Papilsky Rules - Latham & Watkins

Number 1069 August 5, 2010 

Client Alert 

Latham & Watkins 

Corporate Department 

New FINRA Rule 5141 to Replace Current 

“Papilsky Rules” Relating to the Sale of 

Securities in Fixed Price Offerings 

“However, in 

addition to 

modifying policies 

and procedures 

to reflect the 

provisions of the 

new rule and 

the elimination 

of certain of the 

requirements of 

the old Papilsky 

Rules, members 

should also be 

reviewing their 

underwriting 

agreements 

and related 

documents to 

make appropriate 

changes.” 

On July 21, 2010, the Securities and 

Exchange Commission approved a 

proposal by the Financial Industry 

Regulatory Authority, Inc. (FINRA 

and formerly, the National Association 

of Securities Dealers, Inc. or NASD) 

to delete current NASD Rules 2730, 

2740 and 2750 (commonly known as 

the Papilsky Rules) and adopt in their 

stead new FINRA Rule 5141. 1 NASD 

Rule 0120(h), which defines the term 

“fixed price offering” for purposes 

of the Papilsky Rules, and associated 

NASD interpretive materials set forth in 

IM-2730, IM-2740 and IM-2750 are also 

being eliminated in connection with the 

adoption of FINRA Rule 5141. 2 

FINRA has not yet indicated the 

effective date for the new rule. 

Background 

The stated purpose of the Papilsky 

Rules was to “protect the integrity of 

fixed price offerings by ensuring that 

securities in such offerings are sold to 

the public at the stated public offering 

price or prices, thereby preventing an 

undisclosed better price.” 3 The Papilsky 

Rules were designed to prevent FINRA 

members from discounting the price of 

securities sold in a fixed price offering 

below the stated public offering price or 

prices. 

In particular, the Papilsky Rules 

provided that: 

• FINRA members who purchase or 

arrange for the purchase of “securities 

taken in trade” in a fixed price 

offering must purchase (or arrange for 

the purchase of) the securities taken 

in trade at a fair market price at the 

time of purchase. (NASD Rule 2730). 4 

• FINRA members may not grant any 

selling concessions, discounts or other 

allowances in connection with a fixed 

price offering to anyone other than a 

broker or dealer that is participating 

in the distribution of the offering. 

(NASD Rule 2740). 5 

• FINRA members may not retain 

securities sold in a fixed price 

offering for their own accounts or 

sell such securities to certain of 

their affiliates or “related persons” 

unless the member has made a bona 

fide offering of the securities to the 

public and has been unable to sell 

the securities in such offering at the 

stated fixed price. (NASD Rule 2750). 6 

New FINRA Rule 5141 

FINRA Rule 5141 will replace certain 

outdated requirements of the Papilsky 

Rules and simplify their provisions while 

still preserving the primary purpose 

of the original rules (i.e., protecting 

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Latham & Watkins | Client Alert 

the integrity of the fixed price offering 

process). 

Specifically, as approved by the SEC, 

FINRA Rule 5141 provides that no 

FINRA member that: 

participates in a selling syndicate or 

selling group or that acts as the single 

underwriter in connection with a fixed 

price offering shall offer or grant, 

directly or indirectly, to any person or 

account that is not a member of such 

selling syndicate or selling group or 

that is a person or account other than 

the single underwriter any securities 

in the offering at a price below the 

stated public offering price (reduced 

price). 7 

FINRA Rule 5141(b) states, however, 

that this general prohibition will not 

impact the ability of members of a 

selling syndicate or selling group to 

purchase and sell securities in the 

offering among themselves. Moreover, 

dispensing with the prohibition currently 

contained in NASD Rule 2750, new 

FINRA Rule 5141 expressly permits 

(subject to the restrictions contained in 

FINRA Rule 5130) 8 a single underwriter 

or member of the selling syndicate or 

selling group to sell securities in the 

offering to an affiliated person so long 

as the affiliated person purchases the 

securities at the fixed public offering 

price and not at a “reduced price.” 9 

Supplementary material provided in 

respect of FINRA Rule 5141 clarifies 

that the term “reduced price” includes, 

without limitation, the offer or grant 

of any “selling concession, discount 

or other allowance, credit, rebate, 

reduction of any fee (including any 

advisory or service fee), any sale of 

products or services at prices below 

reasonable commercially available rates 

for similar products and services . . . 

or any purchase of or arrangement to 

purchase securities from the person or 

account at more than their fair market 

price in exchange for securities in the 

offering.” 10 

The new rule continues to provide an 

exception with respect to the provision 

of “research.” In particular, FINRA 

Rule 5141 will not prevent a member 

from selling securities in a fixed price 

offering to a person or account to which 

it has provided research so long as the 

recipient of the research pays the stated 

public offering price for the securities 

and the research is provided pursuant to 

the requirements of Section 28(e) of the 

Securities Exchange Act of 1934. 11 

The new rule also provides guidance 

to FINRA members that also serve as 

investment advisers, noting that such 

a member “may exempt securities 

that are purchased as part of a fixed 

price offering from the calculation of 

annual or periodic asset-based fees that 

such member charges to a customer, 

provided such exemption is part of the 

member’s normal and ordinary course 

of business with the customer and is 

not in connection with an offering.” 12 

Although the new rule does not address 

the alternative practice employed by 

certain participating members whereby 

two fixed public offering prices are 

disclosed — one price that includes the 

full underwriting discount and a second 

price that excludes all or a portion of the 

underwriting discount and is applicable 

to those purchasers who already pay 

asset-based fees to the selling member 

— it would appear that this alternative 

practice should also continue to be 

permitted under the new rule provided 

the multiple fixed prices are adequately 

disclosed in the prospectus or other 

offering document. 

Practical Impact of the Rule 

Change 

FINRA has not yet indicated the 

implementation date for new FINRA 

Rule 5141. However, in addition to 

modifying policies and procedures to 

reflect the provisions of the new rule 

and the elimination of certain of the 

requirements of the old Papilsky Rules, 

2 Number 1069 | August 5, 2010


members should also be reviewing 

their underwriting agreements and 

related documents to make appropriate 

changes. 

Significantly, unlike NASD Rule 

2740(c), FINRA Rule 5141 does not 

require members to obtain the written 

agreement of non-US broker-dealers 

participating in a fixed price offering 

to comply with the provisions of the 

Papilsky Rules and NASD Rule 2420. 13 

FINRA Rule 5141 also does not require 

members to make quarterly filings with 

FINRA with respect to designated sales, 

nor does it require specific records to be 

kept and maintained by members that 

are designated by their customers to 

receive selling credit as now required by 

NASD Rule 2740 (although FINRA does 

note that such members remain subject 

to other applicable FINRA and SEC 

recordkeeping requirements). 14 

Moreover, new FINRA Rule 5141 may 

permit the establishment of certain 

referral and advisory arrangements 

previously thought to be prohibited 

by the literal words of current NASD 

Rule 2740. In particular, outside the 

parameters of an interpretive letter 

issued by FINRA (then NASD) staff 

in 2003, 15 most referral and advisory 

arrangements between a FINRA 

member that was participating in a 

fixed price offering and another entity 

that was not itself a broker-dealer that 

was also participating in the offering 

were thought to be impermissible 

under NASD Rule 2740 since the 

arrangement, if it involved the payment 

of compensation based on or tied to the 

amount of compensation received by 

the FINRA member in the fixed price 

offering, could be viewed as the grant 

(or sharing) of a concession or “other 

allowance” in connection with the fixed 

price offering. It now appears, however, 

that such an arrangement would not 

be prohibited by new FINRA Rule 

5141, provided it does not, directly or 

indirectly, confer a “reduced price” in 

respect of any securities purchased or 

sold in the offering, and, accordingly, 

should be permissible to the extent 

the terms of the arrangement are not 

inconsistent with NASD Rule 2420 

(or, assuming it is ultimately adopted, 

proposed FINRA Rule 2040) or any other 

applicable laws, rules and regulations. 

Finally, it is worth noting that new 

FINRA Rule 5141 provides that the 

prohibition with respect to selling the 

offered securities at a “reduced price” 

applies only “until the termination of 

the offering or until a member, having 

made a bona fide public offering of the 

securities, is unable to continue selling 

such securities at the stated public 

offering price.” 16 This language should 

preserve the ability of underwriters to 

change the initial offering price shown 

on the cover of the prospectus from 

time to time if they are unable to sell 

all the offered securities at such initial 

fixed offering price and, in connection 

with under-subscribed offerings, should 

continue to permit underwriters to 

place securities they are unable to 

sell to the public in the offering in an 

investment account or with an affiliate 

without running afoul of the rule. 17 

Accordingly, new FINRA Rule 5141 

should not change customary practices 

in connection with “sticky” deals. 



Endnotes 

1 

See SEC Release No. 34-62539; File No. 

SR-FINRA-2010-029 (July 21, 2010). NASD 

Rules 2730, 2740 and 2750 are generally 

referred to as the “Papilsky Rules” because 

of the court decision with which they are often 

associated, Papilsky v. Berndt, Fed. Sec. L. Rep 

(CCH) 95,627 (S.D.N.Y. June 24, 1976). 

FINRA issued a notice to its members relating 

to the proposed rule on August 4, 2009 and 

originally submitted the rule proposal to the 

SEC shortly thereafter, but then withdrew it 

for technical reasons in November 2009. The 

proposed rule was re-submitted to the SEC, 

without substantive change, on May 27, 2010. 

See FINRA Regulatory Notice 09-45 (August 

2009) (FINRA Notice 09-45); SEC Release 

No. 34-62299 (June 16, 2010) (the Proposing 

Release). 

2 

The definition of “fixed price offering” is now set 

forth in the supplementary materials to FINRA 

Rule 5141 and is essentially unchanged from 

the definition currently set forth in NASD Rule 

0120(h). As so defined, the term “fixed price 

offering” refers to securities publicly offered 

(in whole or in part) in the United States at a 

stated offering price or prices. See FINRA Rule 

5141.04. The term includes offerings registered 

in the United States under the Securities Act 

of 1933, as well as offerings that, although 

public, are not required to be registered under 

the Securities Act pursuant to an applicable 

exemption (e.g., bank securities offered pursuant 

to Section 3(a)(2) of the Securities Act). The 

term, however, does not include offerings of 

securities that are privately placed or offered and 

sold pursuant to Rule 144A under the Securities 

Act. It is also important to note that the term 

“fixed price offering” does not prohibit “multiple 

price” offerings so long as the different fixed 

prices are adequately disclosed. See Proposing 

Release; NASD Notice to Members 81-3. 

3 

FINRA Notice 09-45. 

4 

NASD Rule 2730 was intended to prevent 

members from paying a higher price for the 

securities taken in trade, thereby lowering the 

purchase price of the securities purchased by 

the investor in the fixed price offering. 

5 

The purpose of NASD Rule 2740 was to prevent 

members from granting discounts to favored 

investors, such that those investors would be 

able to purchase securities in the offering at a 

lower price than other investors. 

6 

NASD Rule 2750 was intended to prevent 

purchasers from obtaining a discount through the 

establishment of an affiliated broker-dealer that 

would receive designated selling credit for the 

sale. 

7 

FINRA Rule 5141(a). 

8 

FINRA Rule 5130 generally prohibits FINRA 

members from selling equity securities offered 

in initial public offerings to certain “restricted 

persons” (a term which includes, among others, 

broker-dealers and certain persons having a 

beneficial interest in a broker-dealer). 

9 

FINRA Rule 5141.03 provides that ordinary 

course transactions between a member and its 

affiliates that are unrelated to the purchase or 

sale of securities in a fixed price offering will not 

be deemed to confer a “reduced price” under the 

rule. 

10 

FINRA Rule 5141.01. 

11 


12 


13 

The adoption of FINRA Rule 5141 does not 

impact existing NASD Rule 2420 (Dealing with 

Non-Members), although such rule is the subject 

of another pending FINRA rule proposal. See 

FINRA Regulatory Notice 09-69 (December 

2009) (proposing, among other things, to delete 

current NASD Rule 2420 and replace it with new 

FINRA Rule 2040) (FINRA Notice 09-69). 

Also note that current NASD Rule 2420(c) 

continues to require an agreement by any 

non-US broker-dealer that receives a selling 

concession, discount or other allowance from 

a FINRA member to agree to the restrictions 

set forth in the rule as if it were itself a FINRA 

member in respect of any sales of securities 

it makes to persons in the United States. The 

FINRA proposal discussed in FINRA Notice 

09-69 would eliminate this requirement and 

further simplify the provisions of existing NASD 

Rule 2420. In particular, if adopted as proposed, 

new FINRA Rule 2040 would (in pertinent part) 

prohibit members from, directly or indirectly, 

paying or offering to pay any “compensation, 

fees, concessions, discounts, commissions or 

other allowances to . . . any person that is not 

registered as a broker-dealer under Section 

15(a) of the Exchange Act but, by reason of 

receipt of any such payments, is required to be 

so registered under applicable federal securities 

laws and [Exchange Act] rules, regulations and 

published guidance issued by the SEC or its 

staff in the form of releases, no-action letters or 

interpretations.” See FINRA Notice 09-69. 



14 

See, e.g., Rules 17a-3 and 17a-4 under the 

Exchange Act. 

15 

See Interpretive Letter to Dana Fleischman 

issued November 24, 2003 (permitting certain 

types of advisory and/or referral payments to 

non-participating broker-dealers under certain 

circumstances) available at http://www.finra.org/ 

Industry/Regulation/Guidance/InterpretiveLetters/ 

P002636 

16 

FINRA Rule 5141(a). Similar to current NASD 

Rule 2750(d), securities offered for sale in a 

fixed price offering are presumed salable for 

purposes of FINRA Rule 5141 “if the securities 

immediately trade in the secondary market at a 

price or prices which are above the stated public 

offering price.” Note, however, that under NASD 

Rule 2750, the presumption as to the failure to 

make a bona fide public offering is triggered if 

the securities trade immediately in the secondary 

market at or above the public offering price. See 

NASD Rule 2750(d). 

17 

In this context, however, FINRA notes that 

“the appropriateness of placing unsold shares 

in a member’s investment account, and the 

subsequent resale of the shares, raises other 

potential issues under the federal securities laws 

or other FINRA rules and is beyond the scope 

of the proposed rule change.” See Proposing 

Release. 



If you have any questions about 

this Client Alert, please contact 

Dana G. Fleischman or any of the 

Latham attorneys with whom you 

normally consult. 

Dana G. Fleischman 

+1.212.906.1220 

dana.fleischman@lw.com 

New York 

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Papilsky Rules - Latham & Watkins

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