[Federal Register Volume 60, Number 137 (Tuesday, July 18, 1995)]
[Notices]
[Pages 36845-36846]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-17519]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35954; File No. SR-NASD-95-21]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by National Association of Securities Dealers, Inc., Relating to
Freely Tradeable Direct Participation Program Securities
July 11, 1995.
On May 23, 1995,\1\ the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association'') filed with the Securities and
Exchange Commission (``SEC'' or ``Commission'') the proposed rule
change pursuant to Section 19(b)(1) of the Securities Exchange Act of
1934 (``Act''),\2\ and Rule 19b-4 thereunder.\3\ The proposed rule
change excludes freely tradeable direct participation program
securities from the prohibition on transactions in discretionary
accounts without written approval. However, the exclusion is restricted
to members that are not affiliated with the freely tradeable direct
participation program.
\1\ The proposal was originally filed with the Commission on May
10, 1995. The NASD subsequently submitted Amendment No. 1 to the
filing which amends Subsections (b)(3)(C) (i) and (ii) to Article
III, Section 34 of the Rules of Fair Practice, by replacing the
phrase ``the NASDAQ System'' in Subsections (i) and (ii) and the
word ``NASDAQ'' in Subsection (ii) with the word ``Nasdaq.'' Letter
from Suzanne E. Rothwell, Associate General Counsel, NASD, to Mark
P. Barracca, Branch Chief, Over-the-Counter Regulation, Division of
Market Regulation, SEC, dated May 22, 1995.
\2\ 15 U.S.C. 78s(b)(1).
\3\ 17 CFR 240.19b-4.
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Notice of the proposed rule change, together with the substance of
the proposal, was issued by Commission
[[Page 36846]]
release (Securities Exchange Act Release No. 35788, May 31, 1995) and
by publication in the Federal Register (60 FR 30133, June 7, 1995). No
comment letters were received. The Commission is approving the proposed
rule change.
I. Background
Article III, Section 34 of the Rules of Fair Practice regulates
participation by members and persons associated with a member in direct
participation programs and limited partnership rollup transactions
(``DPP rule''). The DPP rule generally prohibits a member or a person
associated with a member from participating in a public distribution of
a direct participation program or a limited partnership rollup
transaction unless the distribution or transaction conforms to certain
suitability and disclosure requirements and standards of fairness and
reasonableness.
Since the adoption of the DPP rule in 1982,\4\ an increasing number
of direct participation programs, such as master limited partnerships,
have issued partnership units, depositary receipts for such units, or
assignee units of limited partnership units that are freely tradeable
in a manner generally analogous to common stock and are quoted on
Nasdaq or listed on registered national stock exchanges.
\4\ The DPP rule was initially approved by the Commission as
Appendix F to Article III, Section 34 on September 16, 1982
(Securities Exchange Act Release No. 19054); 47 FR 42226 (September
24, 1982).
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A direct participation program security is considered freely
tradeable under Section 34 if it is either (1) a secondary public
offering of or a secondary market transaction in a direct participation
program security for which quotations are displayed on Nasdaq or which
is listed on a registered national securities exchange, or (2) a
primary offering of a direct participation program for which an
application for inclusion on Nasdaq or listing on a registered national
securities exchange has been approved.
To address the increased transparency and liquidity associated with
the nature of the secondary markets for freely tradeable direct
participation program securities, the NASD amended the DPP rule to
exempt freely tradeable direct participation program securities from
the suitability requirements of Subsections 34(b)(3) (A) and (B) of the
DPP rule.\5\
\5\ See Securities Exchange Act Release No. 23619 (September 15,
1986); 51 FR 33968 (September 24, 1986). However, freely tradeable
direct participation program securities are still subject to the
general suitability rules of the NASD. See NASD's Rules of Fair
Practice, Article III, Section 2. Section 2(a) states:
[I]n recommending to a customer the purchase, sale or exchange
of any security, a member shall have reasonable grounds for
believing that the recommendation is suitable for such customer upon
the basis of the facts, if any, disclosed by such customer as to his
other security holdings and as to his financial situation and needs.
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Recently, the NASD considered whether Monthly Income Preferred
Securities (``MIPS''), a new financial instrument which is a freely
tradeable direct participation program security, ought to be subject to
the discretionary account restrictions in Article III, Section 34.\6\
In its consideration, the NASD determined that the concerns which
attach to the use of discretionary authority for illiquid, unmarketable
direct participation program securities are not present with freely
tradeable direct participation program securities.
\6\ MIPS are preferred securities issued by a parent company's
subsidiary, which is structured as a limited partnership or limited
liability company. The subsidiary issues MIPS to investors and
invests the proceeds in convertible subordinated debentures of the
parent. Interest on the debentures of the parent are paid to the
subsidiary, which in turn pays the equivalent rate of interest to
MIPS holders in the form of dividends. MIPS are eligible to be
listed on a national securities exchange or The Nasdaq Stock Market
and have flow-through tax consequences for investors, which means
that they are considered direct participation programs and,
therefore, subject to Section 34.
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II. The Terms of Substance of the Proposed Rule Change
The proposed rule change reverses the order of current Subsections
(b)(3)(C) and (D) to Section 34 and adds a reference to Subparagraph
3(C) in new Subparagraph 3(D) to exclude freely tradeable direct
participation program securities from the prohibition on transactions
in discretionary accounts without written approval. However, the
exclusion for freely tradeable direct participation program securities
in newly designated Subparagraph (3)(D) restricts the exclusion to
members that are not affiliated with the direct participation program.
III. Discussion
The Commission believes that the rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\7\ which require that the
rules of the Association be designed to prevent fraudulent and
manipulative acts and promote just and equitable principles of trade.
The rule change relieves members of their obligation to comply with the
prohibitions against discretionary transactions in freely tradeable
direct participation program securities without written approval
because the transactions do not present the substantial conflicts of
interest and regulatory concerns that the prohibitions were intended to
address. Furthermore, freely tradeable direct participation securities
that are included on Nasdaq or listed on a registered national
securities exchange provide investors with a liquid and available
market for trading surplus securities placed in their discretionary
accounts without written approval.
\7\ 15 U.S.C. 780-3.
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The exclusion for freely tradeable direct participation program
securities is limited to members that are not affiliated with the
direct participation program. Where such an affiliation is present, the
Commission agrees with the NASD that substantial conflict of interest
and regulatory concerns continue to exist and the exclusion should not
be made available.
The NASD's members' use of discretionary authority for transactions
in freely tradeable direct participation program securities is
consistent with the NASD's 1986 amendments to Section 34 exempting
freely tradeable direct participation program securities from the
suitability and disclosure requirements of Section 34. The heightened
suitability and disclosure requirements, which are necessary where
direct participation program securities lack liquidity and
marketability, are unnecessary where a ready, liquid market exists.
In addition, discretionary transactions in freely tradeable direct
participation program securities would remain subject to the general
discretionary account requirements contained in Article III, Section 15
of the Rules of Fair Practice.\8\
\8\ Article III, Section 15(a) of the Rules of Fair Practice
provides that ``[n]o member shall effect with or for any customer's
account in respect to which such member or his agent or employee is
vested with any discretionary power any transactions of purchase or
sale which are excessive in size or frequency in view of the
financial resources and character of the account.''
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change SR-NASD-95-21 be, and hereby is,
approved.
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. 95-17519 Filed 7-17-95; 8:45 am]
BILLING CODE 8010-01-M