FINRA Rule 5130 Evolves Further to Address Non-US Investors and Securities Offerings

August 2, 2019 (Updated August 8, 2019)

FINRA and its predecessor NASD have long worked to promote fairness in the allocation of new issues of equity securities by prohibiting allocations to broker-dealers and persons who, among other things, own or control, directly or indirectly, more than 10% of a broker-dealer or who are portfolio managers (Restricted Persons).[1] FINRA Rule 5130 reflects these principles, and also includes exemptions and exclusions to recognize that some entities and offerings do not implicate new issue allocation concerns.[2] FINRA also has adopted Rule 5131 to, among other things, prohibit “spinning,” which refers to allocations of new issues to persons in a position to direct hiring of broker-dealers to provide investment banking services.[3] Rules 5130 and 5131 referred to together as the “Rules.”

The Proposal

The US Securities and Exchange Commission (SEC) has published for notice and comment a FINRA proposal that, if adopted, would provide much needed clarification on the application of the Rules to non-US investors, including non-US retirement plans, non-US investment companies, and sovereign wealth funds, as well as to non-US offerings of securities.[4] The proposed amendments would apply as follows:

  • Foreign Employee Retirement Benefit Plans: The proposed amendments to Rule 5130 would create a general exemption from Rule 5130 for foreign retirement benefit plans. The general exemption would be available for foreign employee retirement benefit plans that (i) have at least 10,000 participants and beneficiaries and $10 billion in assets, (ii) are operated such that a wide range of employees, regardless of income or position, can participate, (iii) are managed by fiduciaries acting in the best interest of the participants and beneficiaries, and (iv) are not sponsored by a broker-dealer. FINRA proposes a corresponding exemption in Rule 5131 as well.[5]


  • Foreign Investment Companies: FINRA proposes to expand the ways that a foreign investment company can fall within the current general exemption from application of Rule 5130. Currently, foreign investment companies are exempt from applicability of the Rule 5130 if they meet the threshold criteria of (1) being organized outside the US and authorized for sale to the public or traded on a foreign securities exchange, and (2) have no more than 5% of owners who are Restricted Persons.[6] FINRA proposes to exempt from Rule 5130 foreign investment companies that meet the threshold criteria but as an alternative to the 5% threshold of Restricted Persons, such funds could have at least 100 direct investors or at least 1000 indirect investors. A fund relying on this exemption would have to demonstrate that it was not formed specifically to invest in new issues. The proposed exemption would impact the current cross referenced exemption for foreign investment companies in Rule 5131 as well, so that foreign investment companies exempt under Rule 5130 also would be exempt under Rule 5131.[7]


  • Sovereign Wealth Funds: Rule 5130 would be amended to exclude sovereign wealth funds and their investment vehicles from the definition of restricted person. This exemption would recognize that, while a sovereign wealth fund may be or become a direct or indirect owner or control person of a broker-dealer, preventing a sovereign wealth fund and its investment vehicles (but not its affiliates) from receiving allocations is not necessary to achieve the public policy underlying the Rule.


  • Regulation S and other non-US Offerings of Securities: FINRA proposes to amend the definition of “new issue” in Rule 5130, which is also used in Rule 5131, to specifically exclude for purposes of both Rule 5130 and Rule 5131 offerings made under Regulation S or otherwise made outside the United States or its territories. It is worth noting that the definition of “new issue” currently is limited to initial public offerings of equity securities made pursuant to a registration statement or offering circular. Therefore, there is some question whether FINRA intended this express exemption to clarify, rather than amend, the scope of offerings to which Rule 5130 and Rule 5131 are applicable. It is possible that this amendment to the Rules will reverse the tendency of certain FINRA member firms to apply the Rules globally, including to new issuers managed by their non-US, non-FINRA member affiliates.

    The proposed amendments to the Rules would also expand and clarify the scope of the exemption for family offices in Rule 5130 and exclude from “covered non-public companies” in Rule 5131 “unaffiliated charitable organizations” that would otherwise fall within the definition, and adopt language making the provisions of the Rules consistent with regard to the exclusion for issuer directed securities. These proposed amendments are:


  • Family Offices: The proposed amendment to Rule 5130 clarifies and expands the exemption from the definition of Restricted Persons in Rule 5130 for family offices by making the terms used consistent with the Investment Advisers Act of 1940. This change would recognize that family offices often invest on behalf of multiple generations and also that key employees who are not family members may be beneficial owners of a family office account that seeks to receive allocations.


  • “Unaffiliated Charitable Organizations”[8]: FINRA proposes to amend Rule 5131 to exclude from “covered non-public companies” those charitable organizations that would otherwise, based on asset size, fall within the definition of “covered non-public company. FINRA does not believe that the appearance of impropriety or the potential to divide loyalty between officers and directors and the companies exists in relation to charitable organizations, in particular because these organizations are not likely to generate significant investment banking business. As a result, FINRA views as low risk the likelihood that a member or its associated persons would allocate new issues to officers and directors of charitable organizations in order to receive investment banking business. FINRA, in its filing to the SEC, specifies that this exclusion would be limited to 501(c)(3) organizations and the definition is limited to such organizations.


  • Issuer Directed Securities: FINRA proposes to amend Rule 5130 to align Rule 5130 with Rule 5131 when a new issue includes issuer directed allocations of securities. While both Rules have provisions excluding allocations that are issuer directed, Rule 5131 allows an affiliate or selling shareholder to direct allocations of securities, while Rule 5130 only exempts directions from issuers. Rule 5130 would be amended to also permit affiliates and selling shareholders to direct allocations.

Finally, FINRA proposes to add supplemental materials to Rule 5131 to add anti-dilution provisions, similar to those already in Rule 5130. Supplemental Material .04 would provide that if an executive officer or director of a public company or covered non-public company or a person materially supported by such a person has a beneficial interest in an account with an equity interest in an issuer or company acquired by the issuer in the year prior to the offering, the account can receive an allocation of the new issuer if the allocation would not increase the account’s equity ownership percentage above its level three months prior to the filing of the registration statement for the offering, there are no special terms, and securities acquired pursuant to the Supplemental Material .04 are essentially restricted for three months following the effective date of the offering.

Next Steps[9]

The SEC published the proposal for notice and comment on August 2, 2019, and the proposal was published in the Federal Register on August 8.[10] Comments should be submitted to the SEC by August 29.[11]The SEC’s release states that the proposed changes to the Rules will be effective within 45 days of the date of publication of the proposal in the Federal Register or such longer period up to 90 days, if the SEC finds it appropriate. As a result, anyone considering commenting on this proposal should act as soon as possible. Areas to consider commenting on include, but are not limited to:

  • The benefits of the proposal for issuers, FINRA members, and potential non-US investors
  • The benefits of the proposal for the US capital markets by attracting non-US investors previously precluded from IPOs
  • Any further refinements to the proposed amendments or points for clarification, such as:
    • Clarification of what is required for a foreign investment company to have been “authorized” for sale to the public
    • Clarification of whether a Regulation S tranche of a global offering would be exempt under the proposed general exemption
    • Specific language in Rule 5131 referencing that the charitable organizations exclusion from “covered private company” refers only to organizations that are 501(c)(3) organizations


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the author, Amy Natterson Kroll, in our Washington, DC, office, or any of the following Morgan Lewis lawyers:

Washington, DC
Steven W. Stone
Ignacio A. Sandoval
David A. Sirignano

Ethan Johnson

Richard Goldman

Tim Levin
Jack O’Brien

[1] The complete definition of “restricted person” is found in Rule 5130(i)(10).

[2] NASD originally adopted the “Hot Issues” interpretive memorandum prohibiting allocations of shares in new issues with significant appreciation on their first day of trading to Restricted Persons. See SEC Release No. 34-35059, File No. SR-NASD-94-15 (Free-Riding and Withholding Interpretation (IM-2110-1)). In 2003, the NASD, concluding that the policy underlying the Hot Issues interpretation applied to all new issues, adopted Rule 2790, prohibiting allocations of any new issue to Restricted Persons. See NASD Notice to Members 03-79, December 23, 2003. FINRA Rule 5130 incorporates the provisions of NASD Rule 2790 and further refinements made by FINRA as practices in the markets have evolved.

[3] FINRA Regulatory Notice 10-60, November 2010.

[5] This amendment would remedy a disparity in treatment due to the differences in exemptive authority in Rule 5130 and Rule 5131. While FINRA Rule 5130(h) permits “the staff, for good cause shown [to] exempt any person, security or transaction,” FINRA Rule 5131(f), however, only permits exemptions “in exceptional and unusual circumstances.” As a result, FINRA has issued a number of individual exemptive letters under Rule 5130 to foreign employee retirement benefit plans, but has not been able to do the same under Rule 5131. See n. 4, infra.

[6] FINRA has in a number of instances granted specific relief from Rule 5130 for foreign employee retirement benefit plans that have demonstrated that through their structure they could not serve as conduits for restricted persons to purchase new issues. See Letter from Gary L. Goldsholle, FINRA, to Edward A. Kwalwasser, Proskauer Rose LLP, dated December 7, 2010; Letter from Afshin Atabaki, FINRA, to Christopher M. Wells, Proskauer Rose LLP, dated November 2, 2012; Letter from Meredith Cordisco, FINRA, to Amy Natterson Kroll, Morgan, Lewis & Bockius LLP, dated July 23, 2015; and Letter from Meredith Cordisco, FINRA, to Amy Natterson Kroll, Morgan, Lewis & Bockius LLP, dated April 16, 2018.

[7] The proposed exemption for foreign investment companies may not be available with regard to funds operating under the European Union’s Undertakings for the Collective Investment in Transferable Securities (UCITS) that are offered to the public. The UCITS regime does not specifically “authorize” funds for sale to the public as contemplated by Rule 5130, despite the fact that the funds may be available for sale to the public under the law of a European Union member state.

[8] An “‘Unaffiliated charitable organization’ is a tax-exempt entity organized under Section 501(c)(3) of the Internal Revenue Code that is not affiliated with the member and for which no executive officer or director of the member, or person materially supported by such executive officer or director, is an individual listed or required to be listed on Part VII of Internal Revenue Service Form 990 (i.e., officers, directors, trustees, key employees, highest compensated employees and certain independent contractors).” FINRA Rule 5131(e)(9).

[9] With the proposed amendments, FINRA is updating Rule 5130 and Rule 5131 based on its experience administering the Rules while preserving the underlying public policies. In the future, FINRA may want to consider further refinements. For instance, FINRA may wish to clarify that an “investment company” for purposes of the definition of “limited purpose broker-dealer” includes private fund, as well as registered investment companies.

[11] The link for submitting comments is open and can be found here.