Rule 5110 Lock-up

Before Ardmore Securities may participate as an underwriter in a public offering of corporate equity, FINRA's Corporate Financing Rule requires that:

1. A.FINRA approve the merits of the issuer's business plan before the offering may proceed.Wrong. No regulator passes on investment merit. Even the SEC clears a registration statement rather than approving the offering.
2. B.Documents and information about the underwriting terms and arrangements be filed with FINRA, which reviews the underwriting compensation for fairness and reasonableness.Correct. The rule is a compensation review, and the member may not participate until FINRA raises no objections.
3. C.The offering be registered with FINRA in place of, rather than in addition to, registration with the SEC.Wrong. FINRA does not register offerings. Securities Act registration with the SEC is unaffected by the FINRA filing.
4. D.The underwriting spread not exceed 5 percent of the public offering price in any corporate equity offering.Wrong. There is no such fixed cap. The 5 percent figure belongs to FINRA's markup policy for secondary market transactions.

Why: The Corporate Financing Rule requires member firms to file documents and information about a proposed public offering with FINRA before participating. FINRA's review focuses on the UNDERWRITING TERMS AND ARRANGEMENTS - principally whether the total underwriting compensation, in cash and in securities, is fair and reasonable given the size, type and risk of the offering. A member may not participate until it receives a no-objections opinion. What FINRA does NOT do is pass judgment on the issuer's business or the merits of the investment; that is nobody's job, since even the SEC clears rather than approves.

As part of its compensation for underwriting the Brightwater Robotics initial public offering, Ardmore Securities receives warrants to purchase Brightwater common stock. Under FINRA Rule 5110, how are those warrants treated?

1. A.They are not underwriting compensation, because Ardmore paid no cash and received no fee.Wrong. Rule 5110 counts value received in any form, including securities of the issuer.
2. B.They are compensation and must be disclosed, but they become freely transferable as soon as the registration statement is effective.Wrong. The disclosure point is right; the securities remain locked up for 180 days from the commencement of sales.
3. C.They are underwriting compensation subject to disclosure and valuation, and to a 180-day lock-up during which they may not be sold, transferred, pledged or hedged, apart from limited exceptions.Correct. Both the compensation treatment and the 180-day lock-up apply.
4. D.They are prohibited outright, because a member may not receive securities of an issuer it is underwriting.Wrong. Securities compensation is permitted; it is regulated as to amount, disclosure and transferability, not banned.

Why: Securities received by a participating member in connection with a public offering are underwriting compensation. They must be disclosed and assigned a value that counts toward the total compensation FINRA reviews for fairness under the Corporate Financing Rule. Rule 5110 also imposes a 180-day lock-up running from the commencement of sales: during that period the securities may not be sold, transferred, assigned, pledged, or hedged, subject to narrow exceptions such as transfers to the member's own officers and partners who agree to the same restriction. The lock-up exists so underwriters cannot immediately monetize aftermarket support they helped create.