Kevin O’Connor, Picard Kentz & Rowe LLP
May 1, 2015
Picard Kentz & Rowe LLP
1750 K Street, NW
Washington, DC 20006
Re: Request for Exemption from FINRA Rule 5131(b)
Dear Mr. O’Connor:
In your letter dated December 11, 2014, you request an exemption from paragraph (b) (Spinning) of FINRA Rule 5131 (New Issue Allocations and Distributions) on behalf of the National Railroad Retirement Investment Trust ("NRRIT" or "Trust"). In addition, you request that the staff confirm that NRRIT can continue to rely on the exemption granted to it under NASD Rule 2790 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings) (the predecessor to FINRA Rule 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings)).
Pursuant to paragraph (f) (Exemptive Relief) of Rule 5131, the staff may in exceptional and unusual circumstances, taking into consideration all relevant factors, exempt a person unconditionally or on specified terms from any or all of the provisions of Rule 5131 that it deems appropriate consistent with the protection of investors and the public interest. For the reasons set forth below, the staff exempts from Rule 5131(b) purchases, directly or indirectly, of new issues1 by NRRIT and allocations of new issues by members to NRRIT.
Based upon your letter, we understand the facts to be as follows. Railroad retirement benefits are a federal entitlement protected by statute. The Railroad Retirement Act of 1935 and the Railroad Retirement Act of 1937, both of which were superseded by the Railroad Retirement Act of 1974 ("1974 Act"), established the railroad retirement system to provide retirement, unemployment compensation, sickness, disability and survivor benefits for U.S. railroad employees. The U.S. Railroad Retirement Board ("RRB"), a Federal agency, has full responsibility for administering the railroad retirement system, including eligibility determinations and the calculation of beneficiary payments. Railroad retirement system funds that are not needed immediately to pay benefits or administrative expenses are invested to provide additional income for the system. Before 2001, investment of such funds was controlled directly by the RRB and was limited to interest-bearing U.S. government or U.S. government-guaranteed securities.
In 2001, however, the 1974 Act was amended to establish NRRIT.2 NRRIT is authorized to invest railroad retirement funds in non-governmental assets (such as equities and debt securities), as well as government securities. NRRIT's sole purpose is to manage and invest railroad retirement assets. The Trust is exempt from federal income taxation pursuant to Section 501(c)(28) of the Internal Revenue Code ("IRC"). While NRRIT is not a department or agency of the federal government, the cash and investments held by the Trust are nevertheless assets of the federal government. Moreover, NRRIT is required to act solely in the interest of the RRB and, through it, the participants and beneficiaries of the programs funded under the 1974 Act. Currently, NRRIT manages approximately $26 billion in assets on behalf of about 538,000 beneficiaries and 234,000 active employees.
NRRIT has seven trustees all of whom are subject to fiduciary standards similar to those under the Employment Retirement Income Security Act ("ERISA"). The RRB may bring civil action to enjoin any act or practice of the Trust that violates the provisions of the 1974 Act, to obtain other appropriate relief to redress such violations or to enforce any provision of the 1974 Act, including action against the trustees with regard to their fiduciary responsibilities.
NRRIT's financial statements are required to be audited annually by an independent public accountant. The Trust must submit an annual management report to Congress on its operations, including a statement of financial position, a statement of operations, a statement of cash flows, a statement on internal accounting and administrative control systems, the independent auditor's report and any other information necessary to inform Congress about its operations and financial condition. NRRIT also must provide to the President, the RRB and the Office of Management and Budget a copy of the management report.
Railroad retirement plans under the 1974 Act are considered "governmental plans" as defined in Section 3(32) of ERISA, and thus such retirement plans, as well as the assets of such plans funded and invested through NRRIT, are excluded from ERISA coverage. In addition, the benefits that NRRIT funds are established and maintained by the Federal government. NRRIT and the railroad retirement plans under the 1974 Act are not sponsored by a broker-dealer.
From time to time, NRRIT may have an opportunity to invest railroad retirement assets in new issues either directly by purchasing new issues or indirectly by investing in an entity, such as a hedge fund or fund of funds, that may purchase new issues. However, because NRRIT invests assets on behalf of the RRB for the benefit of the hundreds of thousands of participants and beneficiaries of the programs funded under the 1974 Act, it is unable to determine whether persons that have a "beneficial interest" in the Trust are "restricted persons" as defined in Rule 5130 or whether such persons are covered executive officers or directors as set forth in Rule 5131(b), and thus cannot make the representations provided under these rules. You are requesting an exemption from Rule 5131(b) for NRRIT so that it can invest railroad retirement assets in new issues. Further, you request that the staff confirm that NRRIT can continue to rely on the exemption granted to it under NASD Rule 2790 (the predecessor to FINRA Rule 5130).
On November 9, 2006, the staff granted an exemption from NASD Rule 2790 to NRRIT because it determined that the rationale for the exemptions for ERISA benefits plans3 as well as state and municipal government benefits plans4 under NASD Rule 2790 applied equally to NRRIT, which is a vehicle for managing and investing the assets of a governmental plan. On December 15, 2008, FINRA adopted NASD Rule 2790 in substantially the same form as FINRA Rule 5130 in the consolidated FINRA rulebook. You have represented that the only facts that have changed since the staff issued its exemption are the amount of assets under management, the number of railroad retirement beneficiaries and the number of active railroad workers. The staff believes that the exemption granted to NRRIT under NASD Rule 2790 continues to apply under FINRA Rule 5130 because there have been no material changes to the facts and representations that formed the basis for the exemption and no substantive changes between NASD Rule 2790 and FINRA Rule 5130.
Rule 5131 addresses abuses in the allocation and distribution of new issues and also is intended to sustain public confidence in the IPO process, which is critical to the continued success of the capital markets. Paragraph (b) of the rule prohibits the practice of "spinning," which refers to an underwriter's allocation of new issue shares to executive officers and directors of a company as an inducement to award the underwriter with investment banking business, or as consideration for investment banking business previously awarded.
The spinning provision generally provides that no member or person associated with a member may allocate shares of a new issue to any account in which an executive officer or director of a public company5 or a covered non-public company,6 or a person materially supported7 by such executive officer or director, has a beneficial interest8: (1) if the company is currently an investment banking services client of the member or the member has received compensation from the company for investment banking services in the past 12 months; (2) if the person responsible for making the allocation decision knows or has reason to know that the member intends to provide, or expects to be retained by the company for, investment banking services within the next 3 months; or (3) on the express or implied condition that such executive officer or director, on behalf of the company, will retain the member for the performance of future investment banking services. The spinning provision incorporates by reference the exemptions for the accounts described in Rule 5130(c)(1) through (3) and (5) through (10), and it also provides an exemption for any other account in which the beneficial interests of executive officers and directors of the company in the aggregate do not exceed 25% of such account.
Paragraph (a) (Annual Representation) of Rule 5131.02 (Written Representations) provides that, for the purposes of the spinning provision, a member may rely upon a written representation obtained within the prior 12 months from the beneficial owner(s) of an account, or a person authorized to represent the beneficial owner(s), as to whether such beneficial owner(s) is an executive officer or director or person materially supported by an executive officer or director and if so, the company on whose behalf such executive officer or director serves. Therefore, to comply with the spinning provision, firms typically issue questionnaires to their customers to ascertain whether any of the persons covered by the spinning provision have a beneficial interest in the account and if so, the company on whose behalf such persons serve.
Paragraph (c)(7) of Rule 5130 provides an exemption for sales to and purchases by an ERISA benefits plan that is qualified under Section 401(a) of the IRC, provided that such plan is not sponsored solely by a broker-dealer. Paragraph (c)(8) of Rule 5130 provides an exemption for sales to and purchases by state or municipal government benefits plans that are subject to state or municipal regulation. The exemption in paragraph (c)(8) was added because state and municipal government benefits plans are expressly excluded from ERISA coverage,9 and do not raise concerns under Rule 5130. As noted above, Rule 5131(b) incorporates by reference the exemptions set forth in paragraphs (c)(7) and (c)(8) of Rule 5130.
The exemptions in paragraphs (c)(7) and (c)(8) of Rule 5130 do not technically apply to NRRIT, as it is neither an ERISA benefits plan nor a state or municipal government benefits plan.10 However, based on your representations and the facts as you have described them, the staff continues to believe that the rationale for the exemptions for ERISA benefits plans as well as state and municipal government benefits plans applies equally to NRRIT. Further, the staff believes that NRRIT's circumstances are truly unique and finds that granting an exemption to NRRIT is consistent with the purposes of Rule 5131(b), the protection of investors and the public interest. For these reasons, the staff exempts from Rule 5131(b) purchases, directly or indirectly, of new issues by NRRIT and allocations of new issues by members to NRRIT.
This exemption applies only to the issue you have raised based on the facts as you have described them, and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved. Any material changes in the facts or representations as you have described them will require further consideration and may not qualify for exemption. In addition, this exemption is subject to modification or revocation if at any time FINRA determines that such action is necessary or appropriate for the protection of investors.
If you have any questions on this matter, please do not hesitate to contact me at (202) 728-8902.
Very truly yours,
- The term "new issue" has the same meaning as in Rule 5130(i)(9). See Rule 5131(e)(7).
- See 45 U.S.C. 231n(j) (2006) (added by Section 105 of the Railroad Retirement and Survivors' Improvement Act of 2001, P.L. 107-90).
- See Rule 5130(c)(7) (then NASD Rule 2790(c)(7)).
- See Rule 5130(c)(8) (then NASD Rule 2790(c)(8)).
- A "public company" is any company that is registered under Section 12 of the Securities Exchange Act of 1934 or files periodic reports pursuant to Section 15(d) thereof. See Rule 5131(e)(1).
- The term "covered non-public company" means any non-public company satisfying the following criteria: (i) income of at least $1 million in the last fiscal year or in two of the last three fiscal years and shareholders' equity of at least $15 million; (ii) shareholders' equity of at least $30 million and a two-year operating history; or (iii) total assets and total revenue of at least $75 million in the latest fiscal year or in two of the last three fiscal years. See Rule 5131(e)(3).
- "Material support" means directly or indirectly providing more than 25% of a person's income in the prior calendar year. Persons living in the same household are deemed to be providing each other with material support. See Rule 5131(e)(6).
- The term "beneficial interest" has the same meaning as in Rule 5130(i)(1). See Rule 5131(e)(2).
- State and municipal government benefits plans are considered governmental plans as defined in Section 3(32) of ERISA, and thus are excluded from ERISA coverage.
- The exemption in paragraph (c)(7) for an ERISA benefits plan is not available to NRRIT because it funds and invests the assets of governmental plans, which are excluded from ERISA coverage. The exemption in paragraph (c)(8) for a state or municipal government benefits plan also is not available to NRRIT because the benefits that NRRIT funds are not established or maintained by a state or municipal government, but, rather, they are established and maintained by the Federal government.