• New FINRA New Issue Rule Will Require Additional Information from Investors in Private Funds
  • April 26, 2011
  • Law Firm: Proskauer Rose LLP - New York Office
  • The Financial Industry Regulatory Authority, Inc. (FINRA) recently adopted new Rule 5131, which will become effective on May 27, 2011. Rule 5131 aims to prohibit “spinning” by brokers, which is directing new issues (i.e., shares of an initial public offering) to corporate insiders and others in a position to refer business back to the broker.

    In order to be able to make the representations to brokers that will be required to comply with the rule, advisers to private funds that participate in initial public offerings will need to obtain additional information from their existing investors about their affiliations with public companies, and certain private companies before the May 27 effective date, and modify their subscription documents in order to obtain the same information, going forward, from new investors.

    Rule 5131 will generally only be relevant when more than 25% of a private fund is owned by Covered Investors (defined below) of any one particular company.

    Rule 5131 prohibits the allocation of new issues by a FINRA broker-dealer to an account in which an executive officer or director of a public company or a covered nonpublic company (each, a Company), or a person materially supported by such executive officer or director (collectively, a Covered Investor), has a beneficial interest if: (i) the Company is currently an investment banking services client of such FINRA broker-dealer (a Related Broker) or the Related Broker has received compensation from the Company for investment banking services in the past twelve months; (ii) the person responsible for making the allocation decision knows or has reason to know that the Related Broker intends to provide, or expects to be retained by the Company for, investment banking services within the next three months; or (iii) new issues are allocated on the express or implied condition that such executive officer or director, on behalf of the Company, will retain the Related Broker for the performance of future investment banking services.

    In order to comply with this new rule, a FINRA broker-dealer must in good faith have obtained within twelve months of such allocation a representation from the beneficial owner(s) of each account receiving a new issue allocation (such as a hedge fund, private equity fund or venture capital fund) as to whether such beneficial owners are Covered Investors (or are partnerships or other accounts in which the beneficial interest of Covered Investors totals at least 25%), and, if so, the Companies they serve. Private fund managers will need to collect this data from their investors in order to be able to make this representation.

    Rule 5131 does not apply to allocations to certain persons including: (1) registered investment companies; (2) certain insurance company general, separate or investment accounts; (3) private funds in which the aggregate beneficial interests of Covered Investors of a particular Company do not exceed 25% (the de minimis exemption); (4) certain publicly traded entities; (5) certain ERISA plans; and (6) state or municipal government benefit plans.

    If you currently manage any accounts or funds that purchase new issues, you will need to contact your existing investors (both U.S. and non-U.S.) in order to determine the status of each client or investor under Rule 5131.