[Federal Register Volume 62, Number 64 (Thursday, April 3, 1997)]
[Notices]
[Pages 15945-15951]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-8470]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38451; File No. SR-NASD-97-12]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc.,
Relating to the Valuation of Illiquid Direct Participation Program and
Real Estate Investment Trust Securities on Customer Account Statements
March 27, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on February
21, 1997, NASD Regulation, Inc. (``NASD Regulation'') filed with the
Securities and Exchange Commission (``SEC'' or ``Commission'') the
proposed rule change as described in Items I, II and III below, which
Items have been prepared by NASD Regulation. The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD Regulation proposes to amend Rule 2340, ``Customer Account
Statements,'' of the Conduct Rules of the National Association of
Securities Dealers, Inc. (``NASD'' or ``Association'') to require
general securities members to provide estimated values for direct
participation program (``DPP'') \1\ securities and real estate
investment trust (``REIT'') securities on customer account statements
under certain circumstances. Below is the text of the proposed rule
change. Proposed new language is italicized and proposed deletions are
bracketed.
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\1\ Paragraph (a)(4) of NASD Rule 2810, ``Direct Participation
Programs,'' defines a DPP as ``a program which provides for flow-
through tax consequences regardless of the structure of the legal
entity or vehicle for distribution including, but not limited to,
oil and gas programs, real estate programs, agricultural programs,
cattle programs, condominium securities, Subchapter S corporate
offerings and all other programs of a similar nature. . . .''
According to NASD Regulation, this definition would cover most
limited partnerships and specifically excludes real estate
investment trusts.
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Rule 2340 Customer Account Statements
(a) General
Each general securities member shall, with a frequency of not less
than once every calendar quarter, send a statement of account
(``statement'') containing a description of any securities positions,
money balances, or account activity to each customer whose account had
a security position, money balance or account activity during the
period since the last such statement was sent to the customer.
(b) DPP/REIT Securities
(1) If a member participated in the public offering of any direct
participation program (DPP) or real estate investment trust (REIT)
securities (as these terms are defined below) and an estimated value of
DPP or REIT securities is available pursuant to subparagraphs (3)(A)
(ii) or (iii), the member shall list the DPP and/or REIT securities on
the statement with an estimated value; except that the member shall not
include on the account statement an estimated value that the member
believes is inaccurate as of the date of the valuation or is no longer
accurate as a result of a material change in the operations or assets
of the program or trust; or
(2) If the member or an affiliate of the member, acting as a
fiduciary, provides estimated values of DPP and/or REIT securities to
accounts that are subject to Employee Retirement Income Securities Act
(``ERISA'') and Internal Revenue Service (``IRS'') regulations, the
member shall disclose the same valuations on the statements of all
other customers owning such securities.
(3) If DPP and/or REIT securities are listed on the statement with
an estimated value:
(A) such estimated value shall be:
[[Page 15946]]
(i) developed from data which is as of a date no more than 18
months prior to the date the statement is issued; and
(ii) provided by an independent source engaged by the member; and/
or
(iii) provided in an annual report of the DPP or REIT distributed
to investors pursuant to Sections 14(a) or 14(c) of the Act, as
applicable, or a periodic report filed by the DPP or REIT with the
Commission under Sections 13 or 15(d) of the Act; or
(iv) developed by the member, if valuations pursuant to
subparagraphs (ii) and (iii) are not available; and
(B) the member shall segregate DPP and/or REIT securities by
listing them on the statement separately from non-DPP and non-REIT
securities and shall include on the statement:
(i) a brief and easily-understood description of the type of
estimated value provided (e.g., that the value represents an estimate
of the investor's interest in the assets owned by the DPP or REIT or
represents an estimate of the value of the investor's DPP and/or REIT
securities) and its source, and how a customer may obtain a complete
and detailed explanation of the valuation methodology employed; and
(ii) disclosure in close proximity to the listing of DPP and/or
REIT securities that DPP and/or REIT securities are generally illiquid
securities and the estimated value disclosed may not be realizable if
the customer seeks to liquidate the security.
(4) In disclosing on the statement an estimated value of DPP and/or
REIT securities, the member shall not;
(A) aggregate the estimated value of DPP and/or REIT securities
with the value of any other securities in any sub-total on the
statement;
(B) aggregate the estimated value of DPP and/or REIT securities
with the value of any other securities in the total account value
unless the statement includes the total estimated value of DPP and/or
REIT securities and the disclosure required by subparagraph (3)(B)(ii)
in close proximity to the total account value; and
(C) include the original issue price of a DPP or REIT security as
the estimated value (unless valuation of the securities by another
method indicates the same dollar amount as the original issue price).
(5) Notwithstanding subparagraphs (b)(1)-(4), if a retirement
account statement prepared in compliance with ERISA and IRS regulations
includes DPP and/or REIT securities and individual values are not
provided for any of the assets in the account, the member shall
disclose on the statement that DPP and/or REIT securities are generally
illiquid securities.
(6) If the DPP and/or REIT securities are listed on the statement
without a price and without an estimated value, the member shall
segregate the DPP and/or REIT securities by listing them on the
statement separately from non-DPP and non-REIT securities and shall
include on the statement disclosures that: DPP and/or REIT securities
are generally illiquid securities; the value of the security may be
different than its purchase price; and, if applicable, accurate
valuation information is not available.
[(b)] (c) Definitions For purposes of this Rule[,];
(1) the term ``account activity'' shall include, but not be limited
to, purchases, sales, interest credits or debits, charges or credits,
dividend payments, transfer activity, securities receipts or
deliveries, and/or journal entries relating to securities or funds in
the possession or control of the member.
(2) [(c) For purposes of this Rule,] the term ``general securities
member'' shall refer to any member which conducts a general securities
business and is required to calculate its net capital pursuant to the
provisions of SEC Rule 15c3-1(a), except for paragraph (a)(2) and
(a)(3).
Notwithstanding the foregoing definition, a member which does not carry
customer accounts and does not hold customer funds and securities is
exempt from the provisions of this section.
(3) the term ``direct participation program securities'' shall
include equity securities issued by a ``direct participation program''
as defined in Rule 2810 that would be included on a customer's
statement of account even if not held by the member, but does not
include securities on deposit in a registered securities depository and
settled regular way, securities listed on a national securities
exchange or The Nasdaq Stock Market, or any program registered as a
commodity pool with the Commodity Futures Trading Commission.
(4) the term ``real estate investment trust securities'' shall
include equity securities issued by a real estate investment trust as
defined in Section 856 of the Internal Revenue Code that would be
included on a customer's statement of account even if not held by the
member, but does not include securities on deposit in a registered
securities depository and settled regular way or securities listed on a
national securities exchange or The Nasdaq Stock Market.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, NASD Regulation included
statements concerning the purpose of and basis for the proposed rule
change and discussed any comments it received on the proposed rule
change. The text of these statements may be examined at the places
specified in Item IV below. NASD Regulation has prepared summaries, set
forth in sections (A), (B), and (C) below, of the most significant
aspects of such statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
(a) Rule 2340 of the NASD Conduct Rules (formerly, Article III,
Section 45 of the NASD Rules of Fair Practice) requires general
securities members to provide account statements to customers on at
least a quarterly basis.\2\ The account statement must contain a
description of any securities position, money balances or account
activity in the accounts since the prior account statements were sent.
Under NASD Rule 2340, ``account activity'' includes, but is not limited
to, purchases, sales, interest credits or debits, charges or credits,
dividend payments, transfer activity, securities receipts or
deliveries, and/or journal entries relating to securities or funds in
the possession or control of the member.
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\2\ ``General securities member'' refers to any member which
conducts a general securities business and is required to calculate
its net capital pursuant to the provisions of SEC Rule 15c3-1(a),
except for paragraphs (a)(2) and (a)(3). However, a member which
does not carry customer accounts and does not hold customer funds
and securities is exempt from the provisions of NASD Rule 2340.
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Background
By letter dated March 9, 1994, the Subcommittee on
Telecommunications and Finance of the U.S. House of Representatives
(``House Subcommittee''), expressed to the NASD (as well as the SEC,
the National Association of State Securities Administrators, and the
Investment Program Association) its concern regarding the information
provided to customers on account statements regarding the current value
of non-publicly traded partnership securities.\3\
[[Page 15947]]
The correspondence noted that the partnerships that are the subject of
their concern do not trade on a regular basis and, thus, regular market
quotes are not available. The House Subcommittee urged that investors
in non-publicly traded partnerships should be provided information on
the performance of their investments and expressed concern that there
may be serious shortcomings in current valuation reporting with respect
to such securities.
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\3\ See Letter from the Honorable Edward J. Markey, Chairman,
and the Honorable Jack Fields, Ranking Republican Member, House
Subcommittee, Committee on Energy and Commerce, U.S. House of
Representatives, to Joseph R. Hardiman, President and Chief
Executive Officer, NASD, dated March 9, 1994.
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In addition, on June 14, 1994, the NASD received correspondence
from the Division of Market Regulation (``Division'') of the Commission
requesting the NASD's views on whether it would be appropriate for
self-regulatory organizations to require that members make certain
disclosures on customer account statements.\4\ Specifically, the June
14 Letter asks for the NASD's views regarding whether it would be
appropriate for self-regulatory organizations to require broker-dealers
to make the following disclosures on customer account statements: (i)
there is no liquid market for most limited partnership interests; (ii)
the values reported on account statements, if any, may not reflect the
values at which customers can liquidate their positions; and (iii) if a
value is reported, the source of the value, a short description of the
methodology used to determine the value, and the date the value was
last determined.
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\4\ See Letter from Brandon Becker, Director, Division,
Commission, to Richard G. Ketchum, Executive Vice President and
Chief Operating Officer, NASD, dated June 14, 1994 (``June 14
Letter'').
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By letters dated May 10, 1994, and August 19, 1994, the NASD
expressed concern to Congress and the SEC that there were
inconsistencies in the manner in which members included valuations for
DPP securities on customer account statements and indicated that the
Association was moving forward to examine the need for regulation in
this area.\5\ NASD Regulation has determined to amend NASD Rule 2340 to
provide regulatory guidance to members regarding the disclosure of
values for DPP securities on customer account statements in order to
regulate the manner in which information is provided to investors
regarding the performance of their DPP investment assets.
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\5\ See Letter from Richard G. Ketchum, Executive Vice President
and Chief Operating Officer, NASD, to the Honorable Edward J.
Markey, Chairman, House Subcommittee, Committee on Energy and
Commerce, U.S. House of Representatives, and the Honorable Jack
Fields, Ranking Republican, House Subcommittee, Committee on Energy
and Commerce, U.S. House of Representatives, dated May 10, 1994; and
Letter from Richard G. Ketchum, Executive Vice President and Chief
Operating Officer, NASD, to Brandon Becker, Director, Division,
Commission, dated August 19, 1994.
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In particular, NASD Regulation has been concerned that a
significant number of NASD members continue to carry DPP securities on
customer account statements at the original purchase price. NASD
Regulation believes that this practice needs to be eliminated. In
addition, NASD Regulation proposes to apply the proposed amendment to
NASD Rule 2340 to the securities of certain REITs, which are excluded
from the Association's definition of DPP security in paragraph (a)(4)
of NASD Rule 2810, in order to ensure similarity of treatment under
NASD Rules of the two products.
Description of Proposed Amendments to NASD Rule 2340
Scope and Definitions
NASD Regulation proposes to apply the new requirements in NASD Rule
2340 to DPP securities and REIT securities. The definitions of DPP and
REIT securities proposed in subparagraphs (c)(3) and (4) of NASD Rule
2340 only encompass unlisted DPPs and REITs, since an investment in
listed securities provides investors with some measure of liquidity and
market values. Thus, the definitions exclude securities listed on a
national securities exchange or The Nasdaq Stock Market, as well as
securities that are in a depository and settle regular way. The
definition of DPP securities proposed in subparagraph (c)(3) also
excludes any program registered as a commodity pool, since those
programs generally offer investors a security that is redeemable by the
issuer, at the customer's option at regular intervals and at
ascertainable values.
Requirements to Place Estimated Values on Customer Account Statements
and Guidance on Appropriate Sources of Valuations--Subparagraphs
(b)(1)-(2)
The proposed rule change contains two specific circumstances under
which general securities members are obligated to provide customers
with estimated values for DPP and/or REIT securities in their
customers' accounts.
In the first circumstance, under subparagraph (b)(1) of the
proposed rule change, if a general securities member participated in
the public offering of DPP or REIT securities, then the member must
list the DPP/REIT securities on its customer account statements with
estimated values if such values are available pursuant to subparagraphs
(b)(3)(A) (ii) or (iii) of the proposed rule change. Where a general
securities member participated in the public offering of DPP or REIT
securities, NASD Regulation believes that the member should inform its
customers of the estimated value of the DPP or REIT securities.
Subparagraph (b)(3)(A)(iii) permits a member to include an estimated
value that is contained in an annual report distributed to investors
pursuant to Sections 14(a) or 14(c) of the Act or in a periodic report
filed with the Commission under Sections 13 or 15(d) of the Act.\6\
This provision is intended to address the concern of members regarding
their liability for disclosing an estimated value by permitting the
member to rely on the liabilities under the federal securities laws
that attach to the general partner's or trustee's disclosure.
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\6\ According to the NASD, the reporting requirements of the Act
do not impose a mandatory obligation on general partners or trustees
to provide an estimated value to investors in a periodic report or
in the annual report.
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Subparagraph (b)(3)(A)(ii) permits a member to include an estimated
value provided by an independent source engaged by the member. Thus,
when a member is obligated to include an estimated value for DPP/REIT
securities on customer account statements under subparagraph (b)(1),
the member may include valuations from both an independent source and
an annual/periodic report, if the member determines to do so.
In considering this mandatory obligation, NASD Regulation
determined that there are circumstances where the member should be
required to refrain from using an estimated value that the member
believes is inappropriate. Therefore, proposed subparagraph (b)(1)
provides that a member shall not include an estimated value of the
securities on the account statement if the member believes that the
estimated value was inaccurate as of the date of the valuation or is no
longer accurate due to a material change in the operations or assets of
the program. With respect to the latter phrase, the assets of a real
estate limited partnership would be considered to be impaired, for
example, where the lessee fails to perform under the lease. Similarly,
the sale of a property would be considered a material change because
the sale reduces the value of the program.
In the second circumstance, under subparagraph (b)(2) of the
proposed rule change, if a general securities member or its affiliate
acts as a fiduciary in connection with partnership or trust securities
which are held in retirement accounts and is disclosing individual
[[Page 15948]]
DPP/REIT estimated values to retirement account holders,\7\ then the
member must disclose the same valuations on the statements of all other
customers owning such securities. NASD Regulation believes that when a
member or its affiliate acts as a fiduciary for retirement accounts and
provides individual DPP/REIT security values to its retirement account
customers, other customers of the broker/dealer should receive the same
values being provided to retirement account customers. NASD Regulation
states that the requirement to disclose the ERISA or IRS valuation to
other customers would not conflict with the fiduciary and custodial
obligations imposed by the Department of Labor and the IRS.
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\7\ According to NASD Regulation, the Employee Retirement Income
Securities Act (``ERISA'') and Internal Revenue Service (``IRS'')
regulations require, at least annually, that a retirement account
fiduciary provide to the account holder a statement of the total
value of all the assets in the account.
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However, according to NASD Regulation, neither the Department of
Labor (which administers ERISA regulations) or the IRS (which
administers IRA and other retirement products) specifically requires
fiduciaries to provide individual values for any assets held in the
retirement account. Therefore, if the general securities member acting
as a fiduciary does not provide individual values for the DPP and REIT
securities in the retirement account, proposed new subparagraph (b)(5),
discussed more fully below, provides an exception from the requirement
to disclose individual values for assets held in a retirement
account.\8\
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\8\ The adoption of such an exception does not represent a view
that the proposed requirement to provide individual ERISA/IRA
valuations to other customers of the broker-dealer will discourage
members from providing such individual valuations. To the contrary,
fiduciaries increasingly are providing individual values for each
asset in a retirement account in order to permit the account holder
to make withdrawals where the account holder has reached the age
when ERISA/IRS regulations require annual mandatory withdrawals that
do not exceed a percentage-of-assets limitation.
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Appropriate Source for Estimated Values--Subparagraph (b)(3)(A)
Proposed subparagraph (b)(3)(A) of NASD Rule 2340 requires that,
where DPP and/or REIT securities are listed on a customer account
statement with an estimated value, such values shall be: (1) Provided
by an independent source engaged by the member; or (2) from a valuation
provided in an annual report distributed to investors or in a periodic
report that must be filed with the SEC (discussed more fully above). A
member may use an estimated value from either or both of these sources.
Under proposed subparagraph (b)(3)(A)(iv), a member may develop an
estimated value for the DPP/REIT securities only when a valuation by an
independent source or from an SEC annual or periodic report is not
available.
Subparagraph (b)(3)(A)(i) requires that any value provided must be
developed from data which is as of a date no more than 18 months prior
to the date the customer account statement is issued. NASD Regulation
believes that this requirement is appropriate because an estimated
value, accurate upon its first use on a customer account statement, may
become stale due to length of time or occurrence of subsequent events
(such as the sale of a major asset of the partnership). NASD Regulation
believes that the 18-month standard provides sufficient time for the
member and for an independent valuation source to develop an estimated
value for DPP/REIT securities based on the audited financials contained
in the Form 10-K of the DPP or REIT that is filed by March 30 and is
based on financial statements dated December 31 of the prior year.
Accordingly, the 18-month standard will allow a member to continue
to use a valuation based, for example, on the December 31, 1995,
financials during April, May, and June 1997, while a new estimated
value based on the December 31, 1996, financials is being developed. In
developing an objective standard, NASD Regulation considered whether
investors would be disadvantaged if an event occurred that would render
an estimated value disclosed on customer account statements obsolete
during the 18-month period. As set forth above, it is the
responsibility of the member to not include an estimated value on the
account statement that the member believes was inaccurate at the time
it was developed or is no longer accurate as a result of a material
change in the operations or assets of the program or trust.
Segregation of DPP/REIT Securities--Subparagraphs (b)(3)(B) and (b)(6)
Subparagraph (b)(3)(B) requires that an estimated value provided
for DPP/REIT securities on a customer's account statement be segregated
from other securities into a separate location on the customer account
statement. NASD Regulation believes that investment in non-publicly
traded DPP and REIT securities and the estimated values that may be
disclosed for those securities regarding their performance differ
sufficiently from the prices of other securities that customers will
benefit from having the DPP/REIT securities grouped together. In
addition, NASD Regulation believes that the segregation of these
securities into a separate location on the customer account statement
should also lessen the possibility of misleading customers regarding
the estimated values for DPP/REIT securities since the valuations will
be distinguished from listed securities and accompanied by cautionary
disclosures.
Subparagraph (b)(6) of the proposed rule change provides that DPP/
REIT securities listed on customer account statements without an
estimated value shall also be segregated. Thus, the requirement to
segregate DPP/REIT securities will apply regardless of whether the
security is listed with or without an estimated value.
Disclosure of the Source of the Estimated Value--Subparagraph
(b)(3)(B)(i)
Proposed subparagraph (b)(3)(B)(i) requires members to provide a
brief and easily-understood statement relating to the source of the
estimated value, provided that the member informs the customer of how
to obtain a more complete and detailed explanation of the methodology.
The provision includes two examples of such a brief statement: (1)
``the value represents an estimate of the investor's interest in the
assets owned by the DPP or REIT;'' or (2) ``the value . . . represents
an estimate of the value of the investor's DPP and/or REIT
securities.'' Another example of acceptable disclosure is that the
estimated value is ``an estimate of value provided to (member's name)
by an independent valuation service on an annual basis based on
information available to the service on (date).''
An example of the disclosure a member may use to inform the
customer of how to obtain a more complete explanation of the valuation
methodology is: ``A general description of the methodology used by the
independent valuation service to determine its estimate of value is
available by telephoning (telephone number).''
Disclosure of Nature of DPP/REIT Securities--Subparagraph (b)(3)(B)(ii)
Proposed subparagraph (b)(3)(B)(ii) requires disclosure in close
proximity to the location of the DPP/REIT securities on the account
statement that DPP securities generally are illiquid securities and the
estimated value disclosed may not be realizable if the customer seeks
to liquidate the security. NASD Regulation considers the requisite
disclosure to be sufficiently proximate if it is located on the same
[[Page 15949]]
page where the DPP and/or REIT securities are listed.
Aggregation of Estimated Values for DPP/REIT Securities with the Value
of Other Securities in Sub-Totals and in the Total Account Value--
Subparagraphs (b)(4) (A) and (B)
Proposed subparagraph (b)(4)(A) prohibits a general securities
member who discloses an estimated value for a DPP and/or REIT security
on a customer account statement from aggregating the estimated value of
the DPP/REIT securities with the value of any other securities in any
sub-total on the statement. Proposed subparagraph (b)(4)(B) allows a
member to include the estimated value of the DPP/REIT securities in the
total account value on the statement if the member provides disclosure
in close proximity to the total account value of the sub-total for DPP/
REIT securities and of the illiquid nature of the securities, as
required by subparagraph (b)(3)(B)(ii), as discussed above. NASD
Regulation considers ``close proximity'' to require that the sub-total
for DPP/REIT securities and the cautionary disclosure appear on the
same page as the total account value.
Use of Purchase Price--Subparagraph (b)(4)(C)
Proposed subparagraph (b)(4)(C) prohibits members from using the
original purchase price of a DPP or REIT security on a customer account
statement as the estimated value unless the valuation of the DPP or
REIT by another method indicates the same dollar amount as the original
issue price. Thus, regardless of the mandatory obligations in proposed
subparagraphs (b)(1) and (b)(2) to disclose an estimated value for DPP/
REIT securities under certain circumstances, the member may not use the
original purchase price as the required estimated value (unless the
valuation of the DPP or REIT by another method indicates the same
dollar amount as the original issue price).
Retirement Account Statements With No Individual Values--Subparagraph
(b)(5)
Proposed subparagraph (b)(5) states that if a retirement account
statement prepared in accordance with ERISA and IRS regulations
includes an aggregate value of the assets held in the account, but does
not provide individual values for any of the assets, then the member
must disclose on the account statement only that DPP and/or REIT
securities included in the account are generally illiquid securities.
As a result of the exception provided in subparagraph (b)(5) from
subparagraphs (b) (1)-(4), the member may include the value of DPP/REIT
securities in the total account value. NASD Regulation believes that
since individual values are not provided for any of the assets in the
retirement account, the other provisions that would, in particular,
require disclosures along with the display of the total account value,
are unnecessary.
Required Disclosure for Unpriced Securities--Subparagraph (b)(6)
When a member discloses no valuation for DPP/REIT securities on a
customer account statement, proposed subparagraph (b)(6) requires the
member to segregate the DPP/REIT securities on the account statement
and include disclosures that DPP/REIT securities are generally illiquid
securities, that the value of the security may be different from its
purchase price, and, if applicable, that accurate valuation information
is not available.
Implementation of Proposed Rule Change
In order to provide members (or their service organizations) with
sufficient time to modify their computer systems to comply with the
proposed rule change, NASD Regulation is requesting that the proposed
rule change become effective six months after Commission approval.
During that time, NASD Regulation will issue a Notice to Members
announcing the Commission's approval of the proposed rule change and
the anticipated effective date. In addition, the staff of the Corporate
Financing Department will respond to inquiries by members and their
service organizations regarding compliance with the proposed rule
change. To the extent that interpretive issues arise during this period
that are generally applicable to those members that are subject to the
proposed rule change, the Association will issue a Notice to Members to
clarify for all members the application of the rule change.
(b) NASD Regulation believes that the proposed rule change is
consistent with the provisions of Section 15A(b)(6) of the Act,\9\
which require that the Association adopt and amend its rules to promote
just and equitable principles of trade and generally provide for the
protection of customers and the public interest, in that the proposed
rule change significantly improves disclosure to public customers on
their account statements of information concerning the value and
performance of securities issued by non-publicly traded DPPs and REITs
in which such customers have invested, while providing safeguards for
both member firms and public customers against the publication of
inaccurate, and therefore misleading, values for such securities.
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\9\ 15 U.S.C. Sec. 78o-3.
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(B) Self-Regulatory Organization's Statement on Burden on Competition
NASD Regulation does not believe that the proposed rule change will
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as amended.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants or Others
The proposed rule change was published for comment in Notice to
Members 94-96 (December 1994). Thirty-nine comments were received in
response thereto from 36 commenters. A copy of the Notice to Members is
attached as Exhibit 2 to the rule filing. A copy of the comment letters
received in response thereto are attached as Exhibit 3 to the rule
filing. Thirty of the 36 commentators generally favored NASD
Regulation's effort to provide regulatory guidance regarding the
disclosure of partnership valuations on customer account statements,
although every letter contained suggested revisions. Six commenters
were opposed to the adoption of the proposed rule change.
Notice to Members 94-96 published an original version of the
proposed rule change which required that customer account statements:
1. Segregate DPP securities from other securities on the account
statement;
2. If illiquid DPP securities are listed without a price,
include disclosure that accurate pricing information is not
available because the value of the security is not determinable
until the liquidation of the partnership and no secondary market
exists;
3. If DPP securities are listed with a price:
a. Not aggregate the value of the DPP securities with the value
of any other securities on the statement or include the value of the
DPP securities in the customer account net worth calculation; and
b. Include disclosure of the methodology used for obtaining the
valuation; and
c. Include disclosure that DPP securities generally are illiquid
securities and that the price listed may not be realizable if the
customer seeks to liquidate the security.
Scope and Definitions
NASD Regulation agreed with the views of commenters that the
regulatory concerns surrounding the value of DPP securities should
extend only to unlisted DPPs and REITs, since an investment in Nasdaq
or exchange-listed securities provides investors with some measure of
liquidity and market
[[Page 15950]]
values.\10\ Accordingly, NASD Regulation revised its proposal to adopt
a definition of DPP and REIT securities in new subparagraphs (c) (3)
and (4) of NASD Rule 2340 that excludes securities listed on a national
securities exchange or the Nasdaq Stock Market, as well as securities
that are in a depository and settle regular way. NASD Regulation also
determined to except from the definition of DPP securities any program
registered as a commodity pool, since those programs offer investors a
security that is redeemable by the issuer, at the customer's option at
regular intervals and at ascertainable values.
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\10\ NASD Regulation expanded the proposal published for comment
in Notice to Members 94-96 to include non-publicly traded REIT
securities (which are not included in the Association's definition
of DPP security) in order to ensure similarity of treatment under
NASD Rules for these products.
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Prices versus Estimated Values
NASD Regulation amended the proposal published for comment to
eliminate the word ``price'' and insert the phrase ``estimated value''
throughout the revised rule. Commenters stated that a ``price'' carried
on a customer account statement gives the appearance to the investor
that the security can be liquidated for an amount that is roughly
equivalent to the price set forth on the customer's account statement.
However, except in the case of those DPPs/REITs which are publicly
listed and traded, estimated values of DPP/REIT securities are not
likely to be realizable if a customer seeks to liquidate his or her
investment.
Requirements to Place Estimated Values on Customer Account Statements
and Guidance on Appropriate Sources of Valuations--Subparagraphs (b)
(1) and (2)
The provisions of the proposal published for comment that provide
guidance for the disclosure of DPP securities with an estimated value
on customer account statements received the most comments. The
commenters generally believed that investors should be provided with a
value for their DPP securities. However, they differed as to the value
to be disclosed, with the greatest amount of comment focused on
valuation methodologies (whether net asset value or securitized value)
and their source (i.e., whether generated by the member or obtained
from the general partners or third-party independent evaluators).
NASD Regulation agrees with the sentiment expressed in a majority
of the comment letters and with the views of correspondence received
from the House Subcommittee, i.e., that investors in non-publicly
traded partnerships and trusts should know how their investments are
performing. However, NASD Regulation believes that there are practical
problems to requiring that all members provide disclosure of the
estimated values of all DPP and REIT securities held by their
customers. A member that was not part of the underwriting syndicate for
the initial public offering would not have conducted due diligence.
Therefore, the member would not have the usual ongoing relationship
with the general partner or trust advisor that would permit the member
to assess the reliability and validity of an estimated value provided
by the general partner/trust advisor or any other source. In
particular, when a customer's DPP/REIT securities are transferred to a
broker-dealer after acquiring them through another member, NASD
Regulation determined that it would be an inappropriate burden for the
member to be required to provide estimated values for the many
different partnerships and trusts held by its customers if the member
did not participate in the initial public offering of the DPP or REIT.
NASD Regulation determined that members should be required to
provide customers who have DPP or REIT securities in their general
securities accounts with estimated values under two specific
circumstances: (1) when the member participated in the underwriting of
the initial or, although rare, follow-on public offering of the
partnership or trust securities and had the opportunity to conduct due
diligence and develop a relationship with the sponsor or general
partner; and (2) when the member or its affiliate acts as a fiduciary
in connection with partnership or trust securities which are held in
retirement accounts and are disclosing individual DPP/REIT security
values to retirement account holder.\11\ NASD Regulation has revised
the proposal published for comment in the Notice to Members to reflect
these requirements by adopting new subparagraphs (b)(1) and (b)(2) of
NASD Rule 2340.
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\11\ ERISA and IRS regulations require, at least annually, that
a retirement account fiduciary provide to the account holder a value
for the aggregate of all the assets in the account. However, as
noted in footnote eight, other ERISA/IRS regulations requiring
mandatory annual withdrawals by the account holder place pressure on
a member acting as a fiduciary to provide individual values for each
asset in a retirement account.
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However, to address concerns that the proposed rule change would
require members to provide estimated values for DPP/REIT securities
held in a retirement account, although neither the Department of Labor
(which administers ERISA Regulations) or the IRS (which administers
IRA, and other retirement type products) specifically require
fiduciaries to provide individual values for DPP/REIT securities and
any other assets held in the retirement account, NASD Regulation
proposed new subparagraph (b)(5) to provide an exception from the
requirement to disclose individual values if the member only provides
an aggregate value for the entire retirement account. See discussion
below of subparagraph (b)(5).
Appropriate Source for Estimated Values--Subparagraph (b)(3)(A)
Commenters expressed concern that the proposal published for
comment did not provide guidance on the different sources of an
estimated value considered appropriate by the Association. Accordingly,
NASD Regulation has amended its original proposal to include a
provision in subparagraph (b)(3)(A) of NASD Rule 2340 that will require
the member's estimated value for DPP or REIT securities to be provided
by an independent source engaged by the member, or be from a valuation
in the DPP's or REIT's annual report distributed to investors, or from
a periodic report filed with the SEC by the DPP or REIT. The member may
develop a value for the DPP or REIT only if a valuation by an
independent source or from an annual or SEC periodic report is not
available.
Prohibition on Using Stale Data--Subparagraph (b)(3)(A)(i)
Many commenters stated that an estimated value, accurate upon its
first use on a customer account statement, may become stale or
inaccurate due to lengthy time or subsequent events (such as the sale
of a major asset of the partnership). NASD Regulation agrees that an
estimated value based on stale information eventually becomes
sufficiently misleading to investors to constitute a fraud. Therefore,
NASD Regulation has amended its original proposal to include a
provision in subparagraph (b)(3)(A)(i) of NASD Rule 2340 that will
preclude members from disclosing an estimated value if the financial
statements and other underlying data used to determine that value are
of a date more than 18 months prior to the date the account statement
is issued. In addition, proposed subparagraph (b)(2) provides an
exception to the mandatory requirement that a member that participated
in the
[[Page 15951]]
distribution of a DPP or REIT security provide an estimated value for
such securities on its customers' account statements where the member
believes that the estimated value was inaccurate as of the date of the
valuation or is no longer accurate as a result of a material change in
the operations or assets of the program or trust.
Segregation of DPP/REIT Securities--Subparagraphs (b)(3)(B) and (b)(6)
NASD Regulation considered and ultimately rejected the views of
several commenters who objected to the requirement that DPP and REIT
securities be segregated from other securities into a separate location
on the customer account statement. NASD Regulation believes that
investments in non-publicly traded DPP and REIT securities and the
estimated values which may be disclosed regarding their performance
differ sufficiently from the prices of other securities that customers
will benefit from having the securities grouped together for ease of
presentation and review.
In addition, NASD Regulation believes that the segregation of DPPs
and REITs into a separate location on the customer account statement
should lessen the possibility of misleading customers regarding values
since they will be distinguished from listed securities. NASD
Regulation also determined that the requirement to segregate DPP/REIT
securities should apply regardless of whether the security is listed
with or without an estimated value. Therefore, proposed subparagraphs
(b)(3)(B) and (b)(6) set forth the requirement to segregate DPP and
REIT securities.
Use of Purchase Price--Subparagraph (b)(4)(C)
In response to the correspondence of the SEC, NASD Regulation
amended the proposal published for comment to add a new provision in
subparagraph (b)(4)(C) prohibiting members from using the original
purchase price of a DPP or REIT security on a customer account
statement as the estimated value. NASD Regulation provided additional
language to clarify that the same dollar value of the purchase price
may be used when a valuation methodology results in the estimated value
and purchase price being equivalent.
Required Disclosure for Unpriced Securities--Subparagraph (b)(6)
In response to comments, NASD Regulation amended the proposal
published for comment to require the following disclosure on the
account statement where a member provides no valuation for a DPP or
REIT: that DPP and/or REIT securities generally are illiquid
securities; the value of the security may be different than its
purchase price; and, if applicable, that accurate valuation information
is not available. This disclosure replaces the provision in the
proposal published for comment that would have required a statement
that the value of the DPP security is not available until the
liquidation of the partnership and that no active secondary market
exists.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reason for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(a) By order approve such proposed rule change, or
(b) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying at the
Commission's Public Reference Section, 450 Fifth Street, N.W.,
Washington, DC Copies of such filing will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to file number SR-NASD-97-12 and should be
submitted by April 24, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30.-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-8470 Filed 4-2-97; 8:45 am]
BILLING CODE 8010-01-M
