[Federal Register Volume 63, Number 100 (Tuesday, May 26, 1998)]
[Notices]
[Pages 28535-28540]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-13850]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40001; File No. SR-NASD-97-95]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change By the National Association of Securities Dealers,
Inc. Relating to Amendments to the Free-Riding and Withholding
Interpretation
May 18, 1998.
I. Introduction
On December 23, 1997,\1\ the National Association of Securities
Dealers Regulation, Inc. (``NASD Regulation'') filed with the
Securities and Exchange Commission (``SEC'' or ``Commission'') a
proposed rule change pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act''),\2\ and Rule 194-b thereunder.\3\ Notice
of the proposal appeared in the Federal Register on February 11,
1998.\4\ The Commission received one comment letter regarding the
proposal.\5\ The
[[Page 28536]]
commenter generally supported the proposed rule change with some
modifications.\6\
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\1\ On March 12, 1998, NASD Regulation filed Amendment No. 1 to
the proposal. Amendment No. 1 revised Paragraph (b)(9)(A)(ii) to
include the shares of a member's parent that are publicly traded on
an exchange or Nasdaq in the exemption granted for shares of members
traded on an exchange or Nasdaq. Section III of this approval order
contains a further discussion of this amendment. In brief, the
technical amendment was necessary to reflect the fact that members
are often part of a holding company structure wherein the parent of
the member is the entity that actually trades on an exchange or
Nasdaq. Amendment No. 1 also corrected a drafting error in the
original proposal's Paragraph (d) of IM-2110-1 to clarify that both
employees and directors may take advantage of an exemption for
issuer directed securities programs. Because this amendment is
technical the statute does not require that it be published for
comment.
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240-19b-4.
\4\ Securities Exchange Act Release No. 39620 (February 4,
1998), 63 FR 7026 (February 11, 1998).
\5\ See letter from Sullivan & Cromwell to Jonathan G. Katz,
Secretary, SEC, dated March 13, 1998.
\6\ On April 9, 1998. NASD Regulation filed Amendment No. 2 to
the proposal. See letter to Katherine A. England, Assistant
Director, Division of Market Regulation. Amendment No. 2 responds to
the comment letter submitted by Sullivan and Cromwell regarding the
proposed rule change. NASD Regulation's response to the comment
letter is discussed in detail in Section III of this approval order.
Because this amendment is technical the statute does not require
that it be published for comment.
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The proposal amends Interpretative Material IM-2110-1 and Rule 2720
to revise certain aspects of the Free-Riding and Withholding
Interpretation (``Interpretation''). The purpose of the Interpretation
is to protect the integrity of the public offering system by ensuring
that members make a bona fide public distribution of ``hot issue''
securities and do not withhold such securities for their own benefit or
use the securities to reward other persons who are in a position to
direct future business to the member. Hot issues are defined by the
Interpretation as securities of a public offering that trade at a
premium in the secondary market whenever such trading commences.
The Interpretation prohibits members from retaining the securities
of hot issues in their own accounts and prohibits members from
allocating such securities to directors, officers, employees and
associated persons of such members and other broker-dealers. It also
restricts member sales of hot issue securities to the accounts of
specified categories of persons, including, among others, senior
officers of banks, insurance companies, registered investment
companies, registered investment advisory firms and any other person
with such organizations whose activities influence or include the
buying and selling of securities. These basic prohibitions and
restrictions are also made applicable to sales by members of hot issue
securities to accounts in which any such persons may have a beneficial
interest and, with some exceptions, to members of the immediate family
of those persons restricted by the Interpretation.
In March 1997, the NASD Regulation Board of Directors (``Board''),
acting upon recommendation from the National Business Conduct Committee
(``NBCC'') \7\ considered various amendments to the Interpretation. The
Board submitted a series of proposed rule amendments to the membership
for comment in Notice to Members 97-30. NASD Regulation received 22
comment letters in response to Notice to Members 97-30. As described
below, the proposal has been amended in response to these comments.
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\7\ The name of this committee has been changed to National
Adjudicatory Council. See Securities Exchange Act Release No. 39470
(December 19, 1997), 62 FR 67927 (December 30, 1997).
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II. Summary Description of the Proposed Rule Change
A. Exemptive Authority
Previously, there has not been a provision in the Interpretation
itself to allow the NBCC, the Board, or NASD Regulation staff to grant
exemptive relief. In the past, the NBCC, relying on the NASD By-Law's
grant of authority to the Board and its Committees, granted exemptions
in certain unique circumstances. NASD Rule 9600 delegates exemptive
authority in the Interpretation to the Office of General Counsel. The
Interpretation previously provided for exemption relief solely in cases
involving sales of issuer-directed securities to non-employee-director
restricted persons pursuant to Paragraph (d)(2) of the Interpretation.
As revised, the Interpretation authorizes NASD Regulation staff,
upon written request and taking into consideration all relevant
factors, to provide an exemption either unconditionally or on specified
terms from any or all of the provisions of the Interpretation,
consistent with the purposes of the Interpretation, the protection of
investors and the public interest. The proposed rule revisions also
provide that persons may appeal decisions of NASD Regulation staff to
the National Adjudicatory Council.
B. Treatment of Direct and Indirect Owner of Broker-Dealers
In 1994, the Interpretation's definition of ``associated person''
was amended to exempt certain passive investors in broker-dealers.\8\
Among other things, the rule amendments approved in the instant filing
address two limitations from the previous amendments. First, the
definition of associated person as previously provided in the
Interpretation did not include non-natural persons that have an
ownership interest in or have contributed capital to a broker-dealer.
Secondly, the Interpretation did not affirmatively specify any
ownership levels at which a natural person becomes an associated person
by reason of his or her ownership interest in a broker-dealer. Rather,
the Interpretation only specified when a natural person is not an
associated person.
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\8\ Securities Exchange Act Release No. 35059 (December 7,
1994), 59 FR 64455, 64457 (December 14, 1994).
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In Notice to Members 97-30, NASD Regulation proposed creating a new
definition of ``restricted person.'' Among other things, commenters
advised the NASD that this approach would result in confusion because
the term ``restricted person'' was already used throughout the
Interpretation. Commenters also observed that when the proposed
restricted persons provisions were read with other sections of the
Interpretation, the Interpretation would appear to be so broad as to
preclude purchases by any entity that owns 10 percent or more of a
broker-dealer or any account in which such entity has a beneficial
interest.
Having considered the potential problems with creating a new
definition of ``restricted person,'' to clarify the application of the
Interpretation to natural and non-natural persons, the Interpretation
has been revised by NASD Regulation to create a new Paragraph (b)(9) of
IM 2110-1. Paragraph (b)(9)(A) would exempt from the Interpretation's
prohibitions purchases by any person who directly or indirectly owns
any class of equity securities of, or who has made a contribution of
capital to, a member, and whose ownership or capital interest is
passive and is less than 10 percent of the equity or capital of a
member, as long as such person purchases hot issues from a person other
than the member in which it has such passive ownership and such person
is not in a position by virtue of its passive ownership interest to
direct the allocation of hot issues.
Alternatively, a second exemption embodied in Paragraph (b)(9)(A)
would exclude purchases by any person who directly or indirectly owns
any class of equity securities of, or who has made a contribution of
capital to, a member, and whose ownership or capital interest is
passive and is less than 10 percent of the equity or capital of a
member, as long as such member's shares, or shares of a parent of such
member, are traded on an exchange or Nasdaq.
In response to commenters' concerns that the rule revisions
proposed in Notice to Members 97-30 would prohibit sales of hot issues
to all entities within many insurance companies that own a broker-
dealer, Paragraph (b)(9)(B) of the proposal exempts sales of hot issues
to any account established for the benefit of bona fide public
customers of a person restricted pursuant to Paragraph (b)(9). This
exception expressly notes that such accounts would include, but are not
limited to, an insurance company's general or separate accounts.
[[Page 28537]]
Finally, Paragraph (b)(9)(C) retains the indirect ownership
provisions originally proposed in Notice to Members 97-30.
Specifically, it provides that any person with an equity ownership or
capital interest in an entity that maintains an investment in a member
shall be deemed to have a percentage interest of the entity of the
member multiplied by the percentage interest of such person in such
entity.
C. Exception to the Public Offering Definition
Heretofore, debt offerings have been included in the
Interpretation's definition of ``public offering.'' The proposed rule
change would provide an exception from the Interpretation for debt
securities other than debt securities convertible into common or
preferred stock. This exclusion is based upon the rationale that such
offerings do not raise the same issues as equity offerings inasmuch as
the price for a particular debt security generally fluctuates based on
interest rate movements rather than demand factors. The definition of
public offering also would except financing instrument-backed
securities that are rated by a nationally recognized statistical rating
organization in one of the four highest generic rating categories.
Lastly, NASD Regulation has reconsidered its earlier position and, in
response to comment letters received regarding Notice to Members 97-30,
revised the term public offering so as to exclude secondary offerings
by an issuer whose securities are actively traded securities. The
modified Interpretation defines actively traded securities to include
securities that have a worldwide average daily trading volume value of
at least $1 million and are issued by an issuer whose common equity
securities have a public float value of at least $150 million.
D. Foreign Mutual Funds
Purchases of shares of investment companies registered under the
Investment Company Act of 1940 were previously exempt from the
Interpretation based upon the rationale that the interest of any one
restricted person in an investment company ordinarily is de minimis and
because ownership of investment company shares generally is subject to
frequent turnover. The proposed rule revisions would extend this
rationale to the purchase of shares of foreign investment companies and
thus exempt such shares from the Interpretation, subject to
verification procedures designed, among other things, to ensure that
the company is listed on a foreign exchange or authorized for sale to
the policy by a foreign regulatory authority.
E. Issuer-Directed Share Exemption
In Notice to Members 97-30, NASD Regulation stated that persons
have requested that the language of Paragraph (d) of the Interpretation
be modified to clarify that the exemption is available to employees of
the issuer who are materially supported by a restricted person and both
employees and non-employee directors. Based upon the comments received
and its own initiative to clarify and streamline the issuer-directed
securities provisions more generally, the proposed rule change modifies
Paragraph (d) of the Interpretation to permit persons associated with a
member and their immediate family members to purchase hot issues. The
amendments clarify that the exemptions apply to employees and directors
of a parent or subsidiary of the issuer, consistent with NASD
Regulation's past practice.
F. Accounts for Qualified Plans Under the Employment Retirement Income
Security Act (``ERISA'')
The Interpretation has not previously expressly addressed the
status of qualified employee benefit plans under ERISA. In direct
response to the requests of commenters, the proposed rule change
clarifies the status of such accounts. To that end, the proposal
incorporates within the Interpretation itself a prior NBCC
interpretation governing the matter. As a general rule, NASD Regulation
believes qualified ERISA plans should not be deemed an ``investment
partnership or corporation'' and should not be considered a
``restricted account'' for purposes of the Interpretation. The proposed
amendments to the Interpretation provide guidance, however, in
determining the factual circumstances wherein a qualified ERISA plan
could be deemed restricted.
III. Comments Letters Received and Amendment No. 2 to the Proposal
As noted above, the Commission received one comment letter from
Sullivan and Cromwell. Amendment No. 2 to the filing responds to the
comment letter and, as discussed below, amends the proposal to address
issues raised by the Sullivan and Cromwell letter.
A. Investment Grade Securities
The proposed rule change exempts from the Interpretation debt
securities (other than debt securities convertible into common or
preferred stock) and financing instrument backed-securities that are
rated by a nationally recognized statistical rating organization in one
of its four highest generic rating categories. Sullivan and Cromwell
recommends that NASD Regulation exempt ``investment grade preferred
securities,'' (i.e., preferred equities) from the Interpretation based
upon its understanding that prices for such securities are principally
based on prevailing interest rates and that many investors view
investment grade preferred securities of different issuers as being
largely fungible.
NASD Regulation does not agree with Sullivan and Cromwell that
``investment grade preferred securities'' should be excluded from the
Interpretation, because NASD Regulation does not believe that the
prices of investment grade preferred securities are based on interest
rate movements to the same extent as investment grade debt. NASD
Regulation believes that demand-side factors play an important role in
the price of many preferred securities. In addition, preferred
securities generally differ from investment grade debt in that they are
rarely collateralized. Moreover, purchasers of preferred securities
often look to the issuer's business and management in determining
whether to purchase the security. For these reasons, NASD Regulation
believes that ``investment grade preferred securities'' should not be
excluded from the Interpretation. Amendment No. 2 to the filing states,
however, that NASD Regulation will evaluate the impact of excluding
investment grade debt and investment grade financing-backed securities
from the Interpretation and will consider in the future whether
preferred equities should also be excluded.
B. Paragraph (b)(9) and Direct/Indirect Owners of Broker-Dealers
In Paragraph (b)(9) of the proposed rule change, NASD Regulation
prohibits members from selling hot issues to any person or to a member
of the immediate family of such person who owns or has contributed
capital to a broker-dealer, other than solely a limited business
broker-dealer as defined in Paragraph (c) of the Interpretation, or the
account in which any such person has a beneficial interest, with
certain exceptions for ownership interest of less than 10%.
Importantly, however, Paragraph (b)(9) exempts sales to the account of
a restricted person that is established for the benefit of bona fide
public customers.
The Sullivan & Cromwell letter makes a number of particularized
comments, which are discussed in detail below. The thrust of Sullivan &
Cromwell
[[Page 28538]]
comments is that Paragraph (b)(9) should be revised to apply only to
institutions that are ``principally engaged in the broker-dealer
business.'' In responding to the suggestion, NASD Regulation notes that
it has rejected this argument many times and continues to believe that
such a narrow approach is inconsistent with the scope and intent of the
Interpretation. As reiterated in Amendment No. 2 to the filing, NASD
Regulation is of the opinion that the proposed revisions by Sullivan
and Cromwell would leave open a substantial possibility of reciprocal
self-dealing among broker-dealer and owners of broker-dealers.
NASD Regulation notes that the Interpretation protects the
integrity of the public offering process by ensuring that members make
a bona fide public distribution at the public offering price of hot
issue securities and do not withhold such securities for their own
benefit or use such securities to reward other persons in the financial
services business who are in a position to direct future business to
the member. NASD Regulation believes the Interpretation also ensures
that members of the securities industry do not take advantage of their
inside position in the industry to the detriment of public investors.
In light of the foregoing rationales, NASD Regulation believes that
persons who own a significant percentage of a broker-dealer, i.e., 10%
or more, should be restricted under the Interpretation.
NASD Regulation notes that it has provided an exemption from the
interpretation for persons that own 10% or more of a broker-dealer by
permitting such persons to purchase hot issues for the benefit of bona
fide public customers, or for an ERISA account pursuant to Paragraph
(f)(3). NASD Regulation does not believe that permitting such persons
to purchase hot issues for proprietary accounts, even if such hot
issues directly or indirectly benefit some public shareholder, is
consistent with the purposes of the Interpretation.
1. Banks and Industrial Companies with Broker-Dealer Subsidiaries and
Affiliates
Sullivan and Cromwell states in its letter that it is concerned
that the proposed rule change would affect the public offering market
by making hot issues unavailable to many institutional customers, and
in particular, banks with broker-dealer subsidiaries and affiliates.
Sullivan and Cromwell observes that proposed Paragraph (b)(9) generally
would prohibit the sale of hot issues to banks with broker-dealer
subsidiaries and affiliates. To the extent that these banks purchase
hot issues on a proprietary basis, NASD Regulation believes that the
Interpretation should apply. NASD Regulation notes, however, that banks
with broker-dealer subsidiaries and affiliates may purchase hot issues
on behalf of bona fide public customers, pursuant to the exemption set
forth in Paragraph (b)(9).
The proposed rule change also would prohibit industrial companies
that own broker-dealers, such as General Electric Company (``GE'') and
Ford Motor Company (``Ford'') from purchasing hot issues for their own
account. Here again, NASD Regulation believes that this is the correct
result. However, companies such as GE and Ford would be able to
purchase hot issues for an account in which they have a beneficial
interest, provided that such account is established for the benefit of
bona fide public customers.
2. Accounts Established for the Benefit of Bona Fide Public Customers
As stated above, Paragraph (b)(a) of the proposed rule change
contains an exemption for sales to the account of any person restricted
under this subparagraph that is established for the benefit of bona
fide public customer. Specifically, Paragraph (b)(9) states that such
accounts would include ``insurance company general and separate
accounts.'' NASD Regulation included these examples because it
understood that investments from such accounts are passed on directly
to policy holders, i.e., bona fide public customers.
The Sullivan and Cromwell letter suggests that the exemption for
accounts established for the benefit of bona fide public customers
applies solely to life insurance companies. As explained by NASD
Regulation, it was not intended that the exemption described in
Paragraph (b)(9) apply solely to life insurance companies. NASD
Regulation intended that the exemption apply across all industries.
Accordingly, Paragraph (b)(9)(B) of the proposed rule change has been
amended. The revised language is set forth below. Additions to the
provision are italicized. Language to be deleted appears in brackets.
This prohibition shall not apply to sales to the account of any
person restricted under this paragraph established for the benefit
of bona fide public customers, including [an] insurance company
general [or] , separate and investment accounts and bank trust
accounts.
3. Shares of a Member Traded as Part of a Holding Company
As originally proposed, Paragraph (b)(9) of the proposed rule
change would exempt any person who owns any class of equity securities
of, or who has made a contribution of capital to, a member, and whose
ownership or capital interest is passive and is less than 10% of the
equity or capital of a member, so long as such member's shares are
publicly traded on an exchange or Nasdaq. Sullivan & Cromwell states
that this exemption does not properly reflect the fact that many of the
largest broker-dealers are subsidiaries of publicly traded holding
companies and are not themselves publicly traded. NASD Regulation
previously addressed this issue in Amendment No. 1 to the filing.
Amendment No. 1 revises paragraph (b)(9)(A)(ii) to include within the
exemption shares of a parent of a member firm that are publicly traded
on an exchange or Nasdaq.
4. Immediate Family Members
Paragraph (b)(9) applies to ``any person, or to a member of the
immediate family of such person.'' Sullivan and Cromwell states that
Paragraph (b)(9) would require a member, for example Merrill Lynch, to
confirm not only that its customer does not own any Merrill Lynch
Parent stock, but also that none of his or her immediate family members
owns any such stock. Sullivan and Cromwell also states that Paragraph
(b)(9) does not exempt immediate family members who are not materially
supported by the restricted person, as does Paragraph (b)(2) of the
Interpretation. Sullivan and Cromwell maintains that it would be almost
impossible for a broker-dealer owned by a publicly traded holding
company to comply with Paragraph (b)(9) since, on its face, it would
require the broker-dealer to obtain complete information regarding the
securities portfolios of each of its customers' immediate family
members. Proposed Paragraph (b)(9), however, is implicated only by
persons who own 10% or more of a member. Nevertheless, NASD Regulation
believes that the provisions regarding the immediate family members of
restricted persons under proposed Paragraph (b)(9) should not be more
restrictive than the provisions in Paragraph (b)(2), which pertain to
associated persons of a member. NASD Regulation has therefore amended
Paragraph (b)(9) so as to exclude immediate family members who are not
materially supported by restricted persons. Revised
[[Page 28539]]
Paragraph (b)(9) is set forth below. New language is italicized.
Sell any of the securities to any person, or to a member of the
immediate family of such person who is supported directly or
indirectly to a material extent by such person, * * *.
5. Miscellaneous Changes to Paragraph (b)(9)
Pursuant to Amendment No. 2, NASD Regulation also corrected an
inadvertent clerical error in Paragraph (b)(9)(C) of the proposed rule
change that was identified by the Sullivan and Cromwell comment later.
The missing language set forth below was contained in the proposed rule
change as published in NASD Notice to Members 97-30, but was omitted
from the rule filing. New language is italicized. Revised Paragraph
(b)(9)(C) has been amended to read as follows:
For purposes of this paragraph, any person with an equity ownership
or capital interest in an entity that maintains an investment in a
member shall be deemed to have a percentage interest in the member
equal to the percentage interest of the entity in the member
multiplied by the percentage interest of such person in such entity.
C. Foreign Investment Companies
Paragraphs (f) and (1)(6) of the proposed rule change would exempt
foreign investment companies i.e., foreign mutual funds, organized
under the laws of the foreign jurisdiction, that have provided to the
member a written certification prepared by counsel or an independent
certified public accountant, which states that: (1) The fund has 100 or
more investors; (2) the fund is listed on a foreign exchange or
authorized for sale to the public by a foreign regulatory authority,
(3) no more than 5% of the fund assets are to be invested in the hot
issue securities being offered, and (4) any person owning more than 5%
of the shares of the fund is not a restricted person.
Sullivan and Cromwell states that while it agrees that an exemption
should be provided for foreign investment companies, it opposes any
requirement that NASD members obtain written certification from an
attorney or accountant. Sullivan and Cromwell proposes instead that
NASD Regulation exempt foreign investment companies based upon their
``status'' under foreign regulatory regimes, for example, any fund
qualified for sale under the European Union's Directive on Undertakings
for Collective Investment in Transferable Securities.
In response to comments received regarding Notice to Members 97-30,
and to alleviate the burdens associated with the written certification
requirement, NASD Regulation modified proposed Paragraph (1)(6) to
permit foreign, and not just U.S., attorneys and accountants to provide
written certifications. NASD Regulation continues to believe, however,
that written certifications are an appropriate method of determining
whether a particular foreign investment company meets the criteria for
exemption from the Interpretation and does not agree that this
requirement should be eliminated.
Sullivan and Cromwell states in its comment letter that if written
certifications are to be required, it recommends two changes. First
Sullivan and Cromwell states that foreign investment companies, like
registered investment companies, do not investigate the status of their
shareholders and thus will be unable to comply with the requirement to
certify that ``any person owning more than 5% of the shares of the fund
is not a person described in Paragraphs (b)(1), (2), (3), or (4) of the
Rule.''
NASD Regulation considered this issue in proposing the exemption
for foreign investment companies but concluded that the concerns of the
Interpretation that restricted persons do not indirectly purchase hot
issues through foreign investment companies were paramount.
Accordingly, if a foreign investment company is owned more than 5% by a
person, an attorney or accountant must certify that such person is not
a restricted person under the Interpretation. The attorney or
accountant providing the written certification required pursuant to
paragraph (1)(6) may rely upon information supplied by the foreign
investment company and any shareholder that owns more than 5% of the
foreign investment company. NASD Regulation is of the opinion that the
shareholder is likely to cooperate with any request by the foreign
investment company, or its counsel or accountant, regarding the
shareholder's status under the Interpretation since the shareholder's
cooperation may enhance the foreign investment company's investment
opportunities by permitting it to invest in hot issues. As a practical
matter, however, the requirement to determine whether a more than 5%
shareholder is a restricted person is unlikely to affect many foreign
investment companies because, as Sullivan and Cromwell concedes in its
comment letter, each foreign investment company must have at least 100
shareholders and, consequently, it is unlikely that the interest of any
one person will exceed the 5% threshold.
Second, Sullivan and Cromwell states that, as drafted, Paragraph
(1)(6) of the Interpretation would require a member firm to obtain a
written certification prior to each hot issue sale to a foreign
investment company. Sullivan and Cromwell views this as unduly
burdensome and recommends that NASD Regulation revise Paragraph (1)(6)
to be consistent with Paragraph (f)(2), which states that ``a written
representation shall be deemed to be current if it is based upon the
status of the account as of a date more than 18 months prior to the
date of the transaction.'' NASD Regulation agrees that members should
not be required to obtain a written certification before each
transaction and will adopt the same standard in effect for
certifications made pursuant to Paragraph (f)(2). Accordingly, the
final sentence of Paragraph (f)(2) of the Interpretation shall be
amended as set forth below. New language is italicized.
For purposes of this paragraph (f) and the certification required
pursuant to paragraph (1)(6). a list or written representation shall
be deemed to be current if it is based upon the status of the
account as of a date not more than 18 months prior to the date of
the transaction.
In addition to responding to the Sullivan and Cromwell
observations, Amendment No. 2 corrected proposed Paragraph (1)(6)(D) to
make the paragraph clearer and more consistent with other parts of the
Interpretation. The revised paragraph is set forth below. New language
is italicized. Language to be deleted from the paragraph appears in
brackets.
Any person owning more than 5% of the share of the fund is not a
restricted person as described in paragraph (b)(1), (2), (3), [or]
(4) or (9) of the [Rule] interpretation.
D. Secondary Distributions
The proposed rule change exempts from the Interpretation secondary
distributions by an issuer whose securities are actively-traded
securities. Sullivan and Cromwell supports the decision to exempt
secondary offerings but objects to the provision in the definition of
``actively-traded securities'' that excludes securities issued by the
distribution participant or an affiliate of the distribution
participant. NASD Regulation's proposed rule change to exempt secondary
offerings was drafted to track the exemption for actively-traded
securities set forth in the SEC's Regulation M. In adopting the
exemption for secondary distributions, NASD Regulation was focusing on
the average daily trading value and public float value provisions of
Regulation M exempt securities. NASD Regulation agrees with Sullivan
and Cromwell concerning secondary offerings of
[[Page 28540]]
members or affiliates of members and proposes revising the definition
of `'actively-traded securities'' to extend the exemption to securities
issued by a distribution participant or an affiliate of the
distribution participant. Paragraph (1)(7)(A), as amended, is set forth
below. Language to be deleted from the paragraph appears in brackets.
Actively-traded securities means securities that have an ADTV value
of at least $1 million and are issued by an issuer whose common
equity securities have a public float value of at least $150
million[; provided, however, that such securities are not issued by
the distribution participant or an affiliate of the distribution
participant].
Finally, Sullivan Cromwell notes that Paragraph (l)(1) refers to
secondary distributions ``by an issuer.'' Sullivan and Cromwell asks
whether secondary distributions by an existing security holder are
subject to the Interpretation. If not, Sullivan and Cromwell recommends
amending the text of proposed Paragraph (l)(1) to extend the exemption
to such distributions. NASD Regulation did not intend to exclude from
the exemption secondary offerings by security holders. Accordingly, it
has revised Paragraph (l)(1) as set forth below. New language is
italicized. Language to be deleted from the paragraph appears in
brackets.
The term public offering shall exclude secondary distributions by an
issuer or any security holder of the issuer, of [whose securities
are] actively-traded securities.
IV. Conclusion
The Commission has carefully considered the comments set forth in
the Sullivan and Cromwell letter. As discussed in detail above, the
NASD Regulation has made a number of technical amendments to the
proposal in response to the Sullivan and Cromwell letter, which the
Commission believes are consistent with the spirit of the
Interpretation. Indeed, the Commission believes the changes to the
proposal which were made pursuant to Amendment No. 1 and No. 2 will
facilitate the ability of NASD member firms to comply with the
Interpretation, because the amendments further clarify the intent of
the proposed rule change. For example, in response to the Sullivan and
Cromwell letter, the Interpretation was amended to clarify that the
exemption in paragraph (b)(9)(B) for sales to the accounts of
restricted persons established for the benefit of bona fide public
customers was intended to apply across all industries, as opposed to
life insurance companies exclusively. Similarly, Amendment No. 1 to the
proposal facilitates member firm compliance by amending the paragraph
(b)(9)(A)(ii) exemption for shares of a member traded on an exchange or
Nasdaq to include an exemption for shares of a member traded as a part
of a holding company. This amendment fosters member firm compliance
with the Interpretation by recognizing that many of the largest broker-
dealers are subsidiaries of publicly traded holding companies and are
not themselves publicly traded.
NASD Regulation has determined not to revise the proposal in
response to Sullivan and Cromwell's suggestion that paragraph (b)(9) of
the Interpretation, which with certain exceptions, prohibits sales of
hit issue securities to any person who owns or has contributed capital
to a broker-dealer, be revised such that it only applies to
institutions engaged ``principally in the broker-dealer business.'' The
Commission agrees with NASD Regulation that such an amendment is
inconsistent with the scope and intent of the proposal, because the
modification would leave open a substantial possibility of self-dealing
between broker-dealers and owners of broker-dealers. Accordingly, the
Commission believes NASD Regulation has a sound investor protection
basis for its decision not to narrow the scope of paragraph (b)(9) of
the Interpretation as requested by Sullivan and Cromwell.
The Commission believes the proposed rule change, as amended, is
consistent with the provisions of section 15(A)(b)(6) of the Act,\9\
which provides in pertinent part that the rules of a national
securities association be designed to prevent fraudulent and
manipulative acts, promote just and equitable principles of trade and
protect investors and the public interest. Specifically, the proposal
preserves public confidence in the fairness of the investment banking
and securities business by ensuring that members of the investment
banking community do not unfairly benefit from public offerings by
virtue of their positions as insiders, to the detriment of public
investors. Preservation of investor confidence in the fairness of the
markets is critical to the continued participation of all classes of
securities marked participants. The Commission believes, moreover, that
the proposed rule change is consistent with section 15A(b)((9) \10\ in
that it will alleviate certain inequities caused by the Interpretation,
which imposed burdens on competition not necessary or appropriate in
furtherance of the purposes of the Act.
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\9\ 15 U.S.C. 78o-3.
\10\ 15 U.S.C. 78o-3.
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In approving this proposal, the Commission notes that it is has
considered the proposal's impact on efficiency, competition, and
capital formation.\11\ The Commission believes the proposal will
facilitate the capital raising process by removing restrictions and
compliance burdens imposed by the Interpretation with respect to
certain transactions where application of the Interpretation does not
enhance investor protection or the public interest. For example, the
proposal excludes from the definition of public offering secondary
offerings by an issuer whose securities are actively traded securities.
At the same time, the Interpretation continues to apply to those
securities allocations that pose a risk of undercutting the
Interpretation's objective of ensuring a bona fide distribution of hot
issue securities to the public.
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\11\ 15 U.S.C. 78c(f).
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It is therefore ordered, pursuant to Section 19(b)(2) \12\ of the
Act, that the proposed rule change SR-NASD-97-95 be and hereby is
approved.
\12\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\13\
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\13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-13850 Filed 5-22-98; 8:45 am]
BILLING CODE 8010-01-M
