Rule Amendments Institute Streamlined Shelf Offering Filing Process, and other Substantive, Organizational, Clarifying and Terminology Changes
On March 20, 2020, FINRA announced in Regulatory Notice 20-101 that it has amended FINRA Rule 5110 (the "Corporate Financing Rule" or the "Rule").2 The amendments institute substantive, clarifying, organizational and terminology changes, while preserving the basic principles of the Rule.3 Of particular note, the amendments will significantly streamline the filing and approval process for shelf offerings that are subject to a filing requirement, including requiring only the registration statement number and fee payment information. The no-objections letter will be issued instantaneously upon submission.
March 20, 2020 was the effective date for certain amendments regarding required documents for FINRA filings, including the extension of the filing deadline from one to three business days following SEC filings. The implementation date for all other amendments, including the shelf offering amendments, is September 16, 2020.
The text of the amended Rule is available here.
Overview of the Amendments
The amendments include:
- Revisions to FINRA filing timing, documentary and information requirements;
- Streamlined filing process for shelf offerings subject to a filing requirement;
- Clarifications regarding certain offering types exempt from filing requirements;
- Expanded list of offerings exempt from both filing and substantive obligations (previously referred to as "exempt offerings"), including closed-end tender offer funds;
- New defined terms and structure relating to underwriting compensation;
- Expansions of venture capital exceptions from underwriting compensation;
- Certain new exceptions to lock-up restrictions; and
- Certain revisions to prohibited terms and arrangements, among other changes.
Amendments to FINRA Filing Requirements
Documentary Filing Requirements
The amendments institute important changes related to timing and documentary requirements for filings under the Corporate Financing Rule (a "FINRA filing"), generally relaxing the same, and were effective as of March 20, 2020. These include:
- Extension of filing deadline: The deadline for required FINRA filings has been extended from one to three business days following filing with the SEC or state securities commission.4
- Engagement letters not related to underwriting terms not required to be filed: Regulatory Notice 20-10 clarifies that "filing of engagement letters that do not contain terms relevant to the underwriting terms and arrangements of the public offering being reviewed pursuant to Rule 5110 is not required (e.g., a stand-alone M&A letter whose terms are unrelated to the public offering being reviewed pursuant to Rule 5110 is not required to be filed)."5 The Public Offering System will be revised to so reflect.
- Only amendments impacting underwriting terms must be filed: Amendments to previously filed documents only must be filed if they impact the underwriting terms and arrangements.6
Information Filing Requirements
The following changes to the information required in a FINRA filing are not effective until September 16, 2020:
- Threshold for representations of association/affiliation with beneficial owners of the issuer raised to 10%: Under the pre-amendment rule, members were required to represent as to whether any beneficial owner of 5% or more of any class of the issuer's securities was an associated person or affiliate of the member. Commenters had requested that such representation, with respect to a fund, be limited to, for example, the fund's general partner, investment manager and certain limited partners. FINRA declined but raised the threshold to 10% of any class of the issuer's equity or equity-linked securities.7
- Written notification to FINRA required if offering not completed to terms, and certain underwriting compensation is received: The amended Rule (the "Amended Rule") requires that in the event that an offering is not completed according to the terms of the agreement entered into with the issuer, any participating member receiving underwriting compensation, other than (i) accountable expenses actually incurred, or (ii) a termination fee or right of first refusal meeting the conditions set forth in Amended Rule 5110(g)(5), must notify FINRA of the same. FINRA will use the information received to apply the compensation to any "revised public offering."8
New Defined Term for Shelf Offering Filing Exemption
The pre-amendment Rule provided a filing exemption for shelf offerings of issuers that met the SEC's pre-1992 standards for eligibility on Forms F-3 and S-3, or pre-1991 standards for offerings on Form F-10. The Amended Rule states the particular eligibility standards in the rule itself, creating the category of an "experienced issuer" with the same standards as the pre-1992 F-3 and S-3 standards:
- 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.9
Under the Amended Rule, offerings on Form S-3, F-3 or F-10 by an "experienced issuer" are eligible for exemption from FINRA filing obligations.10 FINRA noted that any guidance or interpretation issued by the SEC or FINRA relating to those eligibility standards remains applicable to the Amended Rule's definition.11
Streamlined Filing Process for Shelf Offerings Subject to a FINRA Filing Requirement
For shelf offerings that are subject to a FINRA filing requirement, the amendments considerably streamline the filing process. As of the September 16 implementation date, filers will only need to provide the Securities Act registration statement number and the Fedwire number reflecting fee payment.12 Upon submission, the filer will immediately receive FINRA's no-objections letter.
These changes institute a considerably more streamlined process for shelf offerings, as FINRA's current shelf offering review programs require a more detailed filing, including information with respect to the offering, the issuer and the securities being registered under the shelf, and require separate filings for each takedown off of the shelf.13 Whereas the current shelf offering program filings required some time to prepare, the new shelf offering filings should be able to be prepared in a matter of minutes, if not seconds (provided that the Fedwire number is available). Further, filers will not need to make filings in respect of takedowns off of the shelf, as the system being developed by FINRA will pull relevant SEC-filed documents from EDGAR.
FINRA may request additional documents related to the filing after approval, which is expected to be conducted on a risk basis.
Through this change, FINRA's stated goal is to facilitate the ability of issuers to take advantage of favorable market conditions on short notice and to quickly raise capital through takedown offerings. We understand that the Corporate Financing Department expects to issue additional guidance before the implementation date.
While these changes, and all streamlining of shelf offering review, is generally welcome, we note that these changes place considerable additional pressure on underwriters and their counsel to reasonably ensure compliance with the substantive requirements of the Corporate Financing Rule at the time of the initial submission. Unlike some of FINRA's current review programs, which allow FINRA to comment on issues before the applicable transaction has occurred, practice under these amendments will shift to after-the-fact review of any issues spotted by FINRA. If issues have been overlooked, or if an interpretive stance has been taken with which FINRA disagrees, then FINRA will need to consider whether to allege a Corporate Financing Rule violation in an enforcement proceeding. This is consistent with current practice with respect to offerings entitled to "same-day clearance."
Offerings Exempt from Filing and Substantive Requirements
The pre-amendment Rule sets out categories of offerings that are exempt from (i) the Rule's filing requirements but are otherwise subject to the Rule's substantive requirements and (ii) both the Rule's substantive and filing requirements. The Amended Rule continues this structure, with the following modifications.
Offerings Not Subject to Filing Requirements
The Amended Rule, consistent with current interpretation, clarifies that the exemption for issuers with outstanding investment grade-rated securities also applies to banks and foreign banks.14
Offerings Not Subject to Filing and Substantive Requirements
Consistent with existing interpretive guidance,15 the Amended Rule expands the list of offerings exempt from both the Rule's filing and substantive requirements to include offerings of a closed-end tender offer fund, provided that the fund complies with certain requirements, including the compensation provisions set forth in FINRA Rule 2341. The Amended Rule also exempts offerings of insurance contracts, unit investment trusts and, in response to comments, issuer self-tender offers.16
The pre-amendment Rule uses the term "Exempt Offerings" to refer to offerings not subject to the Rule's filing and substantive requirements. The Amended Rule instead refers to "Offerings Not Subject to Filing and Rule Compliance."
In the pre-amendment Rule, whether an item was deemed to be underwriting compensation turned on whether that item was an "item of value": any item of value received by the underwriter or its related persons in the 180 days preceding the SEC filing and running until 90 days following effectiveness was presumed to constitute underwriting compensation. The term item of value was not defined, but the rule provided non-exhaustive lists of items that would and would not be considered items of value.
The Amended Rule does not use the term item of value, but instead defines the term "underwriting compensation" as:
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. In addition, underwriting Icompensation shall include finder's fees, underwriter's counsel fees and securities.17
Further, the Amended Rule also creates the new defined term "review period," defined as 180 days preceding the SEC filing date through the 60-day period following: (i) for a firm commitment offering, the effective date; (ii) for a best efforts offering, final closing and (iii) for a takedown or any other continuous offering made pursuant to Securities Act Rule 415, the 60-day period following the final closing.
Like the pre-amendment Rule, the Amended Rule provides two non-exhaustive lists of examples of payments and benefits that are and are not considered underwriting compensation, with many of the examples derived from the pre-amendment Rule's lists.
However, there are some new additions to those lists, including the following examples of payments or benefits that are not considered underwriting compensation:
- Securities acquired in the secondary market by a participating member that is a broker-dealer in connection with the performance of bona fide customer facilitation activities and bona fide market-making activities if acquired at a fair price (taking into account, among other things, customary commissions, mark-downs and other charges); and
- The payment or reimbursement of legal costs resulting from a contractual breach or misrepresentation by the issuer.18
In Regulatory Notice 20-10, FINRA addressed the scope of underwriting compensation in offerings with U.S. and non-U.S. components, addressing two scenarios:
- Where a non-U.S. underwriter is not an affiliate of a participating member, the non-U.S. underwriter's compensation is not underwriting compensation under the Rule. Commenters had noted inconsistent industry practice in this regard.19
- Where a firm participating in the non-U.S. offering is an affiliate of a participating member and thus would be captured by the participating member definition, the regulatory notice stated that for the non-U.S. firm's underwriting compensation to not constitute underwriting compensation for the U.S. offering, the affiliates would need to divide underwriting compensation to separately allocate the underwriting compensation received by the non-U.S. firm for the non-U.S. portion of the global offering.
Securities Acquired from Third Parties or Through Directed Share Programs
The Amended Rule includes Supplementary Materials addressing when securities acquired from third-parties or through issuer directed share programs20 should be deemed underwriting compensation, adopting a principles-based approach.
- Securities Acquired from Third Parties: Supplementary Material .03 provides that FINRA will consider the following factors, among other relevant factors and circumstances: (i) nature of the relationship between the issuer and the third party, (ii) nature of the transactions, including whether acquired in the ordinary course of business and (iii) any disparity between the price paid and the offering price.
- Securities Acquired in Directed Share Programs: As the term "participating member" includes associated persons of the member and any immediate family, Supplementary Material .04 addresses issuer securities received in issuer directed share programs. FINRA notes that it will consider the following factors, among other relevant factors and circumstances: (i) the existence of a pre-existing relationship between the issuer and the person acquiring the securities, (ii) the nature of the relationship and (iii) whether the securities were acquired on the same terms and at the same prices as other similarly situated persons participating in the directed share program.
Expansion of Venture Capital Exceptions to Underwriting Compensation Definition
The Amended Rule modifies and expands the existing venture capital exceptions from classification as underwriting compensation, with the stated goal of facilitating the participation of broker-dealers in bona fide venture capital transactions. The amendments:
- Broaden venture capital exceptions regarding purchases and loans by certain affiliates, and investments in and loans to certain issuers, by removing the limitation on acquiring more than 25% of the issuer's total equity;21
- Except securities purchases based on investment history before the review period (e.g., conversions of securities previously acquired, securities acquired as a result of stock splits or pro rata rights offerings, and securities acquired to prevent dilution);22
- Expand the scope of the exemption for securities acquired in private placements with institutional investors to include securities received as compensation for services generally (and no longer limited to acting as placement agent), and raise from 20% to 40% the percentage of securities that participating members may acquire23; and
- Institute a new exception for co-investments with a mutual fund: at least 15% of the securities sold in the private placement must be acquired, at the same time and on the same terms, by an open-end investment company not traded on an exchange, and such fund must not be an affiliate of a FINRA member participating in the offering.24
Additional Exceptions from Lock-Up Restrictions
The Amended Rule continues to require a 180-day lock-up restriction on securities that are considered underwriting compensation, subject to exceptions. Commenters had requested that FINRA shorten the FINRA lock-up period for follow-on offerings, given that the insider lock-up period is commonly shorter for such offerings.25 FINRA declined, but the amendments institute exceptions for situations in which market forces or other factors obviate the need for a lock-up, and these exceptions may mitigate the impact of the lock-up restrictions in follow-on offerings.
The amendments institute the following additional exceptions, among others:
- Significantly, in response to comments,26 securities that are "actively-traded" as defined in Rule 101(c)(1) of Regulation M;
- The issuer of the securities meets the registration requirements of Forms S-3, F-3 or F-10;
- Securities that are registered and sold as part of a firm commitment offering;
- A non-convertible or non-exchangeable debt security; and
- Securities acquired in one of the venture capital exceptions.27
Whereas the pre-amendment Rule had provided that the lock-up restrictions commence on the date of effectiveness or commencement of sales, the Amended Rule provides that the lock-up restriction begins on the date of the commencement of sales.28
Prohibited Terms and Arrangements
The Amended Rule also updates the list of prohibited terms and arrangements in connection with a public offering of securities.29 For example, under the Amended Rule, it is prohibited for any underwriting compensation to be paid prior to the commencement of sales of the public offering, except (i) an advance against accountable expenses actually anticipated to be incurred or (ii) advisory or consulting fees for services provided in connection with the offering that are subsequently completed according to the terms of an agreement entered into by an issuer and participating member.
Although the amendments do not alter the basic principles of the Rule, they re-organize the Rule's structure, make clarifying changes and institute both small and large substantive changes, including an extension of the filing deadline for required FINRA filings from one to three business days (already effective), and a significant streamlining of the FINRA shelf offering filing process (effective September 16, 2020) that will change the tenor of the FINRA filing process for shelf offerings. Firms should review their WSPs and other procedures to determine whether any revisions should be made in respect of the amendments. We will closely monitor developments, including any guidance issued on the new shelf offering filing process.
1 See Regulatory Notice 20-10, FINRA Amends the FINRA Corporate Financing Rule, available at https://www.finra.org/rules-guidance/notices/20-10.
2 For background on the amendments, please see our prior publications: (i) FINRA Proposes Substantive and Organizational Amendments to Corporate Financing Rule (Jun. 6, 2019), available at https://www.shearman.com/perspectives/2019/06/finra-proposes-substantive-and-organizational-amendments-to-corporate-financing-rule hereinafter, "June 2019 Client Memo" and (ii) FINRA Proposes Broad Range of Amendments to Corporate Financing Rule (April 26, 2017), available at https://www.shearman.com/perspectives/2017/04/finra-amndts-to-corporate-financing-rule. Our full range of publications relating to the Corporate Financing Rule, and other topics, are available at https://brokerdealer.shearman.com/.
3 FINRA's Corporate Financing Rule regulates the underwriting terms and arrangements of FINRA members' participation in U.S. public offerings. The Rule requires a FINRA member that participates in a U.S. public offering to file certain information and documentation with FINRA, unless subject to an exemption, and receive confirmation that FINRA raises no objection with respect to the fairness and reasonableness of the proposed underwriting terms and arrangements. It also mandates certain disclosure, prohibits certain terms and arrangements and requires lock-ups of securities that constitute underwriting compensation, among other obligations.
4 Rule 5110(b)(4).
5 Rule 5110(b)(5)(A)(ii).
6 Rule 5110(b)(5)(A)(iii).
7 Amended Rule 5110(a)(4)(B)(iii). All Amended Rule references reflect the numbering of the version of the Rule effective September 16, 2020 and onwards.
8 Amended Rule 5110(a)(4)(C).
9 Amended Rule 5110(h)(1)(C).
10 See Exchange Act Release No. 34-87855, Dec. 23, 2019, at 72406.
11 FINRA filing exemptions can potentially be lost if there is a conflict of interest as that term is defined in Rule 5121. In our June 2019 Client Memo (link above at note 2), we noted the concern that Forms S-3 and F-3 allow offerings by certain persons other than the issuer itself, i.e., guaranteed subsidiaries, and that, under the proposed definition of "experienced issuer," no exception would be available for guaranteed subsidiaries. In the final Rule, for primary and follow-on offerings that are exempt under Amended Rule 5110(h)(1)(C), this concern appears to have been addressed because the "registrant" is required to be the experienced issuer. However, the exchange offer filing exemption of Amended Rule 5110(h)(1)(E) is less clear and is subject to interpretation, because the language would appear to require the entity issuing the security to be the experienced issuer.
12 Amended Rule 5110(a)(4)(E).
13 FINRA's current shelf offering programs would be discontinued following the shelf offering process established in the amendments.
14 Amended Rule 5110(j)(2).
15 See, for example, Russell D. Sacks, Shearman & Sterling, Request for Exemption from the Provisions of NASD Conduct Rule 2710, available at https://www.finra.org/rules-guidance/guidance/exemptive-letters/russell-d-sacks-shearman-sterling-llp.
16 Amended Rule 5110(h)(2).
17 Amended Rule 5110(j)(22).
18 Amended FINRA Rule SM .01(b)(4), (21).
19 See, for example, SIFMA's May 30, 2019 comment letter, available at https://www.sec.gov/comments/sr-finra-2019-012/srfinra2019012-5603986-185507.pdf. SIFMA May 30, 2019 Letter
20 Supplementary Material .01(b)(14),(16)-(18).
21 Amended Rule 5110(d)(1).
22 Amended Rule 5110(d)(4).
23 SIFMA May 30, 2019 Letter.
25 Amended Rule 5110(e)(2).
26 Amended Rule 5110(e)(1).
27 Amended Rule 5110(g).
28 Amended Rule 5110(a)(3)(A)(ii).
29 Amended Rule 5110(g)(2).
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