[ by Howard Haykin ] FINRA proposes to amend FINRA Rule 5110 (Corporate Financing Rule), so as to address: (i) current deferred compensation arrangements for financial advisory services in connection with public offerings, (ii) eliminate an anomalous filing requirement for exchange traded funds (ETFs) structured as statutory or grantor trusts, and (iii) make certain ministerial amendments to, among other things, reflect electronic filing requirements.  Comment Period ends 7/23/12. Background and Discussion - Deferred Compensation Arrangements. The Corporate Financing Rule requires member firms to file with FINRA’s Corporate Financing Department ("CorpFin") 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 have provisions that allow issuers to defer payment until after the completion of a capital-raising transaction (deferred compensation arrangement). Some issuers are concerned that up-front payments for financial advisory services could adversely affect its business.  Conversely, underwriters ("U/Wers") and other advisers may be concerned that an issuer might unreasonably renege on paying the deferred compensation after the financial advisory services have been provided. To address this issue, engagement letters often provide for termination fees - sometimes called "tail fees" or "rights of first refusal."  Termination fee permits an U/Wer to receive fees if its services are terminate, and the issuer consummates a similar transaction with another U/Wer in lieu of the transaction subject to the engagement letter.  A right of first refusal (ROFR) grants an underwriter the right to act in an agreed upon capacity in a subsequent financing transaction.  Both arrangements provide issuers and U/Wers with greater flexibility to negotiate deferred compensation arrangements. Current Version of Corporate Financing Rule. At present, the rule only permits termination fees in exchange offers or similar transactions in which substantial structuring and advisory services beyond traditional underwriting and distribution services have been provided.  The rule permits ROFRs, but the staff has interpreted the rule to prohibit ROFRs when a member’s participation in the original transaction is terminated. The restrictions on the establishment of termination fees and ROFRs in the Corporate Financing Rule may unnecessarily interfere with the ability of issuers and U/Wers to negotiate deferred or other appropriate compensation arrangements that may be better suited to the issuer’s business interests.  For this reason, FINRA proposes to amend the Corporate Financing Rule to permit termination fees and ROFRs in a wider set of circumstances. FINRA Rule 5110(f)(2)(D), As Proposed. The rule would be amended to allow termination fees and ROFRs when the written agreement between the issuer and U/Wer specifies that:

• amount of the termination fee must be reasonable in relation to the services contemplated in the agreement and fees arising from services provided under an ROFR must be customary for those type of services;
• issuer has a right of “termination for cause,” which includes the member’s material failure to provide the services contemplated in the agreement; and,
• issuer’s termination for cause eliminates any obligations with respect to any termination fee or ROFR.

Proposed Cut-Off Periods: As amended, the rule would retain requirements related to certain time periods.  Thus, an offering or other transaction described in the agreement would have to be consummated within 2 years of the date the engagement is terminated, and would have to continue to prohibit any ROFR with a duration of more than 3 years from the date of effectiveness or commencement of sales of a public offering. These time limitations will help ensure that the issuer is not subject to a termination fee or ROFR even after its business and operations may have significantly changed. Filing Requirements for Certain ETFs. Most ETFs are structured as open-end investment companies or UITs that offer redeemable securities.  Investment companies and UITs are exempt from regulation under the Corporate Financing Rule and are not required to be filed with FINRA’s CorpFIN. However, some ETFs are structured as Delaware statutory trusts or grantor trusts.  The portfolio assets in these trusts typically are commodities, currencies or other assets that are not securities.  Currently, there's no exemption for public offerings of ETFs structured in this manner and therefore these offerings are required to be filed under the rule. The provisions in the Corporate Financing Rule re: underwriting terms and arrangements are not designed for the ETF distribution methodology by which a “basket” of the underlying assets is deposited into the ETF’s portfolio and “creation units” of shares are provided to the broker-dealer in return.  ETFs should be treated consistently, without regard to the chosen legal structure, which is dictated primarily by the nature of the assets in the portfolios rather than differences in distribution methods or underwriting terms and arrangements. Accordingly, the proposed amendments would exempt from the rule’s filing requirement offerings of securities issued by ETFs formed as grantor or statutory trusts in which the portfolio assets include commodities, currencies or other assets that are not securities. Administrative Changes. FINRA would make certain ministerial amendments to certain provisions to, among other things, reflect the acceptance of electronic filings. FINRA Staff Contacts. Direct questions to: Joseph Price, SVP, CorpFin / Advertising Regs. - (240) 386-4623; Paul Mathews, Director, CorpFin Dept - (240) 386-4639; or, Lisa Jones Toms, Assoc. Director & Senior Counsel, CorpFin Dept - (240) 386-4661. For further details, go to: [FINRA RegNote 12-27, June 2012].