period of time. The latest amendment to Rule 5131 promulgates that (i)any lock-up agreement or other restriction on the transfer of the issuer’s shares by officers and directors of the issuer shall provide that such restrictions will apply to their issuer-directed shares; and (ii) at least two business days before the release or waiver of any lock-up or other restriction on the transfer of the issuer's shares, the book-running lead manager will notify the issuer of the impending release or waiver and announce the impending release or waiver through a major news service, except where the release or waiver is effected solely to permit a transfer of securities that is not for consideration, and where the transferee has agreed in writing to be bound by the same lock-up agreement terms in place for the transferor.

Agreement Among Underwriters.  The agreement between the book-running lead manager and other syndicate members must require, to the extent not inconsistent with SEC Regulation M, that any shares trading at a premium to the public offering price that are returned by a purchaser to a syndicate member after secondary market trading commences be used to offset the existing syndicate short position or, if no syndicate short position exists, the member must offer returned shares at the public offering price to unfilled customers’ orders pursuant to a random allocation methodology.

Market Orders.  No member may accept a market order for the purchase of IPO shares prior to the commencement of trading on the secondary market.

The comment period for this, third amendment, to proposed rule 5131 ended on April 8, 2010. The text of the original rule and all subsequent Amendments can be found at FINRA.org. 

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