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This question is definitely targeting the carve out procedure. Under FINRA’s freeridding and withholding rules broker dealers who engage in the sale of IPOs must make a full and complete offering of all shares. Firms may not withhold the shares for their own account nor for the accounts of employees or those financially dependent on their employees. Series 7 registered persons (and their financial dependents) are known as restricted persons and are prohibited from purchasing shares of IPOS. These rules are in effect for initial public offerings, but they are especially prevalent when dealing with a hot issue. A hot issue is one that trades at an immediate premium to its offering price in the secondary market. A broker dealer may not free ride by withholding securities for its own account or for the accounts of those listed above. FINRA Rule 5130 covers initial offerings of common stock only. Exempt from the rule are offerings of additional issues, bonds, and preferred shares. These offerings may be purchased by registered persons. FINRA Rule 5130 requires that a broker dealer (not the Rep) obtain an eligibility statement from all account owners who purchase a new issue of stock within 12 months prior to the purchase. This eligibility statement attests to the fact that the person is not restricted from purchasing new issues. If a member of the syndicate or selling group receives an order for a new issue from a financial intermediary such as a bank or an investment adviser, the member selling the securities to the customer of the financial intermediary may rely on the financial intermediary’s representation that their client is not restricted from purchasing new issues. Some people may purchase hot issues so long as the amount is not substantial and they have a history of purchasing new issues. These conditionally approved people are:
• Employees of financial institutions not able to direct the securities business of the institution.
• Non-supported family members.
• Accounts where the restricted persons’ interest is limited to 10 percent or
less or where a maximum of 10 percent of the allocation of new issue is for the benefit of such persons. This is known as the carve out procedure Let's look at the carve out procedure more closely. To ensure you know how to handle this on your exam. Let's say a representative has an institutional account for a hedge fund and that the fund has $100 million of investable assets. The account is seeking an allocation of 10,000 shares of a IPO. If $8 million of the fund’s assets were obtained from restricted people, the fund would be allowed to purchase shares of an IPO without any restrictions or requirements. However, if $50 million of the fund’s assets were received from restricted people, the fund would be subject to the carveout procedure to ensure that no more than 10 percent of the allocation would benefit restricted people. In this case 1,000 of the shares could be allocated to restricted people and the remaining 9,000 shares would have to be for the benefit of the non restricted capital contributors