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Aug 01, 2017

Family Offices Included as ‘Investment Advisers’ Under IPO Allocation Rule 5131(b)

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On May 9, 2017, the Financial Industry Regulatory Authority, Inc. (“FINRA”) issued an interpretive letter (the “Letter”)[1] regarding its IPO allocation rule 5131(b) and its exception 5131.02(b) (the “IPO Allocation Rule”, or “Rule”).[2]  As described below, the Letter includes family offices (“Family Offices”)[3] under exception 5131.02(b)’s meaning of “investment adviser,” with the practical effect of allowing broker-dealer accounts to avoid looking through to their beneficial owners where such beneficial owners are unaffiliated private funds managed by Family Offices, when making IPO Allocation Rule representations.

According to the guidance set forth in the Letter, funds invested in the broker-dealer account and managed by a Family Office must still satisfy 5131.02(b)’s other requirements, besides being managed by an Investment Adviser, in order to invoke the exception. [4]

Compliance With the Spinning Rule: The Broker-Dealer Making the Allocation May Rely on a Representation From Accounts Seeking an Allocation

Under the Rule, a FINRA-member broker-dealer is prohibited from allocating “new issue securities” to any accountwhich includes an investment fund or other collective investment vehicleif an executive officer or director of a public reporting company or “covered non-public company”[5] has a beneficial economic interest (including the right to share in gains or losses) in the account, if any of the following are true: (i) the company is currently an investment banking client of the member; (ii) in the 12-month period prior to the allocation, the member received compensation from the company for investment banking services; (iii) the FINRA member expects to provide or be retained for investment banking services in the three-month period following the allocation; or (iv) the allocation is made on the condition that such executive officer or director, on behalf of the company, retain the member for performance of future investment banking services.

To facilitate compliance with the spinning prohibition, the Rule permits members to rely on written representations, obtained within the prior 12 months, from an account’s beneficial owners, attesting to the companies, if any, at which the beneficial owners serve as executive officers or directors (or attest that they are materially supported by persons holding such offices).

The Letter Provides Relief for Broker-Dealer Accounts That Are Owned, in Part or in Whole, by Collective Investment Vehicles Managed by Family Offices

Exception 5131.02(b) permits a FINRA member to rely upon a written representation, obtained within the prior 12 months, from an account that does not look through to the beneficial owners of any “unaffiliated private fund,” so long as such funds meet certain requirements, including being managed by an “investment adviser.”

FINRA notes in the Letter that Family Offices may perform equivalent functions to regulated investment advisers, including investing the assets of a pooled investment vehicle or providing other forms of investment advice. It continues that, while Family Offices are excluded from the definition of Investment Adviser set forth under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), the policy reasons for the Advisers Act’s exclusion are not at issue in the context of Rule 5131(b), and because unaffiliated private funds, managed by Family Offices, that otherwise meeting exception 5131.02(b)’s requirements are unlikely to be used for spinning, the exclusion is not carried into this context. 

Footnotes

[1]  The Letter is available at http://www.finra.org/industry/interpretive-letters/may-9-2017-1200am.
[2]  See FINRA R. 5131(b), Spinning. For more information regarding the IPO Allocation Rule, please see “FINRA New Issue (IPO) Allocation Rule to Take Effect May 27, 2011; Investment Funds Must Now Consider Compliance” (January 14, 2011), available at http://www.shearman.com/~/media/files/newsinsights/publications/2011/01/finra-new-issue-ipo-allocation-rule-to-take-effe__/files/view-full-memo-finra-new-issue-ipo-allocation-ru__/fileattachment/am011411finranew-issueipoallocationruletotakeeff__.pdf; and for more information regarding the IPO Allocation Rule and its exception under 5131.02(b), please see “SEC Approves Amendment to FINRA IPO Allocation Rule 5131, Easting Compliance for Fund Investors” (December 6, 2013), available at http://www.shearman.com/~/media/files/newsinsights/publications/2013/12/sec-approvesamendmenttofinraipoallocationrule-5131easingcomplianceforfundinvestorsfiafr120613.pdf.
[3]  See Rule 202(a)(11)(G)-1 of the Investment Advisers Act of 1940, as amended, for a definition of family office, available at https://www.law.cornell.edu/cfr/text/17/275.202%28a%29%2811%29%28G%29-1.
[4]  Such other requirements include that the fund: (1) is an “unaffiliated private fund” as defined in the IPO Allocation Rule, (2) has assets greater than $50 million; and (3) was not formed for the specific purpose of investing in the account.
[5]  See Rule 5131(e)(3) for a definition of  “covered non-public company”.

Authors and Contributors

Russell Sacks

Partner

Financial Institutions Advisory & Financial Regulatory

+1 212 848 7585

+1 212 848 7585

New York

Jennifer D. Morton

Counsel

Financial Institutions Advisory & Financial Regulatory

+1 212 848 5187

+1 212 848 5187

New York