[Federal Register Volume 84, Number 84 (Wednesday, May 1, 2019)]
[Notices]
[Pages 18592-18618]
[FR Doc No: 2019-08774]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-85715; File No. SR-FINRA-2019-012]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend
FINRA Rule 5110 (Corporate Financing Rule--Underwriting Terms and
Arrangements) To Make Substantive, Organizational and Terminology
Changes

April 25, 2019.
    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 April 11, 2019, 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 5110 (Corporate Financing
Rule--Underwriting Terms and Arrangements) (the ``Rule'') to make
substantive, organizational and terminology changes to the Rule. The
proposed rule change is intended to modernize Rule 5110 and to simplify
and clarify its provisions while maintaining important protections for
market participants, including issuers and investors participating in
offerings. The proposed rule change would also update cross-references
and make other non-substantive changes within FINRA rules due to the
proposed amendments to Rule 5110.
    The text of the proposed rule change is available on FINRA's
website 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 the
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The ability of small and large businesses to raise capital
efficiently is critical to job creation and economic growth. Since its
adoption in 1992 in response to persistent problems with underwriters
dealing unfairly with issuers, Rule 5110 has played an important role
in the capital raising process by prohibiting unfair underwriting terms
and arrangements in connection with the public offering of securities.
Moreover, Rule 5110 continues to be important to ensuring investor
protection and market integrity through effective and efficient
regulation that facilitates vibrant capital markets.
    Rule 5110 requires a member that participates in a public offering
to file documents and information with FINRA about the underwriting
terms and arrangements.\3\ FINRA's Corporate Financing Department
(``Department'') reviews this information prior to the commencement of
the offering to determine whether the underwriting compensation and
other terms and arrangements meet the requirements of the applicable
FINRA rules.\4\
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    \3\ The following are examples of public offerings that are
routinely filed: (1) Initial public offerings (``IPOs''); (2)
follow-on offerings; (3) shelf offerings; (4) rights offerings; (5)
offerings by direct participation programs (``DPPs'') as defined in
FINRA Rule 2310(a)(4) (Direct Participation Programs); (6) offerings
by real estate investment trusts (``REITs''); (7) offerings by a
bank or savings and loan association; (8) exchange offerings; (9)
offerings pursuant to SEC Regulation A; and (10) offerings by
closed-end funds.
    \4\ FINRA does not approve or disapprove an offering; rather,
the review relates solely to the FINRA rules governing underwriting
terms and arrangements and does not purport to express any
determination of compliance with any federal or state laws, or other
regulatory or self-regulatory requirements regarding the offering. A
member may proceed with a public offering only if FINRA has provided
an opinion that it has no objection to the proposed underwriting
terms and arrangements. See current Rule 5110(b)(4)(B)(ii). See also
proposed Rule 5110(a)(1)(C)(ii).
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    Rule 5110 was last revised in 2004 to better reflect the various
financial activities of multi-service members.\5\ After years of
experience with those amendments, and subsequent narrower amendments
that addressed industry practices regarding particular underwriting
terms and arrangements, FINRA recently conducted the equivalent of a
retrospective review \6\ to further modernize the Rule by, among other
things, significantly improving the administration of the Rule and
simplifying the Rule's provisions while maintaining important
protections for market participants, including issuers and investors
participating in offerings.
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    \5\ In recognition of the expansion in the variety of services
provided by members to their corporate financing clients, such as
venture capital investment, financial consulting, commercial
lending, hedging risk through derivative transactions and investment
banking services, the Rule was revised in 2004 to accommodate the
expanded corporate financing activities of members, while protecting
issuers and investors from unreasonable or coercive practices. See
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).
    \6\ Because the review began before FINRA initiated formal
retrospective review procedures, it did not follow the specific
procedures that are now followed.
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    As part of this retrospective review, FINRA engaged in extensive
consultation with the industry to better understand what aspects of the
Rule needed to be modernized, simplified and clarified. This
retrospective review, including its industry consultation component and
comments FINRA received in response to Regulatory Notice 17-15 (April
2017) (``Notice 17-15 Proposal'') (as further discussed in Items II.B.
and II.C. infra), has shaped and informed this proposed rule change.
The proposed rule change includes a range of amendments to Rule 5110,
including reorganizing and improving the readability of the Rule. FINRA
proposes changes to the following areas: (1) Filing requirements; (2)
filing requirements for shelf offerings; (3) exemptions from filing and
substantive requirements; (4) underwriting

compensation; (5) venture capital exceptions; (6) treatment of non-
convertible or non-exchangeable debt securities and derivatives; (7)
lock-up restrictions; (8) prohibited terms and arrangements; and (9)
defined terms.\7\ The changes to these areas should lessen the
regulatory costs and burdens incurred when complying with the Rule.
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    \7\ As discussed below, the proposal retains the current
approach to itemized disclosure of underwriting compensation, but
makes explicit the existing practice of disclosing specified
material terms and arrangements related to underwriting
compensation, such as exercise terms, in the prospectus. In
addition, the proposed rule change does not include any changes to
current Rule 5110(h) (Non-Cash Compensation). These provisions are
the subject of a separate consolidated approach to non-cash
compensation. See Regulatory Notice 16-29 (August 2016).
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Filing Requirements
    The proposed rule change would amend Rule 5110's filing
requirements to create a process that is both more flexible and more
efficient for members. The proposed rule change would allow members
more time to make the required filings with FINRA (from one business
day after filing with the SEC or a state securities commission or
similar state regulatory authority to three business days).\8\ This
change is intended to help with logistical issues or inadvertent delays
in making filings without impeding FINRA's ability to timely review the
underwriting terms and arrangements.
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    \8\ See proposed Rule 5110(a)(3)(A). The documents and
information required to be filed under Rule 5110 are filed in
FINRA's Public Offering System (``FINRA System'') for review and, if
available, the associated SEC document identification number should
be provided. See proposed Rule 5110(a)(4).
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    The proposed rule change would clarify and further reduce the types
of documents and information that must be filed by directing members to
provide the SEC document identification number if available,\9\ and
require filing: (1) Industry-standard master forms of agreement only if
specifically requested to do so by FINRA; \10\ (2) amendments to
previously filed documents only if there have been changes relating to
the disclosures that impact the underwriting terms and arrangements for
the public offering in those documents; \11\ (3) a representation as to
whether any associated person or affiliate of a participating member is
a beneficial owner of 5 percent or more of ``equity and equity-linked
securities''; \12\ and (4) an estimate of the maximum value for each
item of underwriting compensation.\13\
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    \9\ Depending on the filing type, an SEC document identification
number could include a document control number, document file number
or accession number. For purposes of clarity, the lack of an SEC
document identification number does not obviate the need to submit
the documents and information set forth in proposed Rule 5110(a)(4).
    \10\ See proposed Rule 5110(a)(4)(A)(ii). A member may use a
master form of agreement which is a standard form used across like
offerings and transactions in which the member participates (e.g., a
master agreement among underwriters).
    \11\ See proposed Rule 5110(a)(4)(A)(iii).
    \12\ See proposed Rule 5110(a)(4)(B)(iii) and proposed Rule
5110(j)(7). Contrast with current Rule 5110(b)(6)(A)(iii), which
requires a statement or association related to ``any class of the
issuer's securities.''
    \13\ See proposed Rule 5110(a)(4)(B)(ii).
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    The proposed rule change would clarify that a member participating
in an offering is not required to file with FINRA if the filing has
been made by another member participating in the offering.\14\ In
addition, rather than providing a non-exhaustive list of types of
public offerings that are required to be filed, the proposed rule
change would instead state that a public offering in which a member
participates must be filed for review unless exempted by the Rule.\15\
The proposed rule change would clarify the general standard that no
member may engage in the distribution or sale of securities unless
FINRA has provided an opinion that it has no objection to the proposed
underwriting terms and arrangements.\16\ The proposed rule change also
would clarify that any member acting as a managing underwriter or in a
similar capacity must notify the other members participating in the
public offering if informed of an opinion by FINRA that the
underwriting terms and arrangements are unfair and unreasonable and the
proposed terms and arrangements have not been appropriately
modified.\17\ Providing members with more time to file relevant
documents and information and reducing the filing of duplicative or
otherwise unnecessary documents and information would lessen members'
filing burdens while maintaining the Rule's important protections for
market participants.
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    \14\ See proposed Rule 5110(a)(3)(B). Participating members are
responsible for filing public offerings with FINRA. While an issuer
may file an offering with FINRA if a participating member has not
yet been engaged, a participating member must assume filing
responsibilities once it has been engaged. As discussed infra,
issuer filings continue to be permitted for shelf offerings.
    \15\ See proposed Rule 5110(a)(2). As discussed infra, the
proposed rule change would add the defined term ``public offering''
to Rule 5110.
    \16\ See proposed Rule 5110(a)(1)(C).
    \17\ See proposed Rule 5110(a)(1)(B).
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    The new provision addressing terminated offerings provides that,
when an offering is not completed according to the terms of an
agreement entered into by the issuer and a member, but the member has
received underwriting compensation, the member must give written
notification to FINRA of all underwriting compensation received or to
be received, including a copy of any agreement governing the
arrangement.\18\ Information regarding underwriting compensation
received or to be received in terminated offerings is relevant to
FINRA's evaluation of compliance with Rule 5110 and, in particular,
paragraph (g)(5) of the proposed Rule. This new provision would allow
FINRA to provide more effective oversight when a member's services have
been terminated.
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    \18\ See proposed Rule 5110(a)(4)(C) and proposed Rule
5110(g)(5). In 2014, FINRA amended Rule 5110 to expand and specify
the circumstances under which underwriting compensation in excess of
a reimbursement of out-of-pocket expenses, such as termination fees
and rights of first refusal (``ROFR''), could be received in
connection with an offering that was not completed or when a member
was terminated from an offering. See Securities Exchange Act Release
No. 72114 (May 7, 2014), 79 FR 27355 (May 13, 2014) (Order Approving
File No. SR-FINRA-2014-004).
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Filing Requirements for Shelf Offerings
    Issuers meeting specified reporting history and other requirements
are eligible to use shelf registration statements. A shelf-eligible
issuer can use a shelf takedown to publicly offer securities on a
continuous or delayed basis to meet funding needs or to take advantage
of favorable market windows. Public offerings by some shelf-eligible
issuers have historically been exempt from Rule 5110's filing
requirement; however, for the reasons discussed below, public offerings
by other shelf-eligible issuers have historically been subject to Rule
5110's filing requirement. The proposed rule change would codify the
historical standards for public offerings that are exempt from the
filing requirement and would streamline the filing requirements for
shelf offerings that remain subject to the filing requirement.
Public Offerings Exempt From the Filing Requirement
    Substantively consistent with the current Rule, the proposed rule
change would exempt from Rule 5110's filing requirement a public
offering by an ``experienced issuer'' (i.e., an issuer with a 36-month
reporting history and at least $150 million aggregate market value of
voting stock held by non-affiliates 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

in the stock).\19\ Unless subject to another exemption, public
offerings of issuers that do not meet the reporting history or float
requirement to be codified in the experienced issuer definition have
historically been subject to Rule 5110's filing requirement, including
shelf offerings by these issuers.
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    \19\ The proposed rule change would delete references to the
pre-1992 standards for Form S-3 and standards approved in 1991 for
Form F-10 and instead codify the requirement that the issuer have a
36-month reporting history and at least $150 million aggregate
market value of voting stock held by non-affiliates 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 in the stock. See proposed Rule
5110(j)(6).
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Public Offerings Subject to the Filing Requirement
    There are many benefits for eligible issuers in using a shelf
registration statement, including the ability of issuers to take
advantage of favorable market conditions on short notice to quickly
raise capital through takedown offerings. While shelf offerings have
historically been less likely to have compliance problems, previously
filed shelf offerings have given rise to issues under Rule 5110,
including those related to: (1) Excessive underwriting compensation;
(2) indeterminate underwriting compensation in the form of convertible
debt or equity securities that do not have a market value; (3)
undisclosed underwriting compensation, primarily in the form of
uncapped expense reimbursements; and (4) termination fees and ROFRs
that do not satisfy the Rule's requirements.
    Given the issues that have arisen in shelf offerings, the proposed
rule change would continue to apply Rule 5110's filing requirement to
shelf offerings by issuers that do not meet the ``experienced issuer''
standard. However, to facilitate the ability of issuers to take
advantage of favorable market conditions on short notice to quickly
raise capital through takedown offerings, the proposed rule change
would streamline the filing requirements for shelf offerings. The
proposed rule change would provide that only the following documents
and information must be filed: (1) The Securities Act of 1933
(``Securities Act'') registration statement number; and (2) if
specifically requested by FINRA, other documents and information set
forth in Rule 5110(a)(4)(A) and (B).\20\
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    \20\ See proposed Rule 5110(a)(4)(E).
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    FINRA would access the base shelf registration statement,
amendments and prospectus supplements in the SEC's Electronic Data
Gathering, Analysis, and Retrieval (``EDGAR'') system and populate the
information necessary to conduct a review in the FINRA System. Upon
filing of the required registration statement number and documents and
information, if any, that FINRA requested pursuant to proposed Rule
5110(a)(4)(E), FINRA would provide the no objections opinion. To
further facilitate issuers' ability to timely access capital markets,
FINRA's review of documents and information related to a shelf takedown
offering for compliance with Rule 5110 would occur on a post-takedown
basis.\21\
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    \21\ Issuers would continue to be permitted to file a base shelf
registration statement in anticipation of retaining a member to
participate in a takedown offering.
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Exemptions From Filing and Substantive Requirements
    Rule 5110 includes two categories of exempt public offerings--
offerings that are exempt from filing, but remain subject to the
substantive provisions of Rule 5110, and offerings that are exempt from
both the filing requirements and substantive provisions of Rule 5110.
The proposed rule change would expand and clarify the scope of the
exemptions, which is expected to reduce members' filing and compliance
costs.
    Consistent with historical practice in interpreting the exemption
that is currently available to corporate issuers, the proposed rule
change would clarify that securities of banks that have qualifying
outstanding debt securities are exempt from the filing requirement.\22\
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    \22\ See proposed Rule 5110(h)(1)(A). The exemption has
historically been interpreted to apply to qualifying securities
offered by a bank; however, the lack of a specific reference to bank
securities in the Rule text has raised questions by members.
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    The proposed rule change would also expand the current list of
offerings that are exempt from both the filing requirements and
substantive provisions of Rule 5110 to include 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.\23\ Exempting these
public offerings is appropriate because they relate to highly regulated
entities governed by the Investment Company Act of 1940 (``Investment
Company Act'') whose offering terms would be subject to FINRA Rule 2341
(Investment Company Securities). In addition, as discussed infra, in
response to comments to the Notice 17-15 Proposal, the proposed rule
change reclassifies three items from the offerings exempt from filing
and rule compliance to offerings excluded from the definition of public
offering. The three items are: (1) Offerings exempt from registration
with the SEC pursuant to Section 4(a)(1), (2) and (6) of the Securities
Act; (2) offerings exempt from registration under specified SEC
Regulation D provisions; and (3) offerings of exempted securities as
defined in Section 3(a)(12) of the Exchange Act. This reclassification
is consistent with the treatment of such offerings in FINRA Rule 5121
(Public Offerings of Securities With Conflicts of Interest).\24\
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    \23\ See proposed Rule 5110(h)(2)(E), (K) and (L).
    \24\ See proposed Rule 5110(j)(18).
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Disclosure Requirements
    The SEC's Regulation S-K requires fees and expenses identified by
FINRA as underwriting compensation to be disclosed in the
prospectus.\25\ The Notice 17-15 Proposal would have modified Rule
5110's underwriting compensation disclosure requirements. Although a
description of each item of underwriting compensation would have been
required to be disclosed, the Notice 17-15 Proposal would have no
longer required that the disclosure include the dollar amount ascribed
to each individual item of compensation. Rather, the Notice 17-15
Proposal would have permitted a member to disclose the maximum
aggregate amount of all underwriting compensation, except the discount
or commission that must be disclosed on the cover page of the
prospectus.
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    \25\ See 17 CFR 229.508(e).
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    FINRA is no longer proposing to eliminate the itemized disclosure
that Rule 5110 currently requires. As discussed in Item II.C. infra,
commenters had conflicting views on the proposed change to allow
aggregation of underwriting compensation with one commenter stating
that the itemized disclosure may be beneficial for investors in better
understanding the underwriting compensation paid and incentives that
may be present in the public offering. Recognizing commenters'
conflicting views, the proposed rule change would retain the current
requirements for itemized disclosure of underwriting compensation and
disclosing dollar amounts ascribed to each such item.\26\ The proposed
rule change would incorporate the requirements for disclosure of
specified material terms and arrangements that are consistent with
current practice.\27\
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    \26\ See proposed Rule 5110(b)(1) and Supplementary Material .05
to Rule 5110. See also proposed Rule 5110(e)(1)(B) requiring
disclosure of lock-ups.
    \27\ See proposed Supplementary Material .05 to Rule 5110.

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    The Notice 17-15 Proposal also included an explicit requirement to
disclose specified material terms and arrangements in the prospectus.
The current proposal includes the same obligation, which makes explicit
the existing practice of disclosing specified material terms and
arrangements related to underwriting compensation in the prospectus.
This explicit provision would require a description for: (1) Any ROFR
granted to a participating member and its duration; and (2) the
material terms and arrangements of the securities acquired by the
participating member (e.g., exercise terms, demand rights, piggyback
registration rights and lock-up periods).\28\
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    \28\ See proposed Supplementary Material .05 to Rule 5110.
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Underwriting Compensation
    The proposed rule change would clarify what is considered
underwriting compensation for purposes of Rule 5110. As an initial
matter, the proposed rule change would consolidate the various
provisions of the current Rule that address what constitutes
underwriting compensation into a single, new definition of
``underwriting compensation.'' Underwriting compensation would be
defined to mean ``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.'' \29\
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    \29\ See proposed Rule 5110(j)(22).
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    Rule 5110 currently provides that all items of value received or to
be received from any source are presumed to be underwriting
compensation when received during the period commencing 180 days before
the required filing date of the registration statement, and up to 90
days following the effectiveness or commencement of sales of a public
offering.\30\ However, this approach may not reflect the various types
of offerings subject to Rule 5110. For example, a best efforts offering
may be distributed for months or years and underwriters may receive
compensation throughout the offering period, or a base shelf
registration statement may become effective months or years before a
takedown offering for which an underwriter is compensated.
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    \30\ See current Rule 5110(d)(1). See also current Rule
5110(b)(6)(A)(vi)b. which provides that details of any new
arrangement entered into within 90 days following the date of
effectiveness or commencement of sales of the public offering must
be filed.
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    To better reflect the different types of offerings subject to Rule
5110, the proposed rule change would introduce the defined term
``review period'' and the applicable time period would vary based on
the type of offering. Specifically, the proposed rule change would
define the review period to mean: (1) For a firm commitment offering,
the 180-day period preceding the required filing date through the 60-
day period following the effective date of the offering; (2) for a best
efforts offering, the 180-day period preceding the required filing date
through the 60-day period following the final closing of the offering;
and (3) for a firm commitment or best efforts takedown or any other
continuous offering made pursuant to Securities Act Rule 415, the 180-
day period preceding the required filing date of the takedown or
continuous offering through the 60-day period following the final
closing of the takedown or continuous offering.\31\ Accordingly,
payments and benefits received during the applicable review period
would be considered in evaluating underwriting compensation.
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    \31\ See proposed Rule 5110(j)(20).
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    The proposed rule change would continue to provide two non-
exhaustive lists of examples of payments or benefits that would be and
would not be considered underwriting compensation.\32\ Although the
Rule would no longer incorporate the concept of ``items of value''
(i.e., the non-exhaustive list of payments and benefits that would be
included in the underwriting compensation calculation), the proposed
non-exhaustive lists are derived from the examples of payments or
benefits that currently are considered and not considered items of
value. The proposed examples of payments or benefits that would be
underwriting compensation is comparable to the list of items of value
in the current Rule with some additional clarifying changes. For
example, the proposed rule change would expand the current item of
value related to reimbursement of expenses to provide that fees and
expenses paid or reimbursed to, or paid on behalf of, the participating
members, including but not limited to road show fees and expenses and
due diligence expenses, would be underwriting compensation.\33\
Consistent with current practice, the proposed rule change would also
include in underwriting compensation non-cash compensation.\34\
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    \32\ See proposed Supplementary Material .01 to Rule 5110.
    \33\ See proposed Supplementary Material .01(a)(2) to Rule 5110.
See also proposed Supplementary Material .01(a)(3) and (4) to Rule
5110 which includes fees and expenses of participating members'
counsel and finder's fees paid or reimbursed to, or paid on behalf
of, the participating members (except for reimbursement of ``blue
sky'' fees) as underwriting compensation.
    \34\ See proposed Supplementary Material .01(a)(14) to Rule
5110.
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    The proposed examples of payments or benefits that would not be
underwriting compensation include several new examples to provide
greater clarity and to address questions raised by members. For
instance, in response to questions from members, the proposed rule
change would clarify that payments for records management and advisory
services received by members in connection with some corporate
reorganizations would not be considered underwriting compensation.\35\
Similarly, the proposed rule change would clarify that the payment or
reimbursement of legal costs resulting from a contractual breach or
misrepresentation by the issuer would not be considered underwriting
compensation.\36\ The proposed rule change also would clarify that
securities acquired pursuant to a governmental or court approved
proceeding or plan of reorganization as a result of action by the
government or court (e.g., bankruptcy or tax court proceeding) would
not be considered underwriting compensation.\37\ These payments are for
services beyond the traditional scope of underwriting activities and,
therefore, are appropriately excluded from the coverage of Rule 5110.
    In addition, to give members reasonable flexibility with respect to
issuer securities acquired in certain circumstances, the proposed rule
change would take a principles-based approach in considering whether
issuer securities acquired from third parties or in directed sales
programs may be excluded from underwriting compensation. This
principles-based approach starts with the presumption that the issuer
securities received during the review period would be underwriting
compensation. However, FINRA would consider the factors set forth in
proposed Supplementary Material to Rule 5110 and discussed below in
determining whether the securities may be excluded from

underwriting compensation.\38\ A participating member is responsible
for providing documents and information sufficient for FINRA to
consider in applying the factors to a particular securities
acquisition.
    With respect to issuer securities received from third parties, it
is important to note that the proposed definition of ``underwriting
compensation'' would include payments, rights, interests, or benefits
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.
However, some acquisitions of issuer securities from third parties for
purposes unconnected to underwriting compensation should not be deemed
underwriting compensation (e.g., securities acquired in ordinary course
transactions executed over a participating member's trading desk during
the review period from third parties).
    To address these situations, the proposed rule change uses a
principles-based approach to considering whether securities of the
issuer acquired from third parties may be excluded from underwriting
compensation. Specifically, under proposed Supplementary Material .03
to Rule 5110, FINRA would consider the following factors, as well as
any other relevant factors and circumstances: (1) The nature of the
relationship between the issuer and the third party, if any; (2) the
nature of the transactions in which the securities were acquired,
including, but not limited to, whether the transactions are engaged in
as part of the participating member's ordinary course of business; and
(3) any disparity between the price paid and the offering price or
market price.
    With respect to issuer securities acquired in directed sales
programs (commonly called friends and family programs), it is important
to note that the proposed definition of ``participating member''
includes any FINRA member that is participating in a public offering,
any affiliate or associated person of the member, and any immediate
family of an associated person of the member, but does not include the
issuer.\39\ However, associated persons and their immediate family
members may have relationships with issuers that motivate the issuer to
sell these persons shares in directed sales programs. These
acquisitions may be unrelated to the investment banking services
provided by the participating member.
    To address these situations, under the proposed rule change FINRA
would take a principles-based approach to considering whether an
acquisition of securities by a participating member pursuant to an
issuer's directed sales program may be excluded from underwriting
compensation. Specifically, under proposed Supplementary Material .04
to Rule 5110, FINRA would consider the following factors, as well as
any other relevant factors and circumstances: (1) The existence of a
pre-existing relationship between the issuer and the person acquiring
the securities; (2) the nature of the relationship; and (3) whether the
securities were acquired on the same terms and at the same price as
other similarly-situated persons participating in the directed sales
program.
Venture Capital Exceptions
    Rule 5110 currently provides exceptions designed to distinguish
securities acquired in bona fide venture capital transactions from
those acquired as underwriting compensation (for brevity, referred to
herein as the ``venture capital exceptions'').\40\ Recognizing that
bona fide venture capital transactions contribute to capital formation,
the proposed rule change would modify, clarify and expand the
exceptions to further facilitate members' participation in bona fide
venture capital transactions. Importantly, the venture capital
exceptions would include several restrictions to ensure the protection
of other market participants and that the exceptions are not misused to
circumvent the requirements of Rule 5110.
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    \35\ See proposed Supplementary Material .01(b)(3) to Rule 5110.
    \36\ See proposed Supplementary Material .01(b)(4) to Rule 5110.
    \37\ See proposed Supplementary Material .01(b)(22) to Rule
5110. See also comments from ABA, Davis Polk and SIFMA discussed in
Item II.C. infra.
    \38\ See proposed Supplementary Material .03 and .04 to Rule
5110.
    \39\ See proposed Rule 5110(j)(15).
    \40\ See current Rule 5110(d)(5).
---------------------------------------------------------------------------

    The proposed rule change would no longer treat as underwriting
compensation securities acquisitions covered by two of the current
exceptions: (1) Securities acquisitions and conversions to prevent
dilution; and (2) securities purchases based on a prior investment
history. This treatment is conditioned on prior investments in the
issuer occurring before the review period. When subsequent securities
acquisitions take place (e.g., as a result of a stock split, a right of
preemption, a securities conversion, or when additional securities are
acquired to prevent dilution of a long-standing interest in the
issuer), the acquisition of the additional securities should not be
treated as underwriting compensation. Accordingly, the proposed rule
change would add these acquisitions to the list of examples of payments
that are not underwriting compensation because they are based on a
prior investment history and are subject to the terms of the original
securities that were acquired before the review period.\41\
---------------------------------------------------------------------------

    \41\ See proposed Supplementary Material .01(b)(14), (16-18).
---------------------------------------------------------------------------

    The proposed rule change also would broaden two of the current
venture capital exceptions regarding purchases and loans by certain
affiliates, and investments in and loans to certain issuers, by
removing a limitation on acquiring more than 25 percent of the issuer's
total equity securities.\42\ The 25 percent threshold limits each
member and its affiliates from acquiring more than 25 percent of the
issuer's total equity securities, which typically establishes a control
relationship. The threshold, which was codified in 2004, provided
protection from overreaching by members at a time when there was a
concern about limiting the aggregate amount of equity acquired in pre-
offering transactions. Subsequent regulatory changes in other areas,
such as the 2009 revision of Rule 5121 regarding public offerings with
a conflict of interest,\43\ have added protections and are more
appropriate to address acquisitions that create control relationships.
---------------------------------------------------------------------------

    \42\ See proposed Rule 5110(d)(1) and (2).
    \43\ Rule 5121 requires prominent disclosure of conflicts and,
for certain types of conflicts, the participation of a qualified
independent underwriter (``QIU'') in the preparation of the
registration statement.
---------------------------------------------------------------------------

    These venture capital exceptions specify that the affiliate must be
primarily in the business of making investments or loans. The proposed
rule change expands the scope of these exceptions to include that the
affiliate, directly or through a subsidiary it controls, must be in
such business and further permits that the entity may be newly formed
by such affiliate. Expanding the scope of the exceptions to cover
direct, indirect or newly formed entities that are in the business of
making investments and loans acknowledges the different structures that
may be used to participate in bona fide venture capital
transactions.\44\
---------------------------------------------------------------------------

    \44\ See proposed Rule 5110(d)(1)(D) and (d)(2)(A)(iv).
---------------------------------------------------------------------------

    Another venture capital exception relates to private placements
with institutional investors. The exception would be available only
when the institutional investors participating in the offering are not
affiliates of a FINRA member. This ensures that such institutional
investors are independent

sources of capital. The provision is further clarified to require that
the institutional investors must purchase at least 51 percent of the
total number of securities sold in the private placement at the same
time and on the same terms. In addition, the proposed rule change would
raise the percent that participating members in the aggregate may
acquire from 20 to 40 percent of the securities sold in the private
placement.\45\ These private placements typically occur before the
syndicate is formed and, therefore, members may not know at the time
whether their participation in the private placement would impact the
issuer's future public offering by triggering the threshold. Because
exceeding the threshold would subject members to the compensation
limits, disclosure provisions and lock-up provisions of the Rule, the
current 20 percent threshold reduces the number of members available
for the syndicate. Increasing the threshold would allow more members to
participate in the private placement and any subsequent public
offering. An increase in the threshold is appropriate and raising it to
40 percent: (1) Would not materially change the operation of the
exception, as the securities acquired in the private placement would
remain subject to the other conditions in the exception; and (2) would
benefit issuers that are in the process of assembling a syndicate.
---------------------------------------------------------------------------

    \45\ See proposed Rule 5110(d)(3)(C).
---------------------------------------------------------------------------

    In response to comments to the Notice 17-15 Proposal, the proposed
rule change would expand the scope of proposed Rule 5110(d)(3) to
include providing services for a private placement (rather than just
acting as a placement agent).\46\ Members' roles in acting as placement
agents and in providing other services in private placements (e.g.,
acting as a finder or a financial advisor) similarly facilitate
offerings. As such, expanding the current venture capital exception
beyond securities received for acting as a placement agent to include
securities received for providing services for a private placement is
appropriate.
---------------------------------------------------------------------------

    \46\ See proposed Rule 5110(d)(3) and Item II.C. infra.
---------------------------------------------------------------------------

    Where a highly regulated entity with significant disclosure
requirements and independent directors who monitor investments is also
making a significant co-investment in an issuer and is receiving
securities at the same price and on the same terms as the participating
member, the securities acquired by the participating member in a
private placement are less likely to be underwriting compensation. To
address such co-investments, the proposed rule change would adopt a new
venture capital exception from underwriting compensation for securities
acquired in a private placement before the required filing date of the
public offering by a participating member if at least 15 percent of the
total number of securities sold in the private placement were acquired,
at the same time and on the same terms, by one or more entities that is
an open-end investment company not traded on an exchange, and no such
entity is an affiliate of a FINRA member participating in the offering.
These conditions lessen the risk that the co-investment would be made
for the purpose of providing undervalued securities to a participating
member in return for acting as an underwriter.
    A public offering may be significantly delayed for legitimate
reasons (e.g., unfavorable market conditions) and during this delay the
issuer may require funding. Furthermore, a member may make bona fide
investments in or loans to the issuer during this delay to satisfy the
issuer's funding needs and any securities acquired as a result of this
funding may be unrelated to the anticipated public offering. The
proposed rule change would provide some additional flexibility in the
availability of the venture capital exceptions for securities acquired
where the public offering has been significantly delayed.
    The proposed rule change would take a principles-based approach
where a public offering has been significantly delayed and the issuer
needs funding in considering whether it is appropriate to treat as
underwriting compensation securities acquired by a member after the
required filing date in a transaction that, except for the timing,
would otherwise meet the requirements of a venture capital exception.
This principles-based approach starts with the presumption that the
venture capital exception would not be available where the securities
were acquired after the required filing date. However, FINRA would
consider the factors in proposed Supplementary Material .02 in
determining whether securities acquired in a transaction that occurs
after the required filing date, but otherwise meets the requirements of
a venture capital exception, may be excluded from underwriting
compensation.
    Specifically, FINRA would consider the following principles, as
well as any other relevant factors and circumstances: (1) The length of
time between the date of filing of the registration statement or
similar document and the date of the transaction in which securities
were acquired; (2) the length of time between the date of the
transaction in which the securities were acquired and the anticipated
commencement of the public offering; and (3) the nature of the funding
provided, including, but not limited to the issuer's need for funding
before the public offering. A participating member is responsible for
providing documents and information sufficient for FINRA to consider in
applying the principles to a particular securities acquisition.
Treatment of Non-Convertible or Non-Exchangeable Debt Securities and
Derivatives
    The proposed rule change would clarify the treatment of non-
convertible or non-exchangeable debt securities and derivative
instruments.\47\ The proposed rule change would expressly provide 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.\48\ Accordingly, the non-
convertible or non-exchangeable debt securities and derivative
instruments acquired in a transaction unrelated to a public offering
would not be subject to Rule 5110 (i.e., a description of the non-
convertible or non-exchangeable debt securities and derivative
instruments need not be filed with FINRA,\49\ there are no valuation-
related requirements and the lock-up restriction does not apply).
---------------------------------------------------------------------------

    \47\ Consistent with the current Rule, the proposed rule change
would define the term ``derivative instrument'' to mean any eligible
OTC derivative instrument as defined in Exchange Act Rule 3b-
13(a)(1), (2) and (3). See proposed Supplementary Material .06(b) to
Rule 5110.
    \48\ See proposed Supplementary Material .01(b)(19) to Rule
5110.
    \49\ See proposed Rule 5110(a)(4)(B)(iv)b.
---------------------------------------------------------------------------

    In contrast, non-convertible or non-exchangeable debt securities
and derivative instruments acquired in a transaction related to a
public offering would be underwriting compensation. For any non-
convertible or non-exchangeable debt securities and derivative
instruments acquired in a transaction related to the public offering,
the proposed rule change would clarify that: (1) A description of those
securities and derivative instruments must be filed with FINRA; and (2)
this description must be accompanied by 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.\50\
---------------------------------------------------------------------------

    \50\ See proposed Rule 5110(a)(4)(B)(iv)a. Generally consistent
with current Rule 5110, the proposed rule change would define the
term ``fair price'' to mean the participating members have priced a
derivative instrument or non-convertible or non-exchangeable debt
security in good faith; on an arm's length, commercially reasonable
basis; and in accordance with pricing methods and models and
procedures used in the ordinary course of their business for pricing
similar transactions. The proposed rule change would also clarify
that a derivative instrument or other security received as
compensation for providing services for the issuer, for providing or
arranging a loan, credit facility, merger, acquisition or any other
service, including underwriting services will not be deemed to be
entered into or acquired at a fair price. See proposed Supplementary
Material .06(b) to Rule 5110.

---------------------------------------------------------------------------

    The proposed rule change would also clarify that the valuation
depends upon whether the non-convertible or non-exchangeable debt
securities or derivative instruments acquired in a transaction related
to a public offering were or were not acquired at a fair price.
Specifically, the proposed rule change would clarify that non-
convertible or non-exchangeable debt securities and derivative
instruments acquired at a fair price would be considered underwriting
compensation but would have no compensation value. In contrast, the
proposed rule change would provide that non-convertible or non-
exchangeable debt securities and derivative instruments not acquired at
a fair price would be considered underwriting compensation and subject
to the normal valuation requirements of Rule 5110.\51\
---------------------------------------------------------------------------

    \51\ See proposed Supplementary Material .06(a) to Rule 5110 and
proposed Rule 5110(c).
---------------------------------------------------------------------------

    The following charts provide an overview of the treatment of non-
convertible or non-exchangeable debt securities and derivative
instruments under Rule 5110.
[GRAPHIC] [TIFF OMITTED] TN01MY19.000

Lock-Up Restrictions
    Subject to some exceptions, Rule 5110 requires in any public equity
offering a 180-day lock-up restriction on securities that are
considered underwriting compensation. During the lock-up period,
securities that are underwriting compensation are restricted from sale
or transfer and may not be pledged as collateral or made subject to any
derivative contract or other transaction that provides the effective
economic benefit of sale or other prohibited disposition.\52\ Because a
prospectus may become effective long before the commencement of sales,
the proposed rule change would provide that the lock-up period begins
on the date of commencement of sales of the public equity offering
(rather than the date of effectiveness of the prospectus).\53\ The
proposed rule change also would provide that the lock-up restriction
must be disclosed in the section on distribution arrangements in the
prospectus or similar document consistent with proposed Supplementary
Material .05 requiring disclosure of the material terms of any
securities.\54\
---------------------------------------------------------------------------

    \52\ Consistent with the current Rule, securities acquired by a
member that are not considered underwriting compensation would not
be subject to the lock-up restrictions of Rule 5110.
    \53\ See proposed Rule 5110(e)(1)(A).
    \54\ See proposed Rule 5110(e)(1)(B).
---------------------------------------------------------------------------

    The proposed rule change would add exceptions from the lock-up
restriction for clarity or to except securities where other protections
or market forces obviate the need for the restriction. Due to the
existing public market for securities of the issuers, the proposed rule
change would add an exception from the lock-up restriction for
securities acquired from an issuer that meets the registration
requirements of SEC Registration Forms S-3, F-3 or F-10.\55\ The
proposed rule change would also add an exception from the lock-up
restriction for securities that were acquired in a transaction meeting
one of Rule 5110's venture capital exceptions.\56\ While these
securities would not be considered underwriting compensation and, thus,
not subject to the lock-up restriction, the exception would provide
additional clarity with respect to these securities.
---------------------------------------------------------------------------

    \55\ See proposed Rule 5110(e)(2)(A)(iii).
    \56\ See proposed Rule 5110(e)(2)(A)(vi).
---------------------------------------------------------------------------

    The proposed rule change would also add 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.\57\ This is intended to give some flexibility to members in
selling securities received as underwriting compensation, while
limiting the proposed exception to firm commitment offerings where the
underwriter has assumed the risk of

marketing and distributing an offering that includes securities the
underwriter received as underwriting compensation. In addition, firm
commitment offers are usually marketed and sold to institutional
investors, who typically purchase a majority of the shares in such
offerings.
---------------------------------------------------------------------------

    \57\ See proposed Rule 5110(e)(2)(A)(viii) and Item II.C.
discussion infra.
---------------------------------------------------------------------------

    The proposed rule change would provide clarity about the treatment
of non-convertible or non-exchangeable debt securities and derivative
instruments acquired in transactions related to a public offering.\58\
The following charts provide an overview of the application of Rule
5110's lock-up requirement to non-convertible or non-exchangeable debt
securities and derivative instruments.
---------------------------------------------------------------------------

    \58\ See proposed Rule 5110(e)(2)(A)(iv).
    [GRAPHIC] [TIFF OMITTED] TN01MY19.001

    The proposed rule change also addresses members' acquisition of
derivative instruments in connection with hedging transactions related
to a public offering. For example, fixed-for-floating swaps are
commonly used in hedging transactions in connection with offerings of
debt securities. These hedging transactions would not be effective if
the derivative securities were subject to lock-up restrictions.
Accordingly, the proposed rule change would provide that the lock-up
restriction does not apply to derivative instruments acquired in
connection with a hedging transaction related to the public offering
and at a fair price.\59\ Derivative instruments acquired in
transactions related to the public offering that do not meet the
requirements of the exception would continue to be subject to the lock-
up restriction.
---------------------------------------------------------------------------

    \59\ See proposed Rule 5110(e)(2)(A)(v).
---------------------------------------------------------------------------

    In addition, the proposed rule change would add an exception to the
lock-up restriction to permit the transfer or sale of the security back
to the issuer in a transaction exempt from registration with the
SEC.\60\ These transactions do not put selling pressure on the
secondary market that the lock-up is designed to prevent. The proposed
rule change would also modify the lock-up exception in current Rule
5110(g)(2)(A)(ii) to permit the transfer of any security to the
member's registered persons or affiliates if all transferred securities
remain subject to the restriction for the remainder of the lock-up
period.\61\
---------------------------------------------------------------------------

    \60\ See proposed Rule 5110(e)(2)(B)(iii).
    \61\ See proposed Rule 5110(e)(2)(B)(i). The proposed rule
change would retain the current exception to the lock up for the
exercise or conversion of any security, if all such securities
received remain subject to the lock-up restriction for the remainder
of the 180-day lock-up period. See proposed Rule 5110(e)(2)(B)(ii).
---------------------------------------------------------------------------

    Finally, because proposed Supplementary Material .01(b)(20) would
provide that securities acquired subsequent to the issuer's IPO in a
transaction exempt from registration under Securities Act Rule 144A
would not be underwriting compensation, the proposed rule change would
correspondingly delete as unnecessary the current exception from the
lock-up restriction for those securities.\62\
---------------------------------------------------------------------------

    \62\ See current Rule 5110(g)(2)(A)(viii).
---------------------------------------------------------------------------

Prohibited Terms and Arrangements
    Rule 5110 includes a list of prohibited unreasonable terms and
arrangements in connection with a public offering of securities. The
proposed rule change would clarify and amend the list, such as
clarifying the scope of relevant activities that would be deemed
related to the public offering \63\ and referring to the commencement
of sales of the public offering (rather than the date of effectiveness)
in relation to the receipt of underwriting compensation consisting of
any option, warrant or convertible security with specified terms.\64\
---------------------------------------------------------------------------

    \63\ See proposed Rule 5110(g)(11). Specifically, to clarify the
scope, the proposed rule change 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.''
    \64\ See proposed Rule 5110(g)(8).
---------------------------------------------------------------------------

    The proposed rule change would 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: (1) An advance against accountable expenses actually
anticipated to be incurred, which must be reimbursed to the issuer to
the extent not actually incurred; or (2) 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.\65\ The proposed rule change
recognizes the practical issue that certain fees and expenses,
including advisor or consultant fees, may be incurred before the
offering is sold and allows such fees so long as the services are in
connection with an offering that is completed in accordance with the
agreement between the issuer and the participating member.
---------------------------------------------------------------------------

    \65\ See proposed Rule 5110(g)(4).
---------------------------------------------------------------------------

    The proposed rule change would also simplify a provision that
relates to payments made by an issuer to waive or terminate a ROFR to
participate in a

future capital-raising transaction.\66\ The application of this
provision has been challenging for members, particularly in
circumstances where the terms of the future offering had not been
negotiated at the time of the proposed public offering. The proposed
rule change would, however, retain the prohibition on any non-cash
payment or fee to waive or terminate a ROFR.\67\
---------------------------------------------------------------------------

    \66\ See current Rule 5110(f)(2)(F)(i).
    \67\ See proposed Rule 5110(g)(7).
---------------------------------------------------------------------------

Defined Terms
    In addition to consolidating the defined terms in one location at
the end of the Rule, the proposed rule change would simplify and
clarify Rule 5110's defined terms. Most notably, the proposed rule
change would make the terminology more consistent throughout the Rule's
various provisions. For example, the proposed rule change would
consolidate the various provisions of the current Rule that address
what constitutes underwriting compensation into a single, new
definition of ``underwriting compensation.'' \68\
---------------------------------------------------------------------------

    \68\ See proposed Rule 5110(j)(22).
---------------------------------------------------------------------------

    The proposed rule change would also add consistency and clarity to
the scope of persons covered by the Rule. Rule 5110 currently
alternates between using the defined term ``underwriter and related
persons'' (which includes underwriter's counsel, financial consultants
and advisors, finders, any participating member, and any other persons
related to any participating member) \69\ and the defined term
``participating member'' (which includes any FINRA member that is
participating in a public offering, any affiliate or associated person
of the member and any immediate family).\70\ The proposed rule change
would eliminate the term ``underwriter and related persons'' and
instead use the defined term ``participating member.'' However, the
proposed definition of underwriting compensation would ensure that the
Rule continues to address fees and expenses paid to persons previously
covered by the term ``underwriter and related persons'' (e.g.,
underwriter's counsel fees and expenses, financial consulting and
advisory fees and finder's fees).\71\
---------------------------------------------------------------------------

    \69\ See current Rule 5110(a)(6).
    \70\ See current Rule 5110(a)(4).
    \71\ Substantively consistent with the current Rule, the
proposed rule change would define ``participating member'' to
include any FINRA member that is participating in a public offering,
any affiliate or associated person of the member, and any
``immediate family,'' but does not include the issuer. See proposed
Rule 5110(j)(15). While not included in the ``participating member''
definition, the broad definition of underwriting compensation would
include underwriter's counsel fees and expenses, financial
consulting and advisory fees and finder's fees. As such, the
definition of underwriting compensation would ensure that the Rule
addresses fees and expenses paid to persons previously covered by
the term ``underwriter and related persons.'' In addition, the term
``immediate family'' is clarified for readability in proposed Rule
5110(j)(8) to mean the spouse or child of an associated person of a
member and any relative who lives with, has a business relationship
with, or provides to or receives support from an associated person
of a member.
---------------------------------------------------------------------------

    The proposed rule change would move the definition of ``public
offering'' from Rule 5121 to Rule 5110.\72\ The term ``public
offering'' is used frequently in Rule 5110 and moving it into the Rule
should simplify compliance. The definition would be modified to add
``made in whole or in part in the United States'' to clarify the
jurisdictional scope of the definition. The proposed rule change would
also move, without modification, the definition of ``Net Offering
Proceeds'' from Rule 5110 to Rule 5121 because the term is used only in
Rule 5121.\73\
---------------------------------------------------------------------------

    \72\ See proposed Rule 5110(j)(18). Rule 5121 would incorporate
the definition in Rule 5110 by reference. See Rule 5121(f).
    \73\ See proposed Rule 5121(f)(9).
---------------------------------------------------------------------------

    In addition, the proposed rule change would modernize Rule 5110's
language (e.g., by replacing references to specific securities
exchanges to instead reference the definition of ``national securities
exchange'' in the Exchange Act). Furthermore, the proposed rule change
would include new defined terms to provide greater predictability for
members in applying the Rule (e.g., ``associated person,''
``experienced issuer,'' \74\ ``equity-linked securities,''
``overallotment option'' and ``review period'').
---------------------------------------------------------------------------

    \74\ As discussed supra, the proposed rule change would delete
references to the pre-1992 standards for Form S-3 and standards
approved in 1991 for Form F-10 and instead codify the requirement
that the issuer have a 36-month reporting history and at least $150
million aggregate market value of voting stock held by non-
affiliates. (Alternatively, $100 million or more aggregate market
value of voting stock held by non-affiliates and an annual trading
volume of at least three million shares). Issuers meeting this
standard would be defined as ``experienced issuers'' and their
public offerings would be exempt from filing, but subject to the
substantive provisions of Rule 5110. See proposed Rule 5110(j)(6).
---------------------------------------------------------------------------

    The proposed rule change would incorporate the definition of
``associated person'' in Article I, Section (rr) of the FINRA By-Laws.
In response to comments on the Notice 17-15 Proposal, the proposed rule
change would also harmonize the definition of bank in the proposed
venture capital exceptions and the exemption in proposed Rule
5110(h)(1). Specifically, the proposed rule change would state that a
bank is ``a bank as defined in Exchange Act Section 3(a)(6) or is a
foreign bank that has been granted an exemption under this Rule and
shall refer only to the regulated entity, not its subsidiaries or other
affiliates.'' In addition, in response to comments and to clarify the
scope of covered persons, the proposed rule change would revise the
issuer definition to refer to the ``registrant or other person''
(rather than ``entity'' as initially proposed in the Notice 17-15
Proposal).
Valuation of Securities
    Rule 5110 currently prescribes specific calculations for valuing
convertible and non-convertible securities received as underwriting
compensation. Rather than the specific calculations in the current
Rule, the Notice 17-15 Proposal would have instead allowed valuing
options, warrants and other convertible securities received as
underwriting compensation based on a securities valuation method that
is commercially available and appropriate for the type of securities to
be valued (e.g., the Black-Scholes model for options). As discussed in
Item II.C. infra, commenters had conflicting views on the proposed
change to the valuation formula and did not provide any information
regarding alternative commercially available valuation methods that may
be used by members. As a result, the proposed rule change would retain
the current methods for valuing options, warrants and other convertible
securities received as underwriting compensation in the current
Rule.\75\
---------------------------------------------------------------------------

    \75\ See proposed Rule 5110(c).
---------------------------------------------------------------------------

    If the Commission approves the proposed rule change, FINRA will
announce the implementation date of the proposed rule change in a
Regulatory Notice to be published no later than 60 days following
Commission approval. The implementation date will be no later than 180
days following publication of the Regulatory Notice announcing
Commission approval.
2. Statutory Basis
    The proposed rule change is consistent with the provisions of
Section 15A(b)(6) of the Act,\76\ 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.
---------------------------------------------------------------------------

    \76\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The proposed rule change would facilitate capital formation by

modernizing Rule 5110. The proposed rule change would simplify the
provisions of the Rule, make it more comprehensible, and improve its
administration.
    For example, the proposed rule change is expected to clarify what
is considered ``underwriting compensation.'' In addition, the proposed
rule change would make the venture capital exceptions more available to
members and not impinge on bona fide investments in, and loans to,
issuers. In general, the proposed rule change would provide members
with greater operational and financial flexibility, and reduce
compliance costs.
    The proposed rule change would maintain important protections for
issuers and investors participating in offerings. The proposed rule
change also would not decrease its ability to oversee underwriting
terms and arrangements.
    In totality, the proposed rule change would reduce the
administrative and operational burdens for members and FINRA, promote
regulatory efficiency, and enhance market functioning while maintaining
issuer and investor protection.

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

    FINRA does not believe that the proposed rule change would result
in any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. All members would be subject to
the proposed amendments.
Economic Impact Assessment
    FINRA considered the economic impacts on members when devising the
proposed rule change. A discussion of the economic impacts is below.
Regulatory Need
    Rule 5110 was last revised in 2004, and since then the capital
markets and financial activities of member firms have continued to
evolve.\77\ The proposed change would modernize Rule 5110 through a
range of amendments. The proposed change would simplify and clarify the
Rule, and better align the Rule with current market practices.
---------------------------------------------------------------------------

    \77\ See 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).
---------------------------------------------------------------------------

Economic Baseline
    The economic baseline for the proposed rule change is current Rule
5110 and its interpretation by FINRA. The proposed rule change is
expected to affect participating members, issuers and investors that
participate in public offerings.
    Rule 5110 regulates the underwriting terms and arrangements in
connection with the public offering of securities. The primary function
of the Rule is to protect issuers (and their investors at the time of
the offering) from unfair underwriting terms and arrangements. Unfair
underwriting terms and arrangements increase the costs to issuers of
raising capital, potentially leading to a less efficient allocation of
capital and thereby imposing a restriction on issuers that need to
access capital markets.
    The Rule also provides protections for issuers and investors
through lock-up restrictions. The restrictions reduce the ability of
participating members to utilize the information they gather as part of
the underwriting process to opportunistically sell the securities they
acquire as compensation in the secondary market (i.e., informed
selling).\78\ The lock-up restrictions thereby decrease the likelihood
that participating members use the securities to extract undue
compensation from issuers, and decrease the likelihood that investors
in the secondary market purchase securities when the securities are
overvalued. The exposure of investors to informed selling decreases as
time elapses and more information about the issuer becomes available.
---------------------------------------------------------------------------

    \78\ Participating members may have greater ability to engage in
informed selling soon after the commencement of sales when they may
have additional information than other market participants. As more
information becomes publicly available, the ability of participating
members to engage in informed selling decreases.
---------------------------------------------------------------------------

    Member firms that participate in offerings, however, incur costs to
comply with Rule 5110. The costs to members include filing and
disclosure requirements, limits to direct and indirect compensation,
and restrictions on financial and investment activities. These costs
decrease the return to members when participating in offerings.
    Rule 5110 requires participating members to file documents and
information with FINRA. FINRA reviews the information to determine
whether underwriting terms and arrangements meet the requirements of
the Rule. To the extent possible, this economic impact analysis will
quantify the economic effects of the proposed rule change using the
information that FINRA collects through its administration of Rule
5110. The analysis will otherwise discuss the economic effects
qualitatively.
    In 2017, FINRA received 1,553 filings related to public offerings
(covering both equity and debt securities). The filings represent at
least 274 members and 1,071 issuers. The total amount of offering
proceeds of the filings were over $151 billion, with a median value of
approximately $38 million per filing.\79\
---------------------------------------------------------------------------

    \79\ The 1,553 filings include shelf offerings. FINRA does not
require filing, in all cases, the total amount of offering proceeds
related to these filings.
---------------------------------------------------------------------------

    Currently, members that participate in fewer offerings are likely
to incur higher marginal costs to interpret and comply with Rule 5110.
In 2017, the median number of filings in which a member participated
was three. This means that approximately half of the members (148 of
274 members) participated in three or fewer offerings. In addition, a
large number of these members (85) participated in only one
offering.\80\
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    \80\ In addition, approximately one-quarter of members (71)
participated in ten or more offerings, whereas ten percent of
members (27) participated in 50 or more offerings. The maximum
number of offerings that any one member participated in was 155.
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Economic Impact
    The proposed amendments would directly impact member firms that
regularly engage in underwriting, issuers that engage member firms for
those services, and the investors that seek to participate in those
offerings. This economic impact analysis seeks to identify the broad
impacts associated with modernizing Rule 5110, as well as specific
amendments related to the acquisition of securities, lock-up
restrictions, filing requirements, and exemptions for offerings that
relate to highly regulated entities.
Modernization
    Overall, the proposed change would modernize Rule 5110 by
simplifying and clarifying its provisions, and by increasing the
consistency of the Rule with current practice. The simplification and
clarification of the Rule would decrease the compliance costs of member
firms that participate in offerings. The decrease in compliance costs
includes the time and expense of internal employees to interpret the
Rule, as well as the potential expenses associated with outside legal
counsel or other outside experts. The simplification and clarification
would also decrease the opportunity costs to participating members from
not acquiring securities so as to not violate the permitted
compensation arrangements under the Rule. Members that participate in
fewer offerings would experience a greater decrease in marginal costs
from the proposed rule changes.

    As a result of the simplification and clarification of Rule 5110,
the underwriting terms and arrangements members negotiate with issuers
are more likely to be in compliance with the Rule, and the documents
and information members file with FINRA are more likely to meet the
regulatory requirements of the rule. This may decrease the amount of
time that FINRA needs to evaluate the underwriting terms and
arrangements and provide an opinion. A decrease in the time needed for
FINRA to provide an opinion could potentially enhance the ability of
issuers to access capital markets faster provided the concurrent review
conducted by the SEC staff has concluded and an offering can be
declared effective.
Securities Acquisitions Not Considered Underwriting Compensation
    The proposed rule change addresses whether the securities and
derivative instruments that participating members acquire are
considered underwriting compensation. The amendments relate to
securities acquired from third parties for purposes unrelated to
underwriting compensation, investments or loans to the issuer when a
public offering has been significantly delayed, and non-convertible or
non-exchangeable debt securities and derivative instruments unrelated
to a public offering.\81\ The amendments also broaden two current
venture capital exceptions, and adopt a new venture capital
exception.\82\
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    \81\ See proposed Supplementary Material .02, .03, .04, and .06
to Rule 5110.
    \82\ See proposed Rule 5110(d)(1), (2), and (4). Among the 1,553
filings FINRA received relating to public offerings in 2017, 17 (one
percent of 1,553) relate to the current venture capital exceptions
under 5110(d)(5).
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    In general, the proposed rule change would provide participating
members additional flexibility and clarity with respect to whether the
securities and derivative instruments they acquire would be subject to
the compensation limits and lock-up restrictions of Rule 5110. The
proposed rule change would therefore decrease the constraints on
participating members to engage in transactions in the ordinary course
of business and obtain the commissions and trading profits therefrom.
The proposed rule change would also decrease the constraints on
participating members to engage in hedging transactions and thereby
manage their risk exposures.
    The venture capital exceptions would increase the total percentage
of shares that participating members may acquire without being
considered underwriting compensation under Rule 5110, and as a result
may increase the number of members that participate in an offering. The
proposed amendments to the venture capital exceptions, therefore, would
increase the number of financial options and amount of capital
available for issuers. The proposed amendments may also improve the
market for offerings.\83\ The venture capital exceptions would thereby
promote capital formation.
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    \83\ See Shane A. Corwin & Paul Shultz, The Role of IPO
Underwriting Syndicates: Pricing, Information Production, and
Underwriter Competition, 60(1) Journal of Fin. 443-486 (2005). The
authors find that larger syndicates increase information production,
analyst coverage, and the number of market makers following the
offering.
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    Conversely, the proposed amendments to the venture capital
exceptions allowing underwriters to acquire additional securities not
considered underwriting compensation may increase potential conflicts
of interest. These acquisitions may create a control relationship,
potentially resulting in a participating member having a conflict of
interest and increasing the costs to issuers and investors.\84\
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    \84\ One commenter expressed concern that removing the
restriction in current Rule 5110(d)(5)(A) and (B) may increase the
potential for conflicts of interest to arise. See NASAA.
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    Two requirements, however, serve to mitigate against these
potential costs to issuers. FINRA Rule 5121 specifically addresses the
conflicts of interest of participating members and requires disclosure
of the conflicts. Further, the proposed amendments also include a
requirement that the securities participating members acquire is at the
same price and with the same terms as the securities purchased by all
other investors. This is intended to ensure that the securities
participating members acquire are not for providing undervalued
securities as a form of underwriting compensation.
    An increase in the percentage of shares that participating members
acquire that is not subject to Rule 5110 may also impose costs on
investors. The securities and derivative instruments that participating
members acquire would not be subject to lock-up restrictions, and may
increase the exposure of investors in the secondary market to informed
selling. As described in further detail below and subject to some
exceptions, the proposed rule change would decrease investor exposure
to informed selling by amending the lock-up restrictions under the
Rule.
Lock-up Restrictions
    The proposed rule change would specify that, consistent with
current practice, the lock-up period begins on the date of commencement
of sales instead of the date of effectiveness of the prospectus.\85\
This would ensure that at least 180 days must pass after the
commencement of sales before participating members may sell the
securities that they receive as underwriting compensation. This
amendment would only impose economic effects on offerings that
otherwise would have begun the lock-up period on the date of the
effectiveness of the prospectus. For these offerings, investors would
have a longer exposure to informed selling from the date of the
commencement of sales, and participating members would have a longer
exposure to fluctuations in security values from the date of the
commencement of sales. In the experience of FINRA staff, however, any
longer exposure would be minimal.
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    \85\ See proposed Rule 5110(e)(1)(A).
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    The proposed rule change would provide exceptions to the lock-up
restrictions.\86\ Although the exceptions to the lock-up restrictions
would provide flexibility and reduce the investment risk of
participating members, the exceptions may also increase the exposure of
investors to informed selling. The scope of the proposed exceptions,
however, reduce the likelihood that investors purchasing the securities
would be at an informational disadvantage. One exception is for
securities acquired from an issuer that meet the registration
requirements of SEC Registration Forms S-3, F-3 or F-10. These
registration requirements relate to issuers with existing public
markets for their securities. Other proposed exceptions to the lock-up
provisions are for sales as part of a firm commitment offering (which
are usually marketed and sold to institutional investors) and sales
back to the issuer.\87\
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    \86\ See proposed Rule 5110(e)(2)(A)(iii) and (viii), and
(B)(iii).
    \87\ Among the 1,553 filings FINRA received relating to public
offerings in 2017, 778 relate to firm commitment offerings. The
proceeds of the offerings were over $110 billion, or approximately
three-quarters of the total proceeds relating to all filings. The
median proceeds were $60 million. The largest maximum proposed
offering proceeds registered was $2.7 billion. Information
describing issuers that meet the registration requirements of SEC
Registration Forms S-3, F-3 or F-10 or sales back to the issuer is
not available.
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Filing Requirements
    In general, the proposed rule change would decrease or streamline
the filing requirements of participating members. For example, unless
otherwise required by FINRA, participating members would not be
required to provide documents relevant to the underwriting terms and

arrangements if industry-standard master forms of agreement are used.
In addition, participating members would not be required to submit
amendments to previously filed documents unless the changes impact the
underwriting terms and arrangements.\88\ The decrease in filing
requirements would decrease the compliance costs of participating
members. The costs for members include the time and expense of legal
counsel and other internal staff to prepare and submit the filings.
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    \88\ See proposed Rule 5110(a)(4)(A) and (E).
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    The proposed changes in filing requirements would decrease the
documents and information that participating members file with FINRA.
FINRA does not believe, however, that the decrease in the documents and
information it receives would reduce its ability to evaluate
underwriting terms and arrangements and provide protections to issuers
and investors. The documents and information are often duplicative or
otherwise unnecessary, or can be accessed through other means.\89\
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    \89\ For example, proposed Rule 5110(a)(4)(E) would streamline
the filing requirements for shelf offerings. A participating member
would file the Securities Act registration number, and the documents
and information set forth in proposed Rule 5110(a)(4)(A) and (B)
only if specifically requested by FINRA. Otherwise, FINRA would
access the base shelf registration statement, amendments, and
prospectus supplements through the SEC's EDGAR system to conduct the
review.
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    In some instances, however, the proposed rule change would increase
the filing requirements of participating members. For example, a new
provision would require participating members of terminated offerings
to provide written notification of all underwriting compensation
received or to be received.\90\ The new requirements would increase the
costs to participating members to file documents and information with
FINRA. The new requirements, however, would increase the ability of
FINRA to oversee underwriting terms and arrangements, and provide
protections to issuers and investors.
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    \90\ See proposed Rule 5110(a)(4)(C) and proposed Rule
5110(g)(5).
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Exemptions for Highly Regulated Entities
    Lastly, the proposed rule change would expand the current list of
offerings that are exempt from its filing requirements and its
substantive provisions.\91\ The offerings relate to highly regulated
entities whose offering terms would continue to be subject to FINRA
Rule 2341. The regulatory protections for issuers and investors would
therefore remain, but participating members would no longer incur the
costs to comply with Rule 5110.
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    \91\ See proposed Rule 5110(h)(2)(E), (K), and (L). The proposed
Rule would also clarify that securities of banks that have
qualifying outstanding debt securities are exempt from the filing
requirement. See proposed Rule 5110(h)(1)(A).
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    Offerings that are subject only to FINRA Rule 2341 are not required
to be filed with FINRA. In the experience of FINRA staff, however, few
filings currently made pursuant to Rule 5110 are also subject to Rule
2341. FINRA therefore does not expect that the costs and benefits of
the proposed amendments relating to these offerings would be material.
Alternatives Considered
    FINRA considered several alternatives in developing the proposed
rule change. FINRA explored how to modernize the Rule and how to
simplify and clarify its provisions, while maintaining the protections
for issuers and investors.
    One alternative to the proposed rule change would be to modify or
eliminate the filing requirement for shelf-offerings by issuers that do
not meet the ``experienced issuer'' standard.\92\ Although a
modification or elimination of the filing requirement would decrease
the compliance costs of participating members, it could increase the
exposure of these issuers to unfair and unreasonable underwriting terms
and arrangements. FINRA believes that the decrease in compliance costs
under this alternative would not justify the increased risk of harm to
issuers.
---------------------------------------------------------------------------

    \92\ See, e.g., ABA and Sullivan.
---------------------------------------------------------------------------

    A second alternative would allow participating members to value
options, warrants, and other convertible securities they receive as
underwriting compensation with common or commercially available
valuation methods. The alternative methods could increase the accuracy
of the valuations but also their variability across offerings and
members. The alternative valuation methods could reduce the ability of
issuers and participating members to agree to terms and the ability of
FINRA staff to evaluate the underwriting terms and arrangements, and
thereby increase the amount of time for issuers to access capital
markets.\93\ FINRA will therefore retain the current valuation methods.
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    \93\ Commenters to the Notice 17-15 Proposal also had
conflicting views on the proposed change to the valuation formula,
and did not provide any information regarding commercially available
valuation methods. See, e.g., NASAA and SIFMA.
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    A third alternative, which was proposed in the Notice 17-15
Proposal, would no longer require the disclosure of the dollar amount
ascribed to each individual item of underwriter compensation in the
prospectus. Instead, participating members could aggregate the
underwriting expenses for all items, except for the discount or
commission. This alternative would have decreased the compliance costs
of participating members. It could have also decreased the ability of
investors to understand the underwriting terms and arrangements,
however, and to decide whether to participate in the offerings.\94\
---------------------------------------------------------------------------

    \94\ Commenters to the Notice 17-15 Proposal had conflicting
views on the proposed change to the disclosure of each individual
item of underwriter compensation. See, e.g., ADISA and NASAA.
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    Other alternatives include different thresholds relating to the
proposed amendments to the venture capital exceptions.\95\ An increase
in the amount of securities that participating members may acquire
before triggering the provisions of the Rule would benefit issuers by
increasing the number of members available to participate in private
placements and subsequent public offerings. However, broader exceptions
may reduce issuer and investor protections if more activities that are
potentially not underwriting compensation are not governed by these
provisions of Rule 5110. The proposed rule change maintains several
restrictions to ensure the protection of other market participants,
including issuers and investors, and is justified by its benefits
including the further promotion of capital formation.
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    \95\ See proposed Rule 5110(d).
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C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published for comment in the Notice
17-15 Proposal. FINRA received 11 comment letters in response to the
Notice 17-15 Proposal. A copy of the Notice 17-15 Proposal is attached
as Exhibit 2a. Copies of the comment letters received in response to
the Notice 17-15 Proposal are attached as Exhibit 2c.\96\
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    \96\ See Exhibit 2b for a list of abbreviations assigned to
commenters.
---------------------------------------------------------------------------

    FINRA has considered the concerns raised by commenters and, as
discussed in detail below, has addressed many of the concerns noted by
commenters in response to the Notice 17-15 Proposal. The comments and
FINRA's responses are set forth in detail below.
General Support and Opposition to the Notice 17-15 Proposal
    Four commenters supported FINRA's efforts to simplify, clarify and
modernize Rule 5110 but did not support all aspects of the Notice 17-15

Proposal.\97\ SIFMA supported some aspects of the Notice 17-15 Proposal
but suggested retooling Rule 5110 to a more disclosure-focused and
principles-based approach. Callcott supported amending Rule 5110 to
require only disclosure of financial relationships between a broker-
dealer and its client in a securities underwriting. The remaining
commenters expressed comments to several specific aspects of the Notice
17-15 Proposal as discussed below.
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    \97\ See ABA, NASAA, Rothwell and Sullivan.
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    The ability of small and large businesses to raise capital
efficiently is critical to job creation and economic growth. Since
1992, Rule 5110 has played an important role in the capital raising
process by prohibiting unfair underwriting terms and arrangements in
public offerings of securities. Rule 5110 continues to play an
important role in ensuring investor protection and market integrity
through effective and efficient regulation that facilitates vibrant
capital markets.
    The proposed rule change strikes an appropriate balance in
modernizing Rule 5110 to allow for some flexibility where appropriate,
while maintaining important protections. For instance, one area where
FINRA is proposing to add some flexibility is to incorporate a limited
principles-based approach to be used by FINRA in determining whether
some securities acquisitions may be excluded from underwriting
compensation. Specifically, the proposed rule change would incorporate
a principles-based approach for acquisitions of securities in venture
capital transactions where there has been a significantly delayed
offering, acquisitions of issuer securities from third parties and
acquisitions of securities pursuant to an issuer's directed sales
program. The proposed rule change would retain Rule 5110's current
objective approach for other securities acquisitions.
    Callcott stated that Rule 5110's complexity imposes costs on all
public underwritings and serves as an incentive to instead conduct
private placements or other transactions. Moreover, Callcott stated
that because ``troubled'' public companies present the highest
liability risks for underwriters, underwriters are unwilling to assist
those companies unless they are adequately compensated for the risk.
Callcott suggests that Rule 5110 does not solve the problem of ``small
troubled'' companies in need of financing; rather, Callcott states the
Rule simply moves the problem to a largely non-transparent and
unregulated alternative financial environment, to the significant
detriment of companies and their investors.
    The application of Rule 5110 to the receipt of underwriting
compensation does not represent a material detriment to small firms or
a disincentive to small firm IPOs. Rather, the decrease in small firm
IPOs is a multi-faceted issue that may be caused by several factors
(e.g., the availability of alternative financing or industry
consolidation). Moreover, the availability of different sources of
financing may be beneficial to some small firms. It is unclear how
removing Rule 5110's restrictions on underwriting terms and
arrangements, and corresponding restrictions on underwriting
compensation, would be a net positive for ``small troubled'' companies
in need of financing.
Filing Requirements
    Three commenters supported allowing members more time to make the
required filings with FINRA (from one business day after filing with
the SEC or a state securities commission or similar state regulatory
authority to three business days) and agreed that the change would help
with logistical issues or inadvertent delays without impeding FINRA's
ability to review the underwriting terms and arrangements.\98\ ABA
supported proposed Rule 5110(a)(4)(A)(ii) to expressly provide that
standard industry forms are not required to be filed in connection with
an offering, unless otherwise specifically requested by FINRA.
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    \98\ See ABA, ADISA and SIFMA.
---------------------------------------------------------------------------

    SIFMA suggested FINRA clarify that the requirement in proposed Rule
5110(a)(1)(B) that the managing underwriter notify the other members if
the underwriting terms and arrangements are unfair and unreasonable and
not appropriately modified be limited to situations where FINRA has
made such determination with respect to the terms and arrangements and
has so notified the managing underwriter. FINRA agrees and made the
suggested change as discussed above in proposed Rule 5110(a)(1)(B).
    ABA suggested that the Rule should permit reliance on filings made
by issuers in proposed Rule 5110(a)(3)(B) or, alternatively, if not
retained, the availability of such reliance should be clarified in
Supplementary Material to Rule 5110. Participating members are
responsible for filing the required documents and information with
FINRA. An issuer may file a base shelf registration statement in
anticipation of retaining a member to participate in a takedown, but a
participating member must file any documents and information as set
forth in proposed Rule 5110(a)(4)(A) and (B) if specifically requested
by FINRA regarding the takedown once the participating member has been
engaged.
    Commenters requested clarifying or deleting the Notice 17-15
Proposal's requirement to file amendments to any documents that contain
``changes to the offering'' in proposed Rule 5110(a)(4)(A)(iii) to
narrow the filing requirement to changes relating to the disclosures
made or to be made in any filing that impact the underwriting terms and
arrangements for the offering.\99\ The commenters suggested that
narrowing the scope of proposed Rule 5110(a)(4)(A)(iii) would
appropriately capture the documents relevant to FINRA's review and
would reduce the burdens on members (and the associated time and cost)
to make unnecessary administrative filings.
---------------------------------------------------------------------------

    \99\ See ABA, ADISA, Davis Polk, Rothwell and SIFMA.
---------------------------------------------------------------------------

    FINRA agrees with the commenters and proposes to narrow the filing
requirement to changes that ``impact the underwriting terms and
arrangements for the public offering.'' Examples of changes impacting
the underwriting terms and arrangements include, but are not limited
to, changes to the size of the offering, the method of distribution
(i.e., firm commitment or best efforts), the amount of underwriting
compensation, the type of underwriting compensation, and any new
termination fee or ROFR that survives termination of the offering.
    Two commenters supported the change in proposed Rule
5110(a)(4)(B)(iii) relating to the representation as to the association
or affiliation between participating members and beneficial owners of 5
percent or more of ``any class of the issuer's securities'' to instead
refer to beneficially owning 5 percent or more of any class of the
issuer's ``equity or equity-linked securities.'' \100\ SIFMA also
supported the proposed elimination of the requirement currently in Rule
5110 to provide a representation as to the association or affiliation
between participating members and ``any beneficial owner of the
issuer's unregistered equity securities that were acquired during the
180-day period immediately preceding the required filing date of the
public offering.'' SIFMA suggested that the narrower focus is
appropriately designed to elicit the most useful information for
reviewing relationships that may affect

the underwriting terms and arrangements.
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    \100\ See ABA and SIFMA.
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    ABA requested guidance with respect to the representation
requirement in proposed Rule 5110(a)(4)(B)(iii) where beneficial owners
of 5 percent or more of any class of the issuer's equity securities are
funds or other types of investment vehicles, which are usually in the
form of limited partnerships or limited liability companies. ABA also
requested that the representation be limited to a statement of
association or affiliation only with respect to the general partner or
investment manager of such fund or investment vehicle, and any limited
partner beneficially owning more than 25 percent of the limited
partnership or limited liability company membership interests of the
fund or investment vehicle.
    Although application of Rule 5110's requirements to beneficial
ownership by funds or other types of investment vehicles historically
has not been problematic, there have been some instances where
conflicts have been identified. When questions have arisen related to
beneficial ownership by funds or other types of investment vehicles,
FINRA has been willing to work with members to address the questions
raised by particular structures and arrangements. Rather than amending
the Rule, FINRA proposes to retain the flexibility afforded by this
established approach because beneficial ownership of 5 percent or more
of an issuer's securities may result in conflicts of interest.
    SIFMA suggested that proposed Rule 5110(a)(4)(B)(iv)--requiring the
filing of a ``description of any securities of the issuer acquired and
beneficially owned by any participating member during the review
period''--should be limited to a description of any securities-based
underwriting compensation acquired during the review period by the
participating member (i.e., no description for securities that do not
constitute underwriting compensation). Limiting the description to
securities that the participating member has determined would be
underwriting compensation could result in an incomplete picture of the
underwriting terms and arrangements. A description of any issuer
securities acquired and beneficially owned by the participating member
during the review period is needed to fully evaluate the underwriting
terms and arrangements of the public offering and to ensure that there
is no circumvention of the Rule.
    While a complete description would be required, the proposed rule
change provides flexibility with respect to whether some securities
would be treated as underwriting compensation under Rule 5110. For
example, because FINRA recognizes that some acquisitions of issuer
securities from third parties are for purposes unconnected to
underwriting compensation, the proposed rule change would incorporate a
principles-based approach in considering whether securities of the
issuer acquired from third parties may be excluded from underwriting
compensation.
    Given the strict limitations on the receipt of underwriting
compensation in terminated offerings imposed by proposed Rule
5110(g)(5), SIFMA suggested deleting the requirement in proposed Rule
5110(a)(4)(C) for a member to file a written notification to FINRA of
all underwriting compensation received or to be received pursuant to
proposed Rule 5110(g)(5), including a copy of any agreement governing
the arrangement if an offering is terminated. SIFMA suggested that at
the very least, if the requirement is retained, the requirement should
be limited to notice to FINRA with respect to the receipt of
termination fees. ABA also did not support the requirement in proposed
Rule 5110(a)(4)(C) and suggested that the lack of an end date for the
requirement would lead to confusion. ABA suggested that, if the
requirement is retained, FINRA should clarify the purpose of the
obligation, confirm that any such payments are tied to the original
failed offering and not a successful subsequent offering, and provide a
sunset provision for the requirement.
    FINRA believes that information regarding underwriting compensation
received or to be received in terminated offerings is relevant to its
evaluation of compliance with Rule 5110 and, in particular, paragraph
(g)(5). Moreover, incorporating a sunset provision into proposed Rule
5110(a)(4)(C) could result in intentionally delaying payment of
underwriting compensation until after the sunset date to circumvent the
requirements of Rule 5110. Accordingly, the proposed rule change would
retain the approach in the Notice 17-15 Proposal.
    Davis Polk requested clarification regarding whether information
relating to unvested securities acquired by participating members
during the review period must be filed under Rule 5110. Davis Polk
suggested that these securities should not constitute underwriting
compensation, as it is unclear whether the conditions precedent to
vesting will ever be satisfied. As noted above, it is important that
FINRA have information on all securities received during the review
period in order to more accurately evaluate the levels of underwriting
compensation. When considering whether vested or unvested securities
acquired by participating members and their associated persons are
underwriting compensation FINRA evaluates why the securities were
granted. For example, unvested directors' options granted to associated
persons of participating members in excess of what other directors
receive would be deemed underwriting compensation, but grants that are
comparable to what other directors receive would not be underwriting
compensation.
Filing Requirements for Shelf Offerings
    SIFMA suggested modifying the exemption in proposed Rule
5110(h)(1)(C) to eliminate the requirement that issuers filing
offerings on Form S-3 need to satisfy the pre-1992 Form S-3 standards
or, alternatively, to provide a filing exemption for offerings by well-
known seasoned issuers (``WKSIs'') that meet current Form S-3
standards. Sullivan suggested exempting all offerings of securities
registered on Forms S-3 and F-3 from both the Rule's substantive and
filing requirements and, at a minimum, exempting WKSIs from Rule 5110.
In light of established market practices, Sullivan believes that these
issuers do not need FINRA's protection in the negotiation of
underwriting terms and arrangements and that FINRA's oversight is an
unnecessary speed bump to these issuers accessing the capital markets.
Davis Polk questioned whether FINRA's goal of investor protection is
furthered by the requirement to file WKSI offerings and suggested that
FINRA's goal should be to make access to capital less expensive.
    Given the availability of documents on the SEC's EDGAR system,
Davis Polk suggested eliminating the requirement to file with FINRA
prospectus supplements and underlying documents for shelf offerings
subject to Rule 5110's filing requirements. Davis Polk suggested that
member's counsel should instead be required, at the time of filing of
the registration statement, to obtain representations from members
that: (1) Underwriting compensation will not exceed 8 percent of the
gross offering proceeds; and (2) members will not engage in any
prohibited arrangements in connection with any takedown from the base
shelf registration statement.
    As discussed in Item II.A., given the regulatory issues that have
previously arisen in shelf offerings, the proposed rule change would
continue to apply Rule 5110's filing requirement to shelf

offerings by issuers that do not meet the ``experienced issuer''
standard. However, to facilitate the ability of issuers to take
advantage of favorable market conditions on short notice and to quickly
raise capital through takedown offerings, the proposed rule change
would streamline the filing requirements for shelf offerings by issuers
that do not meet the ``experienced issuer'' standard. Specifically,
with respect to these shelf offerings, the proposed rule change would
provide that only the following documents and information must be
filed: (1) The registration statement number; and (2) if specifically
requested by FINRA, other documents and information set forth in
proposed Rule 5110 (a)(4)(A) and (B).
    FINRA would access the base shelf registration statement,
amendments and prospectus supplements in the SEC's EDGAR system and
populate the information necessary to conduct a review in the FINRA
System. Upon filing of the required registration statement number and
documents and information, if any, that FINRA requested pursuant to
proposed Rule 5110(a)(4)(E), FINRA would provide the no objections
opinion. To further facilitate issuers' ability to have quicker access
to capital markets, FINRA's review of documents and information related
to a shelf takedown offering for compliance with Rule 5110 would occur
on a post-takedown basis.
    Davis Polk suggested adding an exemption to the filing requirement
for any offering on Forms S-3 and F-3 or any IPO: (1) Of an issuer
controlled by a venture capital or private equity fund with $100
million in assets under management; or (2) with proceeds of $75 million
or more. Davis Polk stated that the filing requirement is not needed as
these issuers are sophisticated professional negotiators and investors
have immediate access to company disclosures through EDGAR, issuer
websites and third party analysis. Alternatively, Davis Polk
recommended that the proposed exemption for shelf offerings be revised
to reflect, at a minimum, the Oct. 21, 1992 Form S-3 and F-3
eligibility requirement of a public float of $75 million or,
preferably, to eliminate the public float requirement entirely, in
accordance with current Form S-3 and F-3 standards. Davis Polk
suggested that the requirement in the exemption that the issuer have
reported under the Exchange Act for three years be modified to one
year, as is the case with current Forms S-3 and F-3, on the grounds
that a three year reporting history does not provide any benefit
because technology provides investors with immediate access to
information.
    As discussed above, the proposed rule change would significantly
reduce the filing obligations for shelf offerings. The underwriting
terms and arrangements in IPOs of issuers controlled by venture capital
or private equity funds or IPOs with proceeds of $75 million or more
are not significantly different from those in other IPOs and FINRA's
filing and review program is necessary for investor protection.
Exemptions From Filing and Substantive Requirements
    Commenters suggested several changes to the proposed exemptions
from Rule 5110's filing requirement or substantive provisions to
expand, modify or clarify the exemptions. Three commenters recommended
not subjecting to Rule 5110's filing requirement public offerings that
otherwise meet a filing exemption but for participation by a QIU
pursuant to Rule 5121.\101\ The commenters suggested that subjecting
these offerings to Rule 5110's filing requirement is unjustified and
unwarranted, increases the issuer's transaction costs, and alters the
composition of underwriting syndicates in ways that do not further
investor or market protection.
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    \101\ See ABA, Davis Polk and SIFMA.
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    Consistent with the approach in the current Rule, proposed Rule
5110(h)(1) would require filing these offerings only if there is
participation by a QIU. Rule 5121 was amended in 2009 to focus on
offerings with significant conflicts of interest that require the
participation of a QIU.\102\ FINRA has a regulatory interest in
reviewing offerings in which a member has a significant conflict of
interest requiring the participation of a QIU. Accordingly, filing and
review of these offerings under Rule 5110 continues to be appropriate.
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    \102\ See Securities Exchange Act Release No. 60113 (June 15,
2009), 74 FR 29255 (June 19, 2009) (Order Approving File No. SR-
FINRA-2007-009). See also Regulatory Notice 09-49 (August 2009).
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    ABA requested revising the exemption from the filing requirement in
proposed Rule 5110(h)(1)(E)(i) for exchange offers to include
situations in which the securities to be acquired in the exchange are
convertible into securities that are listed on a national securities
exchange as defined in Section 6 of the Exchange Act. FINRA believes
extension of the exemption to these convertible securities is unlikely
to be problematic for market participants. Accordingly, the proposed
rule change would expand proposed Rule 5110(h)(1)(E)(i) to exempt from
the filing requirement exchange offers where the securities to be
issued or the securities of the company being acquired are listed, or
convertible into securities that are listed, on a national securities
exchange as defined in Section 6 of the Exchange Act.
    ABA suggested that in many cases the role played by a member acting
as a distribution manager in connection with an exchange offer is
limited to contacting investors and recording their intention to tender
and that the member receives nominal compensation for these services.
Accordingly, ABA requested exempting from Rule 5110's filing
requirement exchange offers in which the compensation to be received by
the distribution manager does not exceed 2 percent of the registered
aggregate dollar amount of the offering and no member acts as an
underwriter for the securities. Distribution managers may provide and
receive compensation for a range of different services related to a
public offering. Given this broad range of services, FINRA does not
agree that providing an exemption from Rule 5110's provisions is
appropriate based on the compensation for distribution manager-related
services being less than the suggested threshold.
    Davis Polk requested that an express exemption from Rule 5110's
filing requirement be added for offerings of convertible debt of an
issuer that has outstanding investment grade rated debt of the same
class as that being offered if there is a bona fide public market in
the common stock underlying the debt (i.e., the debt meets the
exemption in proposed Rule 5110(h)(1)(B) and the underlying common
stock generally meets the exemption in proposed Rule 5110(h)(1)(A)).
FINRA has not received requests for an exemption for this type of
convertible debt and, as such, the potential consequences of an express
exemption in the current market environment are unclear. Exemptive
relief from the filing requirement for this type of convertible debt
may be available on a case-by-case basis as necessary and appropriate.
To the extent that FINRA begins receiving numerous such requests, FINRA
will evaluate whether an express exemption is warranted.
    Davis Polk suggested that filing has not been previously required
for shelf offerings registered for the benefit of selling shareholders
that are intended to be sold in ordinary market transactions by members
acting as agents (commonly called ``dribble out offerings'') and
requested that an express exemption from the filing requirement be
added to Rule 5110. Davis Polk also suggested an express exemption from
the filing requirement for block trades in light of

the highly competitive nature of negotiations between issuers and
underwriters in connection with these offerings. Dribble out offerings
and block trades are typically handled through shelf takedown
offerings. As previously discussed, the proposed rule change would
modify the requirements for shelf offerings to no longer require the
filing of each takedown offering.
    ABA stated that the proposed exemption in the Notice 17-15 Proposal
from the filing requirement for follow-on offerings by qualifying
tender offer funds should be extended to also cover IPOs by these
entities. ABA requested that, if continued filing of IPOs by these
issuers is required, Rule 5110 should be amended to provide that the
underwriting terms and arrangements for these offerings, while subject
to the filing requirements of Rule 5110, will be reviewed for
compliance with the requirements of Rule 2341. As discussed in Item
II.A. supra, FINRA believes that it is appropriate to consider
compensation for distribution of both IPOs and follow-on offerings of
tender offer funds under the compensation limitations in Rule 2341.
Accordingly, the proposed rule change would exempt both IPOs and
follow-on offerings of tender offer funds from Rule 5110.\103\
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    \103\ See proposed Rule 5110(h)(2)(L).
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    As offerings of open-end funds and continuously offered interval
funds and tender offer funds are exempted from Rule 5110, JLL suggested
exempting offerings of continuously offered perpetual-life, publicly
offered non-listed REITS (``PLRs'') from the filing requirement. Open-
end funds and continuously offered interval funds and tender offer
funds are investment companies whose offerings can be appropriately
regulated under the Investment Company Act; however, PLRs are generally
exempt from the Investment Company Act. Because the protections of the
Investment Company Act would not apply, the proposed rule change would
not exempt PLRs from the filing requirement.
    ABA suggested that the exemption from Rule 5110's filing
requirement for securities offered by issuers with qualifying debt
securities be expanded to include offerings by issuers that are
organized limited liability companies, limited partnerships, business
trusts or other legal persons.\104\ The Notice 17-15 Proposal would
have replaced ``corporate issuer'' with ``corporation'' in this
exemption. Rather than including a lengthy list of different types of
legal persons, the proposed rule change would revert to the use of
``corporate issuer.'' This approach, which is consistent with Rule 5110
currently, covers a broad range of legal entities that have qualifying
debt securities and has not been problematic in practice.
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    \104\ See proposed Rule 5110(h)(1)(A).
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    CAI supported the proposed exemption in Rule 5110(h)(2)(E) from the
filing and substantive requirements of Rule 5110 for ``any insurance
contracts not otherwise included'' as appropriately resolving members'
questions about the status of insurance contracts under FINRA rules.
SIFMA also supported the addition of proposed exemptions from the
filing and substantive requirements of Rule 5110 for insurance
contracts \105\ and unit investment trust securities.\106\
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    \105\ See proposed Rule 5110(h)(2)(E).
    \106\ See proposed Rule 5110(h)(2)(K).
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    ABA requested clarification as to whether the exemption from the
filing and substantive provisions of Rule 5110 for securities issued
pursuant to a competitively bid underwriting arrangement meeting the
requirements of the Public Company Utility Holding Company Act
(``PUHCA'') remains tied to that Act. The Energy Policy Act of 2005
repealed the PUHCA Act of 1935 and adopted the PUHCA of 2005.\107\ The
exemption for any securities issued pursuant to any competitively bid
underwriting arrangement meeting the requirements of the PUHCA
continues to be appropriate. Accordingly, consistent with the current
Rule, the proposed rule change would exempt from the filing and
substantive requirements of Rule 5110 securities issued pursuant to a
competitively bid underwriting arrangement meeting the requirements of
the PUHCA.\108\
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    \107\ See Energy Policy Act of 2005, Public Law 109-58, 119
Stat. 594 (2005).
    \108\ See proposed Rule 5110(h)(2)(H).
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    Sullivan stated that all offerings of investment grade debt,
preferred stock and other fixed-income securities should be exempt from
Rule 5110's filing and substantive requirements. Sullivan stated that
these offerings involve the tightest underwriting spreads and are
intensely negotiated by issuers and, accordingly, the protections of
Rule 5110 are not necessary for these offerings. Although some
offerings of investment grade debt, preferred stock and other fixed-
income securities are intensely negotiated by issuers, offerings of
these securities have previously involved unreasonable and unfair
underwriting terms and arrangements. Because Rule 5110 prohibits
unreasonable and unfair underwriting terms and arrangements, it is
appropriate for the Rule's protections to continue to apply to these
offerings.
Disclosure of Underwriting Compensation
    The Notice 17-15 Proposal would have no longer required that the
disclosure include the dollar amount ascribed to each individual item
of compensation. Instead the Notice 17-15 Proposal would have permitted
a member to disclose the maximum aggregate amount of all underwriting
compensation, except the discount or commission that must be disclosed
on the cover page of the prospectus. The Notice 17-15 Proposal also
included a requirement to disclose specified material terms and
arrangements in the prospectus, which is consistent with current
practice. A description would be required for: (1) Any ROFR granted to
a participating member and its duration; and (2) the material terms and
arrangements of the securities acquired by the participating member
(e.g., exercise terms, demand rights, piggyback registration rights and
lock-up periods).\109\
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    \109\ See proposed Supplementary Material .05 to Rule 5110.
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    Commenters expressed differing viewpoints on the proposed
prospectus disclosure requirement changes in the Notice 17-15 Proposal.
ADISA supported changing the disclosure requirements to require
disclosure only of the aggregate amount of all compensation, other than
discounts and commissions, in the prospectus. On the other hand, NASAA
supported retaining the requirement in Rule 5110 for itemized
underwriter compensation disclosure in the prospectus and did not
support the proposed disclosure requirement changes in the Notice 17-15
Proposal. NASAA stated that itemized compensation: (1) Allows investors
to understand how money is being disbursed to underwriters; (2)
provides investors with a better understanding of incentives underlying