FINRA Proposes Rule to Grant Exemptions from FINRA Rule 5131 without SEC Approval (with Lofchie Comment)

FINRA filed with the SEC a proposed rule change to amend FINRA Rule 5131 ("New Issue Allocations and Distributions") in order to provide FINRA with general exemptive authority under the rule.

FINRA Rule 5131 addresses potential abuses in the allocation and distribution of "new issues." The rule essentially prohibits investment banks from either (i) selling access to public offerings in return for extra compensation by purchasers or (ii) allocating IPO shares to corporate insiders in exchange for underwriting business. FINRA filed the proposed rule change to be effective immediately.

Lofchie Comment: More interesting than the specific subject matter of this exemptive authority (e.g., IPO allocations) is the notion that FINRA should be able to grant exemptions from its own rules. Although it is described in legal terms as a "self-regulatory organization," FINRA is in many respects a creature spawned by the SEC. Under Section 19 of the Exchange Act, FINRA generally cannot adopt any rule without SEC approval and further, the SEC may force FINRA to adopt such rules as the SEC deems appropriate. A corollary to FINRA's lack of rulemaking authority over its own rules is that FINRA generally also lacks the discretion to grant any exemption from its own rules.FINRA is subject not only to SEC rulemaking power, but also to the enforcement authority of the SEC. At times, the SEC has been quite critical of FINRA for failing to enforce rules.All of this can make FINRA a difficult regulatory agency to seek either permission or forgiveness from, in that it not only lacks the legal authority to grant forgiveness (which is a form of exemptive authority) but also is actually under the threat of enforcement action if it makes such a grant. This is unfortunate because forgiveness is appropriate in many circumstances; e.g., when a rule is violated unintentionally, when the violator went to the regulator, when no harm was done or when any harm done was repaired. Permission is obviously appropriate when a strict reading of a rule conflicts with the policy of the rule or when the cost of enforcing the rule would be clearly disproportionate to the benefits.The proposed rule change states (at page 8) that FINRA "would use its exemptive authority only in circumstances that are truly unique." It is concerning that the use of exemptive authority is being so described (why does something that is "unique" make it worthy of exemption, as opposed to something that is a common problem?). Given that FINRA is a real regulatory authority, it would be better for all concerned if it had the power to exercise that authority through permission and forgiveness, subject (needless to say) to ex-post-review by the SEC, rather than the SEC's sanctioning FINRA for acting in good faith in granting permission or forgiveness.

See:Text of Proposed Rule Change.