[Federal Register Volume 60, Number 138 (Wednesday, July 19, 1995)]
[Notices]
[Pages 37117-37122]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-17731]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35961; File No. SR-NASD-95-29]


Self-Regulatory Organizations; Filing of Proposed Rule Change by 
National Association of Securities Dealers, Inc. to the Corporate 
Financing Rule at Article III, Section 44 of the Rules of Fair Practice 
Regarding Rights of First Refusal

July 12, 1995.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on June 1, 1995, 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.

    \1\ 15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to amend Article III, section 44 of the Rules 
of Fair Practice regarding rights of first refusal. Proposed new 
language is in italics; proposed deletions are bracketed.

Rules of Fair Practice, Article III, The Corporate Financing Rule, 
Underwriting Terms and Arrangements

    Section 44
* * * * *
    (c) Underwriting Compensation and Arrangements
* * * * *
    (3) Items of Compensation
    (A) For purposes of determining the amount of underwriting 
compensation received or to be received by the underwriter and 
related persons pursuant to paragraph (c)(2) above, the following 
items and all other items of value received or to be received by the 
underwriter and related persons in connection with or related to the 
distribution of the offering, as determined pursuant to paragraph 
(c)(4) below shall be included:
* * * * *
    (ix) any right of first refusal provided to the underwriter and 
related persons to underwrite or participate in future public 
offerings, private placements or other financings [by the issuer], 
which will have a compensation value of 1% of the offering proceeds 
or that dollar amount contractually agreed to by the issuer and 
underwriter to waive or terminate the right of first refusal;
* * * * *
    (6) Unreasonable Terms and Arrangements
* * * * *
    (B) Without limiting the foregoing, the following terms and 
arrangements, when proposed in connection with the distribution of a 
public offering of securities, shall be unfair and unreasonable:
* * * * *
    (v) any right of first refusal provided to the underwriter and 
related persons [regarding] to underwrite or participate in future 
public offerings, private placements or other financings which:
    (1) has a duration of more than [five (5)] three (3) years from 
the effective date of the offering; or
    (2) has more than one opportunity to waive or terminate the 
right of first refusal in consideration of any payment or fee;
    (vi) any payment or fee to waive or terminate a right of first 
refusal regarding future public offerings, private placements or 
other financings provided to the underwriter and related persons 
which:
    (1) has a value in excess of the greater of one percent (1%) of 
the offering proceeds in the public offering where the right of 
first refusal was granted (or an amount in excess of one percent if 
additional compensation is available under the compensation 
guideline of the original offering) or five percent (5%) of the 
underwriting discount or commission paid in connection with the 
future financing (including any overallotment option that may be 
exercised), regardless of whether the payment or fee is negotiated 
at the time of or subsequent to the original public offering; or
    (2) is not paid in cash.
    Subsection (vi)-(xii) are renumbered (vii)-(xiii).
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 may be examined at the places specified in 
Item IV below. The NASD has prepared summaries, set forth in sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

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

Background

    The NASD developed its policy on the valuation of rights of first 
refusal in the early 1970s. Rights of first refusal are typically 
negotiated in connection with an issuer's initial public offering and 
grant the underwriter a right to underwrite or participate in any 
future public offerings, private placements, or other financings by the 
issuer for a certain period of years. The NASD values rights of first 
refusal as a non-cash item of compensation at one 

[[Page 37118]]
percent of the offering proceeds and currently limits the duration of 
the right to 5 years.\2\ To the extent that an underwriting agreement 
includes a provision specifying a dollar amount for the waiver or 
termination of a right of first refusal, it has been the policy of the 
NASD Corporate Financing Department (``Department'') under the 
Corporate Financing Rule to value the right of first refusal on the 
basis of the specified dollar amount in place of the one percent 
valuation.

    \2\ See, Corporate Financing Rule at Article III, Section 44 of 
the Rules of Fair Practice (Corporate Financing Rule), section 
(c)(3)(A)(ix) and section (c)(6)(B)(v). NASD Manual, paragraph 2200D 
at pages 2206 and 2209.
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    The NASD believes that members should be permitted to negotiate to 
waive or terminate a right of first refusal in the event that the 
issuer wishes to use a different underwriter to subsequently raise 
additional capital through a public or private offering of its 
securities, provided that amounts negotiated are limited to an amount 
that has some relation to the size of the subsequent offering in which 
the member is not participating. Because use of right of first refusal 
are primarily confined to certain underwriters of companies that are 
generally small and without significant operating history, the NASD has 
found that issuers negotiating with an underwriter for the first time 
in connection with an initial public offering often may not fully 
comprehend that they have agreed to extend their relationship with the 
underwriter for as many as five years, nor be in a position to 
influence the terms of the right. In addition, the NASD has observed 
that certain underwriters routinely negotiate to receive rights of 
first refusal at the time of an initial public offering and later 
negotiate to waive or terminate their rights, apparently without any 
original intent to actually underwrite any subsequent offering of 
securities by the issuer.
    The NASD is concerned that underwriters not be permitted to avoid 
underwriting compensation limits by negotiating to waive or terminate a 
right of first refusal with no limitation whatsoever on the amount of 
compensation they might negotiate to receive. The NASD is also 
concerned that an issuer may find it difficult to negotiate appropriate 
underwriting compensation with a new underwriter, where the issuer has 
determined to sever its relationship with its former underwriter and 
the former underwriter requires a substantial payment to waive or 
terminate its right of first refusal. Finally, the NASD believes that 
the policy on rights of first refusal should also protect investors, 
who ultimately incur the cost when an issuer compensates an underwriter 
for waiving or terminating a right of first refusal.

Description of Proposed Rule Change

Three-Year Duration

    Currently, the NASD Corporate Financing Rule at section 
44(c)(6)(B)(v) to Article III of the Rules of Fair Practice prohibits, 
as unreasonable, any ``right of first refusal'' regarding future public 
offerings, private placements or other financings that has a duration 
of more than five (5) years from the effective date of the offering. 
The NASD is concerned that smaller issuers entering into these 
agreements may not be in a position to fully evaluate the ramifications 
of agreeing to a right of first refusal with a term of five years. In 
addition since the NASD staff rarely, if ever, sees a right of first 
refusal with a term less than five years, the duration of rights may 
not be freely negotiated by the issuer and the underwriter. The NASD 
has determined that a right of first refusal with a duration of five 
years is overreaching and that a three-year period is more appropriate. 
The NASD is proposing to modify section 44(c)(6)(B)(v) to Article III 
of the Rules of Fair Practice to reduce the duration of the right of 
first refusal from five years to three years. That portion of 
subparagraph (v) referring to the proposed three-year limitation is 
proposed to be separated and numbered as new subparagraph (v)(1).

Number of Payments for Waiver/Termination

    The NASD finds that certain underwriters routinely negotiate to 
receive rights of first refusal at the time of an initial public 
offering and later negotiate, repeatedly, to waive or terminate their 
rights, apparently without any original intent to actually underwrite 
any subsequent offerings of securities by the issuer. The NASD is 
concerned over underwriters receiving a ``stand-aside'' payment for 
each subsequent offering by an issuer that has established a 
relationship with a new underwriter, where the original underwriter is 
no longer providing any bona fide services to the issuer.
    The NASD also is concerned that multiple stand-aside payments by 
the issuer to a member result in difficulty for both the member and the 
NASD in tracking the payments received over the term of the right. Such 
tracking is important in order to insure compliance with the Corporate 
Financing Rule's compensation guidelines for the original offering.\3\

    \3\ The NASD anticipates that the former underwriter will 
contact the NASD Corporate Financing Department when it is 
negotiating a waiver or termination of a right of first refusal to 
obtain information on whether additional compensation is available 
under the compensation guideline applicable to the original 
offering.
    The NASD, therefore, proposes to add a new subparagraph (v)(2) to 
section 44(c)(6)(B) to Article III of the Rules of Fair Practice to 
limit a member to one opportunity to waive or terminate a right of 
first refusal in consideration of any payment or fee. The NASD notes 
that an underwriter not wishing to terminate its right of first refusal 
for future offerings may preserve its right by waiving its 
participation in a particular offering without accepting payment for 
such waiver.

Limitation on Waiver/Termination Compensation

    The NASD believes that members should be permitted to negotiate to 
waive or terminate a right of first refusal in the event that the 
issuer wishes to use a different underwriter to subsequently raise 
additional capital through a public or private offering of its 
securities. However, the NASD believes that the amounts negotiated for 
the waiver or termination of the right should be limited to an amount 
that has some relation either to the original offering or to the 
subsequent offering in which the member is not participating.
    The NASD is concerned that the cost to the issuer of raising 
additional capital may become excessive where the issuer's former 
underwriter requires an excessive payment to waive or terminate its 
right of first refusal. The NASD, therefore, proposes to limit the 
amount of such waiver/termination payments by adding a new subparagraph 
(vi) to section 44(c)(6)(B) to Article III of the Rules of Fair 
Practice. New subparagraph (vi)(1) would prohibit any payment to waive 
or terminate a right of first refusal that has a value in excess of the 
greater of 1% of the original offering (or a higher amount if 
additional compensation is available under the compensation guideline 
applicable to the original offering) or 5% of the underwriting discount 
or commission paid in connection with the future offering (including 
any overallotment option that may be exercised), regardless of whether 
the payment or fee is negotiated at the time of or subsequent to the 
original public offering.
    The proposed provision is intended to balance the interests of 
former underwriters and issuers by prescribing 

[[Page 37119]]
a formula for waiver/termination payments that allows former 
underwriters to participate in the success of issuers, while at the 
same time not jeopardizing that success with a payment so large that it 
harms an issuer's ability to conduct and realize the benefits of a 
secondary offering.\4\ The proposed one percent limitation reflects the 
NASD's belief that it is appropriate that the former underwriter be 
permitted to negotiate a fee that is at least equal to the valuation of 
the right of first refusal in connection with the NASD's review of the 
original offering in the event that the issuer wishes to sever its 
relationship with the former underwriter.\5\ The five percent 
alternative limitation reflects the NASD's belief that the former 
underwriter that assumed the risk of distributing the issuer's IPO 
should be allowed to participate or equitably benefit in the issuer's 
subsequent offering of securities, including any overallotment option 
that may be exercised, regardless of whether the payment or fee is 
negotiated at the time of or subsequent to the original public 
offering.

    \4\ The NASD does not include the payment to waive or terminate 
a right of first refusal as compensation in connection with its 
review of the subsequent offering of securities. The proposed rule 
change does not modify this practice.
    \5\ For example, where the offering proceeds of the original 
offering were $10 million and the new offering is to be $150 
million, with a discount of 6 percent or $9 million, the member 
could negotiate a fee for waiver or termination of the right of 
first refusal of up to $450,000 (5 percent of $9 million), which is 
greater than 1 percent of $10 million, or $100,000.
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Cash Payment Requirement

    The NASD also proposes adding provision (2) to the new subparagraph 
(vi) of section 44(c)(6)(B) to Article III of the Rules of Fair 
Practice to specify that compensation to members for waiving or 
terminating a right of first refusal must be in the form of cash. The 
NASD believes this provision will limit the waiver/termination payment 
to a percentage of the capital raised in the secondary offering and 
protect the company's shareholders from dilution resulting from the 
issuance of shares to a former underwriter.
Additional Clarifications

    The proposed rule change would revise subparagraph (ix) to section 
44(3)(A) and subparagraph (v) to section 44(6)(B) to Article III of the 
Rules of Fair Practice to make the rule language consistent. The rule 
change to subparagraph (ix) to section 44(c)(A) would clarify policy 
that any right of first refusal provided to the underwriter and related 
persons to underwrite or participate is applicable to all future 
``public'' offerings and ``private placements or other financings.''
    The proposed rule change would also revise subparagraph (v) to 
section 44(6)(B) to Article III of the Rules of Fair Practice to 
clarify current policy that all unreasonable terms and arrangements 
cited under subparagraph (v) to section 44(6)(B) shall apply to any 
right of first refusal ``provided to the underwriter and related 
persons to underwrite and participate in'' future public offerings, 
private placements or other financings.

Implementation of Rule

    The NASD is proposing to make the proposed rule change applicable 
to filings made with the Corporate Financing Department of the NASD 
that are not yet effective with the SEC on the date of implementation 
of the rule change announced by the NASD in a Notice to Members 
following SEC approval. The implementation date announced by the NASD 
will not be more than 90 days following SEC approval of the rule 
change. Thus, offerings filed with the Corporate Financing Department 
that have not become effective with the SEC on the date of 
implementation announced by the NASD will be required to comply with 
the proposed rule change, regardless of whether the Corporate Financing 
Department has previously issued an opinion that it has no objections 
to the terms and arrangements. It is the intention of the Corporate 
Financing Department after the proposed rule change has been published 
for comment to include a notification with all correspondence with 
counsel to members regarding this proposed amendment to the Corporate 
Financing Rule.
    The NASD believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) of the Act which provides that the 
proposed rule change be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and a national market system, and, in general, to protect 
investors and the public interest in that the proposed rule change will 
preserve ``rights of first refusal'' as a valuable item of compensation 
to an underwriter, while protecting issuers and investors from 
excessive payments to waive or terminate a right of first refusal 
granted to a former underwriter.

(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 proposed rule change was published for comment in Notice to 
Members 94-82 (Oct. 1994). Four comments were received in response 
thereto and were generally opposed to the proposed rule.\6\

    \6\ Comment letters were submitted by Lew Lieberbaum and Co., 
Inc.; Spelman & Co., Inc.; Kelley Drye and Warren; and Bachner, 
Tally, Polevoy and Misher.
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    The major issues raised by the commenters can be generally 
categorized as follows: (1) The duration of a right of first refusal, 
(2) the number of payments permitted for waiver or termination of a 
right, (3) limits on waiver/termination compensation, (4) the cash 
payment requirement, and (5) the valuation of rights of first 
refusal.\7\

    \7\ Notice to Member 94-82 incorrectly stated that the NASD is 
proposing to amend the methodology employed by the NASD for valuing 
a right of first refusal, which as currently valued for compensation 
purposes is 1% of the gross proceeds of the offering, or the amount 
specified in the underwriting contract to waive or terminate the 
right. The incorrect rule language would have limited the 
compensation value of a right of first refusal to the ``lesser of'' 
1% of the gross offering proceeds on the contracted amount. The NASD 
is not considering such a proposed rule change and the comments 
opposing this proposal, therefore, are not discussed in this filing.
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Duration of the Right of First Refusal

    The proposed rule change would limit the term of a right of first 
refusal to a maximum of three years.\8\ Two commenters argued that 
early stage companies operate unprofitably for more than three years 
after an IPO and, as a result, limiting a right of first refusal to 
three years could prevent the underwriter from realizing the benefits 
of underwriting an offering for a financially stable issuer. Two 
commenters also argued that securities offerings of smaller issuers are 
inherently riskier for the underwriter than securities offerings of 
more financially-stable companies. Typically, small early-stage 
companies are not well known to the public market and, because of the 
size and limited 

[[Page 37120]]
resources of the underwriter or restrictions as a result of state blue 
sky laws, the offering is limited with regard to possible purchasers of 
the securities. These commenters believe, therefore, that the 
underwriter should be compensated commensurate with the greater risk of 
the IPO. One commenter suggested that there is no downside to the 
issuer to a five-year right of first refusal. The issuer is not 
obligated to use the services of the original underwriter, but rather 
is merely prevented from undertaking an offering with another 
underwriter without compensating the original underwriter. Furthermore, 
one commenter argued that the issuer and underwriter are free to 
negotiate a right of first refusal of lesser duration, and to limit 
expressly duration to three years would hinder the ability of an early 
stage company to gain access to the public capital markets by reducing 
the incentive to underwrite such a company's securities.

    \8\ Two commenters expressed concern with the proposed reduction 
in the maximum permissible duration of a right of first refusal from 
five years to three years and one commenter generally agreed that 
the 3-year limit was reasonable, and one commenter expressed no 
view.
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    In response to the above comments, the NASD remains concerned that 
smaller issuers entering into these agreements may not be in a position 
to evaluate fully the ramifications of agreeing to a right of first 
refusal with terms of five years. The NASD also has concluded that such 
issuers are often not in a position to influence such terms. In support 
of this belief, the NASD finds that it rarely if ever sees a right of 
first refusal with a term of less than five years. The five-year 
maximum term is routinely included in letters of intent and 
underwriting agreements and appears to be presented to issuers as a 
usual and customary underwritten arrangement that is non-negotiable.
    One commenter suggested that offerings that meet the definition of 
``small business issuer'' under Regulation S-B of the Securities Act of 
1933 (the ``Securities Act'') and offerings conducted under Regulation 
A of the Securities Act be permitted to retain a five year right of 
first refusal while rights in offerings of all other issuers would be 
limited to three years. The commenter argues that the NASD has 
historically acknowledged the inherent risk of underwriting small 
issuers by permitting a greater percentage of underwriting compensation 
for smaller offerings, and proposes that a comparable analysis be 
applied to the duration of a right of first refusal.
    In response, the NASD believes the commenter's suggestion would 
exempt from the proposed rule change those smaller issuers who are most 
unable to evaluate the ramifications of the rights of first refusal and 
who have the least ability to influence the right's terms. Upon review, 
the NASD also does not believe the 3-year limitation will reduce the 
ability of smaller issuers to obtain financing from members.
    One commenter agreed that the three-year limitation appeared 
reasonable but that there should be room for exceptions. For example, 
the commenter suggests that if an issuer does exceptionally well during 
this period and issues securities of an affiliated company in a spinoff 
transaction, the underwriter's three-year time period should begin anew 
as vis-a-vis the spinoff. The NASD notes that exceptions to the 
Corporate Financing Rule may be granted by a Hearing Subcommittee of 
the Corporate Financing Committee in connection with a member's request 
for review of a staff determination that proposed offering terms and 
arrangements are unfair and unreasonable. With regard to the 
commenter's example, the NASD does not believe the contractual 
obligation of a company to its original underwriter under a right of 
first refusal should automatically become the obligation of that 
company's affiliate when it goes public through a spin-off transaction.

Number of Payments for Waiver/Termination

    The proposed rule change would permit only one payment to a member 
for waiving a right of first refusal in connection with a subsequent 
financing. Upon such payment, the right would be deemed to be 
terminated.\9\

    \9\ Three of the four commenters were opposed to limiting the 
receipt of compensation for waiving or terminating a right of first 
refusal to one time.
    Commenters argued that such a limitation unfairly penalizes the 
underwriter and that one payment should not affect subsequent offerings 
during the term of the right. Despite such arguments, the NASD's 
concerns remain regarding underwriters receiving a ``stand-aside'' 
payment for each subsequent offering by an issuer that has established 
a relationship with a new underwriter when the original underwriter is 
no longer providing any bona fide services to the issuer. In addition, 
the NASD believes that multiple payments result in greater difficulty 
for both the member and the NASD in terms of tracking the amounts 
received over the term of the right in order to insure compliance with 
the compensation guideline of the original offering. The NASD also 
notes that an underwriter not wishing to terminate its right of first 
refusal for future offerings may preserve its right by waiving its 
participation in a particular offering without accepting payment for 
such waiver.
    One commenter argued that the NASD is unnecessarily interfering 
with the contractual relationship between the issuer and the 
underwriter, who are free to negotiate a termination of the right if 
they so desire. In response, the NASD notes that the Corporate 
Financing Rule is intended to regulate certain contractual provisions 
between underwriters and issuers to protect the investors in these 
issues. The NASD believes this provision of the proposed rule change 
will protect the investors of smaller issuers who are less likely to be 
able to influence or negotiate the termination of the right of first 
refusal.
    One commenter argued that this provision of the proposed rule 
change would force members to relinquish their right for very small 
payment because the secondary offering is not likely to be as large as 
the example cited in Notice to Members 94-82 and in footnote 3 of this 
filing (where the original offering was $10 million and the new 
offering is $150 million). The commenter argues that an underwriter may 
be willing to accept substantially less to waive its right in order to 
allow an issuer other financing options if the right of first refusal 
were to remain intact with respect to future financings. In response, 
the NASD notes that under the proposed rule change, underwriters may 
waive their right to an unlimited number of times if they do not 
receive a payment. Therefore, an underwriter not wishing to terminate 
its right of first refusal for future offerings may preserve the right 
by waiving its participation in an offering and by not accepting 
payment for the waiver.

Limits on Waiver/Termination Compensation

    The proposed rule change would limit the amount of any payment or 
fee to waive or terminate a right of first refusal to the greater of 1 
percent (1%) of the original offering proceeds or 5 percent (5%) of the 
commission paid with respect to the subsequent offering. One commenter 
argued that there should be no limitation on the amount of the 
permitted fee for waiving or terminating a right and that any fee 
should be determined by arms-length negotiation between the issuer and 
the underwriter, who are uniquely capable of judging the value of the 
right. The commenter states that in many cases the right of first 
refusal has no value to the member because many early-stage issuers do 
not achieve a level of growth sufficient to warrant a subsequent 
offering of their securities and, therefore, the member has forfeited 
1% of the original offering 

[[Page 37121]]
to obtain a right for which it derives no related benefit.
    As discussed above, the NASD remains concerned about the initial 
capacity of smaller issuers to understand the ramifications of the 
right of first refusal in an IPO and its ability to influence the terms 
of the right. Moreover, to protect the investors in the issuer, the 
NASD has concluded that its concerns necessitate the restrictions 
contained in the proposed rule change.
    The commenter also argues that it is the issuer that has the upper 
hand in setting the terms of the secondary offering and if the member 
does not agree to these terms, the issuer is free to arrange for the 
secondary offering to be underwritten by another member. In response, 
the NASD considers it unlikely that issuers intentionally set the terms 
of their secondary offerings to discourage the initial underwriter. The 
NASD believes the normal priority for issuers when setting the terms of 
their secondary offerings is optimum capital formation. In particular, 
the typical secondary offering of a small business issuer is 
considerably larger than the issuer's initial public offering.
    The above commenter, while opposing a payment limitation, suggested 
in lieu of the proposed limitation that the NASD adopt a range of 
permissible cash payments as a percentage of the subsequent offerings 
depending on the size and stage of development of the issuer and the 
dollar amount of the offering. The commenter considers the 5 percent 
limitation arbitrary and suggested that payments up to 20% of the 
underwriting compensation of the subsequent offering be permitted to be 
received by underwriters of small business issuers or of offerings of 
less than $25 million in order to allow a fair compensation to the 
member. In response, the NASD believes that a payment equal to 20% of 
the underwriting compensation of a subsequent offering would create a 
hardship for smaller issuers, and consequently their investors, in 
terms of reduced net proceeds and/or the ability to attract a new 
underwriter. The NASD's determination to base the percentage at 5% was 
not arbitrary but determined after considerable deliberation to balance 
the interests of the former underwriter and the issuer and arrive at a 
percentage that allowed the former underwriter to participate in the 
success of the issuer, while not jeopardizing the success with a 
payment so large that it affects the issuer's ability to conduct and 
realize the benefits of a secondary offering.
    One commenter stated that this is an ideal proposal that serves 
both parties. It ensures that the original underwriter is justly 
rewarded if the issuer becomes highly successful by preventing the 
issuer from severing all ties with the original underwriter without 
compensating it in a manner that is consistent with the underwriter's 
previously provided services and interests. At the same time, the 
proposed provision would permit the issuer to ascertain the actual cost 
of terminating or waiving the right at the time of the original and 
subsequent offering. The commenter also supported this proposal on the 
basis that it is appropriate to base the amount of payment to the 
original underwriter on the amount of the new underwriter's 
compensation.

Cash Payment Requirement

    The proposed rule change specifies that compensation to members for 
waiving or terminating a right of first refusal must be in the form of 
cash. One commenter argued that the proposal to require only cash 
payments in consideration of the waiver or termination of a right would 
work to the detriment of both underwriters and issuers since early-
stage companies often lack the liquidity to make substantial cash 
payments. The commenter believes that requiring issuers to make 
payments in cash could reduce working capital and damage a small 
company's ability to meet payment obligations, thus jeopardizing the 
company's ability to function as a going concern. In response, the NASD 
believes that a company should have sufficient cash available from the 
proceeds of the subsequent offering to make any necessary payment to a 
former underwriter holding a right of first refusal. The NASD also 
believes this provision of the proposed rule change is appropriate to 
protect the company's shareholders from the dilution resulting from the 
issuance of securities to a former underwriter.\10\

    \10\ Any such securities would, moreover, be in addition to 
securities that the former underwriter previously acquired in 
connection with the original public offering.
Other Comments

    Two commenters addressed the NASD's statements that issuers 
negotiating with an underwriter often may not be in a position to 
influence the terms of the right of first refusal or fully comprehend 
that they have agreed to extend their relationship with the underwriter 
for five years. One commenter noted, specifically, that issuers are 
represented by counsel and that most issuers have knowledgeable, 
competent officers who are aware of the terms of their agreement with 
the underwriter. This commenter argued that the proposed rule change 
imposes undue restrictions on the ability of underwriters and issuers 
to negotiate a mutually acceptable arrangement. In spite of such 
arguments, the NASD's concerns remain that small issuers, even with 
counsel, may not understand the ramifications of the right of first 
refusal, nor be able to influence the terms of these agreements. The 
NASD has often found that issuer's counsel is generally experienced in 
corporate law and inexperienced in securities law matters. The NASD 
reiterates the regulatory purposes of the Corporate Financing Rule is 
to protect investors in such issuers. One commenter stated that it 
appears that the committees of the NASD are representative of major 
sized firms putting forth recommendations for rule changes that will 
eventually give the major underwriters and wire houses more and more 
control of the industry. In response, the NASD notes that the standing 
Committees of the NASD Board of Governors consist of members from both 
large and small firms. The Corporate Financing Committee was the review 
committee for the proposed rule change and, at the time this matter was 
considered, was chaired by an individual representing a very small NASD 
member.

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, 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 

[[Page 37122]]
Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying 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 File Number SR-NASD-95-29 and 
should be submitted by August 9, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\

    \11\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-17731 Filed 7-18-95; 8:45 am]
BILLING CODE 8010-01-M