August 13, 2010

FINRA’s Papilsky Rules Updated

Last month, the SEC approved new FINRA Rule 5141, which will replace the current NASD rules collectively referred to as the “Papilsky” rules. As noted in this alert from Latham & Watkins, the new rule will simplify and eliminate some provisions of the Papilsky rules, which seek to prevent broker-dealers participating in fixed price securities offerings from offering to favored clients any securities at a price that is at a discount to the public offering price.

The Papilsky rules originally came about as a result of the decision in Papilsky v. Berndt, which was a case where a shareholder of an investment company brought a derivative suit against the directors of the investment company and its advisor, alleging violations of fiduciary duties in failing to “recapture” brokerage commissions, underwriting commissions and tender offer fees for the investment company and its shareholders. The court held that, in the absence of an SEC or self regulatory organization rule to the contrary, recapture of the commissions and fees was legal and therefore the failure of the advisor to bring the potential for recapture to the attention of the independent directors of the fund constituted a breach of fiduciary duty. In the wake of this decision, the SEC and NASD worked to clarify the regulatory position on such “recapture” and other arrangements, resulting in NASD Rules 2730, 2740 and 2750.

The new Rule 5141 continues to prohibit FINRA members from selling securities in fixed priced offerings at other than the public offering price. FINRA intends to issue a Regulatory Notice announcing approval of the rule and announcing an effective date, which must take place within 90 days of SEC approval. The effective date will be no more than 180 days following the Regulatory Notice.

The change to the Papilsky rules will require some changes to underwriting agreements to reflect the new requirements specified in Rule 5141.

More FINRA Stuff: IPO Allocations

FINRA recently filed an amendment to its proposal to amend FINRA Rule 5131 with the SEC. The rule changes seek to regulate conflicts-of-interest and other abuses in the allocation of securities in initial public offerings. The SEC Is expected to publish the proposal for comment very soon.

Is a CEO Pledge of Allegiance the Answer?

The SEC has taken the very admirable step of opening up the comment process on Dodd-Frank Act implementation ahead of time, and hopefully the pace at which comments are submitted will increase, given that the SEC is going to need to act very soon on many of the rules it needs to implement. With respect to the corporate governance and compensation provisions of the Act that affect public companies, it seems that probably the first rulemaking out of the box (other than proxy access adoption) will be rule proposals to implement Say-on-Pay, Say-on-Frequency and Say-on-Parachutes. In order to have those rules in place for the proxy season, we would expect to see proposals within the next 30 days or so. It seems likely that those rule proposals will look much like the implementing rules adopted for the TARP Say-on-Pay votes, with additional rules necessary to address the quirks of the Dodd-Frank Act, such as the Say-on-Frequency vote (or rather should I say “poll,” because it sounds like that is how it will be structured).

Some comments have already trickled in, including this note from an experienced investor who has a truly novel idea in these times of many recycled ideas: require CEOs to swear to protect and defend the interests of the company along with an annual certification as to their fairness, honesty and integrity. You never know, this one might get some traction.

– Dave Lynn