In September 2010, the U.S. Securities and Exchange Commission (SEC) approved the new Rule 5131 of the United States Financial Industry Regulatory Authority (FINRA). This Rule 5131 supplements the existing FINRA Rule 5130 (referred to together as the Rules) which prohibits brokers that are FINRA members from selling “new issues” to a private investment fund if the fund has investors who are classified as “restricted” under the Rules, unless the fund has a mechanism in place that excludes such “restricted” persons from receiving allocation of profits from “new issues” or the fund avails itself of a “de minimis” exemption pursuant to which a portion of any “new issue” profits and losses may be allocated to “restricted” persons.
Rule 5131 in effect creates a new category of “restricted” persons, extending the existing Rule 5130 to include executive officers and directors (or persons materially supported by such officers or directors) of a “public company” or a “covered non-public company” which is or has been an investment banking services client of the broker in the previous twelve months or is expected to become an investment banking client in the next three months, or there is an express or implied condition that the broker will be retained for future performance of investment banking services.
“Public company” refers to a publicly traded company registered with the SEC. “Covered non-public company” refers to any other company (whether organized within or outside of the United States) that has (a) income of at least US$1 million in the last fiscal year or in two of the last three fiscal years and shareholders' equity of at least US$15 million; (b) shareholders' equity of at least $30 million and a two-year operating history; or (c) total assets and total revenue of at least US$75 million in the latest fiscal year or in two of the last three fiscal years. Investment banking services do not include prime brokerage or trading services.
The implementation date of this new Rule has recently been extended to 16 September 2011. There is no grandfathering for existing funds or investors as of such date. Accordingly, investors of a private investment fund should be required to execute a statement representing to the fund whether they fall within the prescription of the Rules and to reconfirm their status annually. Private investment funds should ensure full compliance with Rule 5131 before the effective date.
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