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Late last week, the SEC approved changes to FINRA Rule 5110 that – among other things – are aimed at simplifying how underwriting compensation is calculated. Here’s an excerpt from the SEC order:

FINRA’s proposed rule change would, among other things, amend provisions of Rule 5110 to: (1) change the valuation method for securities acquisitions that are considered to be underwriting compensation; (2) add certain securities acquisitions to the existing exclusions from underwriting compensation; (3) treat nonconvertible preferred securities the same as nonconvertible debt securities; and (4) make other modifications for clarity and to improve the operation of the rule.

Here’s more detail on what the rule will do, based on the SEC’s order:

– Replace the “bona fide public market” valuation method with a more predictable valuation method, as the new method would be based on readily available market data (the closing market price of the security traded on a U.S. registered national securities exchange or a “designated offshore securities market”) instead of requiring a calculation that included average daily trading volume and public float.

– Expand the exclusions from underwriting compensation to include additional narrowly tailored exclusions, which are based on exemptive relief that FINRA has previously provided and would need to comply with specific conditions in the amended rule: (1) debt-for-equity exchanges; and (2) capital investments for direct participation programs (“DPPs”) and unlisted real estate investment trusts (“REITs”).

– Treat nonconvertible preferred securities the same as nonconvertible debt securities – i.e., they are considered to have no compensation value and excluded from underwriting compensation – as long as the nonconvertible preferred securities are acquired at a fair price. FINRA noted that both non-convertible debt and non-convertible preferred securities cannot be converted to common stock and provide predetermined payments to holders, resulting in fixed sources of income. In addition, FINRA will maintain the ability to oversee underwriting terms and arrangements because participating members would continue to be required to file documents and information in connection with certain public offerings.

– Amend Rule 5110(g)(5)(B) to add tail fees to the types of termination fees that are allowed as underwriting compensation, if specific requirements are met. Under the amended rule, the same requirements that apply to termination fees will also apply to tail fees. If these requirements are not met, tail fees would constitute unreasonable arrangements under Rule 5110.

– Make non-substantive, technical changes.

FINRA believes the amendments will result in fewer exemption requests and reduce situations where underwriters and companies have to negotiate different forms of compensation for compliance reasons – providing more predictability and certainty to members while also maintaining guardrails to protect investors.

In addition to the amendments to FINRA Rule 5110, the Commission also approved amendments to FINRA Rule 5123, which addresses private placements of securities. The amendments to Rule 5123 expand the available filing exemptions for sales to accredited investors to include offerings sold to investors meeting the accredited investor categories for certain family offices and for certain entities with assets under management in excess of $5,000,000, consistent with the Commission’s addition of those categories to the accredited investor definition in August 2020.

– Liz Dunshee