When a company goes public, rules govern who can buy shares at the offering price. These restrictions exist to prevent industry insiders from scooping up shares in "hot" IPOs before the general public gets a chance.
What You'll Learn
- Who qualifies as a "restricted person" under FINRA's new issue rules
- Which exceptions allow certain accounts to purchase IPO shares
- The compliance requirements underwriting firms must follow when selling new issues
New Issue Restrictions
- FINRA restricts certain persons from purchasing shares in an Initial Public Offering (IPO) at the offering price
- The concern: "hot" IPOs (those expected to trade above the offering price) could be allocated to industry insiders rather than the general investing public
- The rule ensures bona fide public offerings where shares are distributed fairly
Think of it this way: Imagine a concert where ticket scalpers (insiders) buy all the tickets at face value and resell them at a markup. The public never gets a fair shot. IPO restrictions work the same way: they keep insiders from grabbing underpriced shares before ordinary investors can participate.
Restricted Persons
| Restricted Person | Why They Are Restricted |
|---|---|
| FINRA member firms and their associated persons | Industry insiders should not benefit at the public's expense |
| Immediate family members of associated persons | Spouse, children, parents, siblings, in-laws; prevents circumvention through family |
| Finders and fiduciaries acting on behalf of the managing underwriter | People involved in the deal should not benefit from it |
| Portfolio managers who buy for their own accounts | They have access to allocation decisions and could favor themselves |
Exam Tip: Gotchas
- "Immediate family" is broader than most students expect: it includes in-laws. Parents-in-law (mother-in-law, father-in-law) sit in the same category as parents, siblings, and spouses. But being in the definition does not make someone automatically restricted; the same circumstances test applies to all of them.
- Immediate family members are restricted based on circumstances, not automatically. A family member is a restricted person if they share a household with the associated person, receive material financial support from them (more than 25% of income), or are employed by the firm. Any one condition is enough; all three do not need to apply. The type of relative does not determine restriction; the relationship circumstances do. A broker's mother-in-law who lives in the same household is restricted. An adult sibling living on their own with no financial ties to the representative is not. The same logic applies in both directions.
- The restriction only applies to the offering price. Restricted persons CAN buy the stock in the aftermarket (secondary market) once it starts trading publicly.
Exceptions to the Restriction
Not everyone is restricted. The following CAN purchase IPO shares:
- Investment companies (mutual funds): they buy for fund shareholders, not for insiders
- Certain employee benefit plans: purchases serve plan participants broadly
- Accounts with de minimis restricted interest: no restricted person has a beneficial interest exceeding 10% in the account
Exam Tip: Gotchas
- The 10% de minimis exception is a common test point. An account can have some restricted person interest, just not more than 10%. An account where a restricted person owns 8% can still receive IPO shares.
Compliance Requirements
- Underwriting firms must obtain a written representation from the purchaser confirming they are not a restricted person before selling IPO shares
- This representation must be obtained within the 12 months prior to the sale
- Records must be maintained for at least 3 years after the last sale of a new issue to the account
Exam Tip: Gotchas
- Written representation is required BEFORE the sale, not after. The firm cannot sell IPO shares first and then ask for confirmation.
- The 12-month window matters. A representation from 13 months ago is no longer valid; the firm must obtain a new one.