Recent Amendments to FINRA Rules 5130 and 5131
While many people extol the virtues of a good spin class (particularly in January, following New Year’s resolutions), in the context of Initial Public Offerings, “spinning” has a severely negative connotation. Spinning was a practice where a bank held back shares of a popular initial public offering to allocate to an executive officer or director of a current or potential investment banking client of the bank instead of placing those shares with investors through the standard public offering allocation process. The practice occurred during a period of significant first day IPO gains, and these allocations were viewed as an incentive for these individuals to direct business to the investment bank.
Spinning and other related practices have been prohibited by various FINRA rules since the early 2000’s. The SEC approved these rules, FINRA Rules 5130 and 5131, in order to ensure that investment banks, as FINRA members, are making bona fide public offerings for the benefit of their customers without using such offerings to reward insiders of such member firms or persons who are in a position to direct business to such firms. This post will cover a few of the key changes to such rules that could impact an issuer considering an IPO.
Rule 5130 generally prohibits an investment bank from selling IPO shares to “restricted persons” (broadly defined as broker-dealer personnel, owners and agents and immediate family members of such persons). Rule 5131 generally prohibits an investment bank from engaging in “spinning,” that is allocating IPO shares to executive officers and directors of a public company or private companies of a certain size if the company is a current or potential client. The rules historically excluded issuer-directed shares (such as directed share programs), and the amendments clarify that securities directed by affiliates and selling shareholders of the issuer are also excluded.
The new amendments also exclude foreign offerings, such as those conducted under Regulation S, as long as the offering is not concurrently registered in the United States. The FINRA rules currently exclude offerings of closed-end funds, business development companies and other similar vehicles because their assets consist of the capital raised through the offering process. There is, therefore, little chance for a premium in the early days of trading. Special Purpose Acquisition Companies have similar trading characteristics, and are now excluded from these FINRA rules.
In an IPO, Rule 5131 requires FINRA members to ensure that the issuer publishes a press release at least two business days prior to the release or waiver of any lock-up agreement with a director or officer. The current rule allowed an exception from this requirement where the waiver or release is in connection with a transfer without consideration where the transferee agrees to be bound by the same lock-up agreement terms. The new rule extends this accommodation to transfers to immediate family members who also agree to be bound by the terms of the lock-up agreement.
Current FINRA Rule 5130 allows a restricted person, such as a broker-dealer or employee of a broker-dealer, to purchase shares in the initial public offering to maintain its ownership position. The amendments to Rule 5131 now afford executive officers and directors of current or potential investment banking clients the same exemption. This anti-dilution exemption is contingent on the following factors: (i) the position must have been held for a year, (ii) the purchase doesn’t increase percentage ownership above the ownership level as of three months prior to filing of the IPO registration statement, (iii) the purchase includes no special terms and (iv) the purchased shares are not sold, transferred, pledged, etc. for three months after the effective date of the offering.
The new amendments were effective January 1, 2020.