Corporate Financing and Underwriting Compensation
Quick Answer
The corporate-financing rule requires a member firm participating in a public offering to file the registration statement, underwriting agreement, and other deal documents with FINRA's Public Offering System (POS). The rule defines underwriting compensation broadly (cash, expense reimbursements, securities, warrants, rights of first refusal, anything tied to the deal), requires that aggregate compensation be fair and reasonable by FINRA staff standards, and imposes a 180-day lock-up on securities received as compensation. Filing must occur within 3 business days of any SEC / state filing or 15 business days before sale if there is no regulator filing.
The corporate-financing rule is the FINRA principal's primary supervisory tool for public offerings. It exists because SEC registration alone does not police the economics of the underwriter's compensation. FINRA review under the corporate-financing rule fills that gap.
Filing Requirement and Timing
| Step | What | When |
|---|---|---|
| 1. Initial filing | Registration statement, proposed underwriting agreement, master forms of selected dealer / agreement among underwriters, and any other documents that define the economics | If filed with SEC / state / other regulator: within 3 business days of that regulator filing. If not regulator-filed: at least 15 business days before sales commence |
| 2. Updates | Amendments and supplements affecting compensation, terms, or syndicate | Each amendment filed with the regulator must be filed with FINRA within 3 business days |
| 3. No-objection letter | FINRA POS reviewer issues a "no-objection" letter once compensation and terms clear review | Required before sales commence |
Filings are made through FINRA's Public Offering System (POS) by a designated managing underwriter. The principal at the managing firm is responsible for confirming the filing happens and that no-objection is received before any sales.
Exam Tip: Gotchas
- The 3-business-day clock runs from the regulator filing, not from the SEC effective date. A deal filed with the SEC on Monday must be filed with FINRA POS by Thursday (close of the third business day). The clock does not wait for SEC effectiveness.
- Sales cannot commence without a FINRA no-objection letter. Even if the SEC has declared the registration effective, a covered offering needs FINRA clearance on compensation before the syndicate can sell.
What Counts as Underwriting Compensation
The corporate-financing rule defines underwriting compensation broadly. Cash spreads are obvious; everything else is what trips firms up.
| Category | Examples |
|---|---|
| Cash compensation | Underwriting discounts, selling concessions, management fees |
| Expense reimbursements | Legal, due-diligence, road-show expenses paid by the issuer |
| Securities compensation | Warrants, "compensation shares," equity participation rights |
| Financial advisory fees | Pre-deal advisory fees, M&A success fees tied to the offering |
| Finder's fees | Payments to finders or "introducers" who source the deal |
| Rights of first refusal (ROFR) | Right to be lead manager on a future financing |
| Other items of value | Above-market consulting agreements, post-deal advisory contracts, anything tied to the offering economics |
Compensation is valued under formulas in the corporate-financing rule. Warrants are valued by Black-Scholes-style assumptions specified in the rule. The valuation of warrants and other non-cash items can swamp the cash spread in determining the total compensation pool.
Think of it this way: FINRA does not just look at the cover-page underwriting discount. The reviewer adds up cash, valued warrants, expense reimbursements, ROFRs, and any other consideration tied to the deal. A principal who approves a deal counting only the spread misses the bigger compensation pool and creates a corporate-financing-rule violation.
Exam Tip: Gotchas
- A right of first refusal counts as compensation. A ROFR on the issuer's next financing has a measurable value (the optionality of guaranteed future business) and is valued under the rule's compensation formulas. ROFRs longer than 3 years are flat prohibited.
- Warrants count at their Black-Scholes-style value. A warrant compensation package can dwarf the cash spread when the strike is below market or the term is long. The rule's valuation formula is non-negotiable; the firm cannot simply call the warrant "nominal" to avoid the calculation.
- Expense reimbursements count even if they look like ordinary business expenses. Issuer reimbursement of underwriter legal fees is compensation. The issuer can pay; the firm just has to count it.
Standards of Fairness
Compensation must be fair and reasonable considering:
- The size of the offering (smaller offerings tolerate higher percentages)
- The type of security (riskier securities tolerate higher compensation)
- The risk to the underwriter (best-efforts vs. firm commitment)
- Market conditions
| Offering Size | Approximate FINRA Compensation Cap |
|---|---|
| Very small offerings (< $5M) | Up to ~10% |
| Mid-size offerings | ~6-8% typical |
| Large offerings ($100M+) | ~3-5% typical |
The FINRA staff publishes guidelines and adjusts them based on market conditions. The principal supervising a deal must verify the compensation falls within current guidelines and that the deal does not include a prohibited term.
Prohibited terms under the corporate-financing rule include:
- ROFRs longer than 3 years
- Tail provisions that extend payment obligations indefinitely
- "Most favored nation" clauses on future financings
- Cash escrow beyond what is reasonable for the offering
- Reciprocal selling-group obligations that lock the issuer into a future relationship
Exam Tip: Gotchas
- The compensation cap varies with offering size. Smaller deals tolerate higher percentages; larger deals get tighter caps. There is no single fair-and-reasonable percentage; the principal looks up the current FINRA guideline for the deal's size and structure.
- Some terms are flat-prohibited regardless of size. A 5-year ROFR is prohibited even on a small deal where the cash compensation is well within guidelines. The principal must check both the percentage and the specific terms.
Lock-Up on Compensation Securities
Securities received as compensation are locked up for 180 days following the offering's effective date. During the lock-up:
- No sale, transfer, hedge, or pledge by the underwriter, related persons, or any successor
- Limited carve-outs (intra-firm transfers, certain estate-planning transfers) require specific conditions under the corporate-financing rule
This lock-up applies on top of any contractual lock-up between the issuer and other shareholders. The 180-day clock runs from the effective date (not the closing date or any later date).
Exam Tip: Gotchas
- The 180-day lock-up is FINRA-required, not just contractual. A firm cannot waive its 180-day lock-up by side-letter; the rule binds the underwriter regardless of issuer consent.
- The lock-up clock runs from EFFECTIVE date, not closing. A deal that closes a week after effectiveness still has its 180-day clock running from effectiveness.
- The lock-up covers hedges and pledges, not just outright sales. A firm that pledges its compensation warrants as collateral has hedged its risk and violated the lock-up.
Related FINRA Rules: Fixed-Offering-Price and Selling-Group Disclosure
Two related rules govern conduct within the offering:
| Rule | What It Does |
|---|---|
| Fixed-offering-price rule | Sale of securities in a fixed-price offering: members may not give a discount, concession, or other allowance to any non-related person that was not also offered to the syndicate at the same price. Designed to enforce the integrity of the fixed offering price during the syndicate. |
| Selling-group disclosure rule | Disclosure of price and concessions in selling-group agreements: agreements must disclose the public offering price, concession to dealers, and any reallowance terms |
The fixed-offering-price rule enforces the discipline of the syndicate. Once the offering price is set, every customer pays it; a member that "rebates" part of the spread to a favored client violates the fixed-offering-price rule unless the rebate was offered to all syndicate members at the same price.
The selling-group disclosure rule is the disclosure backbone that makes the fixed-offering-price discipline enforceable. Selected dealers must know exactly what concession and reallowance they receive, so that any deviation is visible.
Exam Tip: Gotchas
- The fixed-offering-price rule prohibits selective discounts, not all discounts. A discount offered to all syndicate members at the same price is permitted; a discount to a single favored client is not. The fixed-price rule is about non-discrimination, not about prohibition.
- Selling-group disclosure is to selected dealers, not to retail customers. Customers see the public offering price; the underwriting spread mechanics are visible to the syndicate desks via the selling-group disclosure agreements.