FINRA Proposes Changes to the Corporate Financing Rule

News Brief

By Cydney Posner

FINRA is proposing a couple of changes with respect to Rule 5110, the Corporate Financing Rule – Underwriting Terms and Arrangements. Under Rule 5110, no member or person associated with a member may participate in a public offering subject to, and not exempt from, the Rule (or FINRA Rule 5121 (Public Offerings of Securities With Conflicts of Interest)), unless specified documents and information (such as the registration statement, the UA and AAU) have been filed with and blessed by FINRA's Corporate financing Department. Typically, these documents are filed by the book-running manager for the offering.

  • Proposed Fee Increase. The first change is a proposal to increase the fees for documents filed under Rule 5110.
    • For the filing of initial documents relating to an offering, the fee would increase to $500 plus .015%, up from .01%, of the proposed maximum aggregate offering price of securities registered (or included on any other type of offering document, where not filed with the SEC), up to a maximum of $225,500, up from $75,500.
    • For an offering under Rule 415 by a WKSI on an automatically effective Form S-3 or F-3, the fee would increase from $75,500 to $225,500.
    • In the event of an amendment or change to the filed documents, there would be an additional fee equal to .015%, up from .01%, of the net increase in the maximum aggregate offering price of all securities registered on an SEC registration statement, or on any related Rule 462(b) registration statement, or reflected on any Rule 430A prospectus, or included on any other type of offering document.
    • In all cases, the aggregate of all filing fees paid in connection with an SEC registration statement or other type of offering document may not exceed $225,500, again an increase from $75,500.

In the absence of the change, fees would have been capped at offerings with an aggregate offering price of $750 million or more. FINRA notes that the filing fee rate has not changed since it was adopted in 1970, although the cap has been adjusted from time to time. In addition, many filings seek expedited review or "same day clearance," and FINRA has "deployed significant technology resources and process enhancements to accommodate those needs." The proposed adjusted fees and fee cap would become effective for filings and amendments made on or after July 2, 2012 (although the SEC has not yet even posted the FINRA filing).

  • Deferred Compensation Arrangements in Public Offerings. The second proposed change to Rule 5110 is currently in the form of a Request for Comments. The proposed amendments address current restrictions related to deferred compensation arrangements for financial advisory services in connection with public offerings.  

Engagement letters between investment banks and issuers with respect to underwriting and financial advisory services may have provisions that allow issuers to defer payment until after completion of the capital-raising transaction. To discourage issuers from cancelling engagements just to avoid the deferred compensation payment, engagement letters may provide for rights of first refusal with respect to participation in a subsequent transaction or termination fees (sometimes called "tail fees"), which permit an underwriter to receive fees if its services are terminated and the issuer then consummates a similar transaction with another underwriter in lieu of the transaction subject to the engagement letter. Both arrangements are intended to provide issuers and underwriters with greater flexibility; however, there have been some limitations imposed on the use of these types of provisions. For example, as interpreted by the staff, ROFRs have been prohibited when a member's participation in the original transaction is terminated.

FINRA now proposes to amend the Corporate Financing Rule to relax some of these restrictions on tail fees and ROFRs. More specifically, FINRA proposes to amend Rule 5110(f)(2)(D) to allow termination fees and ROFRs when the written agreement between the issuer and underwriter specifies (among other requirements that are currently part of the Rule) the following:

  • the amount of the termination fee must be reasonable in relation to the services contemplated in the agreement, and fees arising from services provided under an ROFR must be customary for those type of services; <
  • the issuer has a right of "termination for cause," which includes the member's material failure to provide the services contemplated in the agreement;
  • an issuer's termination for cause eliminates any obligations with respect to any termination fee or ROFR; 
  • the termination fee requires that any offering or other transaction for which a fee is payable must be consummated within two years of the date the engagement is terminated by the issuer; and
  • any ROFR provided to the underwriter or related persons to underwrite or participate in future transactions may not have a duration of more than three years from the commencement of sales of the public offering or the termination date of the engagement between the issuer and underwriter.

As noted, the proposed amendments would retain the requirements in the existing rule that termination fees can be paid and ROFRs can be executed only within certain time periods. Accordingly, the proposed amendments would require that an offering or other transaction described in the agreement must be consummated within two years of the date the engagement is terminated, and would continue to prohibit any ROFR with a duration of more than three years from the date of effectiveness or commencement of sales of a public offering. These time limitations are intended to prevent an issuer from being subject to termination fees or ROFRs even after its business and operations may have changed significantly.

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