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Amendments to FINRA New Issue Rules 5130 and 5131 Effective January 1, 2020

KEY POINTS

  • Amendments to FINRA Rules 5130 and 5131, which govern the offer and sale of “New Issue” securities went into effect on January 1.

  • FINRA Rule 5130 prohibits a broker-dealer from selling New Issues to accounts in which “Restricted Persons” have a beneficial interest.

  • FINRA Rule 5131 restricts broker-dealers from selling New Issues to accounts that are beneficially owned by persons that are executive officers or directors of public companies and certain covered non-public companies having specified relationships with the broker-dealer, and persons materially supported by these persons.

  • Private fund managers and broker-dealers should update their relevant forms, certifications, and policies and procedures to reflect these changes.

On November 5, 2019, the SEC approved amendments to FINRA Rules 5130 and 5131, which govern the offer and sale of “New Issue” securities (the “Rules”). (Under the Rules, “New Issue” means any initial public offering (IPO) of an equity security as defined in Section 3(a)(11) of the Securities Exchange Act of 1934 made pursuant to a registration statement or offering circular, subject to certain exceptions.) These amendments went into effect on January 1, 2020. In general, the amendments to the Rules broaden the categories of investors that are exempt from the Rules’ restrictions. Therefore, additional types of investors may now be able to invest in New Issues directly and through their investments in private investment funds.

Private fund managers and broker-dealers should update their relevant forms, certifications, and policies and procedures to reflect these changes, some of which are summarized below.

Background

FINRA Rule 5130 prohibits a broker-dealer from selling New Issues to accounts in which “Restricted Persons” have a beneficial interest. The term “Restricted Person” includes broker-dealers and their personnel, finders and fiduciaries in securities offerings, portfolio managers, persons owning a broker-dealer, and, in some cases, persons materially supported by, or the immediate family members of these persons. FINRA Rule 5131 restricts brokerdealers from selling New Issues to accounts that are beneficially owned by persons that are executive officers or directors of public companies and certain covered non-public companies having specified relationships with the broker-dealer, and persons materially supported by these persons.

Summary of Significant Changes

The amendments include the following changes:

  • New general exemption for US and foreign employee retirement plans. ERISA retirement plans that are not sponsored solely by a broker-dealer are generally exempt from the Rules 5130 and 5131. However, foreign employee retirement benefits plans and certain US retirement plans do not qualify for this exemption. The amendments to the Rules add a general exemption for any US and foreign employee retirement plan that: 1) has at least 10,000 participants and beneficiaries and $10 billion in assets; 2) permits employees regardless of income or position to participate; 3) is administered by trustees and managers that have a fiduciary obligation to administer the funds in the best interests of the participants; and 4) is not sponsored by a broker-dealer.

  • Foreign investment companies. Under Rule 5130, an investment company organized under the laws of a foreign jurisdiction is exempt if 1) it is listed on a foreign exchange for sale to the public; and 2) no person owning more than 5 percent of the foreign investment company is a Restricted Person. The amendments add two alternative tests for the 5 percent Restricted Person threshold, as follows: 1) the non-US investment company has 100 or more direct investors; or 2) the non-US investment company has 1,000 or more indirect investors. This exemption covers only foreign investment companies that were not formed for the specific purpose of permitting Restricted Persons to invest in new issues.

  • Sovereign entity exemption. The definition of “Restricted Person” under Rule 5130 includes, among others, certain direct and indirect owners of a broker-dealer. The amendments exclude “sovereign entities” from the scope of owners of a broker-dealer that is restricted under Rule 5130. Therefore, a sovereign wealth fund would now be permitted to invest in New Issue securities regardless of its direct or indirect ownership of a broker-dealer. “Sovereign entities” are generally defined as a sovereign nation, (or its political subdivisions, agencies or instrumentalities), or a pool of capital or an investment fund or other vehicle owned or controlled by a sovereign nation and created for the purpose of making investments on behalf or for the benefit of the sovereign nation.

  • Exclusion for foreign offerings. The amended Rules exclude from the definition of “New Issue” securities offshore offerings made pursuant to Regulation S under the Securities Act of 1933 (as well as other offerings made outside of the United States), unless the securities offered and sold under Regulation S or in another form of offshore offering are made as part of an offering that is also registered in the United States as part of a concurrent IPO of an equity security in the United States.

  • SPACs. Currently, FINRA Rule 5130 excludes from the definition of “New Issue” the offerings of business development companies, direct participant programs and real estate investment trusts. The amendments add a new exclusion from the definition of “New Issue” for initial public offerings of special purpose acquisition companies (SPACs).

  • Issuer directed securities. The amended Rules allow one or more affiliates and selling shareholders to direct allocations of securities in compliance with the other conditions of the Rules.

  • Charitable organizations. Due to their size, some charitable organizations met the definition of a covered non-public company for purposes of FINRA Rule 5131. Therefore, executive officers or directors of these organizations were subject to that Rule’s prohibitions. Rule 5131 was amended to exclude from “covered non-public companies” those charitable organizations that would otherwise, based on asset size, fall within the definition of “covered non-public company.” This exclusion is limited to 501(c)(3) organizations.

  • Family offices and family investment vehicles. The definition of “Restricted Persons” in FINRA Rule 5130 includes “portfolio managers,” but not portfolio managers that are advisers to family investment vehicles. A “portfolio manager” is defined as any person (or certain of their immediate family members) who has authority to buy or sell securities for a bank, savings and loan institution, insurance company, investment company, investment advisor or collective investment account. The Rule amendments align the definition of family investment vehicles with the concept of family offices set forth in the Investment Advisers Act of 1940 and, thereby, expand the definition of family investment vehicles. Advisers to these family investment vehicles are no longer considered “portfolio managers” for purposes of Rule 5130 and, therefore, are no longer Restricted Persons.

What Should Private Funds, Managers and Broker-Dealers Do Now?

Firms should revise their new issues questionnaires and related documentation, as necessary, to reflect the changes to the Rules that became effective January 1.

©2020 Katten Muchin Rosenman LLP

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About this Author

Wendy E. Cohen, Financial Services Lawyer, Katten Muchin Law firm
Partner

Wendy E. Cohen represents investment managers and other sponsors of domestic and offshore securities and commodities hedge funds, funds of funds and other public and private pooled investment vehicles, as well as their service providers, including their managers, brokers, financial intermediaries and other financial institutions, and investment professionals. She provides advice on all corporate and related matters facing investment funds, including structure and organization, ongoing operations, restructuring and dissolution.

Having practiced for...

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David Y. Dickstein, Financial Services Lawyer, Katten muchin law firm
Partner

David Dickstein represents broker-dealers, investment advisers, investment companies and hedge funds in connection with a variety of regulatory, compliance and operational matters. David regularly counsels investment advisers on registration and regulatory matters, such as the need for registration, conflict of interest disclosures, soft dollars and best execution, firm advertising and marketing, federal and state pay-to-play matters, trade allocations and personal trading. He also advises broker-dealers on registration and ongoing compliance matters, mutual fund supermarkets on mutual fund distribution issues and brokerage and advisory firms on structuring and offering wrap fee programs and other financial products. In addition, David provides assistance in responding to Securities and Exchange Commission (SEC) investigations and examinations and in conducting compliance audits and regulatory reviews.

212-940-8506
Michael T. Foley, Katten, Lawyer, Finance, FINRA, Chicago
Special Counsel

Michael Foley represents broker-dealers, investment advisers and other financial services industry participants with respect to a broad spectrum of legal and regulatory matters arising under the federal securities laws.

Michael has nearly 20 years of experience in private practice and in-house at both a large, full-service broker-dealer and at an online discount broker-dealer, advising broker-dealers and other financial institutions regarding compliance with the federal securities and commodities laws, and with the regulations of the US Securities and Exchange...

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Mark Goldstein, Katten Law Firm, New York, Financial Law Attorney
Special Counsel

Mark Goldstein focuses his practice on advising investment advisers, mutual funds and private investment funds. Mark has more than 25 years of experience advising clients on compliance and regulatory requirements, corporate matters, and the federal securities laws. He has extensive experience advising on the formation, distribution, structuring and on-going operational aspects of a wide array of investment products, including mutual funds, private investment funds, offshore funds, funds offered to separate accounts of insurance companies as funding vehicles for variable...

212-940-8507
Christian B. Hennion, Finance Attorney, Katten Muchin Law Firm
Associate

Christian B. Hennion concentrates his practice in financial services and asset management matters, including counseling fund managers, registered investment advisers and commodity trading advisors on both transactional and regulatory matters. Chris has advised a wide range of US and international managers, from start-ups to large institutions, regarding a variety of matters, including private fund launches and reorganizations, advisory engagements, Investment Advisers Act and Commodity Exchange Act compliance obligations, Securities and Exchange Commission (SEC) and Commodity Futures...

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