New Issue Allocations and Spinning

Everything in this lesson runs on the same defined term. If the offering is not a new issue, none of it applies, however large the deal.

What Is a Quid Pro Quo Allocation?

No member or person associated with a member may offer or threaten to withhold shares it allocates of a new issue as consideration or inducement for the receipt of compensation that is excessive in relation to the services provided by the member.

Two acts are named, not one. Offering shares on that basis and threatening to withhold them on that basis are each prohibited.

Exam Tip: Gotchas

• The compensation must be excessive in relation to the services provided. Ordinary commission business alongside an allocation is not the violation; the excess is what the rule measures.
• A threat is enough. The rule reaches a threat to withhold shares, so no allocation needs to be withheld for the prohibition to bite.

When Is an Allocation to an Executive Officer, Director or Materially Supported Person's Account Prohibited?

No member or person associated with a member may allocate shares of a new issue to any account in which an executive officer or director of a public company or a covered non-public company, or a person materially supported by such executive officer or director, has a beneficial interest, in any of three situations:

• The company is currently an investment banking services client of the member, or the member has received compensation from the company for investment banking services in the past 12 months.
• The person responsible for making the allocation decision knows or has reason to know that the member intends to provide, or expects to be retained by the company for, investment banking services within the next 3 months.
• The allocation is made on the express or implied condition that the executive officer or director, on behalf of the company, will retain the member for the performance of future investment banking services.

The prohibition does not apply to allocations to any account of a type the new issue purchase restriction rule lists among its general exemptions, other than the account in which the beneficial interests of that rule's restricted persons do not exceed 10% of the account in the aggregate.

It also does not apply to any other account in which the beneficial interests of the company's executive officers and directors and the persons they materially support in the aggregate do not exceed 25% of such account.

Exam Tip: Gotchas

• The look-back and the look-forward are different lengths. Compensation received looks back 12 months; an expectation of being retained looks forward 3 months.
• The 25% test is an aggregate across the covered persons. It is not a per-person threshold, and it is measured against the account rather than against the allocation.
• The forward-looking branch uses a knowledge standard. It asks what the person responsible for the allocation decision knows or has reason to know, not what the firm intends in the abstract.

Which Companies and People Does the Spinning Ban Reach?

The third criterion for a covered non-public company is conjunctive: total assets and total revenue must each reach $75 million. The first is conjunctive too, pairing an income test with an equity test.

Exam Tip: Gotchas

• Investment banking services is an open list. The rule says "include, without limitation", so an unlisted service can still be investment banking services.
• A fiduciary fee is not a beneficial interest. A manager paid a performance fee on a collective investment account does not thereby hold a beneficial interest in that account.
• Same-household persons are deemed to support each other. No income calculation is needed to bring a household member inside the material support definition.

Which Allocations Are Carved Out of the Spinning Ban?

Three items of Supplementary Material lift the prohibition:

• Issuer-directed allocations: allocations of securities directed in writing by the issuer, an affiliate of the issuer, or a selling shareholder, so long as the member has no involvement or influence, directly or indirectly, in those allocation decisions with respect to the issuer-directed securities.
• Anti-dilution allocations: an account holding a beneficial interest of a covered person is carved out where all four conditions below are met.
• Foreign non-member broker-dealers: a foreign non-member broker-dealer participating in an underwriting syndicate for the sale of a new issue (a syndicate that may include a member affiliate of the non-member broker-dealer) and allocating new issue securities to a non-United States person, provided that allocation decision is not made at the direction or request of a member or an associated person of a member.

The four anti-dilution conditions are:

• The account has held an equity ownership interest in the issuer, or in a company that has been acquired by the issuer in the past year, for a period of one year prior to the effective date of the offering.
• The allocation shall not increase the account's percentage equity ownership in the issuer above the ownership level as of three months prior to the filing of the registration statement in connection with the offering.
• The allocation shall not include any special terms.
• The new issue allocated shall not be sold, transferred, assigned, pledged or hypothecated for a period of three months following the effective date of the offering.

Exam Tip: Gotchas

• The anti-dilution carve-out has two different three-month clocks. One measures the pre-filing ownership level; the other is a post-effective transfer restriction.
• Issuer direction must be in writing and the member must be entirely out of the decision. Any involvement or influence, direct or indirect, defeats the carve-out.

What Written Representations May a Member Rely On?

For purposes of the spinning ban, a member may rely on a written representation obtained within the prior 12 months from the beneficial owners of the account, or a person authorized to represent them, as to whether a beneficial owner is an executive officer or director or a person materially supported by one, and if so, the companies on whose behalf that person serves.

A member may also rely on a written representation obtained within the prior 12 months from a person authorized to represent an account that does not look through to the beneficial owners of any unaffiliated private fund invested in the account, except for beneficial owners that are control persons of the investment adviser to that private fund, that the fund meets four conditions:

• It is managed by an investment adviser.
• It has assets greater than $50 million.
• It owns less than 25% of the account and is not a fund in which a single investor has a beneficial interest of 25% or more.
• It was not formed for the specific purpose of investing in the account.

An unaffiliated private fund is a private fund, as the Investment Advisers Act defines one, whose investment adviser does not have a control person in common with the investment adviser to the account. A control person is a person with direct or indirect control over the investment adviser, as Form ADV defines that term.

Two limits close the representation regime. A member may not rely upon any representation that it believes, or has reason to believe, is inaccurate. And a member shall maintain a copy of all records and information relating to whether an account is eligible to receive a new issue allocation under the spinning ban for at least three years following the member's allocation to that account.

Exam Tip: Gotchas

• Both representations refresh on the same 12-month clock. A representation older than 12 months no longer supports reliance.
• Belief defeats reliance before knowledge does. The bar is a representation the member believes, or has reason to believe, is inaccurate.

What Must the Book-Running Lead Manager Report to the Issuer?

In a new issue, the book-running lead manager must provide two reports to the issuer's pricing committee or, if the issuer has no pricing committee, its board of directors:

• A regular report of indications of interest (IOIs), including the names of interested institutional investors and the number of shares indicated by each, as reflected in the book-running lead manager's book of potential institutional orders, and a report of aggregate demand from retail investors.
• After the settlement date of the new issue, a report of the final allocation of shares to institutional investors as reflected in its books and records, including the names of purchasers and the number of shares purchased by each, and aggregate sales to retail investors.

The institutional side is reported name by name and share by share; the retail side is reported in the aggregate on both reports.

Exam Tip: Gotchas

• The final allocation report is due after the settlement date, not after pricing. The indications report runs during the build; the allocation report follows settlement.
• The recipient is the pricing committee first. The board of directors receives the reports only where the issuer has no pricing committee.

How Are Lock-Ups and Returned Shares Handled?

Any lock-up agreement or other restriction on the transfer of the issuer's shares by officers and directors, entered into in connection with a new issue, must provide two things:

• The restriction will apply to their issuer-directed shares.
• At least two business days before the release or waiver of any lock-up or other transfer restriction, the book-running lead manager will notify the issuer of the impending release or waiver and announce it through a major news service.

That two-business-day requirement, both the notice to the issuer and the announcement, has an exception with two halves, and both must hold. The release or waiver must be effected solely to permit a transfer of securities that is not for consideration or that is to an immediate family member, as the new issue purchase restriction rule defines that term.

The transferee must also have agreed in writing to be bound by the same lock-up agreement terms in place for the transferor.

Supplementary Material relaxes who may speak. The announcement requirement is satisfied where the announcement is made by the book-running lead manager, another member or the issuer, so long as it otherwise complies with the paragraph. Disclosure of a release or waiver in a publicly filed registration statement in connection with a secondary offering satisfies the requirement for an announcement through a major news service.

The agreement between the book-running lead manager and other syndicate members must require, to the extent not inconsistent with SEC Regulation M, that any shares trading at a premium to the public offering price that are returned by a purchaser to a syndicate member after secondary market trading commences be handled in one of two ways:

• Used to offset the existing syndicate short position; or
• If no syndicate short position exists, the member must either offer the returned shares at the public offering price to unfilled customers' orders pursuant to a random allocation methodology, or sell them on the secondary market and donate the profits to an unaffiliated charitable organization, on the condition that the donation be treated as an anonymous donation to avoid any reputational benefit to the member.

Exam Tip: Gotchas

• The returned-shares provision reaches only shares trading at a premium. Shares returned below the public offering price are outside it, as are shares returned before secondary market trading commences.
• The two choices arise only where no syndicate short position exists. Where one exists, the offset is the required treatment and there is no election.
• An immediate family member is a defined class. It covers parents, in-laws, spouse, siblings, children and any other individual to whom the person provides material support.

What Should You Check on Exam Day?

• Confirm the offering is a new issue before applying any part of this rule.
• On a spinning question, test all three triggers: a current or 12-month client, a 3-month expectation, or an express or implied condition of future retention.
• Check both carve-out limbs, the general-exemption account types other than the 10% restricted-person account and the 25% aggregate test, then the issuer-directed, anti-dilution and foreign broker-dealer exceptions before calling an allocation prohibited.
• Distinguish the two reports to the issuer: indications of interest during the build, final allocations after the settlement date.
• On returned shares, confirm a premium price, a return after secondary trading commences, and whether a syndicate short position exists.