Contingency Offering Mechanics

Now that you understand which commitment types are contingency offerings (all-or-none, mini-max, part-or-none), the next layer is the investor-protection regime that attaches the moment the contingency representation is made. Two SEC rules govern the structure, and they apply automatically; underwriters and issuers cannot opt out.

The Two Rules Side-by-Side

Think of it this way: The prohibited-representations rule polices what the underwriter SAID; the escrow rule polices what the underwriter DOES with the money. The first makes the label binding; the second makes sure the cash is recoverable if the label is not honored.

Exam Tip: Gotchas

• Both rules attach automatically once the contingency representation is made. Issuers and underwriters cannot opt out of either rule by drafting the offering documents differently. The rules are triggered by the AON, part-or-none, or mini-max label itself.
• A plain best-efforts offering with NO contingency representation does NOT need escrow. The escrow obligation flows from the contingency, not from the agent (best-efforts) structure on its own.

The Prohibited Representations Rule

The prohibited-representations rule makes it a manipulative and deceptive practice to label an offering as all-or-none, part-or-none, or minimum-maximum unless two conditions are satisfied:

• Prompt refund is made to purchasers if the represented amount of securities is not sold at the specified price within the specified time, AND
• The total amount due to the issuer is received by the issuer by a specified date

In effect, the rule enforces the contingency promise. An underwriter cannot represent an offering as AON and then quietly keep going, or keep the investor money, if the contingency fails.

Think of it this way: The rule treats the AON or mini-max label as an enforceable promise to the investor. Use the label and you must honor the refund mechanic; refuse to honor it and you have made a deceptive representation. There is no "we tried our best" defense to a failed contingency offering once the label has been used.

Exam Tip: Gotchas

• The rule covers AON, PART-OR-NONE, and MINI-MAX representations, not just AON. Part-or-none (sometimes used interchangeably with mini-max) and any other minimum-success structure carry the same prohibited-representations regime.
• The refund obligation is unconditional once the contingency fails. "We almost cleared the minimum" is not a defense. Either the represented amount sells by the deadline at the specified price, or investor funds are returned in full.

The Escrow Rule

The escrow rule applies to best-efforts contingency offerings (AON, part-or-none, mini-max) and dictates how a broker-dealer must handle the investor funds it receives during the contingency period. Two paths are permitted; both protect investor capital from sitting in the broker-dealer's general operating account.

A broker-dealer receiving investor funds during a contingency offering must promptly either:

• Deposit the funds in a separate bank account with the broker-dealer designated as agent or trustee for the investors, OR
• Transmit the funds to a bank escrow agent under a written escrow agreement

The escrow path carries additional structural protections:

• The escrow bank must be unaffiliated with BOTH the broker-dealer AND the issuer
• The escrow agreement should be in place before the broker-dealer receives any investor funds
• The escrow account cannot be controlled by the issuer, the broker-dealer, or an attorney
• Funds can be released to the issuer only after the contingency is satisfied; if it is not, funds must be promptly refunded to investors

The SEC staff has interpreted "promptly" to mean by noon of the next business day after the broker-dealer receives the funds.

Think of it this way: The rule is a structural firewall. Investor money cannot pass through the broker-dealer's general bank account on its way to the issuer, because if the contingency fails the broker-dealer must be able to refund every dollar without first having to wrestle it back from operating creditors or commingled funds. Either segregate it in a clearly-marked agent/trustee account or hand it to an outside bank. There is no third path.

Exam Tip: Gotchas

• The escrow bank must be UNAFFILIATED with both the broker-dealer AND the issuer. A captive bank-affiliate of the broker-dealer cannot hold the escrow. Same for an issuer-affiliated trustee.
• "Promptly" means by NOON of the next business day, not "within a reasonable time." Investor funds cannot sit in the broker-dealer's accounts even briefly.
• Funds may NEVER flow into the broker-dealer's general operating account, even temporarily. The rule treats commingling as a per-se violation, not as a curable technical defect.

Why the Two Rules Work in Tandem

Each rule plugs a different gap. The prohibited-representations rule makes the AON or mini-max label a real promise; the escrow rule makes sure the promise can actually be honored.

Think of it this way: Without the prohibited-representations rule, an underwriter could use the AON label as marketing material and then ignore the refund obligation when the deal fell short. Without the escrow rule, the underwriter could honor the refund obligation only if it happened to still have the money on hand. Together the two rules close both ends of the loop.

Exam Tip: Gotchas

• The two rules attach to the same trigger but enforce different things. The prohibited-representations rule governs the representation (the AON or mini-max label and the refund promise); the escrow rule governs how the broker-dealer must hold the money while the contingency is open. The exam tests both, and an answer that pairs the wrong rule with the wrong substance is a common trap.
• The contingency, not the agent structure, is the trigger. A plain best-efforts offering with no minimum, no maximum, and no AON representation does not need an escrow. The rules attach when the underwriter uses a contingency label.