FINRA Increases Corporate Financing Rule Filing Fees and Proposes Amendments Regarding Deferred Compensation Arrangements
FINRA recently increased its filing fees with respect to offering documents filed pursuant to FINRA Rule 5110 (the Corporate Financing Rule) and proposed amendments to the Corporate Financing Rule concerning deferred compensation arrangements in public offerings.
Revised Corporate Financing Rule Fees
Under the Corporate Financing Rule, FINRA reviews underwriting or other arrangements for fairness and reasonableness in connection with certain public offerings, including initial and secondary offerings of unseasoned issuers, best efforts offerings of direct participation programs and real estate investment trusts.
Effective July 2, 2012, FINRA increased the filing fees for filing offering documents pursuant to the Corporate Financing Rule from .01 percent to 0.015 percent of the proposed maximum aggregate offering price, plus $500, and increased the maximum filing fee cap from $75,500 to $225,500. The fee changes will apply to initial filings and to the net increase in the maximum aggregate offering price of any amendment filings. In the case of a well-known seasoned issuer, the filing fee on an automatically effective shelf offering on Form S-3 has been increased from $75,500 to $225,500, regardless of the size of the offering.
Deferred Compensation Proposal
The Corporate Financing Rule requires member firms to file with FINRA’s Corporate Financing Department documents and information about the underwriting terms and arrangements in public offerings in which they will participate. Before a public offering is filed, investment banks may enter into engagement letters with issuers for underwriting and financial advisory services, and these engagement letters often include provisions that allow issuers to defer payment until after the completion of a capital-raising transaction.
A deferred compensation arrangement responds to issuer concerns that an up-front payment for financial advisory services could adversely affect the issuer’s business. To address the risk that an issuer that has received financial advisory services might unreasonably cancel an engagement to avoid the deferred compensation payment, underwriters often negotiate for termination fees (e.g. tail fees) or rights of first refusal in their engagement letter with the issuer. A termination fee permits an underwriter to receive fees if its services are terminated and the issuer completes a similar transaction with another underwriter in lieu of the transaction subject to the engagement letter. A right of first refusal grants an underwriter the right to act in an agreed upon capacity in a subsequent financing transaction. Both arrangements provide issuers and underwriters with greater flexibility to negotiate deferred compensation arrangements.
Termination fees are currently permitted under the Corporate Financing Rule, but only in the limited context of exchange offers or similar highly-structured transactions in which substantial advisory services have been provided. Rights of first refusal are also currently permitted; however, a current interpretation of the Corporate Financing Rule prohibits rights of first refusal when a member’s participation in the original transaction is terminated.
FINRA believes that the restrictions on termination fees and rights of first refusals in the Corporate Financing Rule may unnecessarily interfere with the ability of issuers and underwriters to negotiate compensation arrangements that may be better suited to the issuer’s business interests. For this reason, FINRA’s proposed amendments would permit termination fees and rights of first refusal in a broader set of circumstances.
Under the proposed amendments to the Corporate Financing Rule, termination fees and rights of first refusal would be permitted when the written agreement between the issuer and underwriter provides:
the amount of the termination fee must be reasonable in relation to the services contemplated in the agreement and fees arising from services provided under a right of first refusal must be customary for those types of services;
the issuer has a right of “termination for cause,” which includes the member’s material failure to provide the services contemplated in the agreement; and
an issuer’s “termination for cause” eliminates any obligations with respect to any termination fee or right of first refusal.
In order to ensure that the issuer is not subject to a termination fee or right of first refusal after an issuer’s business and operations have significantly changed, the proposed amendments retain the time limitations in the existing Corporate Financing Rule with respect to the payment of termination fees and the execution of rights of first refusal. Under these time frames, an offering or other transaction must be consummated within two years from the date an engagement is terminated for a termination fee to be paid. In addition, rights of first refusal with a duration of more than three years from the commencement of sales of a public offering or termination of the engagement of the underwriter would continue to be prohibited under the Corporate Financing Rule.
Timing for Comments
The comment period for the proposed amendments to the Corporate Financing Rule expires on July 23, 2012. Before becoming effective, the proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be filed with the SEC.
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