small firms assisting small businesses raising capital: a ... · finra staff and industry panelists...

© 2017 Financial Industry Regulatory Authority, Inc. All rights reserved. 1

Small Firms Assisting Small Businesses Raising Capital: A Discussion of Regulation A+, Regulation D and Direct Offerings Thursday, November 9 10:15 a.m. – 11:15 a.m.

This session focuses on business and regulatory developments related to the JOBS Act and how FINRA small firms can use Regulation A-plus (A+) and Regulation D to raise capital for clients. Join FINRA staff and industry panelists as they discuss recent trends in Reg A+, Regulation D and crowdfunding offerings.

Moderator: Joseph Price Senior Vice President and Counsel FINRA Corporate Financing/Advertising Regulation Panelists: Sara Hanks Co-Founder and Chief Executive Officer CrowdCheck, Inc. John Hullar Chairman and Managing Partner W.R. Hambrecht, Co. Darryl Steinhause Partner DLA Piper LLP (US)


Small Firms Assisting Small Businesses Raising Capital: A Discussion of Regulation A+, Regulation D and Direct Offerings Panelist Bios: Moderator:

Joseph E. Price is Senior Vice President, Corporate Financing/Advertising Regulation, at the Financial Industry Regulatory Authority. The FINRA Corporate Financing Department regulates capital-raising activities of broker dealers; including equity, debt, REIT, closed-end fund, limited partnership offerings and private placements. The FINRA Advertising Regulation Department regulates broker dealer sales materials, mutual fund advertisements, social media and other communications with the public. Mr. Price previously worked in various capacities at the Securities and Exchange Commission. He was an Assistant General Counsel and a Special Counsel in the Office of General Counsel and he was the Deputy Chief of the Office of Disclosure and Investment Adviser Regulation in the Division of Investment Management. Prior to working at the SEC, he was a litigator in the Bureau of Competition at the Federal Trade Commission. Mr. Price also worked as a Compliance Investigator at the Coffee, Sugar & Cocoa Exchange. He was an Adjunct Professor at Georgetown University Law Center from 1994 to 2002, where he taught “Current Issues in Securities Regulation” and “Disclosure under the Federal Securities Laws.” He graduated with distinction in economics from the University of Wisconsin and received his J.D. from Fordham University.

Panelists: Sara Hanks, co-founder and CEO of CrowdCheck, is an attorney with more than 30 years of experience in the corporate and securities field. CrowdCheck provides due diligence, disclosure and compliance services for online capital formation. Its services help entrepreneurs and project sponsors through the disclosure and due diligence process, give investors the information they need to make an informed investment decision and avoid fraud and help intermediaries avoid liability. Ms. Hanks’ prior position was General Counsel of the bipartisan Congressional Oversight Panel, the overseer of the Troubled Asset Relief Program (TARP). Prior to that, Ms. Hanks spent many years as a partner of Clifford Chance, one of the world’s largest law firms. While at Clifford Chance, she advised on capital markets transactions and corporate matters for companies throughout the world. Ms. Hanks began her career with the London law firm Norton Rose. She later joined the Securities and Exchange Commission and as Chief of the Office of International Corporate Finance led the team drafting regulations that put into place a new generation of rules governing the capital-raising process. Ms. Hanks received her law degree from Oxford University and is a member of the New York and DC bars and a Solicitor of the Supreme Court of England and Wales. She serves as co-Chair of the SEC’s Advisory Council on Small and Emerging Companies. She holds a Series 65 securities license as a registered investment advisor. John Hullar is Chairman and Managing Partner of W.R. Hambrecht, Co. Prior to joining WRH+Co, Mr. Hullar spent 11 years at Wells Fargo Securities, serving as President and CEO. Before joining Wells Fargo Securities, Mr. Hullar was Director of Worldwide Sales at Hambrecht & Quist, where he oversaw all aspects of U.S. and International Institutional Sales and Accounts, Executive Financial Services and Venture Services Sales. Prior to joining Hambrecht & Quist, Mr. Hullar was an Executive Director at Morgan Stanley where he held leadership positions in Institutional Equities in New York, Tokyo, and London. Mr. Hullar holds a B.A. from Yale University. He was a member of the Yale University Development Board; a Trustee and Chair of Finance at The Hamlin School and The Branson School; and a Trustee of The First Tee Chapter of San Francisco. Darryl Steinhause is Partner of DLA Piper LLP (US) and has more than 35 years advising clients regarding complex securities and tax structures. Viewed as a pioneer in tenant in common, Delaware statutory trusts and REIT roll-up transactions, Mr. Steinhause’s creative structuring has made him one of the most sought after attorneys in the real estate syndication space. He represents both sponsors and institutional investors in a variety of deal structures, including private placements, Regulation A offerings, publicly registered transactions and institutional funds. Noted for his ability to create solutions and structure complex deals, Mr. Steinhause has acted as securities and tax counsel to over $10 billion of real estate syndications. He also acted as special tax counsel with respect to the bankruptcy work-out of the Sunwest Management portfolio and helped achieve an outstanding result for the investors in the


Sunwest Management controlled properties. Mr. Steinhause has spoken at numerous events regarding securities and broker-dealer issues, the new crowd-funding and Regulation A+ rules and other seminal topics in the industry. Mr. Steinhause was selected to the prestigious Top 100 Lawyers in California list (selected from over 200,000 lawyers in the state as one of the top 100 lawyers who are doing creative, cutting-edge work) from 2011 to 2016. Mr. Steinhause was honored by The Daily Journal as a Real Estate Deal Maker for 2011 (only 20 lawyers are selected and inclusion is based on significant impact and demonstrated creativity, adaptability and tenacity).

2017 Small Firm Conference

November 8 – 9 | Santa Monica, CA

Small Firms Assisting Small Businesses

Raising Capital: A Discussion of

Regulation A+, Regulation D and Direct

Offerings

FINRA Small Firm Conference | © 2017 FINRA. All rights reserved.

Moderator

Joseph Price, Senior Vice President and Counsel, FINRA Corporate Financing/Advertising Regulation

Panelists

Sara Hanks, Co-Founder and Chief Executive Officer, CrowdCheck, Inc.

John Hullar, Chairman and Managing Partner, W.R. Hambrecht, Co.

Darryl Steinhause, Partner, DLA Piper LLC (US)

1

Panelists

Small Firms Assisting Small

Businesses Raising Capital

A Discussion of Regulation A+, Regulation D,

and Direct Offerings

November 9, 2017

Darryl Steinhause

DLA Piper LLP US

[email protected]

All Rights Reserved 11/06/2017

www.dlapiper.com November 6, 2017 3

I. My client says he wants to obtain some funds for his business –

what do I do? How do I navigate the marketplace?

A. How much do you need to raise?

B. When do you need the funds?

C. How do you plan on raising the funds?

D. How many private offerings have you been involved with

over the last 12 months?

E. How is the deal structured?

1. Debt

2. Equity

F. Is this offering viable?

How Do I Navigate the Marketplace?


Types of Offerings

II. Types of Offerings

A. Section 4(a)(2)

1. A transaction by an issuer not involving any public

offering

2. No specific definition

3. Used for private transactions

4. Courts have looked at:

a. Sophistication of investors

b. Information provided to investors

c. Limited offerees

d. Limited sales activities

5. Restricted securities

6. Must blue sky


Types of Offerings

7. In practice it is used

a. When there are limited investors

i. No specific number

b. Used if sophisticated non-accredited investors

because the requirements of Rule 506 cannot be

met

c. An option if there is a failed Rule 506 offering

without general solicitation

d. Not typically used for crowdfunding


Types of Offerings

C. Section 4(a)(6)

1. True Crowdfunding

a. Issuer can sell up to $1,070,000 in any 12-month

period

b. Investors

i. If annual income or net worth <$107,000, then

investor can invest the greater of: (i) $2,200 or

(ii) 5% of the lesser of the investor’s income or

net worth

ii. If both annual income and net worth

$107,000, then investor can invest: 10% of

the lesser of (i) investor’s income or (ii) net

worth

iii. Overall cap of $107,000 to any investor in any

12-month period


Types of Offerings

c. Transactions are required to occur through a

broker/dealer or funding portal

d. Transferability is limited—cannot transfer for 1 year

e. Blue sky – only notice and fee

f. Used for small raises - typically technology

companies

g. Usually equity but can be debt

2. Limited use because of:

a. $1.07 million limit

b. Broker/dealer required

c. Expensive


Types of Offerings

C. Intrastate Offering Section 3(a)(11)

1. Limited to sales in one state

2. Used in private transactions

3. Requirements

a. Issuer must be doing business in the state

b. All offers and sales must only be to the residents of

the state

c. The investors must hold the securities

4. New Rule 147A

a. Allows for sales through the internet – no limit on

offers

b. Effective April 20, 2017

5. Required to blue sky in the state

6. Can advertise if state allows

7. A limited type of crowdfunding

8. Many states have their own crowdfunding rules


Types of Offerings

D. Rule 504

1. Recent change – increased limit to $5,000,000


3. Advertising is allowed if state registration or only

accredited investors

4. Must Blue Sky – must register in many cases

5. Bad actor rules apply

6. In the past, limited use because of state requirements –

use should increase under new provisions


Types of Offerings

E. Rule 506(b)

1. Most common way to raise funds in a syndication

2. No general solicitation

a. C&DIs

i. The use of an unrestricted, publicly available

website constitutes a general solicitation

ii. Factual business information that does not

condition the public mind or arouse public

interest in a securities offering is not an offer

and may be disseminated widely

iii. Factual business information typically is limited

to information about the issuer, its business,

financial condition, products, services or

advertisement of such products or services


Types of Offerings

3. Can include up to 35 non-accredited investors but most

sponsors do not have necessary information and require

disclosure

4. Platforms are not set up for non-accredited investors

5. Pre-existing relationship

a. Citizen VC

b. C&DIs

i. A Regulation D offering to a prospective

investor with whom the issuer, or a person

acting on the issuer’s behalf, has a pre-

existing, substantive relationship does not

constitute a general solicitation

ii. A “pre-existing” relationship is one that the

issuer has formed with an offeree prior to the

commencement of the securities offering

iii. There is no minimum waiting period to

establish a pre-existing, substantive

relationship with a prospective offeree


Types of Offerings

iv. A “substantive” relationship is one in which the issuer

(or a person acting on its behalf) has sufficient

information to evaluate, and does, in fact, evaluate, a

prospective offeree’s financial circumstances and

sophistication

v. There may be facts and circumstances in which a third

party, other than a registered broker/dealer, could

establish a “pre-existing, substantive relationship”

sufficient to avoid a “general solicitation”


7. No Blue Sky except notice and fee

a. Remember to file – new bad actor rules could be fatal

8. Bad actor rules apply

9. Only way to use it in crowdfunding is to use a platform with pre-

qualified investors

a. Significant issue for the platforms


Types of Offerings

F. Rule 506(c)

1. Same as 506(b) except allows general solicitation

2. 2 additional requirements

a. Must file Form D and check the box

b. Must take reasonable steps to verify that the

investors are accredited

i. No self-certification

ii. Must take steps even if accredited

c. Issuer must still comply with the other requirements

of Regulation D

3. Verification – safe harbor

a. Net worth qualification:

i. Assets: bank statements, brokerage

statements, securities holdings, CDs, tax

assessments and appraisal of assets;

ii. Liabilities: consumer report (credit report) from

nationwide agency; and

iii. Reports and statements dated within 3 months

of purchase


Types of Offerings

b. Income qualification:

i. 2 years of tax returns and a written

representation regarding the current year

c. Written confirmation (within 3 months of purchase)

from any one of the following persons that the

investor is accredited:

i. Registered broker/dealer

ii. Registered investment adviser

iii. Attorney; or

iv. Certified public accountant

d. Different interpretations in the industry. Is it any

one of the 6; or is it (i) through (iv) and either (A) or

(B)


Types of Offerings

4. Eliminates “foot-faults”


6. No blue sky except notice and fee

7. Rule 506(c) may be the best crowdfunding alternative

other than the platforms for smaller transactions

a. Advertising is being monitored by the SEC

b. If a broker/dealer is involved, the broker/dealer

must approve the advertising

c. Advertising is subject to Section 10b-5


Types of Offerings

G. Regulation A

1. Eligible issuers

a. Issuers organized in and their principal place of

business in the United States or Canada

b. Certain issuers are not eligible

i. Reporting companies subject to Exchange Act

reporting requirements

ii. 40 Act companies

a) BDC’s

iii. Blank check companies

a) Blind pool allowed

iv. An entity issuing undivided interests in oil and

gas

v. Failure to file Regulation A reports during last 2

years

vi. SEC registration revoked in the last 5 years

vii. Certain bad actors


Types of Offerings

c. Eligible securities

d. Equity securities – including warrants

e. Debt securities

i. Debt securities exchangeable into equity

securities

f. Asset-backed securities are excluded

2. Offering limitation

a. Tier 1 – limited to $20 million in a 12-month period

b. Tier 2 – limited to $50 million in a 12-month period

c. Selling shareholders allowed to sell 30%

3. Investment limitations

a. Accredited — no limits

b. Non-accredited purchasers limited to 10% or the

greater of the investor's annual income or net worth

i. This limitation does not apply if the security is

publicly traded on a national securities exchange


Types of Offerings

4. Types of Disclosures

a. Form 1-A

b. Form S-1 or S-11

5. Integration Rules

a. No integration with prior sales of securities

b. No integration with subsequent sales of securities

that are:

i. Registered

ii. Issued under Rule 701

iii. Employee benefit plan

iv. Regulation S

v. Under the crowdfunding rules

vi. Made no more than 6 months after the

completion of the Regulation A offering

c. You can do multiple offerings at the same time as

long as they comply with both rules

d. SEC looking at integration of multiple Regulation A

offerings


Types of Offerings

6. Reporting requirements – Tier II

a. Annual - Form 1-K

b. Semi-annual - Form 1-SA

c. Current reports - Form 1-U

d. Special financial reports - Form 1-K

e. Exit reports - Form 1-Z

7. Section 12(g)

a. Tier II exempt if:

i. Complies with reporting requirements

ii. Engages a transfer agent

iii. Revenues of less than $50 million and public

float of less than $75 million


Types of Offerings

8. Securities freely transferable under Federal law

a. May need a state exemption

9. No blue sky except notice and fee

a. States are still figuring it out

b. Some states are very expensive

10. Has become an important element in crowdfunding

a. Cost is decreasing – but still high

b. SEC approval is reasonable

i. Three to four months

ii. Works better with blind pool

c. Typically need a broker/dealer or platform to sell

i. Issuers are beginning to advertise

ii. About 10-15% of the Reg A filings are debt.

But typically longer term debt


How Does the Issuer Plan on Raising

the Funds?

III. How does the issuer plan on raising the funds?

A. Issuer direct

1. Usually difficult for most issuers to raise significant funds

2. Most issuers run out of friends and family

3. There are significant broker/dealer issues if a serial

issuer

4. Section 3a4

a. Broker/dealer

i. Any person that engages in the business of

effecting transactions in securities for the

accounts of others must register as a

broker/dealer

ii. Issuers themselves do not have to register



the Funds?

iii. Rule 3a4-1 provides an exemption for persons

who work for the issuers

a) no performance based compensation

b) the person (i) primarily performs, or

intends to perform, substantial duties for

the issuer other than the sale of securities,

(ii) is not, and has not for the prior 12

months, been an associated person of a

broker/dealer, and (iii) does not participate

in more than one offering every 12 months

iv. State broker/dealer rules

b. Both (i) sales of securities and (ii) sales and

disposition of portfolio securities

c. Blass Speech and enforcement actions

i. Ranieri Partners

ii. BlackStreet Capital



the Funds?

5. Sell through RIA’s

a. Difficult

6. Issuer direct sales usually occur through:

a. Section 4(a)(2) offering

b. Intrastate offering

c. Rule 506(b) offering

d. Rule 506(c) offering

7. Most platforms are associated with a broker/dealer

B. Broker/Dealer

1. Make sure the broker/dealer can actually raise funds

2. Broker/dealers typically sell pursuant to Rule 506(b) and

Regulation A

3. Broker/dealers do not like to use Rule 506(c)

4. Additional requirements

a. Offering must be submitted to FINRA

b. Advertising must be approved by the broker/dealer


Single-tier Platform

IV. Single-tier Platform

A. A platform that just lists the securities on the platform

B. Rule 506(b) or Rule 506(c)

1. If Rule 506(b) platform – limited to investors on the

platform

C. This is best used for a Rule 506(b) or Rule 506(c) offering

(Sometimes a Regulation A offering)

D. Will the offering sell?

1. Look at the track record of platform


Two-tier Platform

V. Two-tier Platform

A. Platform forms their own LLC’s to invest in the project

sponsor

B. These platforms are based on AngelList and FundersClub

1. Not from crowdfunding but SEC no action letters

C. Investment must be managed by investment advisors

D. Most of these platforms now use a broker/dealer

E. No solicitation except through the website

F. These platforms typically use Rule 506(b) and sometimes

use Rule 506(c)

G. These platforms also sell Regulation A securities directly

from the platform

H. These platforms have been the most successful

1. Read the fine print


Cost

VII. Cost

A. Typically lower costs – Section 4(a)(2) – but if institutional

funding more expensive and typically sponsor fees and

profits are limited

B. Rule 506(b), Rule 506(c) and interstate are average costs

C. Regulation A is fairly expensive

The information contained herein is the confidential and proprietary information of WRH+Co. Any use, reproduction, dissemination or disclosure of the information contained herein is strictly prohibited.

November 9, 2017

2017 FINRA

Small Firm Conference

Small Firms Assisting

Small Businesses Raising Capital

28

"I want to challenge entrepreneurs to revolutionize the new-issue process, urging them to come public early and let the public participate…"

-- Bill Hambrecht

29

Regulation A+ Presentation Outline

WRH+Co – Overview

• Heritage & Culture

• Data-driven Selection Process

Reg A+ Review and Experience

• Case Studies

What We Have Learned

Recommendations

30

WR Hambrecht + Co, like Hambrecht & Quist beforeit, has consistently identified new trends andbusiness opportunities throughout its history.

WRH+Co was founded in January 1998 to level theplaying field for investors and our corporate clients.Our Founder, Bill Hambrecht, is a SiliconValley pioneerthat has been financing growth companies from Appleto Google during his time at Hambrecht & Quist andWRH+Co.

WRH+Co has been focused on opening up the investing world to as many people as possible at fair market prices and was instrumental in reforming Regulation A to help accomplish that for growth companies and investors. Bill Hambrecht was influential in the structure and implementation of the JOBS Act, and his remarks and letters were cited over 40 times in the SEC’s release of the final rule.

From the folks who

brought you Apple,

Adobe and

Genentech…

31

WR Hambrecht + Co Guiding Principles

Throughout our history, WRH+Co has been an innovative leader with

a core philosophy based on three tenets:

• Identifying exceptional companies

• Helping them raise capital and go public early

• Delivering efficient market pricing

32

Public Markets Once Embraced Emerging Growth Companies

In July 1986, Adobe Systems filed to sell

500,000 shares and raise approximately

$5.5 million (~$13 million in 2017

dollars)

• At the time, the company was four

years old and had 49 employees

• The public markets provided Adobe

with the capital to grow, create jobs

and stay independent of OEMs

In February 21, 2017, Adobe Systems

now has a market capitalization of over

$59 billion and 2016 revenue of $5.8

billion

• Currently, Adobe has over 15,000

employees and is consistently

named a top place to work

• Adobe has a 23% annualized

return since inception; $100

invested in Adobe in 1986 would

now be worth approximately

$40,000

Other Sub- $50MM IPOs:

StarbucksAOL

Peet’s CoffeeWhole FoodsPanera Bread

OdwallaIntel

AmgenOracleCisco

33

Reg A+ to Date

• SEC published final rules in June of 2015

• ~ 75 Filings in 2017 YTD, seeking to raise $1.77 billion

• Real Estate has the most filings as a class

• Since inception, six Reg A+ have listed on National Exchanges

• All completed in 2017 YTD

• NYSE: Myomo (MYO)

• Nasdaq: Adomani (ADOM), Arcimoto (FUV), Chicken Soup for the Soul (CSSE), Fat Brands

(FAT), ShiftPixy (PIXY)

• Institutions and BDs typically require Exchange Listing for IPO Securities

• Crowdsourcing is evolving

Common misconception remains in the marketplace: Reg A+ is “Crowdfunding” or necessarily includes some crowdfunding component

34

Reg A+ Distribution Strategy

35

WRH+Co Case Studies : Elio

Self-sponsored, self marketed offering (no underwriter or broker/dealer support)

100% retail distribution• 6,300 investors, 60% reservation-holders for Elio vehicle• Average purchase ~ 200 shares• Total capital raised of $16.7 million

WRH+Co facilitated Secondary Trading on OTX QX Market• DTC eligibility• 15c211 for permission to quote• Served as market-maker

PIXY: Nasdaq

• One of 3 Regulation A+ Offerings brought to the public in June 2017 and thesecond to list on Nasdaq.

• Listed on June 30, 2017 – Opened at $6.30 and closed at $7.70 on first trading day

• Shares sold at fixed price of $6/share with a market cap of $172 at the issue.

• WR Hambrecht + Co used its extensive network of broker-dealer partners to place2 million shares

• Roughly 700 investors contributed at an average purchase of nearly $17,500

• The combined legal and accounting fees for this recent offering of ShiftPixy talliedsubstantially less than conventional S-1 Offerings that cost well over $1 million.

WRH+Co Case Studies: ShiftPixy

11

FUV: Nasdaq

• One of 5 Regulation A+ Offerings brought to the public in 2017 and the fourth tolist on Nasdaq.

• Listed on September 21, 2017 – Opened at $5.90 and closed at $5.75 on firsttrading day

• Shares sold at fixed price of $6.50/share with a market cap of $103 million at theissue.

• WR Hambrecht + Co used its extensive network of broker-dealer partners to place3 million shares

• Roughly 900 investors contributed at an average purchase of nearly $20,000

• The combined legal and accounting fees for Arcimoto’s offering talliedsubstantially less than conventional S-1 Offerings that cost well over $1 million.

WRH+Co Case Studies: Arcimoto

12

38

What have we learned?

• Large numbers of issuers consider Reg A+ an attractive alternative to private financing or registered offering

• Promise of less expensive, more efficient pathway to public offering has largely been realized

• Distribution of Reg A+ offerings remains challenging

• Institutions not relevant or appropriate for many deals

• Broker-dealers generally will not participate in “unlisted” deals

• Crowd is highly unpredictable

• Disconnect remains between issuers, investors, brokers and underwriters regarding benefit/value of Reg A+

• Marketing spend not a panacea

• Need to examine aftermarket trading concerns

39

Recommendations

• Continued support of Reg A+ via cooperation, education and data dissemination

• Consider efforts to differentiate Reg A+ securities from broader “unlisted” market• Distinctions for underwritten offerings?• DTC eligibility standard?• Book-entry vs. physical certificates?• Emphasize protection against fraudulent offerings

• Attempt to better clarify differences between Reg A+ and crowdfunding

• Need to examine aftermarket trading concerns

1

Regulatory Notice 15-32

September 2015

Executive SummaryFINRA is publishing this Notice to provide guidance regarding the FINRA filing requirements and review procedures that apply to firms that participate in Regulation A+ offerings. Specifically, FINRA’s Corporate Financing Rules require firms that participate in Regulation A+ offerings to file with FINRA information specified in the rules. FINRA’s Communications with the Public Rule and its Suitability Rule also apply to a firm’s participation in these offerings. FINRA also reminds firms that communications with the public concerning a Regulation A+ offering of direct participation program (DPP) securities must be filed with FINRA.

Questions regarding this Notice may be directed to:

00 Joseph E. Price, Senior Vice President, Corporate Financing/Advertising Regulation, at (240) 386-4642;

00 Amy C. Sochard, Senior Director, Advertising Regulation, at (240)386-4508; or

00 Kathryn M. Moore, Associate General Counsel, Office of General Counsel, at (202) 728-8200.

Background and Discussion

Regulation A+

Regulation A under the Securities Act of 1933 has been a longstanding exemption from the registration requirement for offerings of up to $5 million of securities in any 12-month period.1 Pursuant to Title IV of the Jumpstart Our Business Startups (JOBS) Act,2 the SEC recently updated and expanded Regulation A with amendments that became effective on June 19, 2015. The new amendments, popularly known as Regulation A+, allow offerings of up to $50 million of securities in a 12-month period. Below, FINRA highlights a few of the amendments to Regulation A.

Notice Type00 Guidance

Suggested Routing 00 Advertising00 Corporate Finance00 Compliance00 Legal00 Registered Representatives00 Senior Management00 Syndicate00 Underwriting

Key Topics00 Communications with the Public00 Compensation Limitations00 Confidential Treatment00 EDGAR00 Investment Banking00 Public Offerings00 Suitability00 Supervision00 Underwriting

Referenced Rules00 FINRA Rule 211100 FINRA Rule 221000 FINRA Rule 231000 FINRA Rule 311000 FINRA Rule 511000 FINRA Rule 5121 00 SEA Rule 14400 SEC Regulation A

Regulation A OfferingsFINRA Filing Requirements and Review of Regulation A Offerings

2 RegulatoryNotice

September 201515-32

While Regulation A continues to require that an offering statement must be prepared on Form 1-A, the amendments provide that the offering statement must be filed electronically with the SEC on EDGAR. Offering statements continue to be subject to review and comment by the SEC and must be qualified by the SEC in a “notice of qualification” prior to any sales of securities. Under the Regulation A+ amendments, certain issuers3 also have an option to submit a draft offering statement to the SEC for non-public review, which must be filed electronically on EDGAR, and all non-public submissions must be filed publicly no less than 21 calendar days before qualification of the offering statement.

Amendments to an offering statement must be filed with the SEC in the same manner as the initial filing. A post-qualification amendment must be filed to reflect any facts or events arising after the qualification date that represent a fundamental change in the information in the offering statement.

In addition, Regulation A+ provides that eligible issuers and intermediaries in Regulation A+ offerings may conduct a solicitation of interest in an offering (testing the waters), including solicitation of non-accredited investors, both before or after the filing of the offering statement.4 Solicitation materials must be filed with the SEC as exhibits to the offering statement.

Corporate Financing Rules

FINRA’s Corporate Financing Rules—Rules 5110, 2310 and 5121—generally: (1) require the filing of specified information in connection with public offerings in which FINRA member firms will participate; (2) prohibit unfair terms and arrangements in connection with public offerings of securities; and (3) impose requirements on offerings in which there is a specified conflict of interest.5 The Corporate Financing Rules require firms that participate in the distribution of securities in a Regulation A+ offering to file documents and other information with the Corporate Financing Department.6 These documents include an offering statement and its exhibits and amendments.7 The documents are required to be submitted no later than one business day after they are filed or submitted to the SEC.8 FINRA accords confidential treatment to all filed documents and information.9 No sales of securities subject to the rules, including Regulation A+ offerings, may commence until FINRA has provided a “no objections” opinion.10

When FINRA issues a “no objections” opinion to proposed underwriting terms and arrangements, the opinion relates solely to the Corporate Financing Rules and does not purport to express any determination regarding compliance with FINRA’s suitability or supervision rules, or any other statutory or regulatory requirements, including that the offering is a qualified Regulation A offering.11

RegulatoryNotice 3

September 2015 15-32

© 2015 FINRA. All rights reserved. FINRA and other trademarks of the Financial Industry Regulatory Authority, Inc. may not be used without permission. Regulatory Notices attempt to present information to readers in a format that is easily understandable. However, please be aware that, in case of any misunderstanding, the rule language prevails.

Communications with the Public Rule

FINRA Rule 2210 governs firms’ communications with the public. The rule requires that communications be fair, balanced and not misleading.12 The rule also requires that an appropriately qualified registered principal approve retail communications distributed to investors prior to use.13 A “retail communication” is defined as any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.14 Firm communications made available to 25 or fewer retail investors within any 30 calendar-day period are defined as correspondence and are also subject to the content standards of Rule 2210.15

Regulation A+ solicitation materials also may need to be filed with FINRA, depending upon the product being offered.16 Rule 2210 requires that retail communications concerning public direct participation programs (as defined in Rule 2310) be filed with the Advertising Regulation Department within 10 business days of first use or publication.17 If a firm uses Regulation A+ solicitation materials concerning a direct participation program security with more than 25 retail investors, the materials would be subject to the rule’s filing requirement and must be approved by an appropriately qualified registered principal of the firm.

Endnotes

1. TheSEChasstatedthatsecuritiespurchasedbyinvestorsinaRegulationAofferingarenot“restricted”securitiesforpurposesofthefederalsecuritieslaws.See80FR21806,at21866.

2. See Pub.L.No.112-106,126Stat.306(2012).

3. RegulationAonlypermitsissuerswhosesecuritieshavenotbeenpreviouslysoldpursuanttoaqualifiedofferingstatementunderRegulationAoraneffectiveregistrationstatementundertheSecuritiesActtosubmittotheSECadraftofferingstatementfornon-publicreview.

4. See SecuritiesActRule255forthetimingandrequirementsfortheuseofsolicitationmaterials.

5. Rule5110governsofferingsofdebtandequitysecurities.Rule2310governsofferingsofdirectparticipationplans.Rule5121governsofferingsinwhichfirmsparticipatinginadistributionhaveaconflictofinterestwiththeissuer.

6. See, e.g., Rule5110(b)(9)(G),whichspecificallylistssecuritiesofferedpursuanttoSECRegulationAasamongthetypesofofferingsforwhichdocumentsandinformationmustbefiledwithFINRA.

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September 201515-32

7. Rule5110(b)(5).See alsoRule5110(b)(5)(B)thatprovidesthatdocumentsthatarefiledwiththeSECthroughEDGARthatarereferencedinFINRA’selectronicfilingsystemshallbetreatedasfiledwithFINRA.

8. Rule5110(b)(4).

9. Rule5110(b)(3).

10. Rule5110(b)(4)(B).

11. FINRARule2111(Suitability)requiresthatamemberoranassociatedpersonmusthaveareasonablebasistobelievethatarecommendedtransactionorinvestmentstrategyinvolvingasecurityorsecuritiesissuitableforthecustomer,basedontheinformationobtainedthroughthereasonablediligenceofthememberorassociatedpersontoascertainthecustomer’sinvestmentprofile.FINRARule3110(Supervision)requireseachmembertoestablishandmaintainasystemtosupervisetheactivitiesofeachassociatedpersonthatisreasonablydesignedtoachievecompliancewithapplicablesecuritieslawsandregulations,andwithapplicableFINRArules.

12. See Rule2210(d)foradditionalcontentstandards,includingthatthemembermustconsiderthenatureoftheaudiencetowhichthecommunicationwillbedirectedandmustprovidedetailsandexplanationsappropriatetotheaudience.

13. See Rule2210(b)(1)(A).TherulealsorequiresprincipalapprovalpriortofilingwithFINRA’sAdvertisingRegulationDepartment.

14. Rule2210(a)(5).

15. Rule2210(a)(2).Correspondencemustbesupervisedinaccordancewiththefirm’sproceduresadoptedpursuanttoRule3110(b)(4).

16. See Rule2210(c)forthetypesofretailcommunicationsthatrequirefiling,includingthoseconcerningpublicdirectparticipationprograms,registeredinvestmentcompanies,registeredderivativesandcollateralizedmortgageobligations.

17. Rule2210(c)(3)(B).

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February 2016

Executive Summary FINRA’s review of securities offering documents has revealed instances in which broker-dealers have not complied with the contingency offering requirements of Rules 10b-9 and 15c2-4 under the Securities Exchange Act of 1934 (SEA). FINRA is publishing this Notice to provide guidance regarding the requirements of SEA Rules 10b-9 and 15c2-4 and to remind broker-dealers of their responsibility to have procedures reasonably designed to achieve compliance with these rules. 1

Questions regarding this Notice should be directed to:

00 Joseph E. Price, Senior Vice President, Corporate Financing/Advertising Regulation, at (240) 386-4623 or [email protected];

00 Paul Mathews, Vice President, Corporate Financing, at (240) 386-4639 or [email protected]; or

00 Josh Bandes, Senior Investigator, Corporate Financing, at (240) 386-5431 or [email protected].

Background & DiscussionBroker-dealers that participate in best efforts public and private securities offerings that have a contingency (i.e., an underlying condition or qualification that must take place by a specified date prior to the issuer taking possession of the offering proceeds) must safeguard investors’ funds they receive until the contingency is satisfied. If the contingency is not met, broker-dealers must ensure that investors’ funds are promptly refunded. FINRA’s reviews of these offerings and subsequent investigations have revealed instances in which broker-dealers have not complied with the requirements of SEA Rules 10b-9 and 15c2-4. Part I of this Notice provides an overview and explanation of best efforts contingency offerings. Part II describes a broker-dealer’s responsibilities in best efforts contingency offerings. Part III describes the requirements for handling investor funds until the contingency is met.

Notice Type00 Guidance

Suggested Routing00 Compliance00 Corporate Finance00 Legal00 Registered Representatives00 Senior Management00 Syndicate00 Underwriting

Key Topics00 Bona Fide Purchases00 Contingency Offerings00 Escrow00 Net Capital00 Underwriting

Referenced Rules & Notices00 FINRA Rule 201000 Notice to Members 84-700 Notice to Members 84-6400 Notice to Members 87-6100 Notice to Members 98-400 Regulatory Notice 10-2200 SEA Rule 10b-900 SEA Rule 15c2-400 SEA Rule 15c3-100 SEA Section 3(a)(6)00 Securities Act Section 17

Contingency OfferingsPrivate Placements and Public Offerings Subject to a Contingency

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I. Best Efforts Contingency Offerings

In a best efforts offering, a broker-dealer does not commit to purchase any securities from the issuer or guarantee that the issuer will receive any amount of money from the offering.2 Furthermore, a best efforts offering subject to satisfaction of an underlying condition is deemed to be a “contingency offering.” The most common contingency offerings reviewed by FINRA are either “all-or-none” or “part-or-none” offerings that require all or a certain amount of the securities to be sold for the offering to close.3 Under SEA Rule 10b-9, a best efforts offering subject to either an “all-or-none” or “part-or-none” contingency must provide for the prompt return of investor funds in the event the requisite contingency fails to be met by a specific date.

II. Broker-Dealer Responsibilities in a Best Efforts Contingency Offering.

As discussed in Regulatory Notice 10-22, a broker-dealer that participates in an offering and recommends a security must, among other requirements, conduct a reasonable investigation of the security and the issuer’s representations about it.4 If the security is offered as part of a contingency offering, the broker-dealer’s reasonable investigation must include a review of the terms of the contingency, including any agreement and disclosure by the issuer regarding the contingency.5

FINRA has reviewed several offerings in which the broker-dealer conducting the offering failed to identify inconsistencies between the escrow agreement and the offering document as it relates to the requirements of the contingency. Such inconsistencies should be “red flags” to a broker-dealer performing a reasonable investigation.

Furthermore, FINRA has found that broker-dealers violated SEA Rule 10b-9 by failing to return subscriber funds after the issuer changed the contingency by reducing the offering minimum.6 FINRA has also found that broker-dealers violated SEA Rule 10b-9 by failing to take the proper steps in response to an issuer’s extension of the offering period.7

Broker-dealers must be aware of any attempt by the issuer to use non-bona fide sales in order to declare an offering sold for the purposes of an “all-or-none” or “part-or-none” offering.8 In general, “non-bona fide sales” are sales of undisclosed purchases by the issuer or broker-dealer, their affiliates or associated persons, or any entities through nominee accounts that are designed to create the appearance of a successful completion of an offering.9 The use of non-bona fide sales in “all-or-none” and “part-or-none” contingency offerings could violate the antifraud provisions of the federal securities laws.10 In one matter, FINRA found that a broker-dealer violated SEA Rules 10b-9 and 15c2-4 when it participated in an offering in which the issuer declared a contingency offering sold by counting non-bona fide sales made to the issuer’s employees.11 Similarly, FINRA found that a broker-dealer violated SEA Rules 10b-9 and 15c2-4 when an issuer used the proceeds from a loan to purchase securities in the offering in order to meet the minimum offering amount. 12

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III. Requirements Concerning Manner of Handling Investor Funds

SEA Rule 15c2-4 requires that upon receiving money or other consideration from an investor in a contingency offering, a broker-dealer must promptly:

00 deposit those funds into “a separate bank account” for which the broker-dealer is the account holder and is designated as agent or trustee “for the persons who have the beneficial interests therein”;13 or

00 transmit those funds to a bank that has agreed in writing to act as the escrow agent for the offering.14

The manner in which a broker-dealer must handle investor funds generally will be determined by two factors. First, pursuant to SEA Rule 15c3-1, only a broker-dealer that maintains at least $250,000 in net capital is allowed to carry customer accounts and receive or hold funds or securities for those persons. Therefore, while not a requirement of SEA Rule 15c2-4, a broker-dealer that maintains less than $250,000 in net capital and deposits investors’ funds into a separate bank account rather than transmitting those funds to an independent bank escrow agent would violate SEA Rule 15c3-1.15 Second, when a participating broker-dealer is an affiliate of the issuer, investors’ funds must be transmitted to an independent bank escrow agent.16

a. Escrow Agreements

In contingent offerings that require an escrow agent, the escrow agreement must be executed with a bank that is unaffiliated with the broker-dealer and the issuer.17 The escrow account should be established before the broker-dealer receives any investor funds. The escrow account may not be controlled by the issuer,18 the broker-dealer19 or an attorney.20 As a general matter, the escrow agent must be a financial institution that meets the definition of a “bank” under SEA Section 3(a)(6),21 although the SEC staff has provided no-action relief to permit certain other entities to act as escrow agents.22

b. Prompt Transmittal of Funds

SEA Rule 15c2-4(b) requires that a broker-dealer promptly transmit funds to either an escrow agent or a separate bank account. SEC staff has interpreted “promptly” to mean by noon of the next business day.23 Failure to promptly transmit funds to either the escrow agent or a separate bank account has resulted in sanctions.24 However, in certain offerings, such as direct participation programs that require suitability determinations by the issuer, the SEC staff has provided procedural guidance under which a broker-dealer can still comply with the “promptly” component of SEA Rule 15c2-4 even if the funds are not transmitted by noon the next business day after they are received.25

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A broker-dealer’s responsibility does not end when it promptly transmits investor funds to an escrow agent or separate bank account. A broker-dealer must also promptly refund investors’ funds if the contingency is not met.26 FINRA has identified a number of instances in which investors did not receive their money back in a prompt manner, if at all, when the contingency did not occur. For example, FINRA found that a broker-dealer violated SEA Rule 10b-9 after it failed to return two investors’ funds, even after the investors demanded their money back.27 In fact, the broker-dealer only returned a portion of one of the investor’s funds after the investor sued the broker-dealer, nearly two years later.

c. Disbursal to the Issuer

Broker-dealers must segregate investor funds they receive at least until the contingency is met. FINRA has found that some broker-dealers improperly disbursed investor funds to issuers before the contingency was satisfied.28

d. Issuer’s Direct Receipt of Investor Funds

FINRA has observed in some contingency offerings that broker-dealers have instructed investors to transmit their funds directly to the issuer. Since SEA Rule 15c2-4 governs the broker-dealer’s receipt of investor funds, funds that are not received by the broker-dealer (absent the circumstance in which there is an affiliation between the broker-dealer and the issuer) are outside the purview of this rule.29 Nevertheless, FINRA reminds broker-dealers that even if SEA Rule 15c2-4 does not apply, the anti-fraud and anti-manipulation provisions of the securities laws as well as FINRA Rule 2010 apply to all of their securities transactions.30 Broker-dealers that participate in contingency offerings in which the issuer does not escrow or otherwise segregate investor funds may violate the securities laws even in the absence of a violation of SEA Rule 15c2-4.

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February 2016 16-08

1. AlthoughthisNoticefocusesonSEARules10b-9and15c2-4,otherrulesarepotentiallyapplicabletocontingencyofferings,includingrulesgoverningsuitabilityandcommunicationswiththepublic.SeeRegulatory Notice 10-22(Apr.2010).

2. Unlikeinabesteffortsoffering,anunderwriterinafirmcommitmentofferingisobligatedtopurchaseallsecuritiesofferedbeforedistributingthemtothepublic.

3. Whilethemajorityofcontingencyofferingsareall-or-noneorpart-or-none,otherunderlyingconditionsuponwhichtheofferingiscontingentmayexist,suchasthecompletionofamergeroracquisition.

4. SeeRegulatory Notice 10-22(Apr.2010).

5. SeeRegulatory Notice 10-22at3(“TheSecuritiesandExchangeCommission(SEC)andfederalcourtshavelongheldthataBDthatrecommendsasecurityisunderadutytoconductareasonableinvestigationconcerningthatsecurityandtheissuer’srepresentationsaboutit.”).

6. Security Research Associates, Inc.,FINRAAWCNo.201303630601(Apr.3,2014);Isaac Schinazi,FINRAAWCNo.2005000777001(Dec.21,2007).See also Tucson Hotel Associates,1985SECNo-Act.LEXIS2922(Mar.12,1985)(investorsmustberefundeduponanissuerreducingtheminimumnumberofunitstobesoldinabesteffortscontingencyoffering);FOLIOfn Investments, Inc.,SECNo-ActionLetter,footnote7ofincomingletter(July15,2015)(providingthat“ifanissuerweretoreducetheminimumnumberofunitstobesoldinanofferingonthePlatform,FoliowouldcancelalltheoutstandingConditionalOffersforthatofferingandrequiretheissuertoterminatethatofferingonthePlatform.”).

7. Janco Partners, Inc.,FINRAAWCNo.2011025505901(Nov.5,2012);CP Capital Securities, Inc.,FINRAAWCNo.2007007145101(Aug.25,2009);European American Equities, Inc.;FINRAAWCNo.2009020941102(Feb.28,2012).See alsoInterpretativeReleaseonRegulationD,SECRel.No.33-6455atQuestion80(Mar.3,1983)(anextensionofanofferingperiodinabesteffortscontingencyofferingrequiresinvestorstoaffirmativelyreconfirmtheirinvestments).

8. SEC v. Coven,581F.2d1020,1028,n.16(2dCir.1978),cert. denied,434U.S.950(1979).SeealsoSECRel.No.33-11532(July11,1975).

9. SECRel.No.33-11532(July11,1975).

10. SEC v. Blinder, Robinson & Co.,etal.,1983U.S.App.LEXIS16806(10thCir.1983).See also A.J. White & Co. v. SEC,556F.2d619(1stCir.1977).

11. Northland Securities, Inc.,NASDAWCNo.E042005007801(Dec.21,2006).

12. Commonwealth Church Finance, Inc.,FINRAAWCNo.2008011619001(Aug.10,2010).

13. SEARule15c2-4(b)(1).Cf.FOLIOfnInvestments,Inc.,SECNo-ActionLetter(July15,2015)(providingthattheDivisionofTradingandMarketswillnotrecommendenforcementactiontotheSECif,subjecttocertainconditionsandinlightofcertainrepresentations,Folioacceptsmoneyreceivedforcertainbesteffortscontingentofferingsfromitscustomersthroughitselectronicplatformthatservicesprivatelyplacedand/orunlistedsecurities).

14. SEARule15c2-4(b)(2).

15. See Traiger Energy Investments,SECRel.No.34-25306(Feb.3,1988)(a“$5,000broker-dealer,”oranon-carryingbroker-dealerthatusesaseparatebankaccountasagentortrusteewouldnotviolateSEARule15c2-4).

Endnotes

© 2016 FINRA. All rights reserved. FINRA and other trademarks of the Financial Industry Regulatory Authority, Inc. may not be used without permission. Regulatory Notices attempt to present information to readers in a format that is easily understandable. However, please be aware that, in case of any misunderstanding, the rule language prevails.

http://www.finra.org/industry/notices/10-22

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February 201616-08

16. Notice to Members 98-4(Jan.1998)(“…abroker/dealeraffiliatedwiththeissuermayonlydepositinvestors’fundsinanescrowaccountwithabankindependentoftheissuerandthebroker/dealer.”);Notice to Members 87-61at4(Sep.1987)(a“broker-dealeraffiliatedwiththeissuermustforwardcheckstoanescrowaccountandmaynotactasagentortrusteeforaseparatebankaccount.”);Notice to Members 84-7at5(Jan.1984)(ifthebroker-dealerandtheissuerareaffiliated“thebroker-dealershouldnotactasagentortrusteeforthefunds[and]instead,anescrowagentshouldbeused.”).See alsoFOLIOfnInvestments,Inc.,No-ActionLetter(July15,2015)(providingthattheDivisionofTradingandMarketswillnotrecommendenforcementactiontotheSECbaseduponFolio’srepresentation,amongotherrepresentationsandconditions,thateachissuerisunaffiliatedwithFolio).

17. Notice to Members 87-61at3(Sept.1987)(“[Rule15c2-4]requiresthatwhenanescrowaccountisusedfordistributionsconductedonacontingencybasis(e.g.,best-effortsall-or-noneorpart-or-noneofferings),theescrowagentmustbeacommercialbankthatisunaffiliatedwitheithertheissuerortheunderwriter.”).

18. Richard Manchester,FINRAAWCNo.2009020397101(Aug.29,2013)(inmultipleandseparateofferings,FINRAfoundthatthebroker-dealerviolatedRule15c2-4bydepositinginvestorfundsintobankaccountsinthenameoftherespectiveissuersratherthanescrowaccounts).See also Provident Asset Management,FINRAAWCNo.2009017497201(Feb.19,2010).

19. Carl E. Lindros,NASDAWCNo.E022004004502(Mar.22,2006);Paulson Investment Company, Inc.,FINRAAWCNo.2007007406901(Jan.28,2009);Philadelphia Brokerage Corporation,NASDAWCNo.E9A2003016102(Feb.14,2006);G.C. Andersen Partners Capital, LLC,FINRAAWCNo.2007007256802(Nov.20,2008)(FINRAfoundthatbroker-dealerviolatedSEARule15c2-4byholdinginvestorfundsinanaccountinwhichthebroker-dealer’semployeeactedasescrowagent);Northland Securities, Inc.,NASDAWCNo.E042005007801(Dec.21,2006)(FINRAfoundthatbroker-dealerviolatedSEARule15c2-4byusinganaffiliateofthebroker-dealerastheescrowagent).

20. Grant Bettingen,NASDAWCNo.E022005007302(Mar.7,2007);Accelerated Capital Grp.,FINRAAWCNo.2011025769301(Jan.7,2014);EDI Financial, Inc.,FINRAAWCNo.2009016266601(Apr.21,2010).

21. Notice to Members 84-7at7(Jan.1984)(a“bank”asusedinExchangeActRule15c2-4referstothedefinitioncontainedinSection3(a)(6)ofthe[Exchange]Act).

22. Notice to Members 87-61at3(Sept.1987).See also Continental Stock Transfer & Trust Company,1989SECNo-Act.LEXIS662(May10,1989);RelianceTrustCo.,2005SECNo-ActLEXIS531(Mar.29,2005).

23. Notice to Members 84-7at4,5(Jan.1984)(notingSECstaff’sstatementthat“[i]ncontingentofferingsnotrequiringsuitabilitydeterminationsbytheissuerorthegeneralpartner,fundsshouldbedepositedortransmittedbynoonofthenextbusinessday.”).See also J.V. Ace & Co., Inc.,50SECat465n.13(“[investor]fundsshouldnormallybedepositedortransmittedbynoonofthebusinessdayfollowingtheirreceipt.”)(citationomitted).

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February 2016 16-08

24. Lowell H. Listrom & Co.,Inc.,48S.E.C.360,362(1985)(broker-dealerviolatedSEARule15c2-4byretainingcustomers’fundsformultipledaysbeforetransmittingthefundstotheescrowagent).See also Brookville Capital Partners LLC,FINRAAWCNo.2008011678303(June7,2010).

25. Notice to Members 84-64(Nov.1984)(NASDpublishedinterpretiveletterdatedOctober16,1984,fromtheSECtoLindaA.Wertheimer,Chairman,SubcommitteeonPartnerships,TrustsandUnincorporatedAssociations,FederalRegulationofSecuritiesCommittee,AmericanBarAssociation,defining“prompttransmittal”asappliedtocontingencyofferingsofinterestsindirectparticipationprogramsrequiringanescrowaccount).

26. See,e.g.,Reid S. Johnson,FINRAAWCNo.2011025504301(Oct.21,2013).

27. Dept. of Enforcement v. Kaweske,NASDDiscip.ProceedingNo.C07040042(Feb.10,2006).

28. Richard Manchester,FINRAAWCNo.2009020397101(Aug.29,2013);Woodrock Securities, L.P.,FINRAAWCNo.2009016279401(Jan.28,2011);Janco Partners, Inc.,FINRAAWCNo.2011025505901(Nov.5,2012).

29. SeeNotice to Members 84-7at2,5(Jan.1984)(“Directreceiptofaninvestor’sfundsbyanissuer…isnotacircumstanceaddressedbytheRule”…“[however][w]hereaninvestorsendshischeckdirectlytoanissuerthatisaffiliatedwithaparticipatingbroker-dealer,‘receipt’ofthefundsisconsideredtobemadebythebroker-dealerwhentheissuerreceivesthecheck.Therefore,theRuleappliesandthebroker-dealerisresponsibleforensuringthattheissuerpromptlytransmitsthefundstoanindependentescrowagent.”).

30. See,e.g.,SEARule10b-5;Section17oftheSecuritiesActof1933.

Executive SummaryThe ability of small and large businesses to raise capital efficiently is critical to job creation and economic growth. Broker-dealers play a vital role in helping businesses raise capital through the securities markets, and as a self-regulatory organization (SRO) for broker-dealers, FINRA has a variety of rules, operations and administrative processes that address their capital- raising activities.

FINRA recently announced a new initiative—called FINRA360—to evaluate various aspects of its operations and programs to identify opportunities to more effectively further its mission. As part of this initiative, FINRA is requesting comment on the effectiveness and efficiency of its rules, operations and administrative processes governing broker-dealer activities related to the capital-raising process and their impact on capital formation.

Questions regarding this Notice should be directed to:

00 Joseph Price, Senior Vice President and Counsel, Corporate Financing/Advertising Regulation, at (240) 386-4642 or [email protected];

00 James S. Wrona, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8270 or [email protected]; or

00 Jeanette Wingler, Associate General Counsel, OGC, at (202) 728-8013 or [email protected].

1


April 2017

Notice Type00 Request for Comment

Suggested Routing00 Compliance 00 Investment Banking00 Legal00 Research00 Senior Management00 Trading

Key Topics00 Capital Acquisition Brokers00 Crowdfunding00 Direct Participation Programs00 Funding Portals00 Investment Banking00 JOBS Act00 Market Making00 Research 00 Trading00 Unlisted REITS

Referenced Rules 00 Capital Acquisition Broker Rules00 FINRA Rules 1060, 2241, 2242, 2310, 4518, 5100 Series, 5250 and 6432

00 Funding Portal Rules00 JOBS Act00 Regulation Crowdfunding00 Regulation M00 SEA Rule 15c2-11

Capital FormationFINRA Requests Comment on FINRA Rules Impacting Capital Formation

Comment Period Expires: May 30, 2017

Action RequestedFINRA encourages all interested parties to comment on this Notice. Comments must be received by May 30, 2017.

00 Comments must be submitted through one of the following methods:00 Emailing comments to [email protected]; or

Mailing comments in hard copy to:

Jennifer Piorko Mitchell Office of the Corporate Secretary FINRA 1735 K Street, NW Washington, DC 20006-1506

To help FINRA process comments more efficiently, persons should use only one method to comment on this Notice.

Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

Before becoming effective, any proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

Background & DiscussionFINRA is an SRO for the broker-dealer industry and is dedicated to investor protection and market integrity through effective and efficient regulation that facilitates vibrant capital markets—including markets that support efficient capital formation.

Well-functioning securities markets can enable businesses of all sizes to access the capital necessary to fund and grow their operations, which can in turn create new jobs and promote economic growth and opportunity. Today, trillions of dollars in capital are raised by companies each year in both registered and unregistered U.S. securities offerings.3 And in recent years, particular attention has been paid to capital raising by small businesses, which represent more than 99 percent of employers in the United States and which create significant numbers of new jobs.4

FINRA members play a critical role in facilitating virtually every stage of the capital-raising process in these markets, such as by underwriting public offerings, advising companies on capital raising and corporate restructuring, acting as placement agents for sales of

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unregistered securities, operating funding portals, and publishing research reports to educate and inform investors. For its part, FINRA promotes the capital-raising process through appropriately tailored rules applicable to its members that are designed to promote transparency and to establish important standards of conduct for the benefit of all market participants, including investors and issuers participating in offerings.

There have also been significant developments recently in the mechanisms companies use to raise capital through securities offerings. In response to directives from the Jumpstart Our Business Startups (JOBS) Act, for example, the SEC has adopted new rules to permit securities-based crowdfunding, updated the rules for exempt offerings under Regulation A and altered the requirements for private offerings under Regulation D. There have also been changes in the statutes and rules governing registered offerings, including initial public offerings (IPOs).

FINRA has taken a number of steps in recent years to modernize its regulation of members’ participation in capital-raising activities. For instance, FINRA recently created the Capital Acquisition Broker (CAB) rule set, which allows members engaged in a limited range of corporate-financing activities—such as advising companies and private equity funds on capital raising and corporate restructuring—to elect to be governed by a targeted set of rules. In response to crowdfunding provisions of the JOBS Act,5 FINRA also created the Funding Portal Rules, which are a set of streamlined rules that are tailored to the limited scope of activities in which funding portals are permitted to engage under the JOBS Act and the SEC’s Regulation Crowdfunding.6 In addition, FINRA amended FINRA Rule 5131, covering new issue allocations and distributions, to create an important exception to facilitate firm compliance when allocating shares of a new issue to the accounts of unaffiliated private funds.7 In FINRA Rule 5141, FINRA consolidated a number of rules regarding the sale of securities in fixed price offerings, creating a simplified rule that removed numerous outdated and redundant requirements, while at the same time maintaining core protections for investors and for the integrity of such offerings.8 Concurrent with the release of this Notice, moreover, FINRA is proposing amendments to FINRA Rule 5110, which prohibits unfair underwriting arrangements, to clarify and streamline its provisions.9

While these changes will increase efficiency and reduce unnecessary burdens on the capital-raising process without compromising important protections for issuers and investors, FINRA is interested in whether additional changes to these or other FINRA rules, operations or administrative processes would further enhance the capital-raising process while ensuring investor protections. Therefore, FINRA is requesting comment on the functioning of its rules that most directly apply to the capital-raising process and their effects on capital formation. An overview of these FINRA rules is set forth below. FINRA recognizes that other FINRA rules not listed here also could have an impact on capital formation and FINRA welcomes comment on them as well.10

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FINRA notes, moreover, that its rules and programs are only part of a broader framework of securities laws, rules and regulations that govern or affect capital formation—such as the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), the JOBS Act, SEC rules, and rules of other SROs (e.g., securities exchanges). Making changes to this broader regulatory framework is beyond FINRA’s control, and in certain cases FINRA rules are mandated by, or must conform to, specific statutory requirements or SEC rules. Nevertheless, FINRA welcomes comment on how its rules and programs relate to this broader regulatory framework and whether there are opportunities for FINRA to more closely align its rules and programs with the work of other regulators in a manner that promotes capital formation and preserves important investor protections.

CAB Rules

The recently approved CAB rules provide members engaged in a limited range of activities with flexibility in structuring their businesses while providing appropriate protections for investors and other market participants.11 New applicants as well as existing members that meet the definition of a CAB may elect to be governed under the CAB rules. CABs are firms that engage in a limited range of activities, essentially advising companies and private equity funds on capital raising and corporate restructuring, and acting as placement agents for sales of unregistered securities to institutional investors under limited conditions.

Because CABs do not engage in many of the types of activities typically associated with traditional broker-dealers, FINRA determined that many of its rules should not apply to these firms, or should be modified to reflect their limited business activities. The CAB rule set is a separate, narrower set of rules to govern these members. Members that elect to be governed under the CAB rules are not permitted, among other things, to carry or maintain customer accounts, handle customers’ funds or securities, accept customers’ trading orders, or engage in proprietary trading or market-making.

Funding Portal Rules

The JOBS Act contains provisions that permit businesses to offer and sell securities through crowdfunding.12 Funding portals that engage in crowdfunding on behalf of issuers must become a member of a national securities association.13 Under the JOBS Act and the SEC’s Regulation Crowdfunding, a funding portal may not: (1) offer investment advice or recommendations; (2) solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal; (3) compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; (4) handle investor funds or securities; or (5) engage in such other activities as the SEC, by rule, determines appropriate.

FINRA’s Funding Portal Rules are streamlined specifically for funding portals and to reflect the limited scope of activity permitted by funding portals while also maintaining investor protection. In addition, the notice requirements of FINRA Rule 4518 enable FINRA to keep track as to which of its members are engaging in crowdfunding activity.

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FINRA Rule 2241 (Research Analysts and Research Reports) and Rule 2242 (Debt Research Analysts and Debt Research Reports)

FINRA’s rules on research analysts and research reports on both the equity and debt sides are intended to foster objectivity and transparency in research and to provide investors with more reliable and useful information to make investment decisions.14 Certain requirements under these rules are derived from applicable statutory mandates and SEC interpretations of those mandates. In addition, in reviewing or modifying its research rules, FINRA seeks to ensure consistency and coordination with applicable SEC research rules (e.g., Regulation AC).

In a companion Regulatory Notice, FINRA is proposing amendments to Rule 2241 and Rule 2242 to create a limited safe harbor for eligible desk commentary prepared by sales and trading or principal trading personnel that may rise to the level of a research report. 15 The proposed safe harbor would be subject to conditions, including compliance with a number of the Rule 2241 or Rule 2242 provisions, to mitigate the most serious research-related conflicts.

Rule 2241

Rule 2241 covers equity research reports.16 The rule implements provisions of Sarbanes-Oxley, which mandates separation between research and investment banking, proscribes conduct that could compromise a research analyst’s objectivity, and requires specific disclosures in research reports and public appearances.17 The rule also applies some requirements imposed on members subject to the “Global Settlement”18 more broadly to all members.19

Rule 2241 requires disclosure of conflicts of interest in research reports and public appearances by research analysts, and limits conflicted conduct—investment banking personnel involvement in the content of research reports and determination of analyst compensation, for example—where the conflicts are too pronounced to be cured by disclosure.20 The rule provides members flexibility in complying with its overarching requirement to establish, maintain and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest without diminishing investor protection. Rule 2241 also exempts members with limited investment banking activity from the review, supervision, budget and compensation provisions in the rule.

Rule 2242

Rule 2242’s requirements with respect to debt research are similar to the Rule 2241 framework with differences to reflect the operation of the debt markets. Rule 2242 adopts a tiered approach that provides retail debt investors with protections similar to those provided to equity investors under Rule 2241, with modifications to reflect differences in the trading of debt securities. At the same time, the rule provides broad exemptions for debt research distributed solely to institutional investors.

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Rule 2242 differs from the equity research rule in three key respects. First, it sets out prohibited and permissible communications between debt research analysts and principal trading and sales and trading personnel, taking into account the need to ration a debt research analyst’s resources among the multitude of debt securities, the limitations on price discovery in the debt markets, and the need for trading personnel to perform credit risk analyses with respect to current and prospective inventory. Second, the rule exempts debt research provided solely to institutional investors from many of the structural protections and prescriptive disclosure requirements that apply to research reports distributed to retail investors, but adds a “health warning” requirement. Third, in addition to the exemption for limited investment banking activity found in Rule 2241, Rule 2242 also contains an exemption for limited principal trading activity from the review, supervision, budget and compensation provisions in the rule related to principal trading activity.

FINRA Rule 2310 (Direct Participation Programs)

Rule 2310 addresses underwriting terms and arrangements in public offerings of direct participation programs (DPPs) and unlisted real estate investment trusts (REITs) (collectively, Investment Programs).21 A DPP is a business venture designed to let investors participate directly in the cash flow and tax benefits of an underlying investment (e.g., oil and gas programs and equipment leasing programs). REITs are investment vehicles for income-generating real estate that benefit from the tax advantages of a trust if they satisfy certain criteria in the Internal Revenue Code.

Due to the complexity of and risks associated with Investment Programs, Rule 2310 includes several provisions to promote investor protection. The rule also promotes fairness by prohibiting unfair and unreasonable compensation. Specifically, Rule 2310 requires that members participating in a public offering of an Investment Program meet certain requirements regarding underwriting compensation, fees and expenses, perform due diligence on the Investment Program, follow specific guidelines on suitability, and adhere to limits on non-cash compensation. The rule also prohibits members from participating in an Investment Program unless the issuer has agreed to disclose valuation-related information to investors.22

FINRA Rule 5100 Series

The FINRA Rule 5100 series governs underwriting and related compensation received by FINRA members in securities offerings. Rules in this series are intended to ensure the integrity of the capital markets and to protect market participants, including investors and issuers participating in offerings.

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Rule 5110 (Corporate Financing Rule – Underwriting Terms and Arrangements)

Rule 5110 prohibits unfair underwriting arrangements in connection with the public offering of securities. The rule was originally developed in 1991 in response to persistent problems with underwriters dealing unfairly with issuers. The rule provides for FINRA staff review of the underwriting terms and arrangements of a member that participates in a public offering. The staff reviews this information prior to the commencement of the offering to determine whether the underwriting compensation and other terms and arrangements meet the requirements of the applicable FINRA rules.

In a companion Regulatory Notice, FINRA is proposing amendments to Rule 5110 to make substantive, organizational and terminology changes to the rule. These changes—which are intended to modernize the rule—should improve the administration of the rule and simplify its provisions. The proposal would retain the primary principle of the rule that a member or person associated with a member should not participate in a public offering in which the terms and conditions, including underwriting compensation, are unfair or unreasonable.

FINRA Rule 5121 (Public Offerings of Securities With Conflicts of Interest)

Rule 5121 prohibits a member from participating in a public offering of its own securities unless the conflicts of interest are disclosed, and in certain circumstances, a qualified independent underwriter participates. Members also must comply with certain net capital, discretionary accounts and filing requirements.

FINRA Rule 5122 (Private Placement of Securities Issued by Members) and FINRA Rule 5123 (Private Placements of Securities)

FINRA also reviews offering documents and information members use in selling their own and other issuers’ private placements.23 Rule 5123 requires members to file with FINRA, within 15 calendar days of the date of first sale of a private placement, a private placement memorandum, term sheet or other offering document, or indicate that no such offerings documents were used. Rule 5122 requires members that offer or sell their own securities to file the private placement memorandum, term sheet or other offering document at or prior to the first time the documents are provided to any prospective investor. Rule 5122 also establishes standards on disclosure and the use of private placement proceeds.

FINRA Rule 5130 (Restrictions on the Purchase and Sale of Initial Public Equity Offerings)

Rule 5130 is intended to promote investor confidence in the capital-raising process by ensuring that: (1) members make bona fide public offerings of securities at the offering price; (2) members do not withhold securities in a public offering for their own benefit or use such securities to reward persons who are in a position to direct future business to members; and (3) industry insiders, including members and their associated persons, do not take advantage of their insider position to purchase new issues24 for their own benefit to the exclusion of public customers.

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FINRA Rule 5131 (New Issue Allocations and Distributions)

Rule 5131 is intended to support public confidence in the IPO process by establishing requirements with respect to the allocation, pricing and trading of new issues. Among other things, the rule prohibits quid pro quo allocations and “spinning,”25 and addresses the conduct of members and associated persons in the areas of book-building, new issue pricing, penalty bids, trading and waivers of lock-up agreements.

FINRA Rule 5141 (Sale of Securities in a Fixed Price Offering)

Rule 5141 protects the integrity of fixed price offerings26 by ensuring that securities in such offerings are sold to the public at the stated public offering price or prices. The rule prohibits the grant of certain preferences (e.g., selling concessions, discounts, other allowances, various economic equivalents) in connection with fixed price offerings of securities.

FINRA Rule 5150 (Fairness Opinions)

Rule 5150 requires specific disclosures and procedures addressing the potential conflicts of interest that may arise when a broker-dealer provides a fairness opinion in a change of control transaction, such as a merger or sale or purchase of assets. The disclosures required by the rule are aimed at informing investor shareholders of potential conflicts, such as whether a member has acted as a financial advisor to any party to the transaction that is the subject of the fairness opinion, and if so, whether it will receive compensation contingent on the successful completion of the transaction.

FINRA Rule 5160 (Disclosure of Price and Concessions in Selling Agreements)

Rule 5160 requires that selling syndicate agreements or selling group27 agreements: (1) set forth the price at which securities are to be sold to the public or the formula by which such price can be ascertained; and (2) state clearly to whom and under what circumstances concessions, if any, may be allowed.

FINRA Rule 5190 (Notification Requirements for Offering Participants)

Rule 5190 sets forth the notice requirements applicable to all members participating in offerings of securities for purposes of monitoring compliance with the provisions of the SEC’s Regulation M. The rule is intended to ensure that FINRA receives pertinent distribution-related information from its members in a timely fashion.

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FINRA Rule 5250 (Payments for Market Making)

Although Rule 5250 does not apply specifically to the capital-raising process, some members have indicated that it may unnecessarily limit certain arrangements that could create greater liquidity in some stocks and thus help facilitate capital formation.

Subject to enumerated exceptions, Rule 5250 prohibits members and their associated persons from accepting any payment or other consideration, directly or indirectly, from an issuer of a security, or any affiliate or promoter thereof, for publishing a quotation or acting as a market maker in a security.28 Exceptions include payment for bona fide services, including, but not limited to, payment for investment banking services such as underwriting compensation and fees. Rule 5250 is intended to ensure that a member acts in an independent capacity when publishing a quotation or making a market in an issuer’s securities.

FINRA Rule 6432 (Compliance with the Information Requirements of SEA Rule 15c2-11)

Although Rule 6432 does not apply specifically to the capital-raising process, some members have indicated that the requirements it imposes on market makers may unintentionally create burdens on the quoting of stocks of smaller companies and thus impede capital formation.

Rule 6432 generally requires that, prior to initiating or resuming quotations in a non-exchange-listed security in a quotation medium, a member must demonstrate compliance with Rule 6432 and the applicable requirements for information maintenance under SEA Rule 15c2-11. Under Rule 6432, a member demonstrates compliance by filing a FINRA Form 211 at least three business days before the member’s quotation is published or displayed in the quotation medium. FINRA processes a member’s Form 211 submission once the required SEA Rule 15c2-11 documentation and related information has been submitted.

Form 211 largely requires members to provide, or reference, if electronic copies are available on EDGAR, the items of information listed in SEA Rule 15c2-11 applicable to the member’s submission. In addition to the SEA Rule 15c2-11 items of information, a member is required to provide the price at which it intends to initiate quotations along with the basis upon which such price was determined. If a member’s initial quotation does not include a priced entry, the member must supplement its prior filing with FINRA before initiating a priced entry. Rule 6432 also contains exceptions that parallel SEA Rule 15c2-11. A FINRA Form 211 filing is not required where a member is relying on an exception to or exemption from SEA Rule 15c2-11. However, under Rule 6432, if relying on the unsolicited customer order exception of SEA Rule 15c2-11(f)(2), a member must comply with the recordkeeping requirements of Rule 6432.01.

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Trading Activity Fee (TAF)

Although the TAF does not apply specifically to the capital-raising process, some members have raised the question of whether the TAF may unintentionally impose disparate burdens on the trading of stocks of smaller companies.

The TAF is the one member regulatory fee FINRA charges that is based on trading activity29 and generally applies to all sales of a covered security, including both sales for the member’s own account and sales on behalf of a customer, regardless of where the trade is executed.30 The revenue from these fees is designed to recover the costs to FINRA of the supervision and regulation of members, including performing examinations, financial monitoring, and FINRA’s policymaking, rulemaking, interpretive and enforcement activities.

Section 1(b) of Schedule A to the FINRA By-Laws includes several exemptions from the TAF, including exemptions for:

00 Transactions in securities offered pursuant to an effective registration statement under the Securities Act of 1933 (Securities Act) (except transactions in put or call options issued by the Options Clearing Corporation) or offered in accordance with an exemption from registration afforded by Section 3(a) or 3(b) thereof, or a rule thereunder;

00 Transactions by an issuer not involving any public offering within the meaning of Section 4(2) of the Securities Act (except any “Reportable TRACE Transaction”); and

00 The purchase or sale of securities pursuant to and in consummation of a tender or exchange offer.

If no exemption applies, then a TAF is assessed on the transaction (e.g., a TAF may be assessed on both equity and TRACE-reportable debt transactions effected in the secondary market).

Although the TAF is calculated on a per share basis, there are transaction-based caps on fees for certain transactions, including a maximum charge of $5.95 per trade for transactions in covered equity securities. If the execution price for a covered security is less than the TAF rate on a per share, per contract, or round turn transaction basis, then no TAF is assessed on that transaction.

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Request for CommentFINRA requests comment on its rules and practices that affect the capital-raising process, including any that are not discussed in this Notice. FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible.

In particular, we request comment on the following questions:

1. Have FINRA’s rules covering the capital-raising process effectively responded to the problem(s) they were intended to address?

2. What have been the economic impacts, including costs and benefits, arising from FINRA’s rules on the capital-raising process? To what extent would these economic impacts differ by business attributes, such as size of the firm or differences in business models?

3. Where have FINRA rules around the capital-raising process been designed particularly effectively? Are there other rules or applications where this approach might enhance capital formation while maintaining investor protections?

4. What, if any, unintended consequences have arisen from FINRA’s rules related to the capital-raising process? How have firms limited or amended their business models and practices in ways unintended by FINRA with a consequence to capital formation or investor protection in order to comply with FINRA’s rules in these areas?

5. Are there other FINRA rules not identified above that impact the capital-raising process? If so, what has been your experience with these rules?

6. Are there any ambiguities in the rules that FINRA should address to aid firms’ compliance and enhance the capital-raising process while ensuring investor protection concerns are addressed?

7. Can FINRA make any of its administrative processes or interpretations related to the capital-raising process more efficient and effective? If so, which ones and how?

8. As currently designed, are the eligibility requirements for the CAB rules over- or under-inclusive in any respect? What changes, if any, to these requirements should be considered? Are the requirements applicable to CABs appropriately tailored to their business activities? Should any changes to these requirements be considered?

9. As currently designed, do FINRA’s funding portal rules appropriately address the requirements and objectives of the JOBS Act and the SEC’s Regulation Crowdfunding? What changes, if any, should be made to FINRA’s rules, and why?

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1. FINRAwillnoteditpersonalidentifyinginformation,suchasnamesoremailaddresses,fromsubmissions.Personsshouldsubmitonlyinformationthattheywishtomakepubliclyavailable.See Notice to Members 03-73(November2003)(OnlineAvailabilityofComments)formoreinformation.

2. SeeSEASection19andrulesthereunder.AfteraproposedrulechangeisfiledwiththeSEC,theproposedrulechangegenerallyispublishedforpubliccommentintheFederal Register.CertainlimitedtypesofproposedrulechangestakeeffectuponfilingwiththeSEC.SeeSEASection19(b)(3)andSEARule19b-4.

3. In2014,forexample,registeredofferingsaccountedfor$1.35trillionofnewcapitalandanestimated$2.1trillionwasraisedthroughallprivateofferingchannels.ScottBauguess,etal.,Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009-2014(October2015), availableathttps://www.sec.gov/files/unregistered-offering10-2015.pdf.

4. AsnotedbytheCongressionalResearchService,forexample,“Congressionalinterestinthe[SmallBusinessAdministration’s(SBA)]accesstocapitalprogramshasincreasedinrecentyears,primarilybecauseassistingsmallbusinessinaccessingcapitalisviewedasameanstoenhancejobcreationandeconomicgrowth.”RobertJayDilger,U.S.Cong.ResearchServ.,R40985,Small Business: Access to Capital and Job Creation, at1(Aug.26,2016)(citationsomitted),availableathttps://fas.org/sgp/crs/misc/R40985.pdf.Moreover,SBAdatashowthatsmallbusinessesaccountedforapproximately60percentofnetnewjobsfrom2009tomid-2013.SeeSBAOfficeofAdvocacy,Frequently Asked Questions about Small Business,at*1(June2016),availableathttps://www.sba.gov/sites/default/

files/advocacy/SB-FAQ-2016_WEB.pdf.SmallbusinessesalsohavebeencreditedwithhelpingAmericarecoverfromtherecessionfollowingthe2008financialcrisis.SeeSBA, Cabinet Exit Memo, SBA: Smart, Bold, Accessible,at*2(January5,2017),availableathttps://obamawhitehouse.archives.gov/sites/whitehouse.gov/files/documents/SBA%20Exit%20 Memo.pdf.

5. Pub.L.112-106,126Stat.306(2012).

6. TheSECadoptedRegulationCrowdfundingonOctober30,2015.SeeSEAReleaseNo.76324(October30,2015),80FR71388(November16,2015)(FinalRule:Crowdfunding).

7. SeeSEAReleaseNo.70957(November27,2013),78FR72946(December4,2013)(OrderApprovingSR-FINRA-2013-037).See also Regulatory Notice 13-43(December2013).

8. SeeSEAReleaseNo.62539(July21,2010),75FR44033(July27,2010)(OrderApprovingProposedRuleChange;FileNo.SR-FINRA-2010-029).See also Regulatory Notice 10-47(October2010).

9. See Regulatory Notice 17-15(April2017)fordetailsoftheproposedamendmentstoRule5110.

10. WhilesomeFINRArulesalsomayimpactFINRAmembersthataresmallbusinesses,FINRAisseparatelyconsideringwhatruleamendmentsorotherstepsFINRAcantaketoeaseregulatoryburdensandfacilitatethegrowthofitssmallermembers.

11. TheSECapprovedtheCABrulesetinAugust2016.SeeSEAReleaseNo.78617(August18,2016),81FR57948(August24,2016)(OrderApprovingRuleChangeasModifiedbyAmendmentNos.1and2toAdoptFINRACapitalAcquisitionBrokerRules;FileNo.SR-FINRA-2015-054).TheCABrulesbecome

Endnotes

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©2017. FINRA. All rights reserved. Regulatory Notices attempt to present information to readers in a format that is easily understandable. However, please be aware that, in case of any misunderstanding, the rule language prevails.

https://www.sec.gov/files/unregistered-offering10-2015.pdf

https://www.sec.gov/files/unregistered-offering10-2015.pdf

https://fas.org/sgp/crs/misc/R40985.pdf

https://fas.org/sgp/crs/misc/R40985.pdf

https://obamawhitehouse.archives.gov/sites/whitehouse.gov/files/documents/SBA%20Exit%20%20Memo.pdf




effectiveonApril14,2017.InordertoprovidenewCABapplicantswithleadtimetoapplyforFINRAmembershipandobtainthenecessaryqualificationsandregistrations,CABRules101-125becameeffectiveonJanuary3,2017.FINRAbeganacceptingapplicationsforentitiesthatarenotcurrentlyregisteredasbroker-dealersbutwishtosoregisterandbesubjecttoFINRA’sCABrules,forexistingmembersrequestingtoelectCABstatus,andforCABassociatedpersonregistrationandqualification,onJanuary3,2017.See Regulatory Notice 16-37(October2016).

12. Crowdfundinggenerallyreferstotheuseoftheinternetbysmallbusinessestoraisecapitalthroughlimitedinvestmentsfromalargenumberofinvestors.

13. FINRAistheonlynationalsecuritiesassociationregisteredunderSEASection15A.

14. SomemembershaveraisedconcernregardingwhethercertainofFINRA’sLettersofAcceptance,WaiverandConsent(AWCs)withotherfirmsimposenewrequirementsforcompliancewiththeresearchrules.AWCsarebasedonexistinglawasappliedtothespecificfactsandcircumstancesatissueandarenotintendedtocreatenewpoliciesorrequirementsonmembers.AswithcompliancewithanyFINRArule,amembershouldconsideritsuniquefactsandcircumstancesandtailoritssupervisorysystemspecificallytoitsbusiness.

15. See Regulatory Notice 17-16(April2017)fordetailsoftheproposedamendmentstoRule2241andRule2242.

16. Rule2241’spredecessor—NASDRule2711(ResearchAnalystsandResearchReports)—wasapprovedbytheSECin2002.Rule2711andthe

NYSE’srulesgoverningresearchreportswereintendedtorestorepublicconfidenceinthevalidityofresearchandtheveracityofresearchanalysts.Thetrustworthinessofresearchhaderodedduetotheinfluencesofinvestmentbankingandotherconflictsthathadmanifestthemselvesduringthemarketboomofthelate1990s.SeeJointReportbyNASDandtheNYSEontheOperationandEffectivenessoftheResearchAnalystConflictofInterestRules(December2005),availableat http://www.finra.org/web/groups/industry/@ip/@issues/@rar/documents/industry/p015803.pdf.

17. See15U.S.C.78o-6.Forexample,Sarbanes-Oxleymandatesspecificrulestoprohibitorrestrictconductrelatedtothepreparation,approvalanddistributionofresearchreportsandthedeterminationofresearchanalystcompensation.Sarbanes-Oxleyalsomandatesspecificrulestodefineperiodsduringwhichbrokersordealerswhohaveparticipated,oraretoparticipate,inapublicofferingofsecuritiesasunderwritersordealersshouldnotpublishorotherwisedistributeresearchreportsrelatingtosuchsecuritiesortotheissuerofsuchsecurities.

18. In2003,federalandstateauthoritiesandself-regulatoryorganizationsreachedasettlementwith10ofthenation’slargestbroker-dealerstoresolveallegationsofmisconductinvolvingconflictsofinterestbetweentheirresearchanalystsandinvestmentbankers.SeeSECLitigationReleaseNo.18438(October31,2003).In2004,twoadditionalfirmssettledsubstantivelyunderthesameterms,whichincludedprovisionstoeffectivelyseparateresearchfrominvestmentbanking.SeeSECLitigationReleaseNos.18854and18855(August26,2004).

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19. Forexample,Rule2241eliminatedtheexceptioninNASDRule2711permittingpre-publicationreviewofresearchbyinvestmentbankingtoverifythefactualaccuracyofinformationinaresearchreport.FactualreviewbyinvestmentbankingpersonnelisnotpermittedunderthetermsoftheGlobalSettlement.However,someprovisionsoftheGlobalSettlementcontinuetoapplyonlytomemberssubjecttothesettlement(e.g.,theGlobalSettlementrequirementswithrespecttochaperoningcommunicationsbetweenresearchandinvestmentbankingpersonnelarenotincorporatedintoFINRArulesandapplyonlytoGlobalSettlementfirms).

20. ConsistentwiththeJOBSActamendmentstotheSEArelatedtoemerginggrowthcompanies(EGC),Rule2241’squietperiod-relatedrequirementsdonotapplyfollowingtheIPOorsecondaryofferingofanEGC.Section3(a)(80)oftheSEAdefinesanEGCas“anissuerthathadtotalannualgrossrevenuesoflessthan$1,000,000,000(assuchamountisindexedforinflationevery5yearsbytheCommissiontoreflectthechangeintheConsumerPriceIndexforAllUrbanConsumerspublishedbytheBureauofLaborStatistics,settingthethresholdtothenearest1,000,000)duringitsmostrecentlycompletedfiscalyear.”

Moreover,pursuanttotheSEAamendmentsimplementingtheJOBSAct,Rule2241’sprohibitiononparticipationinpitchmeetingsdoesnotapplytoaresearchanalystthatattendsapitchmeetinginconnectionwithanIPOofanEGCthatisalsoattendedbyinvestmentbankingpersonnel.However,researchanalystsstillareprohibitedfromsolicitinganinvestmentbankingservicestransactionorpromisingfavorableresearchduringpermissibleattendanceatthosepitchmeetings.See SEC,JOBSAct,FrequentlyAskedQuestionsAboutResearch

AnalystsandUnderwriters,availableathttp://www.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm.See alsoFINRA,ResearchRulesFrequentlyAskedQuestions,availableathttp://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq.

21. Rule2310’spredecessor—NASDRule2810—wasadoptedin1980toaddressissuesarisingfrommembers’participationinoilandgasprogramsandrealestatesyndicationsinthe1970s.SeeSEAReleaseNo.16967(July8,1980),45FR47294(July14,1980).Therulehasbeenamendedperiodicallytoincludeadditionalprogramsandprocedurestoaddressnewdevelopmentsregardingmembers’participationinInvestmentPrograms.Forexample,somesignificantamendmentstoRule2810includethefollowing:in1982,amendmentstoincludesuitability,duediligenceanddisclosurerequirements;seeSEAReleaseNo.19054(September16,1982),47FR42226(September24,1982);in1984,torequirethatsalesincentivesbeincash;seeSEAReleaseNo.20844(April11,1984),49FR15041(April16,1984);in1986,toexemptcertainsecondaryofferings;seeSEAReleaseNo.23619(September15,1986),51FR33968(September24,1986);in1994,toapplytolimitedpartnershiprolluptransactions;seeSEAReleaseNo.34533(August15,1994),59FR43147(August22,1994);andin2003,tomodifythenon-cashcompensationprovisions;seeSEAReleaseNo.47697(April18,

2003),68FR20191(April24,2003).

22. TheSECrecentlyapprovedFINRA’sproposedamendmentstoRule2340andRule2310thatrequiregeneralsecuritiesmemberstoprovidemoreaccuratepershareestimatedvaluesoncustomeraccountstatements,shortenthetimeperiodbeforeavaluationisdeterminedbasedonanappraisalandprovidevariousimportantdisclosures.SeeSEAReleaseNo.73339(October

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http://www.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm



http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq

http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq

10,2014),79FR62489(October17,2014)(OrderApprovingSR-FINRA-2014-006,asModifiedbyAmendmentNo.1).See alsoFINRARegulatory Notice 15-02(January2015).

23. FilingsunderRules5122and5123arenoticefilings.Accordingly,FINRAwillnotrespondtoafilingorissueanoobjectionsletter.AllfilingsunderRules5122and5123areaffordedconfidentialtreatment.

24. “Newissue”meansanyIPOofanequitysecurityasdefinedinSection3(a)(11)oftheSEAmadepursuanttoaregistrationstatementorofferingcircular,subjecttosomeexceptions.SeeFINRARules5130(i)(9)and5131(e)(7).

25. Specifically,Rule5131(a)(QuidProQuoAllocations)prohibitsamemberfromusinganallocationofanewissueasameansofobtaininga“kickback”fromtherecipientintheformofexcessivecompensationforotherservicesofferedbythemember.Rule5131(b)(Spinning)prohibitsallocationsofnewissuestoexecutiveofficersanddirectorsofcurrent,andcertainformerorprospective,investmentbankingclients.

26. Rule5141.04defines“fixedpriceoffering”tomeantheofferingofsecuritiesatastatedpublicofferingpriceorprices,allorpartofwhichsecuritiesarepubliclyofferedintheUnitedStatesoranyterritorythereof,whetherornotregisteredundertheSecuritiesAct,exceptthatthetermdoesnotincludeofferingsof“exemptedsecurities”or“municipalsecurities”asthosetermsaredefinedinSEASections3(a)(12)and3(a)(29),respectively,orofferingsofredeemablesecuritiesofinvestmentcompaniesregisteredpursuanttotheInvestmentCompanyActwhichareofferedatpricesdeterminedbythenetassetvalueofthesecurities.

27. FINRARule1060(b)(15)defines“sellinggroup”tomeananygroupformedinconnectionwithapublicoffering,todistributeallorpartofanissueofsecuritiesbysalesmadedirectlytothepublicbyorthroughmembersofsuchsellinggroup,underanagreementwhichimposesnofinancialcommitmentonthemembersofsuchgrouptopurchaseanysuchsecuritiesexceptastheymayelecttodoso.FINRARule1060(b)(16)defines“sellingsyndicate”tomeananysyndicateformedinconnectionwithapublicoffering,todistributeallorpartofanissueofsecuritiesbysalesmadedirectlytothepublicbyorthroughparticipantsinsuchsyndicateunderanagreementwhichimposesafinancialcommitmentuponparticipantsinsuchsyndicatetopurchaseanysuchsecurities.

28. TheRule5250prohibitiononreceivingpaymentsformarketmakingincludeswithinitsscopethereceiptofpaymentsforsubmittingaForm211toFINRApursuanttoRule6432,whichsetsforththestandardsapplicabletomembersfordemonstratingcompliancewithSEARule15c2-11.

29. SeeFINRABy-Laws,ScheduleA,Section1(a).FINRAhasthree“MemberRegulatoryFees”setforthinSection1ofScheduleAtotheFINRABy-Laws:theTAF,theGrossIncomeAssessment,andthePersonnelAssessment.

30. “Coveredsecurities”forpurposesoftheTAFincludeexchange-registeredsecurities,over-the-counterequitysecurities,securityfutures,TRACE-EligibleSecurities(asdefinedinFINRARule6710)otherthanU.S.TreasurySecurities,andmunicipalsecuritiessubjecttothereportingrequirementsoftheMunicipalSecuritiesRulemakingBoard.SeeFINRABy-Laws,ScheduleA,Section1(b)(1).

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