Papilsky Rules - Latham & Watkins

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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
Latham & Watkins | Client Alert 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. 3 Number 1069 | August 5, 2010
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