Question 1

What is FINRA, and what role does it play in an IPO?

Accepted Answer

FINRA (the Financial Industry Regulatory Authority) is a private, not-for-profit membership organization — a self-regulatory organization, not a government agency — that is responsible under federal law for overseeing member broker-dealers. It is registered with the SEC and performs its work under the SEC's supervision. FINRA writes and enforces rules governing member firms and their registered representatives, examines firms for compliance, monitors markets for misconduct, administers qualification exams, and operates a dispute resolution forum. In an IPO, the underwriters are FINRA member broker-dealers, so their compensation and contractual arrangements with the issuer fall under FINRA's Corporate Financing Rule (Rule 5110) and are reviewed by FINRA's Corporate Financing Department — a review that runs alongside, and separately from, the SEC's disclosure review of the registration statement.

Question 2

What is FINRA Rule 5110, the 'Corporate Financing Rule'?

Accepted Answer

FINRA Rule 5110 — titled 'Corporate Financing Rule — Underwriting Terms and Arrangements' — bars FINRA members and their associated persons from taking part in a public offering on terms, including the total underwriting compensation, that the rule treats as unfair or unreasonable. Rule 5110(a)(2) makes FINRA review the default: unless a filing exemption under paragraph (h) applies, every public offering in which a member participates must be filed with FINRA for review. Rule 5110(a)(1)(B) additionally obligates a member acting as managing underwriter, or in a similar capacity, to alert the other members participating in the offering if FINRA has communicated an adverse opinion on the underwriting terms and arrangements and those terms have not been appropriately modified. The rule applies to the underwriters' terms and arrangements; it is separate from the SEC's review of the issuer's disclosure.

Question 3

Who must file with FINRA, by when, and what must be filed?

Accepted Answer

A member participating in a public offering that is required to be filed must submit the documents and information specified in Rule 5110(a)(4) through FINRA's Public Offering System no later than three business days after those documents are filed with or submitted to the SEC (including confidential filings or submissions) or a state securities commission or other similar U.S. regulatory authority — or, if the offering is not filed with or submitted to any such authority, at least 15 business days before sales commence. Under Rule 5110(a)(3)(B), a member need not file if the filing has been made by the member responsible for managing the offering or by another member in the syndicate or selling group, so in practice a single filing — commonly submitted by the managing underwriter or by a third party such as counsel on the member's behalf, per FINRA's public-offering filing guidance — covers the syndicate. Required documents under Rule 5110(a)(4) include the registration statement or other offering document, the proposed underwriting agreement and related agreements (such as engagement letters, letters of intent, consulting agreements, underwriter's warrant agreements, and escrow agreements), amendments that change information about the underwriting terms and arrangements, and the final versions of the distribution documents. Required information includes an estimate of the maximum public offering price, an estimate of the maximum value of each item of underwriting compensation, a representation as to whether any officer or director of the issuer, or any beneficial owner of 10% or more of any class of the issuer's equity and equity-linked securities, is an associated person or affiliate of a participating member, and a description of securities the participating members acquired during the review period.

Question 4

What standard does FINRA apply, and what terms does the rule treat as unreasonable?

Accepted Answer

FINRA reviews whether the underwriting terms and arrangements, including the aggregate underwriting compensation, are fair and reasonable. Rule 5110(g) identifies specific terms that are deemed unreasonable when proposed in connection with a public offering. Terms the rule treats as unreasonable include, among others: a non-accountable expense allowance exceeding 3% of offering proceeds; an overallotment option covering more than 15% of the amount of securities being offered; a right of first refusal on future transactions lasting more than three years from the commencement of sales of the offering; underwriting-compensation securities (such as underwriters' warrants) that are exercisable or convertible more than five years from the commencement of sales; and, for securities received as underwriting compensation, demand registration rights lasting more than five years or piggyback registration rights lasting more than seven years from the commencement of sales. The aggregate amount of compensation is evaluated against the facts of each offering rather than a single fixed percentage cap stated in the rule.

Question 5

What is FINRA's 'no objections' opinion, and can an IPO proceed without it?

Accepted Answer

Rule 5110(a)(1)(C) blocks members from distributing or selling securities in any public offering that must be filed under the rule until two things have happened: the documents and information the rule specifies are on file with FINRA, and FINRA has issued its opinion that it has no objection to the proposed underwriting terms and arrangements. FINRA's filing guidance makes the practical point directly: without a No Objections Letter in hand, a firm may not take part in distributing the securities to investors. During review, FINRA's Corporate Financing Department may issue a Defer letter (identifying regulatory concerns that require clarification or additional documents) or an Unreasonable letter (where the terms and arrangements do not appear to comply with the corporate financing rules); a No Objections Letter marks completion of the review. FINRA's Public Offerings page puts the average review at 10 to 25 business days, and FINRA operates a Limited Review program that provides faster clearance for eligible non-shelf offerings. FINRA's opinion addresses the underwriting terms and arrangements only — it is not an approval of the offering, its price, the issuer, or the accuracy of the issuer's disclosure, and neither FINRA nor the SEC approves securities offerings.

Question 6

What counts as underwriting compensation?

Accepted Answer

Rule 5110(j)(22) defines underwriting compensation broadly: everything of value — whether a payment, right, interest, or other benefit — that a participating member receives, from any source, for underwriting, allocation, distribution, advisory, or other investment banking services connected with a public offering. The definition expressly reaches finder's fees, fees of underwriter's counsel, and securities. Supplementary Material .01 to Rule 5110 lists examples, including underwriting discounts and commissions; reimbursed fees and expenses (such as road show, due diligence, and counsel fees); finder's fees; financial consulting and advisory fees; stock, options, warrants, and other equity securities received by participating members; rights of first refusal; compensation for serving as an advisor to the issuer's board; and fees paid to a qualified independent underwriter under Rule 5121. Securities acquired by a participating member during the 'review period' — which runs from 180 days before the required filing date through 60 days after the effective date of the offering or, for best-efforts offerings, the final closing — are examined as potential underwriting compensation, subject to the acquisitions that paragraph (d) excludes.

Question 7

What lock-up applies to securities received as underwriting compensation?

Accepted Answer

Rule 5110(e)(1) imposes a lock-up on securities received as underwriting compensation: for 180 days beginning on the date sales of the public equity offering commence, those securities cannot be sold, transferred, assigned, pledged, or otherwise disposed of, and cannot be hedged or economically disposed of through short sales, derivatives, puts, or calls, except as paragraph (e)(2) permits. The rule requires that this lock-up restriction be disclosed in the section of the prospectus (or similar document) that describes the distribution arrangements. Rule 5110(e)(2) provides exceptions, including for securities that are 'actively-traded' within the meaning of SEC Regulation M and for securities acquired in transactions that paragraph (d) excludes from underwriting compensation. This FINRA lock-up on the underwriters' compensation securities is distinct from the contractual lock-up agreements that underwriters typically require of an issuer's officers, directors, and pre-IPO shareholders.

Question 8

Which offerings are exempt from the FINRA filing requirement?

Accepted Answer

Rule 5110(h)(1) exempts specified offerings from the filing requirement — although they generally must still comply with the rule's substantive provisions — including offerings by 'experienced issuers' registered on SEC Forms S-3, F-3, or F-10 and offerings of investment-grade rated non-convertible debt or preferred securities. An 'experienced issuer' under Rule 5110(j)(6) is an issuer that has a 36-calendar-month reporting history and meets a public-float test: at least $150 million aggregate market value of voting stock held by non-affiliates, or at least $100 million of such market value combined with annual trading volume of at least three million shares. Rule 5110(h)(1) also exempts, among others, certain exchange offers and offerings by charitable institutions. Separately, Rule 5110(h)(2) places certain offerings outside the rule altogether, including registered investment company securities, variable contracts, and municipal securities. A first-time equity IPO does not qualify for the experienced-issuer exemption, so IPO underwriting terms are filed and reviewed.

Question 9

What filing fee applies to a FINRA corporate financing filing?

Accepted Answer

Section 7 of Schedule A to the FINRA By-Laws sets the fee for filing initial documents under the Corporate Financing Rule at $500 plus 0.015% of the proposed maximum aggregate offering price, not to exceed $225,500. An additional fee of 0.015% of any net increase in the maximum aggregate offering price applies to amendments, and total filing fees for a single SEC registration statement or other offering document are capped, in the aggregate, at $225,500. A flat fee of $225,500 applies to an offering of securities on an automatically effective Form S-3 or F-3 shelf registration statement by a well-known seasoned issuer as defined in Securities Act Rule 405. Fees may be rounded to the nearest dollar. These amounts reflect the current version of the Schedule A, Section 7 page, whose most recent amendment shown is SR-FINRA-2012-029 (effective July 2, 2012).

Question 10

What happens if an underwriter has a conflict of interest — FINRA Rule 5121?

Accepted Answer

FINRA Rule 5121 (Public Offerings of Securities With Conflicts of Interest) restricts a member with a conflict of interest from participating in a public offering unless the conflict is prominently disclosed and specified structural conditions are met — in many cases, participation by a qualified independent underwriter. Under Rule 5121(f)(5), a conflict of interest exists where, among other circumstances, the securities are to be issued by the member; the issuer and the member (or the member's associated persons) are in a control relationship; or at least 5% of the net offering proceeds (not including underwriting compensation) are intended to pay down credit extended by the member, its affiliates, or associated persons, or to be otherwise directed to them. Rule 5121(a) permits participation with prominent disclosure where the member primarily responsible for managing the offering is free of the conflict, the securities have a bona fide public market, or the securities are investment-grade rated — and otherwise requires a qualified independent underwriter that participates in preparing the offering document and exercises the usual standards of due diligence. Rule 5121(c) also bars a member with a conflict from selling the affected securities to a discretionary account unless the account holder gives specific written approval of the transaction and the member retains documentation of that approval.

Question 11

Who is barred from buying IPO shares — FINRA Rule 5130?

Accepted Answer

FINRA Rule 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings) bars members from selling 'new issues' — initial public offerings of equity securities — to accounts in which 'restricted persons' hold a beneficial interest, and from buying new issues for the members' own accounts. Restricted persons include FINRA members and other broker-dealers; most broker-dealer personnel and their qualifying immediate family members; finders and persons acting in a fiduciary capacity to the managing underwriter (such as attorneys and accountants on the deal); portfolio managers — persons with authority to buy or sell securities for a bank, savings and loan institution, insurance company, investment company, investment adviser, or collective investment account; and specified owners of broker-dealers. Before selling a new issue, a member must in good faith have obtained, within the prior 12 months, a representation from the account holder (or certain conduits) that the account is eligible. Exemptions cover, among others, registered investment companies, certain employee retirement plans and charities, and accounts in which restricted persons' beneficial interests do not exceed 10% in the aggregate (the de minimis exemption).

Question 12

How does FINRA Rule 5131 police IPO allocation abuses?

Accepted Answer

FINRA Rule 5131 (New Issue Allocations and Distributions) prohibits quid pro quo allocations — offering or threatening to withhold IPO shares as consideration or inducement for compensation that is excessive in relation to the services the member provides — and 'spinning,' the allocation of new issues to executives and directors of companies from which the member seeks investment banking business. Under the spinning prohibition in Rule 5131(b), a member may not allocate new issue shares to an account in which an executive officer or director of a public or covered non-public company (or a person materially supported by one) has a beneficial interest if the company is a current investment banking client, the member received investment banking compensation from it in the past 12 months, the member intends or expects to be retained by it within the next 3 months, or the allocation is conditioned on receiving future investment banking business; the prohibition does not apply where such persons' interests in the account do not exceed 25% in the aggregate. Rule 5131(d)(2) also addresses lock-up releases in connection with new issues: lock-up agreements covering the issuer's officers and directors must provide that, at least two business days before any release or waiver takes effect, the book-running lead manager will notify the issuer and announce the impending release or waiver through a major news service, subject to limited exceptions.

Question 13

How does the FINRA review fit into the IPO timeline?

Accepted Answer

The FINRA filing is due within three business days of the SEC filing or confidential submission, so FINRA's review runs in parallel with the SEC's disclosure review — and the offering cannot be completed until both tracks conclude, because Rule 5110 bars members from selling until FINRA provides its no-objections opinion and SEC Rule 461 ties acceleration of effectiveness to the status of that review. Under SEC Rule 461(a) (17 CFR 230.461), no later than the time it files the last pre-effective amendment, the registrant must inform the Commission whether the underwriters' compensation and the other arrangements among the registrant, the underwriters, and participating broker-dealers have been reviewed to the extent required and whether a statement expressing no objections has been issued. Rule 461(b)(6) lists, among the situations in which the Commission may refuse to accelerate the effective date, the case in which those arrangements, if required to be reviewed, have been reviewed but no statement expressing no objections has been issued — the CFR text still refers to FINRA's predecessor, the NASD. In practice, underwriting terms are typically cleared with FINRA before the registration statement is declared effective and the IPO prices.

Rule	What it governs	Who or what it restricts	Rulebook source
FINRA Rule 5110 — Corporate Financing Rule (Underwriting Terms and Arrangements)	Filing and review of underwriting terms, arrangements, and compensation in public offerings; no member may sell in a covered offering until FINRA provides an opinion of no objections	Participating members (underwriters and their affiliates and associated persons); compensation must not be unfair or unreasonable; securities received as compensation carry a 180-day lock-up	FINRA Rule 5110 (rulebook) · source
FINRA Rule 5121 — Public Offerings of Securities With Conflicts of Interest	Participation in offerings where a member has a conflict of interest — for example, the member is the issuer, shares a control relationship with the issuer, or at least 5% of net proceeds will be directed to the member	Conflicted members: prominent disclosure required and, absent an exception (such as a bona fide public market or investment-grade rating), a qualified independent underwriter must participate; written approval needed for sales to discretionary accounts	FINRA Rule 5121 (rulebook) · source
FINRA Rule 5130 — Restrictions on the Purchase and Sale of Initial Equity Public Offerings	Who may buy 'new issues' — initial public offerings of equity securities	Bars sales of new issues to accounts of restricted persons (broker-dealers, their personnel and owners, finders and deal fiduciaries, portfolio managers), subject to exemptions including a 10% de minimis threshold	FINRA Rule 5130 (rulebook) · source
FINRA Rule 5131 — New Issue Allocations and Distributions	Allocation and distribution conduct in new issues, including lock-up releases and flipping	Prohibits quid pro quo allocations and spinning to executive officers and directors of investment banking clients (25% aggregate account threshold; 12-month lookback and 3-month forward window); requires issuer notice and a major-news-service announcement by the book-running lead manager at least two business days before a lock-up release or waiver	FINRA Rule 5131 (rulebook) · source

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