[Federal Register Volume 59, Number 153 (Wednesday, August 10, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-19444]


[[Page Unknown]]

[Federal Register: August 10, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34485; File No. SR-NASD-94-15]

 

Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
the NASD's Free-Riding and Withholding Interpretation

August 3, 1994.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on March 
18, 1994, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by the NASD. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to amend its Free-Riding and Withholding 
Interpretation, an Interpretation of the NASD's Board of Governors 
under Article III, Section 1 of the Association's Rules of Fair 
Practice.\1\ Below is the text of the proposed rule change. Proposed 
new language is in italics; proposed deletions are in brackets.

    \1\NASD Manual, Rules of Fair Practice, Art. III, Sec. 1 (CCH) 
2151.06.
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``Free-Riding and Withholding'' Introduction
    The following Interpretation of Article III, Section 1 of the 
Association's Rules of Fair Practice is adopted by the Board of 
Governors of the Association pursuant to the provisions of Article VII, 
Section 3(a) of the Association's By-Laws and Article I, Section 3 of 
the Rules of Fair Practice.
    This Interpretation is based upon the premise that members have an 
obligation to make a bona fide public distribution at the public 
offering price of securities of a public offering which trade at a 
premium in the secondary market whenever such secondary market begins 
(a ``hot issue'') regardless of whether such securities are acquired by 
the member as an underwriter, as a selling group member, or from a 
member participating in the distribution as an underwriter or a selling 
group or otherwise. The failure to make a bona fide public distribution 
when there is a demand for an issue can be a factor in artificially 
raising the price. Thus, the failure to do so, especially when the 
member may have information relating to the demand for the securities 
or other factors not generally known to the public, is inconsistent 
with high standards of commercial honor and just and equitable 
principles of trade and leads to an impairment of public confidence in 
the fairness of the investment banking and securities business. Such 
conduct is, therefore, in violation of Article III, Section 1 of the 
Association's Rules of Fair Practice and this Interpretation thereof 
which establishes guidelines in respect to such activity.
    As in the case of any other Interpretation issued by the Board of 
Governors of the Association, the implementation thereof is a function 
of the District Business Conduct Committees and the Board of Governors. 
Thus, the Interpretation will be applied to a given factual situation 
by individuals active in the investment banking and securities business 
who are serving on these committees or on the Board. They will construe 
this Interpretation to effectuate its overall purpose to assure a 
public distribution of securities for which there is a public demand.
    The Board of Governors has determined that a member who makes an 
allocation to a restricted person or account of an offering that trades 
at a premium in the secondary market shall not be considered to have 
violated this Interpretation if it cancels the allocations for such 
restricted person or account, prior to the end of the first business 
day following the date on which secondary market trading commences and 
reallocates such security at the public offering price to an non-
restricted person or account.

Interpretation

    Except as provided herein, it shall be inconsistent with high 
standards of commercial honor and just and equitable principles of 
trade and a violation of Article III, Section 1 of the Association's 
Rules of Fair Practice for a member, or a person associated with a 
member, to fail to make a bona fide public distribution at the public 
offering price of securities of a public offering which trade at a 
premium in the secondary market whenever such secondary market begins 
regardless of whether such securities are acquired by the member as an 
underwriter, a selling group member or from a member participating in 
the distribution as an underwriter or selling group member, or 
otherwise. Therefore, it shall be a violation of Article III, Section 1 
for a member, or a person associated with a member, to:
    1. Continue to hold any of the securities so acquired in any of the 
member's accounts;
    2. Sell any of the securities to any officer, director, general 
partner, employee or agent of the member or of any other broker/dealer, 
or to a person associated with the member or with any other broker/
dealer, or to a member of the immediate family of any such person; 
provided however, that:
    (a) This prohibition shall not apply to a person in a limited 
registration category as that term is defined below; and
    (b) The prohibition shall not apply to sales to a member of the 
immediate family of a person associated with a member whose is not 
supported directly or indirectly to a material extent by such person if 
the sale is by a broker/dealer other than that employing the restricted 
person and the restricted person has no ability to control the 
allocation of the hot issue.
    3. Sell any of the securities to a person who is a finder in 
respect to the public offering or to any person acting in a fiduciary 
capacity to the managing underwriter, including, among others, 
attorneys, accountants and financial consultants, or to [a member of 
the immediate family of any such person;] any other person who is 
supported directly or indirectly, to a material extent, by any person 
specified in this paragraph.
    4. Sell any securities to any senior officer of a bank, savings and 
loan institution, insurance company, [registered] investment company, 
[registered] investment advisory firm or any other institutional type 
account (including, but not limited to, hedge funds, investment 
partnerships, investment corporations, or investment clubs), domestic 
or foreign, or to any person in the securities department of, or to any 
employee or any other person who may influence or whose activities 
directly or indirectly involve or are related to the function of buying 
or selling securities for any bank, savings and loan institution, 
insurance company, [registered] investment company, [registered] 
investment advisory firm, or other institutional type account, domestic 
or foreign, or to [a member of the immediate family of any such 
person;] any other person who is supported directly or indirectly, to a 
material extent, by any person specified in this paragraph.
    5. Sell any securities to any account in which any person specified 
under paragraphs (1), (2), (3) or (4) hereof has a beneficial interest;
    Provided, however, a member may sell part of its securities 
acquired as described above to:
    (a) persons enumerated in paragraphs (3) or (4) hereof; and
    (b) members of the immediate family of persons enumerated in 
paragraph (2) hereof provided that such person enumerated in paragraph 
(2) does not contribute directly or indirectly to the support of such 
member of the immediate family; and
    (c) any account in which any person specified under paragraph (3) 
or (4) or subparagraph (b) of this paragraph has a beneficial interest;

if the member is prepared to demonstrate that the securities were sold 
to such persons in accordance with their normal investment practice 
[with the member], that the aggregate of the securities so sold is 
insubstantial and not disproportionate in amount as compared to sales 
to members of the public and that the amount sold to any one of such 
persons is insubstantial in amount.
    6. Sell any of the securities, at or above the public offering 
price, to any other broker/dealer; provided, however, a member may sell 
all or part of the securities acquired as described above to another 
member broker/dealer upon receipt from the latter in writing assurance 
that such purchase would be made to fill orders for bona fide public 
customers, other than those enumerated in paragraphs (1), (2), (3), (4) 
or (5) above, at the public offering price as an accommodation to them 
and without compensation for such.
    7. Sell any of the securities to any domestic bank, domestic branch 
of a foreign bank, trust company or other conduit for an undisclosed 
principal unless:
    (a) An affirmative inquiry is made of such bank, trust company or 
other conduit as to whether the ultimate purchasers would be persons 
enumerated in paragraphs (1) through (5) hereof and satisfactory 
assurance is received that the ultimate purchasers would not be such 
persons, and that the securities would not be sold in a manner 
inconsistent with the provisions of paragraph (6) hereof; otherwise, 
there shall be a rebuttable presumption that the ultimate purchasers 
were persons enumerated in paragraphs (1) through (5) hereof or that 
the securities were sold in a manner inconsistent with the provisions 
of paragraph (6) hereof;
    (b) A recording is made on the order ticket, or its equivalent, or 
on some other supporting document, of the name of the person to whom 
the inquiry was made at the bank, trust company or other conduit as 
well as the substance of what was said by that person and what was done 
as a result thereof;
    (c) The order ticket, or its equivalent, is initialed by a 
registered principal of the member; and
    (d) Normal supervisory procedures of the member provide for a close 
follow-up and review of all transactions entered into with the referred 
to domestic bank, trust companies or other conduits for undisclosed 
principals to assure that the ultimate recipients of securities so sold 
are not persons enumerated in paragraphs (1) through (6) hereof.
    8. Sell any of the securities to a foreign broker/dealer or bank 
unless:
    (a) In the case of a foreign broker/dealer or bank which is 
participating in the distribution as an underwriter, the agreement 
among underwriters contains a provision which obligates the said 
foreign broker/dealer or bank not to sell any of the securities which 
it receives as a participant in the distribution to persons enumerated 
in paragraphs (1) through (5) above, or in a manner inconsistent with 
the provisions of paragraph (6) hereof; or
    (b) In the case of sales to a foreign broker/dealer or bank which 
is not participating in the distribution as an underwriter, the selling 
member:

    (i) Makes an affirmative inquiry of such foreign broker/dealer 
or bank as to whether the ultimate purchasers would be persons 
enumerated in paragraphs (1) through (5) hereof and receives 
satisfactory assurance that the ultimate purchasers of the 
securities so purchased would not be such persons, and that the 
securities would not be sold in a manner inconsistent with the 
provisions of paragraph (6) hereof;
    (ii) A recording is made on the order ticket, or its equivalent, 
or upon some other supporting document, of the name of the person to 
whom the inquiry was made at the foreign broker/dealer or bank as 
well as the substance of what was said by that person and what was 
done as a result thereof; and
    (iii) The order ticket, or its equivalent, is initialed by a 
registered principal of the member.

    The obligations imposed upon members in their dealings with foreign 
broker/dealers or banks by this paragraph 8(b) can be fulfilled by 
having the foreign broker/dealer or bank to which sales falling within 
the scope of this Interpretation are made execute Form RF-1, or a 
reasonable facsimile thereof. This form, which gives a blanket 
assurance from the foreign broker/dealer or bank that no sales will be 
made in contravention of the provisions of this Interpretation, can be 
obtained at any District Office of the Association or at the Executive 
Office. The acceptance of an executed Form FR-1, or other written 
assurance, by a member must in all instances be made in good faith. 
Thus, if a member knows or should have known of facts which are 
inconsistent with the representations received, such will not operate 
to satisfy the obligations imposed upon him by this paragraph.

Scope and Intent of Interpretation

    In addition to the obvious scope and intent of the above 
provisions, the intent of the Board of Governors in the following 
specific situations is outlined for the guidance of members.

Limited Business Broker/Dealer

    The restrictions placed on associated persons pursuant to Paragraph 
2 of the Interpretation shall not apply to persons associated with NASD 
members engaged solely in the purchase or sale of either investment 
company/variable contracts securities or direct participation program 
securities.

Issuer Directed Securities

    This Interpretation shall apply to securities which are part of a 
public offering notwithstanding that some or all of those securities 
are specifically directed by the issuer to accounts which are included 
within the scope of paragraphs (3) through (8) above. Therefore, if a 
person within the scope of those paragraphs to whom securities were 
directed did not have the required [an] investment history [with the 
member or registered representative from whom they were to be 
purchased], the member would not be permitted to sell him such 
securities. Also, the ``disproportionate'' and ``insubstantial'' tests 
would apply as in all other situations. Thus, the directing of a 
substantial number of securities to any one person would be prohibited 
as would the directing of securities to such accounts in amounts which 
would be disproportionate as compared to sales to members of the 
public. If such issuer-directed securities are sold to the issuer's 
employees or directors or potential employees or directors resulting 
from an intended merger, acquisition, or other business combination, 
such securities may be sold without limitation as to amount and 
regardless of whether such employees have an investment history as 
required by the Interpretation; provided, however, that in the case of 
an offering of securities for which a bona fide independent market does 
not exist, such securities shall not be sold, transferred, assigned, 
pledged, or hypothecated for a period of three months following the 
effective date of the offering. This Interpretation shall also apply to 
securities which are part of a public offering notwithstanding that 
some of those securities are specifically directed by the issuer on a 
non-underwritten basis. In such cases, the managing underwriter of the 
offering shall be responsible for insuring compliance with this 
Interpretation in respect to those securities.
    Notwithstanding the above, sales of issuer directed securities may 
be made to non-employee/director restricted persons without the 
required investment history after receiving permission from the Board 
of Governors. Permission will be given only if there is a demonstration 
of valid business reasons for such sales (such as sales to distributors 
and suppliers [or key employees], who are in each case incidentally 
restricted persons), and the member seeking permission is prepared to 
demonstrate that the aggregate amount of securities so sold is 
insubstantial and not disproportionate as compared to sales to members 
of the public, and that the amount sold to any one of such persons is 
insubstantial in amount; provided, however, that such securities shall 
not be sold, transferred, assigned, pledged, or hypothecated for a 
period of three months following the effective date of the offering.

Stand-By Purchasers

    Securities purchased pursuant to a stand-by arrangement shall not 
be subject to the provisions of the Interpretation if the following 
conditions are met:

1. The stand-by agreement is disclosed in the prospectus.
2. The stand-by arrangement is the subject of a formal written 
agreement.
3. The managing underwriter represents in writing that it was unable to 
find any other purchasers for the securities.
4. The securities purchased shall be restricted from sale or transfer 
for a period of three months.\2\

    \2\When the securities are sold by stand-by purchasers, the 
stand-by purchasers would need to comply with all applicable 
regulatory requirements including prospectus delivery pursuant to 
Section 5 of the Securities Act of 1933 (``Securities Act'').
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Investment Partnerships and Corporations

    A member may not sell [securities of a public offering which trade 
at a premium in the secondary market whenever such secondary market 
begins (``hot issue''),] a hot issue to the account of any investment 
partnership or corporation, domestic or foreign (except companies 
registered under the Investment Company Act of 1940) including but not 
limited to, hedge funds, investment clubs, and other like accounts 
unless the member complies with either of the following alternatives:
    (A) prior to the execution of the transaction, the member has 
received from the account a current list of the names and business 
connections of all persons having any beneficial interest in the 
account, and if such information discloses that any person [enumerated 
in paragraphs (1) through (4) hereof] restricted under this 
Interpretation has a beneficial interest in such account, any sale of 
securities to such account must be consistent with the provisions of 
this Interpretation, or
    (B) prior to the execution of the transaction, the member has 
obtained a copy of a written representation [current opinion] from 
counsel admitted to practice law before the highest court of any state 
or the account's independent certified public accountant stating that 
such counsel or accountant reasonably believes that no person with a 
beneficial interest in the account is a restricted person under this 
Interpretation and stating that, in providing such [opinion] 
representation, counsel or accountant:

(1) Has reviewed and is familiar with this Interpretation;
(2) Has reviewed a current list of all persons with a beneficial 
interest in the account supplied by the account manager;
(3) Has reviewed information supplied by the account manager with 
respect to each person with a beneficial interest in the account, 
including the identity, the nature of employment, and any other 
business connections of such persons; and
(4) has requested and reviewed other documents and other pertinent 
information and made inquiries of the account manager and received 
responses thereto, if counsel or the accountant determines that such 
further review and inquiry are necessary and relevant to determine 
the correct status of such persons under the Interpretation.

    The member shall maintain a copy of the names and business 
connections of all persons having any beneficial interest in the 
account or a copy of the current [opinion of counsel] written 
representation in its files for at least three years following the 
member's last sale of a new issue to the account, depending upon which 
of the above requirements the member elects to follow. For purposes of 
this section, a list or [opinion] 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.

Beneficial Interest

    The term beneficial interest means not only ownership interests, 
but every type of direct financial interest of any persons enumerated 
in paragraphs (1) through (4) hereof in such account [, including, 
without limitation, management fees based on the performance of the 
account].
    Provided, however, that no restricted person shall be deemed to 
have a beneficial interest in an account receiving a hot issue as a 
result of ownership of an interest in an investment partnership or 
corporation, or similar type account (``investment entity''), if the 
following conditions are met.
    1. The investment entity establishes a separate brokerage account, 
with a separate identification number, for its new-issue purchases. At 
the end of each fiscal year, the general partner, or similarly situated 
party, will certify in writing to its independent certified public 
accountants that: (a) all hot issues purchased by the investment entity 
were placed in this new-issue account; and (b) that the participants in 
the new-issue account are not restricted persons under this 
Interpretation.
    2. Prior to the execution of the initial hot issue transaction, the 
investment entity's accountant or attorney will provide a written 
representation that complies with paragraph B of the section of this 
Interpretation entitled ``Investment Partnerships and Corporations.''
    3. As part of its audit procedure for the investment entity, the 
indendent certified public accountant will confirm in writing to the 
investment entity that all allocations for the new-issue account were 
made in accordance with the provisions of the applicable investment 
entity agreement that restricts participation in hot issue purchases.
    4. The investment entity will maintain in its files copies of the 
certifications, representations, and confirmations referred to in 
paragraphs (1)-(3) above for at least three years following the last 
purchase of a hot issue for the new-issue account.
    5. The investment entity will accept investment funds from other 
investment entities only if such other accounts provide the same 
documentation and assurances described in paragraphs (1)-(4) above that 
restricted persons will not participate in the purchase of hot issues.
    6. The certifications and documents required in paragraphs (1)-(3) 
above shall be provided to the member holding such account at such time 
as these certifications and documents are filed with the investment 
entity and its independent certified public accountant and, the member 
shall make such documentation available to the NASD upon request.

Venture Capital Investors

    This Interpretation shall not prohibit the sale of hot issues in an 
initial public offering to a person restricted under the Interpretation 
or to an account in which such restricted person has a beneficial 
interest (a ``Venture Capital Investor'') if the following conditions 
are met:
    1. The Venture Capital Investor has held an ownership interest in 
the company issuing the hot issue securities for a period of one year 
prior to the effective of the public offering;
    2. The acquisition of the hot issue securities in the public 
offering does not increase the percentage equity ownership of the 
Venture Capital Investor in the company above that held three months 
prior to the filing of the registration statement in connection with 
the offering;
    3. The Venture Capital Investor received no special terms in 
connection with the purchase; and
    4. The securities purchased shall be restricted from sale or 
transfer for a period of three months following the conclusion of the 
offering.

Violations by Recipient

    In those cases where a member or person associated with a member 
has been the recipient of securities of a public offering to the extent 
that such violated the Interpretation, the member or person associated 
with a member shall be deemed to be in violation of Article III, 
Section 1 of the Rules of Fair Practice and this Interpretation as well 
as the member who sold the securities since their responsibility in 
relation to the public distribution is equally as great at that of the 
member selling them. In those cases where a member or a person 
associated with a member has caused, directly or indirectly, the 
distribution of securities to a person falling within the restrictive 
provisions of this Interpretation the member or person associated with 
a member shall also be deemed to be in violation of Article III, 
Section 1 of the Rules of Fair Practice and this Interpretation. 
Receipt by a member or a person associated with a member of securities 
of a hot issue which is being distributed by an issuer itself without 
the assistance of an underwriter and/or selling group is also intended 
to be subject to the provisions of this Interpretation.

Violations by Registered Representative Executing Transaction

    The obligation which members have to make a bona fide public 
distribution at the public offering price of securities of a hot issue 
is also an obligation of every person associated with a member who 
causes a transaction to be executed. Therefore, where sale are made by 
such persons in a manner inconsistent with the provisions of this 
Interpretation, such persons associated with a member will be 
considered equally culpable with the member for the violations found 
taking into consideration the facts and circumstances of the particular 
case under consideration.

Disclosure

    The fact that a disclosure is made in the prospectus or offering 
circular that a sale of securities would be made in a manner 
inconsistent with this Interpretation does not take the matter out of 
its scope. In sum, therefore, disclosure does not affect the 
proscriptions of this Interpretation.

Explanation of terms

    The following explanation of terms is provided for the assistance 
of members. Other words which are defined in the By-Laws and Rules of 
Fair Practice shall, unless the context otherwise requires, have the 
meaning as defined therein.

Associated Person

    A person associated with a member or any other broker/dealer, as 
defined in Article I, paragraph (m) of the NASD's By-Laws, shall not 
include a person whose association with the member is limited to a 
passive ownership interest in the member of ten percent or less, and 
who does not receive hot issues from the member in which he or she has 
the ownership interest; and that such member is not in a position to 
direct hot issues to such person.

Public Offering

    The term public offering shall mean any primary or secondary 
distribution of securities made pursuant to a registration statement or 
offering circular including exchange offers, rights offerings, 
offerings made pursuant to a merger or acquisition, straight debt 
offerings and all other securities distributions of any kind whatsoever 
except any offering made pursuant to an exemption under Section 4(1), 
4(2) or 4(6) of the Securities Act of 1933, as amended, or pursuant to 
Rule 504 (unless considered a public offering in the states where 
offered), Rule 505 or Rule 506 adopted under the Securities Act of 
1933, as amended [all distributions of securities whether underwritten 
or not; whether registered, unregistered or exempt from registration 
under the Securities Act of 1933, and whether they are primary or 
secondary distributions, including intrastate distributions and 
Regulation A issues, which shall at an immediate premium, in the 
secondary market]. It shall not mean exempted securities as defined in 
Section 3(a)(12) of the Securities Exchange Act of 1934.

Immediate Family

    The term immediate family shall include parents, mother-in-law or 
father-in-law, husband or wife, brother or sister, brother-in-law or 
sister-in-law, son-in-law or daughter-in-law, and children. In 
addition, the term shall include any other person who is supported, 
directly or indirectly, to a material extent by the member, person 
associated with the member or other person specified in paragraph[s] 
(2)[, (3), or (4)] above.

Normal Investment Practice

    Normal investment practice shall mean the history of investment of 
a restricted person in an account or accounts maintained by the 
restricted person. [maintained with the member making the allocation. 
In cases where an account was previously maintained with another 
member, but serviced by the same registered representative as the one 
currently servicing the account for the member making the allocation, 
such earlier investment activity may be included in the restricted 
person's investment history.]
* * * * *

Disproportionate

    In respect to the determination of what constitutes a 
disproportionate allocation, the Association uses a guideline of 10% of 
the member's participation in the issue, however acquired.
* * * * *

Insubstantiality

* * * * *
Sales By Issuers in Conversion Offerings
Definitions
* * * * *
Conditions for Exemption
    (b) * * *
    Sales to Members, Associated Persons of Members and Certain Related 
Persons
    (1) If the purchaser is a member, person associated with a member, 
member of the immediate family of any such person to whose support such 
person contributes, directly or indirectly, or an account in which a 
member or person associated with a member has a beneficial interest:
    (A) the purchaser shall be an eligible purchaser;
    (B) the securities purchased shall be restricted from sale or 
transfer for a period of [150 days] three months following the 
conclusion of the offering; and
    (C) the fact of purchase shall be reported in writing to the member 
where the person is associated within one day of payment.
Sales to Other Restricted Persons
    (2) If the purchaser is not a person specified in Subsection (b)(1) 
above, and is [the purchaser shall be] an eligible purchaser pursuant 
to Subsection (a)(2), the conditions of Subsection (b)(1) shall not 
apply to such purchaser.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements are set forth in Sections (A), (B), and (C) 
below.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

(i) Purpose of the Proposed Rule Change
    (a) Overview of Free-Riding and Withholding 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 while 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 using sales of such securities to directors, officers, 
employees and associated persons of 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 other persons 
within such organizations whose activities influence or include the 
buying or 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 limited exceptions, to members of the immediate 
family of those persons restricted by the Interpretation.
    (b) Rule proposal background. At its May 1992 meeting, the Board of 
Governors appointed a special committee (the ``Committee'') to examine 
the Interpretation to determine if the Interpretation's restrictions, 
definitions and obligations are relevant in today's securities markets. 
The Committee was comprised of representatives of the Association's 
National Business Conduct, Corporate Financing and Insurance Affiliated 
Members Committees as well as members of the NASD Board of Governors. 
The Board also asked the Committee to examine various interpretative 
issues that had been raised with the NASD. The Committee met numerous 
times from May 1992 until April 1993 and received input and 
suggestions, both in writing and in person, from members, issuers, law 
firms, the NASD's Legal Advisory Board, and the staff of various NASD 
departments.
    In June 1993, the NASD published for comment proposed modifications 
to the Interpretation based on its review and suggestions received. The 
NASD received 36 comment letters on the proposed modifications. The 
Committee considered the comments and made final recommendations to the 
National Business Conduct Committee (``NBCC'') in November 1993. The 
Board considered and approved the NBCC's recommendations on November 
14, 1993.
    The proposed rule change includes language clarifications to 
facilitate understanding of the Interpretation's application, as well 
as substantive modifications. The following discusses the substantive 
modifications proposed.
    (c) Substantive proposed modifications. The NASD is proposing 
several substantive modifications to the Interpretation, including 
changes in connection with limited business broker/dealers, investment 
partnerships and corporations, stand-by arrangements, venture capital 
investors, securities offerings covered by the Interpretation, and 
issuer-directed securities. The NASD believes that the proposed 
substantive changes clarify the scope of the Interpretation and remedy 
certain unintended effects the Interpretation has had in its present 
form. Specifically, the NASD believes that the Interpretation has 
prohibited transactions which do not implicate the Interpretation's 
objective of a bona fide distribution of hot issue securities to the 
public, and may have created unduly burdensome restrictions and expense 
for NASD members and their customers. Thus, the NASD believes that the 
proposed changes, described further below, appropriately restrict 
prohibited persons from receiving hot issues without engendering 
unintended restrictions inconsistent with the purpose of the 
Interpretation.
    1. Stand-by arrangements. If an offering begins trading at a 
premium when the secondary market begins, the Interpretation's 
restrictions are implicated and may affect the successful completion of 
the offering by prohibiting the sale to stand-by purchasers, due to a 
person restricted under the Interpretation having a beneficial interest 
in the stand-by account. The NASD believes that securities purchased 
pursuant to a stand-by arrangement (i.e., an agreement to purchase 
securities not purchased during the offering period) by a restricted 
account should not be subject to the Interpretation if the conditions 
proposed are met. The NASD believes that the proposed conditions 
(prospectus disclosure, a formal agreement, absence of any other 
purchaser and a three month holding period) remedy any potential 
derogation from the Interpretation that such a sale could cause, while 
facilitating a bona fide distribution of the securities offered.\3\

    \3\Of course, any resales by the stand-by purchasers would need 
to be conducted in compliance with all applicable regulatory 
requirements including prospectus delivery pursuant to Section 5 of 
the Securities Act of 1933.
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    2. Definition of immediate family. The Interpretation presently 
restricts immediate family members of persons enumerated in Paragraph 2 
(persons associated with broker/dealers), and Paragraphs 3 and 4 of the 
Interpretation (persons having a connection to the offering and 
individuals related to banks, insurance companies and other 
institutional type accounts) from participating in hot issue 
distributions. The Interpretation defines immediate family members very 
broadly and includes such persons as father-, mother-, brother- and 
sister-in-law. An immediate family member of a person associated with a 
broker/dealer is prohibited from purchasing hot issues to the same 
degree as the associated person, unless it can be demonstrated that the 
associated person does not contribute directly or indirectly to the 
support of the immediate family member. In the latter circumstance, the 
immediate family member of the associated person may purchase a hot 
issue under the same conditions as those persons restricted pursuant to 
Paragraphs 3 and 4 of the Interpretation. Specifically, such persons 
may purchase hot issues if: (1) The securities were sold to such 
persons in accordance with their normal investment practice with the 
member making the distribution; and (2) the securities sold are 
insubstantial and not disproportionate in amount as compared to sales 
to members of the public and that the amount sold to any one such 
person is insubstantial.
    The NASD believes that in its present form, the immediate family 
member provisions often place inequitable restrictions on a person with 
a fairly attenuated connection to a restricted person named in the 
Interpretation (e.g., the sister-in-law of a bank vice-president), and 
often result in unduly burdensome compliance difficulties for members 
monitoring whether such persons are restricted or become restricted. 
The NASD believes that the proposed modifications to the immediate 
family member provisions will ensure that those persons with a 
substantial nexus to a restricted person will be similarly restricted 
under the Interpretation, provide a clearer test for NASD members in 
determining whether such persons are restricted, and eliminate the 
Interpretation's application to persons not intended to be restricted.
    The proposed modifications would:
    (a) retain the investment history exemption, and expand it to 
include the use of investment history at firms other than the member 
making the allocation. The burden of obtaining such information would 
remain with the firm making the sale;
    (b) eliminate the immediate family restrictions on persons other 
than those associated with broker/dealers (categories 3 and 4 
referenced above) and the Interpretation would only apply to the 
enumerated individuals in those categories and to persons who are 
supported directly or indirectly to a material extent by the restricted 
person;
    (c) with respect to persons associated with broker/dealers, 
continue to apply the immediate family restrictions to persons 
supported by the restricted individual and to allocations by the 
restricted individual's firm, but would no longer prohibit sales to 
non-supported family members of a person associated with a broker/
dealer by a broker/dealer that does not employ the restricted person, 
where the restricted person has no ability to control the allocation of 
the hot issue.
    There would continue to be a violation if it could be determined 
that the restricted person has a beneficial interest in the account to 
which an allocation was made.
    3. Venture capital investors. The NASD believes that bona fide 
venture capital investors should be allowed to purchase a hot issue to 
maintain their percentage ownership in an entity, notwithstanding that 
the venture capital investor may be a restricted person, or that such 
person may have a beneficial interest in the venture capital account. 
The NASD notes that the venture capital investor often plays a pivotal 
role in the continued viability of an entity prior to its public 
offering, and that such an investor should be allowed to maintain his 
or her own ownership interest after the entity completes its public 
offering.
    The venture capital investor, in order to purchase the hot issue 
without implicating the Interpretation's restrictions, would have to 
meet the following conditions:
    (a) one year of preexisting ownership in the entity;
    (b) no increase in the investor's percentage ownership above that 
held for the three months prior to the filing of a registration 
statement in connection with the initial public offering;
    (c) a lack of special terms in connection with the purchase; and
    (d) the venture capital investor shall not assign, sell, pledge, 
hypothecate or otherwise dispose of the securities for a period of 
three months following the effective date of the registration statement 
in connection with the offering.
    The NASD believes that the conditions imposed on the venture 
capital investor ensure that the securities may be purchased by a bona 
fide venture capital investor who has had an on-going interest in an 
entity, and protect against any attempt to circumvent the 
Interpretation's restrictions by investing in an entity shortly before 
its public offering.
    4. Investment partnerships and corporations. The Interpretation, 
under ``Investment Partnerships and Corporations,'' generally disallows 
sales of a hot issue to an investment partnership or corporation, or 
similar account (``investment partnership'') if a restricted person has 
a beneficial interest in the entity. Thus, an investment partnership 
with several limited partners would be ``tainted'' due to the limited 
partnership interest of the restricted person. In August 1992 and 
October 1993 Notices to Members, the NASD announced it was going to 
allow investment partnerships, on an interim basis, to use a ``carve 
out'' mechanism to prevent restricted persons with an interest in an 
investment partnership from participating in hot issue allocations. 
This ``carve out'' mechanism requires the NASD member making such 
allocation to set up a separate account for these transactions and 
obtain from the investment partnership and its accountants 
documentation that indicates that the restricted persons are prevented 
from participating in a hot issue allocation.
    The NASD believes that the carve-out methodology is the most 
equitable and appropriate approach for investment partnerships in which 
restricted persons have a beneficial interest, and that the carve-out 
procedure should be codified as proposed under the Beneficial Interest 
section of the Interpretation. The carve-out procedure would not allow 
a person restricted under the Interpretation to receive a hot issue 
allocation inconsistent with the Interpretation's provisions; but would 
also not inequitably penalize those not restricted under the 
Interpretation due to their interest in an investment partnership in 
which a restricted person also has an interest. A typical scenario is 
where a limited partnership with a large number of limited partners is 
restricted under the Interpretation because one of the limited partners 
is an officer of an insurance company, and therefore restricted under 
Paragraph 4 of the Interpretation. Rather than restricting the whole 
limited partnership, the carve-out procedure would allow the limited 
partnership to purchase the hot issue by properly allocating the hot 
issue away from the restricted limited partner according to the 
specified requirements proposed.
    In addition, the NASD believes that a beneficial interest, as 
defined under the Interpretation, should not be created by the receipt 
of a management fee based on the performance of an account. The NASD 
believes that investment partnerships and other similar accounts 
typically require that the management fee structure of such accounts 
include a performance-based component. Thus, an investment advisor 
restricted under Paragraph 4 of the Interpretation could restrict an 
entire investment partnership, in which no restricted persons have an 
interest, based solely on the investment advisor receiving a fee based 
on the performance of the securities in the investment partnership 
account. The Beneficial Interest provision of the Interpretation is 
intended to address those accounts in which a restricted person has a 
substantive, albeit not necessarily direct ownership, interest that 
should be appropriately restricted. The NASD believes that the receipt 
of a performance-based fee, without the existence of any other 
beneficial interest, should not create such an interest.
    5. Definition of public offering. In its present form, the 
Interpretation's definition of a public offering includes virtually any 
and all distributions of securities, whether registered or unregistered 
under the Securities Act. The NASD has found that the definition has 
had the unintended effect of implicating the Interpretation's 
restrictions for bona fide private placements of securities which do 
not present the potential abuses that the Interpretation is intended to 
guard against. The NASD believes that the proposed modification to the 
definition, which in essence does not apply the Interpretation to a 
traditional private placement of securities, is appropriate because 
such distributions generally are limited in scope and have holding 
periods placed on the privately placed securities. Thus, the NASD 
believes that such placements should not be within the purview of the 
Interpretation in that distribution is limited and that the potential 
for restricted persons to purchase the securities and resell or 
``flip'' them in a short period of time is limited due to the resale 
restrictions placed on such offerings.
    6. Associated person definition. Article I, Section (m) of the NASD 
By-Laws defines a ``person associated with a member'' to include a 
partner of a broker/dealer and any person who is directly or indirectly 
controlling or controlled by such member, whether or not such person is 
registered with the Association. The NASD has found that a certain 
degree of confusion exists as to the status of passive investors in 
broker/dealers, such as broker/dealer limited partners, equity owners, 
or subordinated lenders.
    The NASD believes, that under certain circumstances, such persons 
should not be considered persons associated with a broker/dealer due to 
their limited, passive investment in a broker/dealer. Thus, the NASD 
has proposed that if a person owns or has contributed 10% or less to a 
broker/dealer's capital, such person should not be construed to be an 
associated person; provided that, such ownership interest is a passive 
investment, the person does not receive hot issues from the member in 
which she has the interest, and that the broker/dealer is not in a 
position to direct hot issues to the person. The NASD believes that the 
limitations placed on such persons in order not to be considered 
associated persons will prevent the same from attempting to use their 
ownership interests in a broker/dealer to effect the purchase of hot 
issues, and circumvent the Interpretation's objective of a bona fide 
distribution of a hot issue.
    7. Persons associated with limited business broker/dealers. Similar 
to the status of persons with a limited ownership interest in a broker/
dealer, the NASD believes that persons associated with certain broker/
dealers that transact a limited securities business should also not be 
restricted as other associated persons under Paragraph 2 of the 
Interpretation. Specifically, the NASD proposes that persons associated 
with broker/dealers whose business is limited to direct participation 
programs or investment company/variable product securities not be 
restricted under the Interpretation to the same extent as those persons 
associated with broker/dealers with a more comprehensive securities 
business.
    Typically, a broker/dealer's business is limited pursuant to a 
restrictive agreement executed by the member as a condition to its 
membership in the Association. In that persons associated with such 
limited broker/dealers are not in a position to sell, distribute, or 
withhold hot issue securities, the NASD does not believe that such 
persons would be in a position to inhibit a bona fide distribution of a 
hot issue security. The NASD notes that the proposed modification 
applies only to a person associated with such a limited broker/dealer, 
and not to the broker/dealer itself. The NASD does not believe that it 
is appropriate for any NASD member to purchase a hot issue security for 
its own account, regardless of the extent of its securities business.
    8. Issuer directed securities. Presently, an employee of an issuer, 
who also is restricted under the Interpretation, must receive 
permission from the NASD Board of Governors in order to purchase hot 
issue securities of its employer, if the employee does not have the 
requisite investment history with the NASD member making the securities 
distribution. For example, an employee of a manufacturing company who 
is married to the senior officer of a bank would be restricted under 
the Interpretation because he or she is the immediate family member of 
a restricted person under Paragraph 3 of the Interpretation. Under the 
proposed changes to Paragraph 3 of the Interpretation, the employee 
would still be restricted if the senior officer of the bank directly or 
indirectly supports the employee. If permission is granted by the board 
of governors, the employee is allowed to purchase the securities of the 
employer without meeting the investment history requirement, but the 
amount purchased would still have to meet the insubstantial and not 
disproportionate tests described above.
    The NASD believes that it is inequitable to impose such 
restrictions on employees of issuers who are in most cases tangentially 
restricted under the Interpretation, in connection with their purchase 
of securities issued by their employer. The NASD notes that issuer-
directed share programs are viewed as a valuable tool in employee 
development and retention, and does not believe that the objectives of 
the Interpretation are furthered by imposing essentially the same 
restrictions on such purchases as those not involving an employer/
employee relationship. Thus, the proposed modifications to the Issuer 
Directed Securities section of the Interpretation will allow employees 
of issuers to purchase hot issue securities of the employer under the 
same terms and conditions as persons associated with NASD members are 
permitted in connection with purchases of securities issued by the 
member, pursuant to an exemption provided in Section 13 of Schedule E 
to the NASD's By-Laws.
    9. Cancellation safe harbor. The NASD believes that it is 
appropriate to clarify in the Interpretation that it will not be a 
violation if a NASD member makes an allocation of a hot issue to a 
restricted person or account, so long as the member cancelled the trade 
and reallocated the security at the public offering price to an 
unrestricted account, prior to T+1 of the initial transaction. The NASD 
believes that the clarification will remedy any concerns caused by 
inadvertent violations of the Interpretation that are corrected by the 
NASD member making the distribution. Sales following cancellation would 
need to be made in compliance with applicable laws, including section 5 
of the Securities Act.
(ii) Statutory Basis For Proposed Rule Change
    The NASD believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act in that the proposed 
changes to the Interpretation will promote just and equitable 
principles of trade by facilitating the bona fide distribution of hot 
issue securities to the public, and protect against the receipt of hot 
issues by persons restricted under the Interpretation. Further, the 
NASD believes that the proposed changes and clarifications to the 
Interpretation are consistent with Section 15A(b)(9) in that they 
alleviate certain inequities caused by the Interpretation, which 
imposed burdens on competition not necessary or appropriate in 
furtherance of the purposes of the Act.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    The Association received 36 letters commenting on Notice To Members 
93-40 (the ``Notice''), the proposed amendments to the Interpretation. 
The commenters include the American Bar Association, the Securities 
Industry Association, twelve law firms, nine investment advisers/asset 
managers, seven broker/dealers, three insurance companies, two 
associations, and one CPA firm. Below is a summary of the more 
significant and/or recurring issues raised in the letters and the 
NASD's position in connection with the same. The topics addressed 
follow the order in which they were presented in the Notice, beginning 
at page 258. Following that discussion are topics not included in the 
Notice, but raised in the comment letters.

Securities to be Covered

    With regard to the solicitation of comments on debt securities, 
those who did comment recommended that rated debt securities, 
especially corporate debt securities, be excluded from the 
Interpretation. The commenters maintained, in general, that the pricing 
of such securities is made in conjunction with a comparison to U.S. 
Treasury securities, that their price fluctuates relative to interest 
rates, and that such securities are typically considered fungible by 
investors, i.e., investors look for a certain grade of debt, and do not 
focus on the issuer, as in equity offerings. Thus, they maintained that 
the abuses that the Interpretation seeks to prevent are not evident in 
rated debt offerings, and that the Interpretation's methodology is 
inapplicable to the trading of such securities.
    The NASD has considered that it does not typically bring 
enforcement actions in this area, but has concluded that the continued 
coverage of debt securities is warranted for purposes of deterring any 
potential future problems in this area.

Stand-by Arrangements

    Those who commented generally supported the proposal. One commenter 
maintained that the five-month holding period was too long in that it 
went beyond the period in which the purchaser should be exposed to the 
market risk for the securities. It proposed a holding period of no 
longer than three months, which it maintains is adequate time for the 
market to establish some equilibrium for the security. Another 
commenter believed that it is unclear to whom an underwriter has to 
represent that it was unable to find any other purchaser for the 
securities, and suggested that a representation in the prospectus 
should suffice.
    The NASD believes that the various holding periods under the 
Interpretation and in the Free-Riding provisions of Schedule E to the 
By-Laws dealing with offerings by members of their own securities 
should be uniform and has therefore proposed a three month holding 
period.

Cancellation of Trades as ``Safe Harbor''

    One commenter believed that there would not be any implications 
under SEC Rule 10b-6 for the proposed safe harbor so long as the 
cancellation and reallocation was completed before settlement date. A 
different commenter suggested that any concerns with Rule 10b-6 could 
be remedied by obtaining a no-action letter from the SEC. Another 
commenter suggested that any notice of cancellations and reallocations 
would have to be given to the restricted purchaser no later than the 
day after purchase, and a further commenter maintained that the 
proposal was too reactive. It suggested that the NASD establish a 
procedure where hot issues were characterized as such before the 
distribution via indications of interest, so as to prevent sales to 
restricted accounts.
    The NASD notes that for purposes of Rule 10b-6, a distribution 
includes ``the entire process by which in the course of a public 
offering the block of securities is dispensed and ultimately comes to 
rest in the hands of the investing public.''\4\ Thus, a distribution 
continues if a broker-dealer withholds any part of an offering in 
proprietary or nominee accounts and later sells those securities to the 
public after secondary trading has begun.\5\ Moreover, a cancellation 
of a bona fide purchase order will not reopen the distribution where 
there is no reason for the underwriter to believe that the purchase 
order would be cancelled.\6\ Whether a particular cancellation and 
reallocation for purposes of compliance with the Interpretation will 
raise an issue under Rule 10b-6 will depend upon the facts and 
circumstances involved in that cancellation and reallocation.

    \4\R. A. Holman & Co. v. SEC, 366 F.2d 446, 449 (2d Cir. 1966), 
modified on other grounds, 377 F.2d 665 (2d Cir. 1966), cert. 
denied, 389 U.S. 991 (1967).
    \5\Wall Street West, Inc., 47 S.E.C. 1003, 1005 (1984).
    \6\Id.
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Immediate Family

    Those who commented strongly supported the lifting of the immediate 
family restrictions on persons restricted under Paragraphs three and 
four of the Interpretation. One commenter expressed concern that the 
retention of the immediate family restriction in connection with 
allocations by the broker/dealer that employs the restricted person (as 
opposed to allocations by broker/dealers that do not employ the 
restricted person) creates a new category of restricted persons that 
may prove burdensome for the member who is making the distribution.
    The NASD does not believe that any new restricted category is being 
created and believes that the proposed modifications are appropriate.

Persons With Limited Registration or Limited Purpose Broker/Dealers

    Several of the commenters supported the proposed exemption as 
described in the Notice. In addition, virtually all proposed that the 
exemption be expanded to apply to all persons, notwithstanding their 
level of registration, if they are associated with broker/dealers that 
do a limited business. They maintained generally that such 
representatives are proscribed from doing any securities business which 
is beyond the scope of the limited broker/dealer's prescribed business 
(e.g., investment company securities), and maintained that the 
potential for abuse by one that has a general license is unlikely. Some 
of the commenters contended that limited broker/dealer representatives 
often have a Series 7 (general securities representative) license in 
order to comply with state law, and one commenter maintained that the 
exemption as proposed would create a disincentive for persons with 
limited registrations from seeking further registration/education. 
Various commenters believed that a firm-based exemption should include 
the firms listed in the Notice as well as firms that do not underwrite 
or distribute initial public offerings, merger and acquisition boutique 
firms that do not trade, and private placement firms.
    The NASD does not believe that it is appropriate for any NASD 
member to purchase a ``hot issue'' for its own account and that the 
categories of exemption should not be expanded to include member firms 
or expanding the categories to be exempted. The NASD, however, agrees 
with the suggestion of several commentators that this exemption be 
expanded to cover all persons associated with direct participation 
program or investment company/variable product broker/dealers 
regardless of their registration status. The Association has considered 
that the NASD's Membership Committee encourages members to qualify 
their registered persons through Series 7 even if they are going to do 
limited activities and that these individuals should not be penalized 
for holding such licenses.

Investment Partnerships and Corporations

    There were several comments on the proposed changes, and opposition 
to applying the Interpretation to investment partnerships and 
corporations in general. First, all those who commented on substituting 
a certified public account's certification in lieu of an attorney 
opinion letter, including the American Institute of Certified Public 
Accountants (``AICPA''), maintained that the certification would not 
work because the certification is more legal than factual, and because 
the analysis for certification would not comply with the ``Attestation 
Standards'' necessary for a CPA to render such a certification.
    Notwithstanding the proposed amendments, several of the Commenters 
had general policy concerns with investment partnerships and 
corporations. Most believed that the Interpretation should not apply to 
partnerships because: (1) partnerships typically represent interests of 
individual investors, thus the objectives of a bona fide distribution 
are furthered by distribution to partnerships; and (2) the 
Interpretation unfairly discriminates between mutual fund type accounts 
and partnerships because of size, maintaining that there is no need for 
delineation because most limited partners have no control over the 
purchase and sale of securities for the account and do not exercise any 
discretion. One commenter maintained that precedent for such a position 
could be found in rules and interpretations under Sec. 16 of the 
Exchange Act, which does not require officers to disgorge profits 
resulting from transactions through investment partnerships.
    Further, most maintained that receipt of performance-based fees 
alone should not restrict an account, maintaining that partnership law 
typically requires that a general partner/manager maintain some de 
minimis equity position in the partnership. In addition, one commenter 
believed that the responsibility for opening up a separate hot issue 
account should rest with the member. Several of the commenters 
suggested various de minimis provisions which would allow the 
participation by investment partnerships in hot issues, notwithstanding 
the presence of a restricted person(s).
    The NASD has considered the comment of the AICPA that accountants 
cannot provide the certification proposed in the Notice and therefore 
has proposed that a written representation of an accountant or counsel 
be substituted for the accountant's certification. This written 
representation would replace the existing ``opinion of counsel'' under 
paragraph B of the Investment Partnerships and Corporations section of 
the Interpretation. The NASD believes that the proposed ``written 
representation'' satisfies the Association's objective of ensuring that 
Members seek the counsel of an independent, qualified third party in 
meeting their obligations under the Interpretation, while not imposing 
any requirements that are unduly burdensome or unnecessarily 
problematic.
    The NASD has also considered various comments that indicate that 
more trustees and institutional investors are demanding that 
performance-based fees be charged rather than asset based fees for 
money management services and therefore has proposed that performance-
based fees be deleted from the definition of beneficial interest under 
the Interpretation.
    In response to other comments, the NASD believes that securities 
placed into a carved out ``hot issue'' account should remain in that 
account until sold. The Association does not believe that such 
securities should be subject to ``journaling'' to the regular account 
after a specified time period in that such a procedure would be 
difficult to monitor.

Foreign Mutual Funds

    The Board of Governors solicited comment as to exempting foreign 
mutual funds from the Investment Partnerships and Corporations section 
of the Interpretation, similar to the exemption provided for sales to 
investment companies registered under the Investment Company Act of 
1940. One commenter suggested that the exemption apply only to foreign 
investment companies which are subject to regulation under foreign laws 
expressly designed for investment companies and/or satisfy minimum 
standards that the NASD would establish. Another commenter expressed 
disappointment that the Notice did not address the application of the 
Interpretation to foreign broker/dealers in general.
    The NASD is concerned as to whether the Association can adequately 
determine whether a foreign country's mutual fund regulation is similar 
to our own. The NASD has concluded, therefore, that no provisions 
should be adopted at this time. If, however, the NASD can develop a 
substantial equivalence standard, the issue could be revisited.

Venture Capital Investors

    Those who commenter generally supported the exemption, and proposed 
certain revisions. One commenter maintained that allowing the venture 
capital investor to purchase only up to his percentage ownership for 
the prior year was too limiting in that a venture capitalist could make 
a crucial contribution after the one year mark, well before the issuer 
goes public, and should be able to recover that contribution in stock. 
Another commenter believed that the requirement that no special terms 
be received by the purchasers should be qualified to limit that to 
``special terms from the member'' because a venture capitalist 
typically enters into special arrangements with the issuer which could 
be construed as prohibited special terms.
    The NASD believes it is an appropriate requirement that a venture 
capital investor have an ownership interest in the entity for at least 
one year prior to the offering; however, in response to the comments, 
the NASD believes that it is appropriate to use three months before the 
date that the registration statement is filed as the date to be used 
for calculating the investors' existing ownership interest. The NASD, 
in keeping with its prior recommendation, believes that a three month 
holding period for the securities received in the distribution is 
appropriate.

Issues Not Addressed in the Notice

Ownership Interests in a Broker/Dealer

    Several commentators asked for advice on when passive investors who 
are limited partners, equity owners or subordinated lenders of a 
broker/dealer would be construed as associated persons under the 
Interpretation. In other words, what ownership or contribution 
percentage would trigger associated person status.
    The NASD believes that if the person owns or has contributed 10% or 
less to the firm's capital, does not receive hot issues from the member 
in which he has the interest, and that member is not in a position to 
direct hot issues to the investor, then the NASD should not construe 
the investor to be an associated person solely by virtue of the 
investment in the broker/dealer.

Category 4 Restricted Persons

    Several commentators asked whether managers/advisors of hedge 
funds, investment partnerships or of other similar entities would be 
construed as a restricted person under Paragraph four of the 
Interpretation (sales to the senior officer of a bank, investment 
company or other institutional type account).
    The NASD believes that managers of investment partnerships or 
corporations, hedge funds, and other similar accounts are clearly 
involved with the buying or selling of securities for an institutional 
type account and, as such, are restricted under Paragraph four of the 
Interpretation.

Private Placements

    Several commentators sought advice on how the Interpretation should 
be applied to members who receive securities of an issuer in a private 
placement. The definition of ``public offering'' as currently set forth 
in the Interpretation is comprehensive. The definition includes all 
distributions ``* * * of securities whether underwritten or not; 
whether registered, unregistered or exempt from registration under the 
Securities Act of 1933, and whether they are primary or secondary 
distributions, including intrastate distributions and Regulation A 
issues, which sell at an immediate premium, in the secondary market.'' 
As such, the definition by its terms covers these private placements. 
Such distributions may involve securities which are either registered 
or unregistered.
    The NASD believes that the definition of public offering is 
unnecessarily broad and does not believe that the Interpretation should 
cover traditional ``private placements'' of unregistered securities. 
Thus, the NASD has proposed a definition of a public offering 
consistent with the definition provided in Schedule E to the 
Association's By-Laws.

Issuer Directed Exemption

    Several commentators requested that employees of an issuer or the 
issuer's parent who are restricted persons be exempt from the 
Interpretation when purchasing shares of their employer or its parent. 
Currently, such exemptions can only be granted on a case-by-case basis 
by the NASD Board of Governors.
    The NASD agrees that the issuer directed share exemption should be 
modified to allow restricted employees to purchase under the same terms 
and conditions as employees of member firms do under Schedule E of the 
By-Laws, thereby eliminating the need for applications to the NASD.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 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 
5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to the file number in the caption 
above and should be submitted by [insert date 21 days from the date of 
publication].

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-19444 Filed 8-9-94; 8:45 am]
BILLING CODE 8010-01-M