Corporate Financing and Conflicts of Interest

The FINRA framework layers on top of the federal registration rules. The federal rules govern whether an offering can happen; the FINRA rules govern whether the underwriting terms and the broker-dealer relationships pass an industry-fairness review.

What Does the FINRA Corporate-Financing Rule Require?

The FINRA corporate-financing rule is the substantive review of underwriting terms.

• No member firm may participate in a public offering with unfair or unreasonable underwriting terms
• Underwriting compensation includes both cash and noncash items received in connection with the offering; the review is not limited to cash fees
• The current rule does not set a universal percentage ceiling. There is no fixed "9 percent IPO / 8 percent other-offering" threshold; FINRA reviews the total compensation package against the unfair-or-unreasonable standard on the specific facts of each deal
• 180-day lock-up on securities deemed underwriting compensation, starting on the date of commencement of sales (not the date of effectiveness)
• Filing deadline: documents filed with the SEC must be filed with FINRA within 3 business days after the SEC filing

The "unfair or unreasonable" standard is a totality-of-the-circumstances test, not a bright-line percentage rule. Study materials sometimes cite legacy percentage benchmarks from an earlier version of the rule; treat those as historical color, not the current tested standard.

Exam Tip: Gotchas

• There is no current fixed compensation percentage ceiling. The rule uses an "unfair or unreasonable" standard evaluated on the whole fact pattern; do not treat any specific percentage as a hard rule.
• The 180-day lock-up clock starts at commencement of SALES, not at effectiveness. A registration that goes effective on day 1 and prices on day 3 starts the lock-up clock on day 3.
• The lock-up is not absolute; the rule lists exceptions. Specified securities fall outside the lock-up, such as a holder's de minimis (1 percent or less) position, securities of an issuer eligible to register on a short-form or shelf statement, and securities that are already part of an actively-traded class. A blanket "everything is locked up for 180 days" answer overstates the rule.
• The 3-business-day FINRA filing deadline runs from the SEC filing, not from effectiveness. Missing it can hold up the deal.

When Does the FINRA Conflicts Rule Require a Qualified Independent Underwriter (QIU)?

The FINRA conflicts rule applies when a member firm participates in a public offering with a conflict of interest.

A conflict exists when, among other situations:

• The member is offering its own securities
• The member is an affiliate of the issuer
• The member will receive 5 percent or more of the net offering proceeds (excluding underwriting compensation)
• The issuer is a controlled or controlling person of the member

A conflict does not automatically require a QIU. A member with a conflict may still participate, with prominent disclosure of the conflict in the offering documents, if any ONE of these conditions is also met:

• A nonconflicted, qualified member primarily manages the offering, and is not itself an affiliate of any conflicted member, or
• The securities being offered have a bona fide public market, or
• The securities are investment grade rated (or are the same series as, and carry equal rights and obligations to, already investment-grade-rated securities)

A qualified independent underwriter (QIU) is the alternative compliance route only when none of those three conditions applies. The QIU acts as an independent check on pricing and disclosure.

QIU requirements: The QIU must:

• Not have a conflict and not be an affiliate of a conflicted member
• Not beneficially own more than 5 percent of any class of securities of the issuer giving rise to the conflict
• Agree to undertake the same legal responsibilities and liabilities of an underwriter under the Securities Act, specifically including registration-statement liability for material misstatements (covered in the civil-liabilities section)
• Have served as an underwriter in at least 3 public offerings of similar size and type in the past 3 years. This is deemed satisfied by acting as sole underwriter, book-running lead, or co-manager on 3 similar-sized debt offerings, or 3 similar-sized equity offerings, in the period
• Have no supervisory principals with disciplinary histories

QIU duties: participate in preparing the registration statement and offering documents, and exercise the usual standards of due diligence in doing so. "Prominent disclosure" of the conflict of interest, the QIU's name, and a brief statement of the QIU's role is required in the offering documents.

Exam Tip: Gotchas

• A conflict does not automatically require a QIU. First check whether the offering qualifies for the disclosure-only route: a nonconflicted qualified manager, a bona fide public market, or investment-grade status. A QIU is needed only when none of those three applies.
• The 5 percent of proceeds test triggers the CONFLICT. The 5 percent ownership cap is what limits who is eligible for the QIU role. Two separate 5 percent tests, two different purposes.
• A QIU must have served as an underwriter in 3 similar public offerings in the past 3 years, which can be satisfied as sole underwriter, book-running lead, or co-manager. The experience requirement is the hard gating threshold; firms without that track record cannot fill the QIU role.
• The QIU accepts the full legal responsibilities and liabilities of an underwriter, including registration-statement liability for material misstatements. The QIU is not a back-row participant; it is an underwriter for liability purposes.

When Must a Broker-Dealer Disclose a Control Relationship With the Issuer?

Two parallel disclosure regimes (one FINRA, one SEC) require broker-dealers to disclose relationships with the issuer to the customer.

• A member that is controlled by, controlling, or under common control with the issuer must disclose that relationship to the customer before entering into a transaction
• The initial disclosure may be made orally or in writing; only when the initial disclosure is made orally must it be supplemented by written disclosure at or before transaction completion
• The SEC's parallel control-disclosure requirement under the Exchange Act covers the same ground

The rules are designed to surface conflicts that customers might not otherwise see. A broker-dealer whose parent company also controls the issuer has an obvious incentive to push the issuer's securities to customers; the disclosure makes that conflict visible at the point of trade.

Exam Tip: Gotchas

• Control-relationship disclosure does not always require both oral and written disclosure. An initial disclosure made in writing satisfies the rule on its own. Only an oral initial disclosure triggers the written-supplement requirement, due at or before completion of the transaction.
• The FINRA and SEC rules are parallel, not redundant. A control relationship triggers both; compliance with one does not satisfy the other automatically, though firms typically handle them together.

When Must a Broker-Dealer Disclose Its Distribution Participation?

A separate FINRA / SEC disclosure regime covers broker-dealer participation in primary or secondary distributions.

• A member acting as broker (or as dealer receiving a customer advisory fee) participating in a primary or secondary distribution must give the customer written notice of that participation at or before transaction completion
• The SEC's parallel distribution-disclosure requirement under the Exchange Act covers the same ground

The distribution disclosure tells the customer that the broker-dealer is not a neutral counterparty for this transaction; the broker-dealer is helping to place the issuer's securities and has an incentive to do so.

Exam Tip: Gotchas

• Distribution-participation disclosure must be in WRITING. Oral disclosure alone is not sufficient.
• The disclosure is required at or before transaction completion. Disclosing the participation after the trade has settled does not satisfy the rule.

Think of it this way: the FINRA framework treats every public offering as a fairness exam with three core questions. Are the underwriting terms fair? (Corporate-financing rule.) Is there an undisclosed conflict between the underwriter and the issuer? (Conflicts rule and QIU.) Is the customer being told about the broker-dealer's relationship with the issuer and with the deal? (Control-disclosure and distribution-disclosure rules.) Each question has a specific rule attached to it, and the deal team has to satisfy all three before the offering can close.

What Should You Check on Exam Day?

• Do not treat any specific percentage as a compensation ceiling; the operative standard is "unfair or unreasonable," evaluated on the whole fact pattern, and it reaches noncash as well as cash compensation.
• Before requiring a QIU, check whether the offering already qualifies for the disclosure-only route: a nonconflicted qualified manager, a bona fide public market, or investment-grade status.
• Keep the two 5 percent tests separate: 5 percent of proceeds triggers the conflict, 5 percent ownership caps QIU eligibility.
• Confirm the QIU's 3-offerings-in-3-years experience requirement and its underwriter-level civil liability.
• Match the disclosure type to its required form: control relationships need written disclosure either up front or, if the initial disclosure was oral, as a supplement at or before completion; distribution participation always needs written disclosure.