What Is the Cooling-Off Rule?

The phrase "cooling-off rule" is actually applied to three specific yet unrelated situations in the business world. The first usage of the phrase refers to the Securities and Exchange Commission (SEC) Regulation M, which specifies key points in the process of floating stock shares or issuing bond offerings. It stipulates a restriction on activity and communication during the period just before these issues are offered for sale to the public.

The second more common usage refers to a long-standing requirement regulated by the vendors to provide consumers with a three-day return period. A third usage refers to a period of time when government employees (specifically SEC or FINRA employees) who join the private sector should be prohibited from engaging in lobbying activities with the agency where they were formerly employed.

Key Takeaways

  • This phrase gets used in multiple ways that have unrelated meanings. Context is important for understanding the implication.
  • The period between issuing prospectus and selling new stock or bond offerings is a cooling-off period where communication between underwriter and issuing company must be minimized or silenced altogether.
  • Consumers who make purchases for hundreds of dollars or more are allowed a cooling-off period where they can return their purchase within three days.
  • Government agencies also expect former employees not to lobby their old agency for a cooling-off period after employment.

Understanding the Cooling-Off Rule

When someone refers to the cooling-off rule regarding the issuance of new securities, they may loosely be referring to the SEC's Regulation M, so called because it refers to a "cooling-off period." The restriction is not officially known as the cooling-off rule, it is known as the SEC's Regulation M (not to be confused with a different Regulation M issued by the IRS). The SEC's regulation refers to the time in-between the day the preliminary prospectus is filed with the SEC and the day when the new security is actually available for sale or trade. This is also known as a quiet period because the underwriter and the issuing company are not allowed to discuss the issue with investors during this time.

Three-Day Return Policy

In consumer-facing businesses, the cooling-off rule can more commonly refers to a consumer protection law regulated by the Federal Trade Commission (FTC), that allows a buyer to release themselves from a purchase agreement within a set number of days of a purchase. The number of days the buyer has to change their mind without incurring any penalty is different for various products and situations. Insurance contracts allow fourteen days after issuance of a new policy for cancellation without penalty. Many businesses will allow for a longer grace period than three days, but they are not required to do so.

One particular exception to this cooling-off rule comes to bear in the purchase of motor vehicles. If a person buys a car from a dealership and completes the transaction at the physical location of the dealer's business address, then the three-day right of rescission is waived. The sale is final from the moment the contract of sale is signed.

However, if someone were to buy a car from an auto show or in any other location that was not the primary business location of the dealer, then the three-day cooling-off rule actually does apply. Since auto auction houses are actually dealers themselves, the location of the auction is their place of business, which is how such transactions are also considered final once purchased.

Lobbying Restrictions

The third usage for the phrase "cooling-off rule" refers to an expected practice that is much less concrete in nature. Government agencies, particularly those involved in finance, such as the SEC, FINRA, the U.S. Treasury Department, or other similar organizations, may find that many of their employees find their way into finance or investment banking careers.

In this capacity, their new employer might find an employee's former connections to government agencies quite valuable when it comes to getting clarification on rules and regulations. However, firms are expected to refrain from sending former employees into lobbying activities immediately after employing them. A one-year cooling-off period is expected.