Amendments to FINRA’s New Issues Rules Alerts

On January 1, 2020, amendments to the Financial Industry Regulatory Authority, Inc. (“FINRA“) Rule 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings) and Rule 5131 (New Issue Allocations and Distributions) came into effect [1]. Per the U.S. Securities and Exchange Commission (“SEC“), the rule changes “exempt additional persons and offerings, modify current exemptions to enhance regulatory consistency, and address unintended operational impediments.” In response to these changes, private fund advisers will need to update certain of their forms (including subscription documents), as well as their policies and procedures.

The Rule Changes

FINRA Rule 5130 prohibits new issue securities from being sold to an account in which a “restricted person” has a beneficial interest. FINRA Rule 5131 restricts broker-dealers from selling new issue securities to an account beneficially owned by executive officers and directors of a public company or a covered non-public company that has certain relationships with the broker-dealer.

The primary amendments to Rules 5130 and 5131 include:

• Rule 5130(c), the list of general exemptions to the restricted person rule, was amended (1) to expand the definition of the foreign investment company exemption, Rule 5130(c)(6), to include investment companies with a minimum threshold of direct or indirect investors, even if a restricted person owns more than 5% of the investment company’s shares, but requires that such investment company was not formed for the purpose of investing in new issues; and (2) to add employee retirement benefits plans to the list of exempt entities, provided they satisfy certain size, operational, and administrative requirements.
• The definition of a “family investment vehicle” was expanded to include entities that are beneficially owned solely by “family members” and “family clients” (as both are defined under the Investment Advisers Act of 1940) in addition to immediate family members.
• The definition of “new issues” was amended to not include (1) Regulation S offerings under the Securities Act of 1933, unless the securities in the offering were also sold in a registered offering in the United States, and (2) special purpose acquisition companies subject to the SEC’s jurisdiction.
• Certain “sovereign entities” are excluded from the definition of “persons owning a broker-dealer” that are considered restricted persons under Rule 5130.
• Unaffiliated 501(c)(3) organizations are excepted from the definition of “covered non-public company” under Rule 5131.

Next Steps

Subscription documents of private funds that may invest in new issues frequently ask investors whether they are an exempted entity or a “restricted person” under FINRA Rule 5130, or are covered by the restrictions of FINRA Rule 5131. Private fund advisers typically re-confirm investor’s responses to these questions on an annual basis. Because these definitions have changed, private fund advisers are encouraged to update their subscription documents and re-confirmation letters, as well as their internal policies and procedures regarding new issues, to identify whether the status of any of their current investors has changed due to these rule amendments.

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[1] The SEC notice can be found here.