[Federal Register Volume 61, Number 148 (Wednesday, July 31, 1996)]
[Notices]
[Pages 40054-40056]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19469]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37471; File No. SR-NASD-96-17]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by National Association of Securities Dealers, Inc. Relating to
the Definitions of Bona Fide Independent Market and Bona Fide
Independent Market Maker
July 23, 1996.
I. Introduction
On April 24, 1996, the National Association of Securities dealers,
Inc. (``NASD'' or ``Association'') submitted to the Securities and
Exchange Commission (``SEC'' or ``Commission''), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule
19b-4 thereunder,\2\ a proposed rule change to Rule 2720 of the NASD's
Conduct Rules \3\ to amend the definitions of ``bona fide independent
market'' and ``bona fide independent market maker.'' A notice of the
proposed rule change appeared in the Federal Register on May 24,
1996.\4\ The Commission received one comment letter endorsing the
proposed rule change.\5\ The Commission is approving the proposed rule
change.
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\1\ 15 U.S.C. Sec. 78s(b)(1) (1988).
\2\ 17 CFR 240.19b-4 (1995).
\3\ Prior to the NASD Manuel reorganization, this rule was
designated as Schedule E of the NASD's By-Laws. See, NASD Notice to
Members 96-24 (April 1996).
\4\ Securities Exchange Act Release No. 37223 (May 17, 1996), 61
FR 26239. Also, the NASD granted an extension of the time for
Commission action on this rule filing to July 31, 1996. Letter to
Katherine A. England, Assistant Director, Division of Market
Regulation, SEC, from John Ramsay, Deputy General Counsel, NASD
Regulation, Inc. (``NASDR''), dated July 19, 1996.
\5\ Letter from Carter K. McDowell, Assistant General Counsel,
BANC ONE Corporation, to Jonathan G. Katz, Secretary, SEC, dated
June 13, 1996.
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The proposed rule change addresses potential conflicts of interest
that arise regarding the conduct of due diligence and the pricing of
securities issued by an NASD member, its parent, or an affiliate of a
member that is going public (``Rule 2720 offering''). Rule 2720 also
would apply to an issuer with which the member has a conflict of
interest. The Rule prohibits a member from underwriting or
participating in the underwriting or distribution of a Rule 2720
offering of equity or debt unless the price of the equity offering is
established no higher, or the yield of the debt offering is established
no lower, than the price recommended by a qualified independent
underwriter. The qualified independent underwriter also must
participate in the preparation of the registration statement and
prospectus, offering memorandum, or
[[Page 40055]]
similar document, and exercise the usual standards of ``due diligence''
regarding the offering. Rule 2720, however, provides an exception from
the qualified independent underwriter requirement for offerings of
equity securities for which a bona fide independent market exists. Rule
2720 defines a bona fide independent market as a market in a security
which has, among other things, at least three bona fide independent
market makers.
The NASD reviewed the definitions of bona fide independent market
and bona fide independent market maker, which were part of the original
version of Rule 2720 when it was adopted as schedule E in 1972. The
NASD proposes to revise the definitions to incorporate new requirements
for listing, public float, trading volume, price, number of bona fide
independent market makers, and limitations on the relationship of the
bona fide independent market maker to the issuer that will
significantly improve the criteria used for determining if a market of
sufficient depth and duration exists to constitute an efficient pricing
mechanism for the securities to be distributed. The proposed new
definitions will permit members, in appropriate situations, to conduct
a secondary offering without the burden and expense of engaging a
qualified independent underwriter. However, in situations where the
market cannot be relied on to price the securities appropriately, a
member would still be required to enlist the services of such an
underwriter.
II. Description of the Proposal
Bona Fide Independent Market Definition
Registration Requirement
The proposed rule change retains the current requirement in the
definition of bona fide independent market that it must be a market in
a security which is registered pursuant to Sections 12(b) or 12(g) of
the Act of issued by a company subject to Section 12(d) of the Act.
Price Requirement
The current definition of bona fide independent market does not
contain a price requirement. The NASD is concerned that a public float
requirement, as set forth blow, without a corresponding standard for
the market price of the securities does not establish a valid benchmark
for a bona fide independent market. Therefore, the NASD is proposing to
adopt a new provision in the definition of a bona fide independent
market that would require that the security have a market price of at
least five dollars ($5.00) per share as of the close of trading on the
day immediately preceding the filing of the registration statement or
offering circular, and have traded at a price of $5 or more per share
on at least 20 of the 30 trading days immediately preceding the date on
which the offering circular or registration statement was filed.
Listing and Market Maker Requirements
The current definition of bona fide independent market does not
contain a listing requirement. The NASD believes that a listing on a
national securities exchange or the Nasdaq Stock Market indicates that
the security trades in an efficient, regulated, and active market and
strengthens the definition of bona fide independent market by adding
the qualitative standards of a regulated trading environment, such as
quote transparency and real-time transaction reporting. Therefore, the
NASD is proposing to adopt as one of the requirements for the
definition of a bona fide independent market that the security, for at
least 90 calendar days immediately preceding the filing of the
registration statement or offering circular, have been listed on, and
is in compliance with, the requirements for continued listing on (i) a
national securities exchange, or (ii) The Nasdaq Stock Market so long
as such Nasdaq listing has two bona fide independent market makers for
a period of at least 30 trading days immediately preceding the filing
of the registration statement or offering circular and the effective
date of the offering. Securities quoted on the NASD OTC Bulletin Board
service and those traded in the general over-the-counter market, such
as the ``pink sheets,'' cannot rely on this requirement.
The proposed requirement that the security have at least two bona
fide independent market makers for listings on the Nasdaq Stock Market
would replace the current requirement of at least three bona fide
independent market makers. Given that a security is permitted to be
listed on the Nasdaq Stock Market with two market makers, the NASD
believes that two market makers are sufficient to demonstrate the
presence of a bona fide independent market irrespective of any Rule
2720 affiliate that may also be making a market in the issuer's
securities.
Trading Volume and Public Float Requirements
The current definition of bona fide independent market contains
independent requirements for trading volume and public float. Under the
current rule, a security is considered to have a bona fide independent
market if, for the 12 months immediately preceding the filing of the
registration statement, it has both an aggregate trading volume of at
least 100,000 shares and a minimum of 250,000 publicly held shares.
Under the proposed rule change, for a bona fide independent market to
exist, a security must have for the 90 calendar day period immediately
preceding the filing of the registration statement or offering circular
either an aggregate trading volume of at least 500,000 shares or a
minimum of 5,000,000 publicly held shares outstanding.
The NASD believes that raising the current aggregate 12-month
trading volume requirement from 100,000 shares to 500,000 shares in the
90-calendar-day period before the filing of the registration statement
or offering circular provides a criterion that better reflects an
active, current and, presumably, efficient market. The increased volume
requirement intimates a pricing efficiency which, in turn, establishes
a better basis for justifying an exemption from the requirement that a
qualified independent underwriter establish the price of the offering.
The NASD considers the alternative requirement of a five-million-
share public float as the minimum necessary to ensure that the market
for an issuer's securities will not suffer undue volatility from the
dilution that occurs when a large number of shares is offered to the
public. In this regard, the NASD notes that a typical ``follow-on''
offering \6\ of a company's stock adds between one- and two-million
shares to the public float, which is equal to a 40 percent dilution at
the five-million-share level.
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\6\ The term ``follow-on'' offering refers to a secondary
offering of shares by the issuer.
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Bona Fide Independent Market Maker Definition
The Rule currently defines a bona fide independent market maker as
one which meets certain net capital requirements, publishes bona fide
bid and ask quotations in a recognized interdealer quotation system,
furnishes such quotes to other brokers and dealers on request, and
stands ready, willing and able to effect transactions at quoted prices
with other brokers and dealers. The current standards of the definition
were developed at the time the Rule was adopted in 1972 as Schedule E
and were applied to all securities in the over-the-counter market.
The NASD believes that the current standards for the definition of
bona fide independent market maker are no longer necessary in light of
the proposed
[[Page 40056]]
requirement of the definition of bona fide independent market that the
security be listed on The Nasdaq Stock Market. Market makers for
securities listed on The Nasdaq Stock Market are required to meet
certain net capital standards, publish bona fide bid and ask quotations
in Nasdaq, which is a recognized interdealer quotation system, furnish
quotes to other brokers and dealers on request, and stand ready,
willing and able to effect transactions at quoted prices with other
brokers and dealers. Therefore, the NASD is incorporating the current
requirements into a single standard requiring that the market maker be
registered as a Nasdaq market maker.
The NASD believes that the definition of bona fide independent
market maker should also provide investors with greater assurance that
the market maker's activities are independent of any influences that
may arise when the issuer's ownership of securities or interest in the
offering become material. Therefore, the NASD is proposing to adopt as
part of the revised definition that a bona fide independent market
maker (i) must not be a recipient of any of the net proceeds of the
offering, (ii) must not be an affiliate of the entity issuing the
securities, and (iii) does not in the aggregate itself beneficially
own, nor together with its associated persons, at the time of the
filing of the registration statement or offering circular, five percent
or more of the outstanding voting securities of the entity issuing the
securities, if a corporation, or five percent or more of a partnership
interest in the distributable profits or losses of the entity, if a
partnership.
III. Discussion
The Commission believes that the proposed rule change is consistent
with the Act and the rules and regulations promulgated thereunder.
Specifically, the Commission believes that approval of the proposed
rule change is consistent with Sections 15A(b)(6) \7\ and 15A(b)(9) \8\
of the Act. Pursuant to Section 15A(b)(6), the proposed rule change
clarifies and strengthens the criteria for determining a bona fide
independent market and the related concept of a bona fide independent
market maker. In so doing, the NASD has removed an impediment to the
functioning of a free and open market by improving the criteria used
for determining that a market of sufficient depth and liquidity exists
to constitute an efficient pricing mechanism for the securities to be
distributed. The new definitions also promote economic efficiency
because in applicable situations, members will now be able to conduct
secondary offerings without incurring the time and expense of engaging
a qualified independent underwriter.
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\7\ Section 15A(b)(6) requires the Commission to determine that
a registered national securities association's rules are designed to
promote just and equitable principles of trade, to remove
impediments to and perfect the mechanism of a free and open market
and national market system; and are not designed to permit unfair
discrimination among customers, issuers, brokers, or dealers.
\8\ Section 15A(b)(9) requires the Commission to determine that
a registered national securities association's rules not impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of the Act.
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The Commission requested clarification from the NASD regarding the
term ``traded'' in proposed paragraph (b)(3)(B) of Rule 2720.\9\ NASDR
has confirmed that ``traded'' encompasses any completed transaction of
the day for the security during normal trading hours, up to and
including the last reported trade for the day.\10\
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\9\ The relevant language of paragraph (b)(3)(B) to Rule 2720 is
as follows: ``. . . and which has traded at a price of five dollars
or more per share in at least 20 of the 30 trading days. . . .''
\10\ Letter to Katherine A. England, Assistant Director,
Division of Market Regulation, SEC, from Alden S. Adkins, General
Counsel, NASD Regulation, Inc., dated July 3, 1996. See also letter
to Katherine A. England, Assistant Director, Division of Market
Regulation, SEC, from John Ramsay, Deputy General Counsel, NASD
Regulation, Inc., dated July 15, 1996, confirming that the
definition applies to trades completed during normal trading hours.
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Pursuant to Section 15A(b)(9), the proposed rule change does not
impose any unnecessary or inappropriate burden on competition, but
reflects an attempt to update definitions that contain provisions that
no longer adequately represent current market practices or pricing. The
revised definitions are stringent enough to properly regulate public
distributions where a member issues its own securities or where a
conflict or control relationship with a parent or affiliate exists,
while still providing protection for investors in this type of
offering.
IV. Conclusion
For the above reasons, the Commission believes that the proposed
rule change is consistent with the provisions of the Act, and in
particular with Sections 15A(b)(6) and 15A(b)(9).
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\11\ that the proposed rule change (SR-NASD-96-17) be, and hereby
is approved.
\11\ 15 U.S.C. 78s(b)(2) (1988).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\12\
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\12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-19469 Filed 7-30-96; 8:45 am]
BILLING CODE 8010-01-M