FINRA Rule 5131 Will Affect Lock-Up Agreements for IPO Shares Held

Peter W. LaVigne, Christopher J. Austin and Richard A. Kline of Goodwin Procter LLP


Original Title: New FINRA Rule 5131 Will Affect Lock-Up Agreements for IPO Shares Held by Officers and Directors of the Issuer

FINRA Rule 5131 (the "Rule"), portions of which became effective on May 27, 2011, provides new prohibitions and requirements for underwriters when they are pricing and allocating IPO shares. While the Rule, known as the IPO Allocations Rule, technically applies only to FINRA member firms, as a practical matter, it will also affect IPO issuers, venture capital investors with board seats holding shares subject to lock-up agreements and buyers of IPO shares. [1]


The Rule had its origins in the IPO market of the late 1990s and 2000. During that period, IPO shares would often begin trading in the market immediately at prices significantly above the IPO price. As a result, allocations of IPO shares were in high demand. In the course of its investigations into certain IPO offerings during the so-called IPO bubble, the SEC learned that some underwriters had a practice of allocating IPO shares to executive officers and directors of companies for whom they were providing investment banking services or hoped to provide investment banking services. This practice came to be known as "spinning." At the same time, there were complaints by some IPO issuers that their shares had been priced too low in the public offering.

In 2003, many of the major investment banks entered into what has become known as the Voluntary Initiative, which specifically curtailed the practice of spinning. By its terms, the Voluntary Initiative was due to expire when FINRA (at that time, the NASD) adopted a rule regulating the practice, but no later than 2008. Although there was not a FINRA rule during the period from 2008 to May 2011, the signatories to the Voluntary Initiative, along with other investment banks, generally continued to abide by its terms. The rulemaking process that the NASD began in 2003 has culminated in the Rule.

Spinning and Pricing Provisions

Some provisions of the Rule have gotten a lot of attention, notably the so-called spinning prohibition, which prohibits the allocation of IPO shares by an underwriter to an account in which an executive officer or director of a public company or covered non-public company, or a person materially supported by such an officer or director, has a beneficial interest if the underwriter is currently providing or expects to provide investment banking services to the public or covered non-public company. Because of concerns about the ability of firms to implement programs for compliance with the spinning prohibition, FINRA has extended the effective date of that provision to September 26, 2011. [2]

The provisions on IPO pricing are effective as of May 27. They are designed to create greater transparency for issuers around the indications of interest process. The Rule will require the book-running lead manager to provide the issuer's pricing committee (or if none, its board of directors) with regular reports of indications of interest before the offering, and of final allocations after settlement, including the names of institutional investors and the number of shares indicated or purchased by each, and aggregate numbers for retail investors. Since most private funds (generally those with at least $50 million in assets) will be treated as institutional investors, the names of private funds indicating an interest in receiving allocations will be made known to the issuer.

New Requirements for Lock-Up Agreements

The provisions relating to lock-up agreements covering shares held by the issuer's officers and directors, which have not been as widely discussed as the spinning prohibition, are in effect for lock-up agreements executed on or after May 27, 2011. The rule affects new lock-up agreements in two ways. First, if a lock-up agreement applies to shares held by an officer or director of the issuer, it must apply to the officer or director's issuer-directed shares acquired in the IPO as well as to shares acquired before the IPO. Second, the agreement must provide that, at least two business days before the release or waiver of any lock-up restriction on the transfer of the issuer's shares, the book-running lead manager will:

  • Notify the issuer of the impending release or waiver; and

  • Announce the impending release or waiver through a major news service

The Rule does not by its terms limit the notification and announcement requirement to cases of discretionary release or waiver by underwriters. It is not clear, however, that notice to the issuer would be necessary in the case where release occurs as a result of satisfaction of pre-agreed automatic early release provisions in the lock-up agreement, such as releases that happen automatically if certain price conditions are met (certain recent IPO lock-ups contained such release language, though it is not common in the marketplace at this time). FINRA has not yet issued guidance on this point.

Notification and announcement are not required where the release or waiver is effected solely to permit a transfer of securities that is not for consideration and where the transferee has agreed in writing to be bound by the same lock-up agreement. The public announcement requirement may be satisfied by an announcement made by the book-running lead manager, another member of the syndicate or the issuer.

The requirements for lock-up agreements apply only to agreements to which the members of the underwriting syndicate are parties (i.e., underwriter lock-ups). They also apply only to shares of officers and directors of the issuer. [3] Venture capital investors who hold seats on the boards of issuers and enter into underwriter lock-up agreements will have their agreements subject to both of the provisions mandated by the rule. Of particular significance is the fact that any release or waiver of the lock-up restrictions before the expiration of the lock-up period will be the subject of a public announcement. Venture capital investors who are board members and who do not want release of their lock-up agreements to be publicly announced may wish to consider resigning from the board before signing the lock-up agreement.

Peter W. LaVigne, Partner,

Peter LaVigne is a partner in Goodwin Procter's Business Law Department and a member of its Financial Services Group. He has extensive experience with broker-dealer and securities regulation, as well as FINRA regulatory filings. LaVigne advises clients on the registration of new broker-dealers, mergers and acquisitions involving broker-dealers and ongoing supervision and compliance responsibilities of broker-dealers and also represents clients with respect to the rules of FINRA (formerly known as the NASD) concerning corporate financing and underwriter conflicts of interest. His experience includes broker-dealer change in control filings, the rules governing fixed price offerings, IPO allocations and research analysts, trade reporting and Rule NMS.

Full Bio

Christopher J. Austin, Partner,

Christopher J. Austin is a partner in Goodwin Procter's Technology Companies Practice. He focuses on general corporate and securities law and has extensive experience in mergers and acquisitions, public offerings, private placements of debt and equity securities and securities law compliance. Austin represents both private and public companies in the technology and life sciences sectors. A significant portion of his practice is capital markets work for investment banks, having represented market leaders such as Citi, Credit-Suisse, Goldman Sachs, Merrill Lynch and Morgan Stanley in connection with public offerings and follow-on offerings of technology companies.

Full Bio

Richard A. Kline, Partner,

Richard A. Kline is a partner in Goodwin Procter's Technology Companies and Securities & Corporate Finance Practices, specializing in all areas of corporate and securities laws with a primary focus on capital markets transactions. He represents a full range of corporate clients on a wide variety of matters, including company formations, venture financings, M&A transactions, capital markets transactions, corporate governance and advising board of directors. Kline has also represented a number of banks in securities transactions.

Full Bio

Goodwin Procter LLP

Goodwin Procter LLP is one of the nation's leading law firms, with offices in Boston, Hong Kong, London, Los Angeles, New York, San Diego, San Francisco, Silicon Valley and Washington, D.C. The firm provides corporate law and litigation services, with a focus on matters involving real estate, REITs and real estate capital markets; private equity; technology companies; financial services; intellectual property; products liability and mass torts; and securities litigation and white collar defense. For additional information, visit Follow us on Twitter@GoodwinProcter. A version of this article originally appeared in Goodwin Procter's Client Alert.

[1] Rule 5131 will also affect investment funds and others who purchase "new issues" under the rule because FINRA member firms will require representations from each purchaser about the purchaser and, in the case of an investment fund, the purchaser's beneficial interest holders. These representations will be necessary to permit the underwriters to determine that they are not selling to a prohibited account.

[2] Please see Goodwin Procter's April 19, 2011 Financial Services Alert for a summary of the amendments to Rule 5131, including the delay of effectiveness for two provisions.

[3] Unlike the spinning prohibition, the lock-up provision does not limit its application to executive officers.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Goodwin Procter LLP. This work reflects the law at the time of writing June, 2011.