Restricted persons

Under FINRA Rule 5130 FINRA Rule 5130 FINRA Rule 5130 (New Issue Rule) prevents brokerage firms from giving initial public offerings (IPOs) to accounts owned by industry insiders. This rule stops people who work in finance from getting special access to new stock offerings that might be underpriced and profitable. , known as the New Issue Rule, restricted persons are individuals and entities that cannot receive allocations of new issues. New issues are initial public offerings New issues New issues (or IPOs) refers to initial public offerings of equity securities, subject to FINRA Rules 5130 and 5131 that restrict certain persons, including financial industry personnel and hedge fund investors, from participating in these offerings. (IPOs) of equity securities—when companies first sell their stock to the public. This classification creates significant challenges for hedge funds that invest in IPOs. These funds must establish procedures to identify which investors are restricted persons and ensure that IPO profits only go to eligible investors.

Rule 5130 creates safeguards for the initial public offering process. The rule ensures that broker-dealersA person or firm engaged in the business of buying and selling securities for the account of others or for its own account. cannot use their market access to favor industry insiders over regular public investors. Without this rule, broker-dealers might allocate valuable IPO shares to themselves, their employees, or other industry participants who could generate business for them. This would give unfair advantages to industry insiders at the expense of ordinary investors.

Rule 5131 FINRA Rule 5131 FINRA Rule 5131 (Anti-Spinning Rule) prohibits broker-dealers from allocating new issues to executive officers and directors of public companies and certain covered non-public companies as a reward for investment banking business, a practice known as "spinning." works alongside Rule 5130 to address additional conflicts of interest. Specifically, Rule 5131 targets the practice of allocating IPO shares to corporate executives or directors with the expectation of receiving their company's investment banking business in return.

Rule 5130(i)(10) defines "restricted person" to include several categories of people and entities. The main categories are FINRA members and other broker-dealers, personnel who work at these broker-dealers (except those at limited business broker-dealers), finders and people who act in a fiduciary capacity to the managing underwriter (such as attorneys, accountants, and financial consultants), portfolio managersInvestment professionals who make decisions about how to allocate assets in investment portfolios on behalf of clients or institutions., certain owners of broker-dealers, and certain immediate family members of all the foregoing persons.

Rule 5131(b) prohibits a practice called "spinning." Spinning involves allocating new issues to executive officers, directors, or other employees of companies with the intention of encouraging those individuals to direct their company's investment banking business to the broker-dealer. This rule operates as a separate restriction alongside Rule 5130. It addresses different conflict-of-interest concerns, though these concerns complement the restricted person prohibitions in Rule 5130.

Like Rule 5130, Rule 5131(b) includes exemptions for certain entity types and thresholds. However, private funds generally cannot use these exemptions.

These rules create significant operational challenges for hedge funds. Funds that manage new issue investments must develop comprehensive compliance processes. They need to determine each investor's restricted person status, calculate what percentage of fund ownership restricted persons hold, allocate new issue profits only to non-restricted investors, and maintain detailed documentation proving compliance with the rules.

The New Issues Rules apply directly only to FINRA members. However, most investment advisers and their managed funds are neither FINRA members nor affiliated with FINRA members. Despite this, Rules 5130 and 5131(b) still affect these funds indirectly. FINRA members are required to obtain annual written statements from account holders about their restricted person status. Additionally, contractual agreements between account holders (including private funds and their advisers) and their brokers often require the account holder to indemnify the broker for losses that result from New Issues Rules violations. Although it remains theoretically possible, regulatory action against a private fund and its adviser for new issue rule violations—such as for market manipulation—could still occur.

Private funds generally cannot use the exemptions available to other types of entities. When a private fund has beneficial ownersInvestors who have economic ownership in a fund, counted for purposes of the Section 3(c)(1) exemption's 100-investor limit. who qualify as restricted persons, the fund typically must rely on the de minimis exemptionA regulatory exception that allows limited participation in restricted activities when the involvement falls below specified minimal thresholds. provided by FINRA Rule 5130(c)(4). This exemption allows an entity that would otherwise be prohibited from purchasing new issues due to restricted person ownership to still participate in new issue offerings under certain conditions.

The exemption works in one of two ways. First, if restricted persons own no more than 10% of the entity's beneficial ownership, the entity can participate in new issues. Second, if restricted persons own more than 10% of the entity, the entity may still invest in new issues as long as those restricted persons receive no more than 10% of the profits and losses from each new issue.

The New Issues Rules only restrict the initial sale and allocation of securities that meet the definition of "new issue." Once a security stops trading at its initial public offering price and begins trading in the secondary market, the New Issues Rules no longer apply to that security. FINRA has allowed the transfer of new issue shares between accounts through journal entries rather than traditional purchase and sale transactions. However, such transfers must occur at prevailing market prices at the time of transfer, not at the IPO price. FINRA has not specifically addressed whether this journalingThe practice of transferring securities between different accounts through internal book entries at current market prices rather than through actual purchase and sale transactions, commonly used for managing IPO allocations. procedure applies to Rule 5131.

On July 23, 2025, FINRA expanded the exemptions to both Rule 5130 and Rule 5131(b) to include business development companiesA type of closed-end investment company that invests in small and mid-sized businesses, subject to specific regulatory requirements under the Investment Company Act. (BDCs). This expansion applied to non-traded, private, and publicly traded BDCs, as long as such BDCs were not formed or maintained specifically to circumvent the restrictions on restricted person participation in new issues. FINRA recognized that BDCs were already subject to comprehensive regulation under the Investment Company Act Investment Company Act of 1940 The Investment Company Act of 1940 is a U.S. law that regulates companies whose main business involves investing in securities. Hedge funds typically use special exemptions under Sections 3(c)(1) or 3(c)(7) to avoid having to register under this law, which allows them to maintain the flexibility they need for their investment strategies and fee structures. , which justified this exemption.

This change did not affect how the rules apply to private hedge funds. Private hedge funds continue to rely on the de minimis exemptions described above.