[Federal Register Volume 59, Number 161 (Monday, August 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20479]
[[Page Unknown]]
[Federal Register: August 22, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34533; File No. SR-NASD-93-3]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Approving Proposed Rule Change and Notice of
Filing and Order Granting Partial Accelerated Approval to Amendments to
Proposed Rule Change Relating to Limited Partnership Rollup
Transactions
August 15, 1994.
I. Introduction
On February 3, 1993, the National Association of Securities
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule
change pursuant to Section 19(b)(1)\1\ of the Securities Exchange Act
of 1934 (``Exchange Act''), and Rule 19b-4 thereunder.\2\ The proposal
subsequently was amended eight times. On April 14, 1993, May 7, 1993,
May 13, 1993, May 14, 1993, August 26, 1993, October 21, 1993,\3\ April
14, 1994, and July 27, 1994, the NASD filed Amendment Nos. 1, 2, 3, 4,
5, 6, 7 and 8, respectively, to the proposed rule change.\4\ The
proposed rule change would amend Article III, Section 34 of the Rules
of Fair Practice to include rules which prevent NASD members or persons
associated with an NASD member from participating in any ``limited
partnership rollup transaction'' (as defined in the proposed rule
change) unless the transaction includes certain specified provisions
designed to protect the rights of limited partners. The proposed rule
change also would amend Article III, Section 34(b)(6) to narrow the
scope of transactions in which members are forbidden to receive
differential compensation (``Differential Compensation Amendment'').
Finally, the proposed rule change would amend Schedule D of the By-Laws
(``Schedule D'') to prohibit the authorization for quotation on the
Nasdaq National Market (``Nasdaq/NM'') of any security which results
from a covered partnership rollup transaction unless the transaction
was conducted in accordance with certain specified procedures designed
to protect the rights of dissenting limited partners.
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\1\15 U.S.C. 78s(b)(1) (1988).
\2\17 CFR 19b-4 (1993).
\3\On December 17, 1993, the Limited Partnership Rollup Reform
Act of 1993 (``Rollup Reform Act'') was enacted.
\4\Amendment No. 1 superseded the original rule filing.
Amendment No. 2 amended the rule language and the NASD's Statement
of Purpose in response to comments of the Commission staff.
Amendment Nos. 3 and 4 made technical changes to the rule. Notice of
the proposed rule change (Securities Exchange Act Release No. 32312,
May 17, 1993) was then published in the Federal Register (58 FR
29655, May 21, 1993). Amendment No. 5 made technical changes to the
rule text and responded to the comment letters that the Commission
received in response to the publication of the release in the
Federal Register. Amendment No. 6 made changes to the rule text to
address issues of state law addressed in comment letters. Amendment
No. 7 amended the rule language to partially conform the rule to the
Rollup Reform Act and narrowed the scope of transactions in which
members were forbidden to receive differential compensation.
Amendment No. 8 amended the rule language to conform the rule to the
Rollup Reform Act in all relevant parts and reordered the text of
the proposed rule change in accordance with Section 34 of the Rules
of Fair Practice.
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Notice of the proposed rule change, together with the substance of
the proposal as amended by Amendment Nos. 1-4, was provided by the
issuance of a Commission release (Securities Exchange Act Release No.
32312, May 17, 1993) and by publication in the Federal Register (58 FR
29655, May 21, 1993). Seven comment letters were received in response
to the Commission release. Three comment letters expressed support for
the proposed rule change.\5\ One comment letter stated that the
proposed rule change should not be adopted ``in the absence of a
legislative mandate.''\6\ Three comment letters neither supported nor
opposed the proposed rule change but offered suggestions on how to
enhance the NASD's rule.\7\
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\5\See letter from Michael B. Pollack, Chairman, Securities Laws
and Regulatory Affairs Committee, Investment Program Association
(``IPA'') to Jonathan Katz, Secretary, SEC dated June 9, 1993;
letter from Deborah A. DeMott, Professor of Law, Duke University
School of Law (``DeMott'') to Jonathan Katz dated June 10, 1993; and
letter from John F. Olson and Nicholas S. Hodge, Committee on
Federal Regulation of Securities, American Bar Association (``ABA'')
to Jonathan Katz dated June 23, 1993.
\6\See letter from Joe M. Bridges, President, Kelley Oil Corp.
(``Kelley'') to Jonathan Katz dated July 6, 1993.
\7\See letter from Gene Oshman, Baker & Botts (``Baker &
Botts'') to Jonathan Katz dated June 10, 1993; letter from Patricia
Magee Daly, Kutak Rock (``Kutak Rock'') to Jonathan Katz dated June
11, 1993; letter from James E. Showen, Hogan & Hartson (``Hogan &
Hartson'') to Jonathan Katz dated November 3, 1993.
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The Rollup Reform Act was enacted on December 17, 1993, as part of
the Government Securities Act Amendments of 1993. Section 3(a) of the
Rollup Reform Act added subparagraph (12) to Section 15A(b) of the
Exchange Act to require that the rules of a registered securities
association prevent members of the association from participating in
any limited partnership rollup transaction unless the transaction
provides procedures to protect certain rights of limited partners.
Section 3(c) of the Rollup Reform Act amended Section 15A(b) of the
Exchange Act to require that the rules of a registered securities
association prohibit the authorization for quotation on an automated
interdealer quotation system sponsored by the association of any
security designated by the SEC as a national market system security
resulting from a rollup transaction, unless the transaction provides
certain rights for limited partners.\8\ The NASD subsequently amended
the proposed rule change to conform the language of the rule to the
Rollup Reform Act.\9\
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\8\Section 3(b) of the Rollup Reform Act added Section 6(b)(9)
to the Exchange Act imposing virtually identical requirements upon
national securities exchanges. See 15 U.S.C. Sec. 78f(b)(9).
\9\See supra n. 4.
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By this release, the Commission: (i) solicits comment on the
Differential Compensation Amendment; (ii) approves the proposed rule
change as amended by Amendment Nos. 1-4; and (iii) grants approval on
an accelerated basis to Amendment Nos. 5, 6 and 8, and grants approval
on an accelerated basis to Amendment No. 7,\10\ except for that portion
of that Amendment proposing the Differential Compensation Amendment,
which the Commission is not approving by this release.\11\
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\10\Interested persons are invited to submit written data, views
and arguments concerning Amendment Nos. 5-8 to the proposed rule
change. See infra Section V.
\11\The Differential Compensation Amendment would eliminate the
definition of ``rollup of a direct participation program'' contained
in Subsections (b)(6)(A) and (B) of Article III, Section 34, which
prohibits the receipt of differential compensation in connection
with the solicitation of investor votes in rollup transactions, and
substitute the term ``limited partnership rollup transaction''
wherever the term ``roll-up of a direct participation program''
currently appears in these Subsections. The effect would be to
permit NASD members to receive diffential compensation in connection
with the solicitation of investor votes in any ``roll-up of a direct
participation program'' that does not also constitute a ``limited
partnership rollup transaction.'' See infra Section III.B.1.
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The text of the proposed rule change is available at the Office of
the Secretary of the NASD and at the Commission.\12\ With respect to
the Differential Compensation Amendment, language proposed to be added
to Subsections (b)(6)(A) and (B) of Article III, Section 34 is in
italics; proposed deletions are in brackets.
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\12\The NASD also will publish the text of the proposed rule
change in an NASA Notice to Members.
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Rules of Fair Practice
Article III
* * * * *
Direct Participation Programs
Sec. 34
* * * * *
(b)
* * * * *
Participation in Rollups
(6)(A) No member or person associated with a member shall
participate in the solicitation of votes or tenders from limited
partners [participants] in connection with a limited partnership rollup
transaction [of a direct participation program or programs]
irrespective of the form of the resulting entity [resulting from the
rollup] (i.e., a partnership, real estate investment trust or
corporation), unless [such] any compensation received by the member:
(i) is payable and equal in amount regardless of whether the
limited partner [participant] votes affirmatively or negatively in the
proposed limited partnership rollup transaction;
(ii) in the aggregate, does not exceed 2% of the exchange value of
the newly-created securities; and
(iii) is paid regardless of whether the limited partners
[participants] reject the proposed limited partnership rollup
transaction.
(B) No member or person associated with a member shall participate
in the solicitation of votes or tenders from limited partners
[participants] in connection with a limited partnership rollup
transaction [of a direct participation program or programs] unless the
general partner(s) or sponsor(s) proposing the limited partnership
rollup transaction agrees to pay all solicitation expenses related to
the limited partnership rollup transaction, including all preparatory
work related thereto, in the event the limited partnership rollup
transaction is rejected.
[For purposes of paragraphs (A) and (B), a rollup of a direct
participation program shall mean a transaction involving an
acquisition, merger or consolidation of at least one direct
participation program, not currently listed on a registered national
securities exchange or traded on the Nasdaq System, into another public
direct participation program or a public corporation or a public
trust.]
* * * * *
II. Background
During the 1980s, over $150 billion of public limited partnership
interests were sold to U.S. investors.\13\ Sources have estimated that
11 million investors have purchased limited partnership interests, of
which approximately eight million are small investors, with an average
investment of about $10,000.\14\ Limited partnership interests
typically are risky and illiquid, due to the lack of an active trading
market for such interests.
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\13\S. Rep. No. 121, 103d Cong., 1st Sess. 4 (1993) (``Senate
Report'') citing testimony of James R. Doty, General Counsel,
Commission, ``Concerning Limited Partnership Roll-Ups,'' before the
Subcommittee on Energy and Agricultural Taxation, Committee on
Finance, United States Senate, July 16, 1991, at 3.
\14\Senate Report, Supra No. 13, at 3.
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A. Structure of A Limited Partnership
In the typical publicly-offered limited partnership, a sponsoring
organization solicits funds from investors to use in the purchase of
real estate, oil and gas facilities, high technology research, or other
enterprises. The sponsor usually serves as the general partner and is
required to manage the assets and fulfill any obligations to the
investors imposed under the terms of the partnership agreement. The
investors are the limited partners. A partnership agreement typically
will provide for limited partners to receive periodic payments during
the term of their investment, a return of their principal, and a
specified return or profit and a portion of any additional proceeds
upon the liquidation of the partnership assets.
B. Reasons to Invest in a Limited Partnership
Investors purchased limited partnerships for several reasons.
Perhaps most important, in the case of real estate partnerships prior
to the 1986 amendments to the Internal Revenue Code (''1986 Tax Act''),
limited partnership investors enjoyed significant tax benefits.\15\
Limited partnerships permitted small investors to participate in
commercial and multi-family real estate, oil and gas facilities, and
other investments previously limited to institutional or other large
investors.\16\ Investors in limited partnerships were promised that
they would realize a return on their investment within a finite period
of time. Investors also were promised that sponsors would not realize
any return on partnership assets until investors received their share
of the profits.
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\15\Id. at 5.
\16\Id.
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C. Advantages for partnership sponsors
Sponsors have a financial incentive to organize limited
partnerships for at least two reasons. First, the sponsor/general
partner expects to realize a profit on any appreciation of the assets
after the limited partners receive their share. Second, the sponsor/
general partner derives income on an on-going basis for the management
services provided in maintaining and operating the property. The
general partner also may receive up-front fees for organizing the
limited partnership.
D. Recent partnership performance
In the late 1980s, the financial climate for limited partnership
deteriorated dramatically. Several factors contributed to limited
partnerships' poor performance. The 1986 Tax Act took away any tax
benefit for limited partnership investors. Real estate and oil and gas
markets also declined precipitously. This, together with a series of
other circumstances, caused many general partners to face a decreasing
revenue base and a growing number of financial problems.\17\ Since
January 1, 1985, the number of limited partnership offerings filed with
the Commission has decreased substantially each year, from a high of
428 in 1985 to a low of 39 in 1991.\18\ Interests in limited
partnerships investing in real estate lost some or all of their
economic value due to the dramatic decline in real estate values during
the late 1980s.
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\17\Id.
\18\In 1992, 50 new limited partnership offerings were filed
with the Commission. H.R. Rep. No. 21, 103d Cong., 1st Sess.
10(1993) (''1993 house Report'').
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Several consequences flowed from the deteriorating climate for
limited partnerships. Many general partners stopped raising new capital
altogether. Sales of assets from existing partnerships exceeded any new
capital raised, thereby eroding assets under management and
significantly reducing general partner management fees.\19\ Some
general partners responded to their predicament by changing the
original partnership agreements and restructuring the limited
partnerships by proposing to reorganize or, in many cases, ``roll up''
existing limited partnership interests into new, publicly-traded
securities.
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\19\Senate Report, supra n. 12, at 5.
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E. Rollups
From January 1, 1985 to June 30, 1994, approximately 82 limited
partnership rollup transactions involving two or more entities were
registered with the Commission. These rollups have involved over 1,900
separate limited partnerships with an estimated aggregate value well
over seven billion dollars.
1. Rollup structure
A typical ``rollup'' will combine several non-traded individual
limited partnerships into a single new entity that publicly trades on a
national securities exchange or on Nasdaq/NM. This entity generally is
an infinite life vehicle which is designed continually to reinvest
proceeds from asset sales, unlike the provisions limited partnerships,
which are investments with a limited or finite term that, at some point
in time, distribute proceeds, if any, to investors. A rollup also can
involve the reorganization of a single partnership into a new entity.
2. Benefits of rollups
In some cases, reorganizing non-traded public limited partnerships
that have lost substantial value and creating a new publicly-traded,
infinite life vehicle can enhance the value of the investments of the
limited partners.\20\ For example, the new entity may offer investors
liquidity previously unavailable, create economies of scale and reduce
administrative costs to improve performance, and create broader
diversification of assets which will improve investment safety.
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\20\Id. at 6.
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3. Criticism of rollup
Critics have said that the vast majority of limited partnership
rollups result in the newly-traded security immediately falling to a
discount to its net asset value, as cash flow from the stronger
partnerships is used to support losses from the weaker
partnerships.\21\ They further argue that ongoing asset management fees
and expenses assessed by the general partners offset, and in fact may
exceed, the promised reduced administrative costs.\22\ As a result, the
limited partners' equity is substantially diluted. One industry witness
testified before Congress that, in the large rollup transactions,
limited partners have realized, on average, a drop of 45 percent from
the exchange value on the first day of trading in their newly issued
rollup securities.\23\ Congressional testimony also disclosed estimates
that these limited partners when taken as a whole have lost
approximately $2 billion in equity, while rollup sponsors have earned
over $250 million in fees.\24\ By one estimate, when compared to
original exchange values, investors involved in public limited
partnership rollups have experience a decline of approximately 70
percent in limited partner equity.\25\
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\21\Id.
\22\Id.
\23\Liquidity Fund, ``Roll-up Performance: Comparison of
Exchange Value and Closing Prices, 1st Day, 90 Days, 120 days,
Current Market Price,'' in ``Limited Partnership Reorganizations, or
`Roll-ups','' Hearing before the Securities Subcommittee of the
Senate Committee on Banking, Housing and Urban Affairs, February 27,
1991, S. Hrg. 102-77, page 29.
\24\Senate Report, supra n. 12 at 6-7.
\25\Id. at 7.
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While investor complaints have been sparked by the enormous
declines in the value of the rollup security compared with the
``exchange value'' stated in the prospectus, rollup sponsors have
argued that the stated exchange value is not intended to be the trading
price of the security, and thus, such comparisons tend to overstate the
magnitude of investor losses.\26\ However, rollup disclosure documents
generally have proven to be almost incomprehensible and it is likely
that sponors did not clearly disclose to investors that the stated
exchange value is not intended to be the trading price of the
security.\27\
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\26\Id.
\27\See 1993 House Report, supra n. 18, at 12:
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Congressinonal testimony revealed at least three other forms of
abuses in connection with rollup transactions. First, financially sound
partnerships are merged with partnerships that are experiencing
financial difficulty, thereby diluting the interest of the limited
partners of the sound partnerships.\28\ Second, some general partners
have modified the original partnership's fee structure in order to give
much larger equity interests or fees to themselves, to the detriment of
the limited partners.\29\ Finally, when the unattractive terms of the
new rolled up security become apparent, the market further discounts
the newly traded security, pushing its price even lower.
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\28\Senate Report, supra n. 13, at 7.
\29\Id.
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F. The Rollup Reform Act
The seriousness of the problem with rollup disclosure documents was
underscored by Commission Chairman Richard Breeden when he stated in
testimony before the Senate Banking Committee in the Spring of 1991
that, ``I have taken a look at some of the documents filed with us in
these roll-up transactions and I would like to meet the person who can
understand all of the disclosures in some of those documents.'' The
Committee notes that a disclosure document which the Chairman of the
Securities and Exchange Commission has difficulty understanding is
likely to prove daunting in complexity to the average small investor in
a limited partnership.
As noted above, Section 3(a) of the Rollup Reform Act amended
Section 15A(b) of the Exchange Act to require that the NASD rules that
promote just and equitable principles of trade include rules to prevent
NASD members from participating in any limited partnership rollup
transaction that does not provide procedures to protect certain
specified rights of limited partners. Such rights include:
(A) The right of dissenting limited partners to:
(i) an appraisal and compensation;
(ii) retention of a security under substantially the same terms
and conditions of the original issue;
(iii) approval of the limited partnership rollup transaction by
at least 75 percent of the outstanding interests of each
participating limited partnership; or
(iv) other rights designed to protect dissenting limited
partners;
(B) The right not to have their voting power unfairly reduced or
abridged;
(C) The right not to bear an unfair portion of the costs of a
proposed rollup transaction that is rejected; and
(D) Restrictions on the general partner's conversion of
contingent interests or fees into non-contingent interests or fees
and restrictions on the general partner's receipt of a non-
contingent equity interest in exchange for fees for services which
have not yet been provided.
The Rollup Reform Act defines a ``dissenting limited partner'' as a
person who, on the date on which rollup soliciting material is mailed
to investors, holds a beneficial interest in a limited partnership that
is the subject of a limited partnership rullup transaction and who
votes against the transaction and complies with procedures established
by the NASD to perfect dissenter's rights.
Section 3(c) of the Rollup Reform Act amended Section 15A(b) of the
Exchange Act to require that the rules of a registered securities
association prohibit the authorization for quotation on an automated
interdealer quotation system sponsored by that association of any
security designated by the Commission as a national market system
security resulting from a rollup transaction, unless such transaction
provides certain rights for limited partners. The rights set forth
under this section are identical to those set forth in Section 3(a) for
registered securities associations.
III. Description of Proposed Rule Change and Comments Received
The NASD's proposed rule change would prevent its members from
participating in any ``limited partnership rollup transaction'' as that
term is defined in the Rollup Reform Act if the transaction does not
provide those procedures to protect the rights of limited partners that
are mandated by the Rollup Reform Act. The proposed rule change also
would narrow the scope of transactions in which members are forbidden
to receive differential compensation. Finally, the proposed rule change
would prohibit the authorization for quotation on Nasdaq of any
security designated by the Commission as a national market system
security resulting from a rollup transaction, unless the transaction
provides certain rights for dissenting limited partners.
Proposed Rule Change to Article III, Section 34
A. Definitions
Subsequent to publication of notice of the proposed rule change,
the NASD proposed to amend the definitions of ``dissenting limited
partner'' and ``limited partnership rollup transaction'' to be added to
Subsection (b)(2)(B).\30\
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\30\The terms ``cash available for distribution,'' ``cash
flow,'' ``limited partner,'' ``limited partnership,'' ``management
fee,'' ``solicitation expenses,'' and ``transaction costs'' are
adopted as published in the notice of the proposed rule change. See
Securities Exchange Release No. 32312, supra n. 4, 58 FR 29655,
29655-56.
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``Dissenting Limited Partner'' is defined in new Subsection
(b)(2)(B)(iii), in accordance with the Rollup Reform Act, as a person
who, on the date on which rollup soliciting material is mailed to
investors, is a holder of a beneficial interest in a limited
partnership that is the subject of a limited partnership rollup
transaction and who votes against the transaction and complies with
procedures established by the NASD to assert dissenters' rights, except
that for purposes of an exchange or tender offer, a person must file an
objection in writing with the party responsible for tabulating votes or
tenders during the period in which the offer is outstanding.31
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\3\1By defining ``dissenting limited partner'' to mean a person
who is a holder of the limited partnership interests on the date on
which soliciting material is mailed, persons who buy limited
partnership interests after that date are prevented from asserting
dissenters' rights. These persons are on notice of the proposed
rollup transaction when they purchase their limited partnership
interests and, therefore, do not need the same type of protections
granted to existing limited partners.
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``Limited Partnership Rollup Transaction'' is defined in new
Subsection (b)(2)(B)(vii), in accordance with the Rollup Reform Act, as
a transaction involving the combination or reorganization of limited
partnerships, either directly or indirectly, where some or all
investors in the limited partnerships receive new securities or
securities in another entity. The definition provides exceptions for
certain kinds of private transactions or other transactions which do
not require the application of the protections of the Exchange Act. In
addition, the term ``limited partnership rollup transaction'' is
defined to include the reorganization of a single limited partnership,
directly or indirectly, in which some or all investors receive new
securities or securities in another entity, if the transaction meets
certain specified criteria in the Rollup Reform Act. The definition
covers both transactions in which securities received in single or
multiple partnership rollups are received directly, and transactions in
which securities are received indirectly through a step
transaction.32
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\3\2See discussion of umbrella partnership real estate
investment trusts (``UPREITs'') infra n. 50 and accompanying text.
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Exclusions The definition of ``limited partnership rollup
transaction'' also incorporates six exclusions, in accordance with the
Rollup Reform Act. A transaction will not be deemed to be a limited
partnership rollup transaction of it: (1) involves only a limited
partnership or partnerships having an operating policy or practice of
retaining cash available for distribution and reinvesting proceeds from
the sale, financing, or refinancing of assets in accordance with such
criteria as the Commission determines appropriate; (2) involves only
limited partnerships wherein the interests of the limited partners are
repurchased, recalled, or exchanged in accordance with the terms of the
preexisting limited partnership agreements for securities in an
operating company specifically identified at the time of the formation
of the original limited partnership; (3) involves only securities to be
issued or exchanged that are not required to be and are not registered
under the Securities Act of 1933 (``Securities Act''); (4) involves
only issuers that are not required to register or report under Section
12 of the Exchange Act, both before and after the transaction; (5)
involves the combination or reorganization of one or more limited
partnerships in which a non-affiliated party succeeds to the interests
of a general partner or sponsor, except those types of transactions as
the Commission may by rule deem to fall within the definition of
``limited partnership rollup transaction,'' if: (a) such action is
approved by not less than 66\2/3\ percent of the outstanding units of
each of the participating limited partnerships; and (b) as a result of
the transaction, the existing general partners will receive only
compensation to which they are entitled as expressly provided for in
the preexisting limited partnership agreements; or (6) involves a
transaction, except as the Commission may by rule deem to fall within
the definition of ``limited partnership rollup transaction,'' in which
the securities offered to investors are securities of another entity
that are reported under a transaction reporting plan declared effective
by the Commission under Section 11A of the Exchange Act before the date
of enactment of the Rollup Reform Act, if: (a) such other entity was
formed, and such class of securities was reported and regularly traded,
not less than 12 months before the date on which soliciting material is
mailed to investors; and (b) the securities of that entity issued to
investors in the transaction do not exceed 20 percent of the total
outstanding securities of the entity, exclusive of any securities of
such class held by or for the account of the entity or a subsidiary of
the entity.
B. Participation in Rollups
The Commission is soliciting comment on the Differential
Compensation Amendment. As noted above, the Differential Compensation
Amendment would amend Subsection (b)(6) to: (i) limit the scope of the
prohibition upon receipt of differential compensation to transactions
constituting ``limited partnership rollup transactions'' instead of
transactions constituting ``rollups of direct participation
programs'';33 and (ii) prohibit the participation of members and
persons associated with members in a limited partnership rollup
transaction unless the transaction includes provisions designed to
protect the rights of limited partners.34
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\3\3Section 34(a)(2) defines ``direct participation program'' as
``a program which provides for flow-through tax consequences
regardless of the structure of the legal entity or vehicle for
distribution. . . .'' (emphasis added). By contrast, new Subsection
(b)(2)(B)(vi) defines ``limited partnership'' as a DPP organized as
a limited partnership. (emphasis added).
\3\4Subsection (b)(6)(C) thus would regulate a member's
solicitation activities, advisory activities, or the writing of a
fairness opinion. Subsections (b)(6)(A) and (B) currently regulate
only a member's receipt of differential compensation in the
solicitation of votes or tenders.
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1. Receipt of Differential Compensation in DPP Rollups Not Also
Constituting Limited Partnership Rollup Transactions. Congress began to
focus on investor protection, fairness and disclosure issues related to
rollup transactions in 1990. One of the early abuses on which Congress
focussed was payment of compensation to soliciting broker-dealer only
when an investor voted in favor of a rollup transaction. The Rollup
Reform Act requires the NASD to adopt rules proscribing the receipt by
members of ``differential compensation'' when soliciting votes for a
limited partnership rollup transaction. The Commission previously had
approved an NASD rule regulating its members' receipt of differential
compensation in DPP rollups.\35\
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\35\See Securities Exchange Act Release No. 29582 (Aug. 19,
1991), 56 FR 42095 (Aug. 26, 1991) (approving SR-NASD-91-24).
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Current Subsections (b)(6) (A) and (B) were adopted in that rule
change to regulate the participation of members in the solicitation of
votes or tenders from participants in a rollup of a DPP. The NASD
stated in Amendment No. 7 that at the time of its adoption, the SEC and
NASD were aware that the definition of ``rollup of a direct
participation program'' was broader than the definition of ``limited
partnership rollup transaction'' then pending in Congress (and proposed
to be amended in this proposed rule change) because it applies to
``direct participation programs'' rather than ``limited partnerships''
and does not include all of the exclusions that are available from the
``limited partnership rollup'' definition.\36\
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\36\But see H.R. Rep. No. 254, 102d Cong., 1st Sess. 95 (1991),
which proposed to define ``partnership'' to include ``such other
entity having a substantially economically equivalent form of
ownership instrument as the Commission determines, by rule
consistent with the purposes of [the Limited Partnership Rollup
Reform Act of 1991], to include within this definition.''
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The NASD continues to be concerned that it may be confusing to have
two definitions of a rollup transaction which are different in scope
set forth in Subsection 34(b).\37\ Therefore, the NASD is proposing to
amend Subsections (b)(6) (A) and (B) by replacing the special rollup
definition in those Subsections with the new definition of ``limited
partnership rollup transaction'' and by substituting the term ``limited
partnership rollup transaction'' wherever the term ``rollup of a direct
participation program'' currently appears. The NASD notes that the
result of this amendment would be to limit the scope of these
Subsections as they would not longer be applicable to almost any DPP
rollup, but only to ``limited partnership rollup transactions'' as
defined in the proposed rule change.
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\37\But see e.g., Fryer, A Rollup Update 6 (Practicing Law
Institute Real Estate Law and Practice Course Handbook No. 400,
1994):
In September 1991, in Notice to Members 91-56, the NASD adopted
rules which restrict differential compensation in connection with
the ``rollup of a direct participation program.'' The term ``rollup
of a direct participation program'' is a broader concept than
``limited partnership rollup transactions'' and accordingly the
limitations in the receipt of compensation and the allocation of
expenses which is addressed in this earlier release will apply even
if the transaction is not considered a ``limited partnership rollup
transaction.''
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The Commission notes that its rules governing roll-up
transactions\38\ apply to transactions that involve the combination or
reorganization of one of more finite-life limited partnerships or
similar entities. The Commission is soliciting comment from interested
persons concerning the potential impact of the Differential
Compensation Amendment on the investing public.
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\38\See Items 901-15 of Regulation S-K, 17 CFR 229.901-915
(1993).
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2. When a Limited Partnership Rollup Transaction is Presumed Not to
be Unfair or Unreasonable. Pursuant to new Subsection (b)(6)(C)(i), the
NASD proposes to define a series of circumstances with respect to
limited partnership rollup transactions which are presumed not to be
unfair or unreasonable. In accordance with the Rollup Reform Act, it is
presumed not to be unfair or unreasonable if dissenting limited
partners are offered one of the following: an appraisal and
compensation, retention of a security with substantially the same terms
and conditions as the original limited partnership, approval of the
rollup transaction by not less than 75 percent of the outstanding units
of each participating limited partnership, or other comparable rights
designed to protect dissenting limited partners. Protections for
limited partners also include the right of limited partners not to have
their voting power unfairly reduced, the right of limited partners not
to bear unfair costs associated with a rollup transaction that is
rejected, and certain restrictions on abusive changes in management
fees and compensation. As noted above, dissenters' rights may be
asserted only by a person who, on the date that rollup soliciting
material is mailed to investors, is a holder of a beneficial interest
in the limited partnership that is the subject of the rollup. The
proposed rule change would require a transaction constituting a
``limited partnership rollup transaction'' to include one of the
provisions set forth in Subsections (b)(6)(C)(i) a., b., or c.,
discussed below.
a. Compensation Based on Appraisal: New Subsection (b)(6)(C)(i)a.
provides that dissenting limited partners must receive compensation
based on an appraisal made by an independent appraiser, unaffiliated
with the sponsor or general partner of the program. The appraisal
provided should consist of an accurate measure of the present financial
value of the dissenting investor's ownership interest in the underlying
assets of the limited partnership.
Forms of compensation based on appraisal may include cash, secured
or unsecured debt instruments, or freely-tradable securities.
Subsection (b)(6)(C)(i) imposes several conditions upon the issuance of
debt instruments to ensure that the debt issued is equivalent in value
to the cash payment and, if readily marketable, would likely trade in
an aftermarket at such value.\39\ This is intended to prevent
dissenting investors from being forced to accept debt instruments
which, reflecting their below-market value, would immediately trade at
a substantial discount.
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\39\All debt instruments must provide for a trustee and an
indenture, and provide for prepayment with 80% of the net proceeds
of any sale or refinancing of the assets of the entity. All debt
instruments must provide the holders with a market rate of interest
equal to at least 120% of the applicable federal rate and have a
term not longer than 8 years. Unsecured debt instruments may be used
only when the entity issuing the debt has a limitation on total
leverage not greater than 70% of the appraised value of its assets.
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Freely-tradable securities may be utilized as compensation only if
issued by a company which has been listed on a national securities
exchange or traded on the Nasdaq Stock Market prior to the transaction.
The number of freely-tradable securities offered in return for
partnership interests would be determined in relation to the average
last sale price of the securities in the 20-day period following the
date of the meeting at which the vote on the rollup occurs.\40\ If the
issuer of the freely-tradable securities and the sponsor or general
partner are affiliated (i.e., if it receives any material compensation
from the issuer or its affiliates in conjunction with the rollup
transaction or the purchase of the general partner's interest), and the
securities issued as compensation are new securities, such securities
must not represent more than 20% of the issued and outstanding
securities of that class after issuance. The 20% limitation on the
amount of securities offered as compensation by an affiliate helps to
establish a threshold below which significant dilution could be
presumed not to have not occurred.
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\40\In response to a comment by the ABA, the NASD clarified that
the ``freely-tradable securities'' referred to in Subsection
(b)(6)(C)(i)a.4. would be valued at a 20-day period ``following the
date of the meeting at which the vote on the limited partnership
rollup occurs. The `vote' referred to may be a vote, consent, or
authorization.'' See Amendment No. 5.
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b. Receipt of a Security With Substantially the Same Terms and
Conditions: New Subsection (b)(6)(C)(i)b. provides that dissenting
limited partners may receive or retain a security with substantially
the same terms and conditions as the original issue if certain
conditions are met. Retention of a security under the same terms and
conditions as the original issue means the provision of a security that
has the same characteristics as the dissenting limited partners'
original limited partnership interest.
c. Comparable Rights: Supermajority Approval, Review by Independent
Committee, and Other Comparable Rights: New Subsection (b)(6)(C)(i)c.
permits members and persons associated with members to participate in a
limited partnership rollup transaction as long as the transaction
includes ``other comparable rights'' provisions designed to protect the
rights of limited partners. This Subsection is intended to provide
flexibility for sponsors and general partners in structuring rollups,
while at the same time providing protections for limited partners.
``Comparable rights'' may include the right to supermajority approval
of the transaction, the right to review of the transaction by an
independent committee, or such other rights as the NASD deems
comparable.
(i) Supermajority Approval. General partners will not be required
to provide the right of compensation, as provided in new Subsection
(b)(6)(C)(i) where at least 75% of the outstanding units of each of the
individual limited partnerships participating approve the rollup
transaction. Any limited partnership that fails to reach the 75%
threshold must be excluded from the rollup transaction. The proposed
rule change, however, would permit a limited partnership rollup
transaction to be consummated even though individual partnerships did
not approve the transaction.
(ii) Review by Independent Committee. The proposed rule change
relating to review by an independent committee will require that the
committee: (1) Be approved by a majority of the outstanding securities
of each participating limited partnership; (2) have access to the books
and records of the partnership; (3) prepare a report to the limited
partners that are the subject of the rollup presenting its findings and
recommendations, including any minority views; (4) have the authority
to negotiate the proposed transaction with the general partner or
sponsor on behalf of the limited partners, but not the authority to
approve the transaction; (5) deliberate for a period no longer than 60
days unless unanimously agreed upon by the members of the independent
committee or if approved by the NASD; (6) may be compensated and
reimbursed by the partnerships subject to the limited partnership
rollup transaction and have the ability to retain independent counsel
and financial advisors to represent all limited partners at the limited
partnerships' expense; and (7) be entitled to indemnification to the
maximum extent permitted by law from the general partners, sponsors,
limited partnerships, and rolled-up entities against claims, causes of
action or lawsuits initiated by any party in interest, including
limited partnerships or limited partners, related to any action or
decision made in furtherance of their responsibilities.
(iii) Other Comparable Rights. Comparable rights for dissenting
limited partners are not limited to supermajority approval or the
establishment of an independent committee, but may include any other
comparable right proposed by general partners or sponsors, provided
that the general partners or sponsors demonstrate to the satisfaction
of the NASD, or if the NASD determines appropriate, to the satisfaction
of an independent committee, that the rights proposed are
comparable.\41\
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\41\The composition of such independent committee to review
proposed alternative comparable rights under this provision may be
different than the independent committee formed pursuant to proposed
Subsection (b)(6)(C)(i)c.2. Additionally, the criteria utilized by
the independent committee to review proposed alternative comparable
rights under this provision may differ from that required by the
independent committee formed pursuant to proposed Subsection
(b)(6)(C)(i)c.2.
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3. When a Rollup Transaction is Presumed to be Unfair or
Unreasonable. Regardless of compliance with Subsection (b)(6)(C)(i), a
limited partnership rollup transaction will be presumed to be unfair or
unreasonable, pursuant to new Subsection (b)(6)(C)(ii)\42\ if: (1)
Certain actions taken by the general partner result in the unfair
conversion and valuation of general partner interests in a limited
partnership rollup transaction; (2) a limited partnership rollup
transaction fails to protect the voting rights of the limited partners;
(3) the transaction costs of a rejected limited partnership rollup
transaction are unfairly apportioned or allocated; or (4) the payment
of fees to general partners in connection with limited partnership
rollup transactions are unfair, unreasonable, or inappropriate.
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\42\Where a limited partnership rollup transaction is determined
by NASD staff to include one of the arrangements considered to be
unfair or unreasonable, the member bears the burden of rebutting the
presumption by demonstrating that the arrangement is not unfair or
unreasonable or that the arrangement does not come within one of the
enumerated unfair and unreasonable arrangement provisions.
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a. Actions Taken By the General Partner: New Subsection
(b)(6(C)(ii)a. provides that it presumptively unfair and unreasonable
for general partners, when determining their interest in the new entity
resulting from a limited partnership rollup transaction, to: (1)
convert an equity interest for which consideration has not been paid
into a voting interest in the new entity if the equity interest was not
otherwise provided for in the limited partnership agreement and
disclosed to limited partners; (2) fail to follow the valuation
methods, if any, in the partnership agreements when valuing their
partnership interests;43 or (3) utilize a projected value of their
equity interest rather than the appraised current value of their equity
interest when determining their interest in the new entity.
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\4\3In its comment letter, the ABA pointed out that partnership
agreements do not generally contain such valuation provisions. The
NASD amended its rule to clarify that it applies to rollups that
contain valuation provisions. See Amendment No. 5.
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b. Voting Rights: New Subsection (b)(6(C)(ii)b. contains four
provisions for the protection of investors with respect to voting
rights. New Subsection (b)(6(C)(ii)b.1. provides that it is
presumptively unfair if the voting rights in the entity resulting from
the limited partnerships rollup transaction do not follow the original
voting rights of the limited partnerships participating in the
transaction. However, the NASD recognizes that certain material changes
to voting rights may be necessary to conform disparate rights that may
exist among participating partnerships. Material changes may be
effected only if the NASD determines that the changes are not unfair or
if an independent committee approves such changes.44
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\4\4See supra n. 41.
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New Subsection (b)(6(C)(ii)b.2. provides that it is presumptively
unfair if a majority45 of the interests in an entity resulting
from a limited partnership rollup transaction is unable to vote to
cause the entity to take certain actions which are ordinarily the
prerogative of the owners rather than management. Thus, it is
presumptively unfair not to permit a vote to amend the limited
partnership agreement, articles of incorporation, bylaws, or indenture.
It is also presumptively unfair not to permit a vote to dissolve the
entity. It is also presumptively unfair not to permit a vote to remove
and elect the general partners, board of directors, trustee, or similar
governing entity. Finally, it is presumptively unfair not to permit a
vote to approve or disapprove the sale of substantially all the assets
of the entity, without concurrence by the sponsor, general partner(s),
board of directors, trustee, or similar governing entity, unless such
actions would be inconsistent with state law.46
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\4\5The term ``majority'' refers to a 50%-plus-one vote except
as superseded by state law or the partnership agreement which may
require a higher standard. See Amendment No. 5.
\4\6In response to several commenters, the NASD amended its rule
to make it clear that it would not conflict with or supersede state
corporate law. See infra n. 54-55 and accompanying text.
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New Subsection (b)(6(C)(ii)b.3. provides that it is presumptively
unfair if the sponsor or general partner proposing a limited
partnership rollup transaction is not required to provide a document
which clearly delineates instructions and procedures of voting against
or dissenting from a proposed transaction.
New Subsection (b)(6(C)(ii)b.4. provides that it is presumptively
unfair if the general partner or sponsor fails to utilize an
independent third party to receive and tabulate all votes and dissents
or fails to require the third party to make the tabulation available to
the general partner and any limited partner upon request at any time
during and after voting occurs.
c. Transaction Costs: Subsection (b)(6(C)(ii)c. provides that it is
presumptively unfair if transaction costs of a rejected limited
partnership rollup transaction are not apportioned between the general
and limited partners in accordance with the final vote as follows: (1)
in the case of a limited partnership rollup transaction which is not
approved, the general partner or sponsor bears transaction costs in
proportion to the total number of abstentions and votes to reject the
transaction, and the limited partners bear transaction costs in
proportion to the number of votes to approve the transaction; or (2) in
the case of a rollup transaction which is approved, but where some
individual partnerships do not approve and are not included in the
approved transaction, the general partner is required to pay costs on
behalf of the limited partnerships who have voted not to approve the
transaction.
With respect to allocating total costs for a rejected limited
partnership rollup transaction, the NASD believes that subsections
(b)(6(B) and (b)(6(C)(ii)d. taken together require the general partner
to pay all the solicitation expenses in addition to transaction costs
in proportion to the total number of abstentions and votes to reject
the transaction. Additionally, limited partnerships which vote to
reject and which are not included in a limited partnership rollup
transaction which is ultimately consummated, may not be assessed any
transaction costs.
d. Fees of the General Partners: New Subsection (b)(6(C)(ii)d.
protects limited partners against the assessment of fees by a general
partner which are unfair, unreasonable, or inappropriate. New
Subsection (b)(6(C)(ii)d.1. provides that it is presumptively unfair
for general partners to receive or convert unearned management fees
discounted to a present value while also proposing to receive new
asset-based fees. A similar presumption of unfairness applies if
property management fees and other fees are inappropriate,
unreasonable, greater than or not competitive with the fees that would
be paid to third parties for performing similar services under proposed
Subsection (b)(6(C)(ii)d.2. Subsection (b)(6(C)(ii)d.3. provides that
substantial and adverse changes in fees are presumed unreasonable if
not submitted to and approved by an independent committee.47
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\4\7See supra n. 41.
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Proposed Rule Change to Schedule D
The NASD is proposing to amend Part I and III to Schedule D to the
NASD By-Laws to establish listing standards for Nasdaq/NM securities
resulting from a limited partnership rollup transaction, as required by
new Section 15A(b)(13) of the Exchange Act. The rule language is the
same as that proposed for inclusion in Subsection (b) of Article III,
Section 34 of the Rules of Fair Practice with two minor exceptions.
When the term ``direct participation program'' is used in the
definition section, a cross-reference is provided to the definition of
that term in Article III, Section 34 of the Rules of Fair Practice. In
addition, the term ``management fee'' is modified to refer only to such
fees related to a ``limited partnership.'' In comparison, the
definition in Article III, Section 34(b) of the Rules of Fair Practice
substituted the term ``direct participation program'' because the term
``management fee'' is used elsewhere in Article III, Section 34(b) of
the Rules of Fair Practice and the definition, therefore, should be
applicable to any DPP.\48\
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\48\The new listing criteria for limited partnership rollups are
included in new Section 3 to Part III of Schedule D. Current
Sections 3 through 7 are redesignated to reflect the addition of new
Section 3 and are amended to reference the limited partnership
rollup criteria. Proposed Section 8 is amended to permit the NASD to
terminate an issue's designation if it no longer complies with the
requirements in redesignated Sections 5 and 6 or 7.
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Application of Proposed Rule Change to UPREITs
UPREIT transactions have certain general characteristics. A limited
partnership or partnerships are consolidated into an operating limited
partnership. The consolidation is generally conducted as a private
placement. In order to effect a non-taxable exchange, the individual
limited partnership interests or the properties are exchanged for the
operating limited partnership units.\49\ The general partner of the
operating limited partnership, a real estate investment trust
(``REIT''), issues beneficial interests to investors in exchange for
cash to raise capital that will purchase some of the operating
partnership units. The operating partnership, in turn, may use the
proceeds to pay the debts of the limited partnerships included in the
operating partnership. It may use the proceeds for other purposes, such
as buying additional properties. The REIT shares may be listed on a
national securities exchange or Nasdaq/NM and, thus, reported under a
transaction reporting plan. As part of the transaction, the unitholders
of the new operating partnership are generally given an open-ended
option after one year to redeem their operating partnership units for
cash from the REIT. Instead of offering cash, the typical REIT may, at
its option, offer unitholders REIT units for the operating partnership
units pursuant to a private exchange offering or a registered exchange
offering, depending on how the offering is structured. It is, however,
optional to the operating partnership unitholders as to whether to
exercise the redemption right.
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\49\Built-in gain is deferred, not eliminated. Also, the
exchange of old partnership interests for operating partnership
units is not necessarily tax-free under all circumstances. After the
proceeds of the public REIT offering are used to pay down debt, if a
partner's share of liabilities of the operating partnership is less
than the same partner's share of liabilities of the old partnership,
the partner will be treated as having received a cash distribution.
If the distribution exceeds the adjusted basis in the partner's
operating units, the partner will recognize taxable gain. If the old
partnerships partly sell and partly contribute property to the
operating partnership, partners in the operating partnership may
realize phantom income.
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A. UPREIT Structures
UPREIT transactions have varying structures. The NASD is currently
aware of at least three structures. First, UPREITs can be structured so
that both the consolidation of limited partnership interests into the
operating partnership and the issuance of REIT shares to investors are
effected pursuant to bona fide private placement exemptions under
Section 4(2) of the Securities Act (``private placement exemption''),
after which the operating partnership units may be redeemed for cash
or, at the REIT's option, exchanged for REIT shares in a private
exchange offering.
A second structure involves the consolidation of limited partners'
interests into the operating limited partnership in a registered
transaction, with a simultaneous public offering of REIT units. The
REIT shares are listed on a national securities exchange or authorized
for quotation on Nasdaq/NM and are reported under a transaction
reporting plan. The offer by the REIT to the limited partners in the
operating partnership to exchange their operating partnership units for
REIT shares is effected as a registered exchange offer.
A third structure involves the consolidation of limited partners'
interests into the operating limited partnership pursuant to a bona
fide private placement exemption, along with a public offering of units
by the REIT general partner. The REIT is listed on a national
securities exchange or Nasdaq/NM. The REIT is thus a reporting company
prior to any exchange offer of REIT shares for operating partnership
units. The offer by the REIT to the limited partners in the operating
partnership to exchange their operating partnership units for REIT
shares is effected as a separate bona fide private placement with the
shares then registered by the REIT for the benefit of new holders
through a shelf-registration statement or as a registered exchange
offer.
B. Applicability of the Proposed Rule Change to UPREIT Transactions
As a result of an understanding reached between the staffs of the
NASD and the SEC, the NASD's Corporate Financing Department intends to
work closely with the SEC's Division of Corporation Finance to review
all direct, indirect and multi-step limited partnership rollup
transactions in their entirety, including UPREIT transactions, for an
initial determination of whether a transaction constitutes a ``limited
partnership rollup transaction.''
The NASD believes that the first type of UPREIT transaction
described above is not subject to the proposed rule change
where the claim of a private placement exemption for the exchange offer
is bona fide. Such a transaction does not meet the definition of
``limited partnership rollup transaction'' because the original limited
partners are receiving securities in the operating partnership that are
not required to be registered under the Securities Act.
The NASD believes that the second type of UPREIT transaction
described above is subject to the coverage of the proposed rule change
because the transaction viewed in its entirety meets the definition of
``limited partnership rollup transaction'' and does not qualify for any
of the exemptions from the definition.
Regarding the third type of UPREIT transaction described above, the
NASD will conduct its review of applicability of the proposed rule
change in conjunction with the SEC's review for an initial
determination of whether the entire transaction should be reviewed as a
roll-up because it is a step transaction that indirectly involves a
roll-up.\50\ In the case of a valid private placement of operating
partnership units followed by a registered exchange of units for REIT
shares in a short period of time, the two transactions may be stepped
together and therefore subject to full review under the proposed rule
change. Another situation where the proposed rule change might be
applicable to the third type of UPREIT transaction is if the claim of a
private placement for the consolidation into the operating partnership
is not bona fide and the operating partnership transaction is required
to be registered with the Commission and conducted as a public offering
at the same time that the public REIT offering occurs. In this instance
also, the NASD would review the transaction for compliance with the
terms of the proposed rule change.
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\50\See supra n. 32 and accompanying text.
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Comments Received on Proposed Rule Change
The Commission received seven comment letters. The comment letters
from the IPA, DeMott, and the ABA expressed support for the proposed
rule change. One comment letter, from Kelley, stated that the NASD
rules should not be adopted ``in the absence of a legislative
mandate.'' The comment letters from Baker & Botts, Kutak Rock, and
Hogan & Hartson neither supported nor opposed the proposed rules but
offered suggestions on how to enhance the NASD's rule.
As noted above, Congress passed the Rollup Reform Act subsequent to
the receipt of the comment letters. The Rollup Reform Act rendered moot
many of the issues raised by commenters. The significant issues that
were raised and not subsequently mooted by the Rollup Reform Act are
addressed below. In addition, the NASD also made several technical
amendments in response to the comment letters.\51\
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\51\See Amendment No. 5.
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A. Right of Compensation Based on Appraisals
Kelly noted that some partnerships, e.g. oil and gas, already
include requirements for a supporting appraisal underlying the exchange
value determination. Therefore, according to Kelley, the NASD's
requirement that dissenters' rights of compensation be based on
appraisal, would give the dissenters the right to a second appraisal
which would be ``redundant and wasteful.''
The NASD has stated that ``an appraisal that functions to determine
the transaction's exchange value could also be used to determine the
value of dissenters's compensation so long as the appraisal is done in
a manner consistent with the appropriate industry practice.''
Hogan & Hartson argues that the appraisal rights provisions under
new Subsection (b)(6)(C)(i) should be clarified to permit one
partnership participating in a rollup to offer one type of right while
another partnership may offer another type of right, stating that such
an option would be satisfactory from a fairness perspective.
New Subsection (b)(6)(C)(i) does not by its terms prohibit
structuring a rollup offering such that different rights may be offered
to different partnerships involved in the same transaction. Further,
the ``other comparable rights'' provision in Subsection
(b)(6)(C)(i)c.3. allows for variations in structuring that, subject to
NASD approval, are indeed comparable to rights provided in the proposed
rule change, including variations in form as well as substance.
B. Compensation of Dissenters
Two commentators\52\ expressed concern about the use of ``freely-
tradable securities'' as compensation for dissenting limited partners,
pursuant to new Subsection (b)(6)(C)(i)a.
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\52\See DeMott and Kelley.
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The use of a ``freely-tradable security'' as compensation is
reasonable. The listing standards of the exchanges and of Nasdaq should
provide adequate protection against dilution when ``freely-tradable
securities'' are offered as compensation.
One the issue of valuation of the ``freely-tradable securities,''
the ABA voiced concern about the method that the NASD will use to
calculate the value of the securities that will be used as
compensation. New Subsection (b)(6)(C)(i) provides that the value of
the freely-tradable security must be determined in relation to the last
sale price ``in the 20-day period following the effective date.'' The
ABA noted that the ``effective date'' must refer to the effective date
of the registration statement rather than to the closing of the rollup
occurs.''\53\
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\53\See Amendment No. 5.
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C. Valuation Provisions
Subsection (b)(6)(C)(ii)a.2. provides that a rollup is presumed to
be unfair if the general partner fails to follow the valuation
provision in the limited partnership agreement. The ABA pointed out
that partnership agreements do not contain such valuation provisions,
and suggested revised language to accommodate such a contingency and
permit reliance on ``more favorable'' valuation provisions than those
in limited partnership agreements ``if any.''
The NASD stated that it does not want to make determinations as to
whether a proposed valuation method is more favorable than those
contained in limited partnership agreements to which investors have
previously agreed. However, the NASD amended its rule to clarify that
Subsection (b)(6)(C)(ii)b.1. applies to rollups which contain valuation
provisions.
Hogan & Hartson argues that the valuation requirements in new
Subsections (b)(6)(C)(ii)a.2. and 3. should be clarified by
explanations of how valuation provisions of limited partnership
agreements and utilization of current value methodology can be both
followed in the event of inconsistency, and requests that the NASD
explain the meaning of the terms ``current value'' and ``future value''
in new Subsection (b)(6)(C)(ii)a.3.
The NASD believes that the use of a ``current value'' for
evaluating equity interests of the roll-up partnerships when
determining the general partner's/sponsor's interest in the new entity
is fair because the guesswork involved in arriving at any ``future
value'' estimate may prejudice the limited partners in favor of the
general partners, especially if the estimated value is exaggerated.
However, the NASD also believes that the valuation of partnership
interests should be appropriate to the particular industry, and that is
permissible, for example, to interpret ``current value'' on a ``going
concern'' or ``liquidation'' basis.
With regard to Subsection (b)(6)(C)(ii)a.2., the NASD generally
believes that the fairest valuation method of all is that method which
reflects, as much as possible, the original agreement or contract
between the general partner/sponsor and limited partners. However, the
NASD believes that if the valuation provisions of the existing
partnership agreements require a future valuation of general partner
interests which would be inconsistent with the proposed rule change's
requirement that current value be used, then the requirement to use
current value supersedes the requirement to follow valuation models in
the original partnership agreements.
D. Voting Rights
When the proposed rule was published in the Federal Register the
Commission specifically sought comment on any potential conflicts
between the NASD's proposal and state contract or corporate law. The
Commission received four comment letters concerning a conflict between
the voting rights provision of proposed Subsection (b)(6)(C)(ii)b.2.
and state corporate law.\54\ The NASD amended its rule to make it clear
that it would not conflict with or supersede state corporate law. In
response to the Commission's concerns and the comment letters received,
the NASD amended its rule to make it clear that the rule would not
conflict with or preempt state corporate law.\55\
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\54\ABA, Baker & Botts, Kelley, and DeMott. The ABA noted that
while the NASD's rule conflicts with most state law, it does not
conflict with the laws of some states, such as Massachusetts.
\55\Additionally, the term ``management'' in Subsection
(b)(6)(C)(ii)2.C. was replaced with the phrase ``general partner,
board of directors, trustee, or similar governing entity'' to
comport with the introductory clause of Subsection (b)(6)(C)(ii)2.C.
See Amendment No. 6.
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Hogan & Hartson argued that the Rollup Reform Act did not mandate
that the NASD impose specific voting rights, especially for the
operating partnership in UPREITs, because very few partnership
agreements provide for such rights in any case.
The Commission believes that the proposed rule change does not
impose specific voting rights. First, as noted above, the rule is
drafted in a manner that defers to applicable state law. Second, if the
NASD staff determines that a particular voting arrangement is
presumptively unfair or unreasonable, the member may nonetheless rebut
the presumption if it demonstrates that the arrangement is not unfair
or unreasonable or that the arrangement does not come within one of the
enumerated unfair and unreasonable arrangement provisions.
E. Transaction Costs
New Subsection (b)(6)(C)(ii)c. requires that transaction costs be
apportioned according to voting so that, in a rejected rollup
transaction, the general partner bears the costs of the transaction in
proportion to the total number of rejections and abstentions. the IPA
suggested that it was inappropriate to require the general partner to
bear the cost of a rejected rollup transaction in proportion to
abstentions.\56\
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\56\Hogan & Hartson argued that the Rollup Reform Act does not
mandate that the general partner or sponsor bear all the costs of a
rejected transaction. However, new Subsection (b)(6)(C)(ii)c.1. does
not require the general partner/sponsor to bear ``all'' costs of a
rollup transaction that is not approved, but only those costs in
proportion to the total number of abstentions and votes to reject
the transaction; limited partners bear costs in proportion to the
number or votes to approve the transaction.
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The Commission disagrees. In proposing Subsection (b)(6)(C)(ii)c.,
the NASD stated that it intended to ``encourage general partners to
structure a fair transaction that will be approved by limited
partners.'' By placing the transaction costs of a rejected rollup on
the general partner or the sponsor, the NASD is imposing the
appropriate burden on the general partner or sponsor to structure a
rollup in a manner intended to secure as many favorable votes as
possible.
F. Fees to the General Partner
New Subsection (b)(6)(C)(ii)d. sets forth criteria to use in
determining whether fees paid to the general partner in a rollup are
presumptively unfair. Subsection (b)(6)(C)(iv)3. provides that changes
in fees which are substantial and adverse to limited partners are
presumed unreasonable if not submitted to or approved by an independent
party. In order to simplify compliance with the terms of Subsection
(b)(6)(C)(ii)(4)(C), the IPA suggested that the NASD, in addition to an
independent committee, be permitted to approve changes in fees which
are substantial and adverse to limited partners.
In its response to this comment the NASD stated that it is not
appropriate for the NASD to make a determination to approve fees that
are substantial or adverse to the limited partners.
G. UPREITs
Hogan & Hartson argues that UPREIT transactions do not trigger the
application of the proposed rule change because such transactions
either do not come under the definition of ``limited partnership rollup
transaction,'' or, conceding the application of the definition, meet
the requirements of one or more transactional exemptions from the
definition. Hogan & Hartson concludes that the only part of the entire
UPREIT transaction under consideration is the potential redemption/
exchange of operating units for cash or REIT shares, not the initial
consolidation of individual partnership interests into operating
partnership units, nor the initial consolidation in conjunction with
the redemption/exchange. Hogan & Hartson argues that the initial
consolidation of limited partnership interests into an operating
partnership that does not have its shares traded on an exchange or
authorized for quotation on Nasdaq/NM does not come within the
definition of a limited partnership rollup transaction and, thus, falls
outside the purview of the proposed rule change.
The Commission disagrees. UPREIT transactions should not be viewed
in discrete stages, as if each stage in the transaction were isolated
from any other stage, with no contemplated interrelationship between
the partners, promoters, investors and financing plans of the
partnership consolidation stage and the partners, promoters, investors
and financing plans of the exchange offering stage.
V. Discussion
The Commission finds good cause for partially approving Amendments
5-8 on an accelerated basis.\57\ As indicated above, the Commission
recognizes that the rule change will provide important benefits to
investors who may be subject to limited partnership rollup transactions
in that the amended proposed rule change will ensure that investors'
rights are protected in accordance with the intent of Congress as
embodied in the Rollup Reform Act. In addition, the Commission finds
that notice in advance of approval of those Amendments intended to
conform the proposed rule change with the Rollup Reform Act is
unnecessary because the Rollup Reform Act itself has given interested
parties constructive notice of pertinent terms of the Amendments. The
Commission also finds that, except as noted above, those amendments to
the proposed rule change not intended to conform the proposed rule
change with the Rollup Reform Act are intended merely to clarify the
rule change. The NASD will implement the rule change on November 1,
1994. The Commission believes that accelerated approval will avoid
unnecessary delay in requiring members to ensure that they participate
in limited partnership rollup transactions only if those transactions
provide for fair treatment of limited partnership investors, protect
the rights of all limited partners, including dissenting limited
partners, and do not contain unfair or unreasonable terms.
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\57\The Commission does not find good cause for approving the
Differential Compensation Amendment.
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The Commission finds that, with the exception of the Differential
Compensation Amendment, the proposed rule change is consistent with the
provisions of Section 15A(b)(6)\58\ of the Exchange Act, which require,
in pertinent part, that the rules of a registered securities
association be designed to prevent fraudulent and manipulative acts,
promote just and equitable principles of trade, and protect investors
and the public interest; the provisions of Section 15A(b)(12)\59\ of
the Exchange Act, which require the rules of a registered securities
association to promote just and equitable principles of trade include
rules to prevent members of the association from participating in any
limited partnership rollup transaction that does not provide procedures
to protect certain specified rights of limited partners; and the
provisions of Section 15A(b)(13)\60\ of the Exchange Act, which require
that the rules of a registered securities association prohibit the
authorization for quotation on an automated interdealer quotation
system sponsored by the association any security designated by the SEC
as a national market system security resulting from a limited
partnership rollup transaction, unless such transaction provides
certain rights for limited partners. The proposed rule change will
restrict member participation in unfair rollup transactions and
prohibit inclusion in Nasdaq/NM of any securities resulting from an
unfair rollup transaction.
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\58\15 U.S.C. Sec. 78o-3(b)(6).
\59\15 U.S.C. Sec. 78o-3(b)(12).
\60\Id.
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The Rollup Reform Act reflects a brief that partnership rollup
transactions, when properly structured, may offer significant benefits
to investors and for businesses that have used these structures to
raise capital. However, Congress has determined that abusive limited
partnership rollup transactions harm investors, undermine investor
confidence and threaten capital formation.\61\ The proposed rule change
will permit rollups to take place but will curtail the abusive
practices that have occurred in the past. The proposed rule change is
designed to ensure the fairness of partnership rollup to the limited
partners by giving dissenters the right to compensation, based on
appraisal, rather than being forced into a rollup. In addition the
proposed rule change contains provisions which prevent the unfair
conversion and valuation of the general partner's interests in a rollup
transaction, prevent investors' voting rights from being unfairly
reduced or abridged, prevent the limited partners from having to bear
an unfair portion of the cost of a transaction that has been rejected,
and prevent the payment of fees to general partners in connection with
a rollup that are unfair, unreasonable, or inappropriate.
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\61\Senate Report, supra n. 9, at 9.
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Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 5-8. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., 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 an copying
in the Commission's Public Reference Room. Copies of the filing will
also be available for inspection and copying at the principal office of
the NASD. All submissions should refer to SR-NASD-93-03 and should be
submitted by September 12, 1994.
It Is Therefore Ordered, pursuant to Section 19(b)(2)\62\ of the
Exchange Act, that the proposed rule change SR-NASD-93-3 be, and hereby
is approved, except with respect to that portion of Amendment No. 7
that proposes amendments to Subsections (b)(6)(A) and (b)(6)(B) of
Article III, Section 34 of the NASD Rules of Fair Practice. For the
Commission, by the Division of Market Regulation, pursuant to delegated
authority.\63\
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\62\15 U.S.C. Sec. 78s(b)(2).
\63\17 CFR 200.30-3(a)(12).
[FR Doc. 94-20479 Filed 8-19-94; 8:45 am]
BILLING CODE 8010-01-M
