[Federal Register Volume 62, Number 64 (Thursday, April 3, 1997)]
[Notices]
[Pages 15945-15951]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-8470]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38451; File No. SR-NASD-97-12]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc., 
Relating to the Valuation of Illiquid Direct Participation Program and 
Real Estate Investment Trust Securities on Customer Account Statements

March 27, 1997.
    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 February 
21, 1997, NASD Regulation, Inc. (``NASD Regulation'') 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 NASD Regulation. 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

    NASD Regulation proposes to amend Rule 2340, ``Customer Account 
Statements,'' of the Conduct Rules of the National Association of 
Securities Dealers, Inc. (``NASD'' or ``Association'') to require 
general securities members to provide estimated values for direct 
participation program (``DPP'') \1\ securities and real estate 
investment trust (``REIT'') securities on customer account statements 
under certain circumstances. Below is the text of the proposed rule 
change. Proposed new language is italicized and proposed deletions are 
bracketed.
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    \1\ Paragraph (a)(4) of NASD Rule 2810, ``Direct Participation 
Programs,'' defines a DPP as ``a program which provides for flow-
through tax consequences regardless of the structure of the legal 
entity or vehicle for distribution including, but not limited to, 
oil and gas programs, real estate programs, agricultural programs, 
cattle programs, condominium securities, Subchapter S corporate 
offerings and all other programs of a similar nature. . . .'' 
According to NASD Regulation, this definition would cover most 
limited partnerships and specifically excludes real estate 
investment trusts.
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Rule 2340  Customer Account Statements

(a) General
    Each general securities member shall, with a frequency of not less 
than once every calendar quarter, send a statement of account 
(``statement'') containing a description of any securities positions, 
money balances, or account activity to each customer whose account had 
a security position, money balance or account activity during the 
period since the last such statement was sent to the customer.
(b) DPP/REIT Securities
    (1) If a member participated in the public offering of any direct 
participation program (DPP) or real estate investment trust (REIT) 
securities (as these terms are defined below) and an estimated value of 
DPP or REIT securities is available pursuant to subparagraphs (3)(A) 
(ii) or (iii), the member shall list the DPP and/or REIT securities on 
the statement with an estimated value; except that the member shall not 
include on the account statement an estimated value that the member 
believes is inaccurate as of the date of the valuation or is no longer 
accurate as a result of a material change in the operations or assets 
of the program or trust; or
    (2) If the member or an affiliate of the member, acting as a 
fiduciary, provides estimated values of DPP and/or REIT securities to 
accounts that are subject to Employee Retirement Income Securities Act 
(``ERISA'') and Internal Revenue Service (``IRS'') regulations, the 
member shall disclose the same valuations on the statements of all 
other customers owning such securities.
    (3) If DPP and/or REIT securities are listed on the statement with 
an estimated value:
    (A) such estimated value shall be:

[[Page 15946]]

    (i) developed from data which is as of a date no more than 18 
months prior to the date the statement is issued; and
    (ii) provided by an independent source engaged by the member; and/
or
    (iii) provided in an annual report of the DPP or REIT distributed 
to investors pursuant to Sections 14(a) or 14(c) of the Act, as 
applicable, or a periodic report filed by the DPP or REIT with the 
Commission under Sections 13 or 15(d) of the Act; or
    (iv) developed by the member, if valuations pursuant to 
subparagraphs (ii) and (iii) are not available; and
    (B) the member shall segregate DPP and/or REIT securities by 
listing them on the statement separately from non-DPP and non-REIT 
securities and shall include on the statement:
    (i) a brief and easily-understood description of the type of 
estimated value provided (e.g., that the value represents an estimate 
of the investor's interest in the assets owned by the DPP or REIT or 
represents an estimate of the value of the investor's DPP and/or REIT 
securities) and its source, and how a customer may obtain a complete 
and detailed explanation of the valuation methodology employed; and
    (ii) disclosure in close proximity to the listing of DPP and/or 
REIT securities that DPP and/or REIT securities are generally illiquid 
securities and the estimated value disclosed may not be realizable if 
the customer seeks to liquidate the security.
    (4) In disclosing on the statement an estimated value of DPP and/or 
REIT securities, the member shall not;
    (A) aggregate the estimated value of DPP and/or REIT securities 
with the value of any other securities in any sub-total on the 
statement;
    (B) aggregate the estimated value of DPP and/or REIT securities 
with the value of any other securities in the total account value 
unless the statement includes the total estimated value of DPP and/or 
REIT securities and the disclosure required by subparagraph (3)(B)(ii) 
in close proximity to the total account value; and
    (C) include the original issue price of a DPP or REIT security as 
the estimated value (unless valuation of the securities by another 
method indicates the same dollar amount as the original issue price).
    (5) Notwithstanding subparagraphs (b)(1)-(4), if a retirement 
account statement prepared in compliance with ERISA and IRS regulations 
includes DPP and/or REIT securities and individual values are not 
provided for any of the assets in the account, the member shall 
disclose on the statement that DPP and/or REIT securities are generally 
illiquid securities.
    (6) If the DPP and/or REIT securities are listed on the statement 
without a price and without an estimated value, the member shall 
segregate the DPP and/or REIT securities by listing them on the 
statement separately from non-DPP and non-REIT securities and shall 
include on the statement disclosures that: DPP and/or REIT securities 
are generally illiquid securities; the value of the security may be 
different than its purchase price; and, if applicable, accurate 
valuation information is not available.
    [(b)] (c) Definitions For purposes of this Rule[,];
    (1) the term ``account activity'' shall include, but not be limited 
to, purchases, sales, interest credits or debits, charges or credits, 
dividend payments, transfer activity, securities receipts or 
deliveries, and/or journal entries relating to securities or funds in 
the possession or control of the member.
    (2) [(c) For purposes of this Rule,] the term ``general securities 
member'' shall refer to any member which conducts a general securities 
business and is required to calculate its net capital pursuant to the 
provisions of SEC Rule 15c3-1(a), except for paragraph (a)(2) and 
(a)(3).
Notwithstanding the foregoing definition, a member which does not carry 
customer accounts and does not hold customer funds and securities is 
exempt from the provisions of this section.
    (3) the term ``direct participation program securities'' shall 
include equity securities issued by a ``direct participation program'' 
as defined in Rule 2810 that would be included on a customer's 
statement of account even if not held by the member, but does not 
include securities on deposit in a registered securities depository and 
settled regular way, securities listed on a national securities 
exchange or The Nasdaq Stock Market, or any program registered as a 
commodity pool with the Commodity Futures Trading Commission.
    (4) the term ``real estate investment trust securities'' shall 
include equity securities issued by a real estate investment trust as 
defined in Section 856 of the Internal Revenue Code that would be 
included on a customer's statement of account even if not held by the 
member, but does not include securities on deposit in a registered 
securities depository and settled regular way or securities listed on a 
national securities exchange or The Nasdaq Stock Market.

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

    In its filing with the Commission, NASD Regulation 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. NASD Regulation 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

    (a) Rule 2340 of the NASD Conduct Rules (formerly, Article III, 
Section 45 of the NASD Rules of Fair Practice) requires general 
securities members to provide account statements to customers on at 
least a quarterly basis.\2\ The account statement must contain a 
description of any securities position, money balances or account 
activity in the accounts since the prior account statements were sent. 
Under NASD Rule 2340, ``account activity'' includes, but is not limited 
to, purchases, sales, interest credits or debits, charges or credits, 
dividend payments, transfer activity, securities receipts or 
deliveries, and/or journal entries relating to securities or funds in 
the possession or control of the member.
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    \2\ ``General securities member'' refers to any member which 
conducts a general securities business and is required to calculate 
its net capital pursuant to the provisions of SEC Rule 15c3-1(a), 
except for paragraphs (a)(2) and (a)(3). However, a member which 
does not carry customer accounts and does not hold customer funds 
and securities is exempt from the provisions of NASD Rule 2340.
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Background

    By letter dated March 9, 1994, the Subcommittee on 
Telecommunications and Finance of the U.S. House of Representatives 
(``House Subcommittee''), expressed to the NASD (as well as the SEC, 
the National Association of State Securities Administrators, and the 
Investment Program Association) its concern regarding the information 
provided to customers on account statements regarding the current value 
of non-publicly traded partnership securities.\3\

[[Page 15947]]

The correspondence noted that the partnerships that are the subject of 
their concern do not trade on a regular basis and, thus, regular market 
quotes are not available. The House Subcommittee urged that investors 
in non-publicly traded partnerships should be provided information on 
the performance of their investments and expressed concern that there 
may be serious shortcomings in current valuation reporting with respect 
to such securities.
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    \3\ See Letter from the Honorable Edward J. Markey, Chairman, 
and the Honorable Jack Fields, Ranking Republican Member, House 
Subcommittee, Committee on Energy and Commerce, U.S. House of 
Representatives, to Joseph R. Hardiman, President and Chief 
Executive Officer, NASD, dated March 9, 1994.
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    In addition, on June 14, 1994, the NASD received correspondence 
from the Division of Market Regulation (``Division'') of the Commission 
requesting the NASD's views on whether it would be appropriate for 
self-regulatory organizations to require that members make certain 
disclosures on customer account statements.\4\ Specifically, the June 
14 Letter asks for the NASD's views regarding whether it would be 
appropriate for self-regulatory organizations to require broker-dealers 
to make the following disclosures on customer account statements: (i) 
there is no liquid market for most limited partnership interests; (ii) 
the values reported on account statements, if any, may not reflect the 
values at which customers can liquidate their positions; and (iii) if a 
value is reported, the source of the value, a short description of the 
methodology used to determine the value, and the date the value was 
last determined.
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    \4\ See Letter from Brandon Becker, Director, Division, 
Commission, to Richard G. Ketchum, Executive Vice President and 
Chief Operating Officer, NASD, dated June 14, 1994 (``June 14 
Letter'').
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    By letters dated May 10, 1994, and August 19, 1994, the NASD 
expressed concern to Congress and the SEC that there were 
inconsistencies in the manner in which members included valuations for 
DPP securities on customer account statements and indicated that the 
Association was moving forward to examine the need for regulation in 
this area.\5\ NASD Regulation has determined to amend NASD Rule 2340 to 
provide regulatory guidance to members regarding the disclosure of 
values for DPP securities on customer account statements in order to 
regulate the manner in which information is provided to investors 
regarding the performance of their DPP investment assets.
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    \5\ See Letter from Richard G. Ketchum, Executive Vice President 
and Chief Operating Officer, NASD, to the Honorable Edward J. 
Markey, Chairman, House Subcommittee, Committee on Energy and 
Commerce, U.S. House of Representatives, and the Honorable Jack 
Fields, Ranking Republican, House Subcommittee, Committee on Energy 
and Commerce, U.S. House of Representatives, dated May 10, 1994; and 
Letter from Richard G. Ketchum, Executive Vice President and Chief 
Operating Officer, NASD, to Brandon Becker, Director, Division, 
Commission, dated August 19, 1994.
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    In particular, NASD Regulation has been concerned that a 
significant number of NASD members continue to carry DPP securities on 
customer account statements at the original purchase price. NASD 
Regulation believes that this practice needs to be eliminated. In 
addition, NASD Regulation proposes to apply the proposed amendment to 
NASD Rule 2340 to the securities of certain REITs, which are excluded 
from the Association's definition of DPP security in paragraph (a)(4) 
of NASD Rule 2810, in order to ensure similarity of treatment under 
NASD Rules of the two products.

Description of Proposed Amendments to NASD Rule 2340

Scope and Definitions

    NASD Regulation proposes to apply the new requirements in NASD Rule 
2340 to DPP securities and REIT securities. The definitions of DPP and 
REIT securities proposed in subparagraphs (c)(3) and (4) of NASD Rule 
2340 only encompass unlisted DPPs and REITs, since an investment in 
listed securities provides investors with some measure of liquidity and 
market values. Thus, the definitions exclude securities listed on a 
national securities exchange or The Nasdaq Stock Market, as well as 
securities that are in a depository and settle regular way. The 
definition of DPP securities proposed in subparagraph (c)(3) also 
excludes any program registered as a commodity pool, since those 
programs generally offer investors a security that is redeemable by the 
issuer, at the customer's option at regular intervals and at 
ascertainable values.

Requirements to Place Estimated Values on Customer Account Statements 
and Guidance on Appropriate Sources of Valuations--Subparagraphs 
(b)(1)-(2)

    The proposed rule change contains two specific circumstances under 
which general securities members are obligated to provide customers 
with estimated values for DPP and/or REIT securities in their 
customers' accounts.
    In the first circumstance, under subparagraph (b)(1) of the 
proposed rule change, if a general securities member participated in 
the public offering of DPP or REIT securities, then the member must 
list the DPP/REIT securities on its customer account statements with 
estimated values if such values are available pursuant to subparagraphs 
(b)(3)(A) (ii) or (iii) of the proposed rule change. Where a general 
securities member participated in the public offering of DPP or REIT 
securities, NASD Regulation believes that the member should inform its 
customers of the estimated value of the DPP or REIT securities. 
Subparagraph (b)(3)(A)(iii) permits a member to include an estimated 
value that is contained in an annual report distributed to investors 
pursuant to Sections 14(a) or 14(c) of the Act or in a periodic report 
filed with the Commission under Sections 13 or 15(d) of the Act.\6\ 
This provision is intended to address the concern of members regarding 
their liability for disclosing an estimated value by permitting the 
member to rely on the liabilities under the federal securities laws 
that attach to the general partner's or trustee's disclosure.
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    \6\ According to the NASD, the reporting requirements of the Act 
do not impose a mandatory obligation on general partners or trustees 
to provide an estimated value to investors in a periodic report or 
in the annual report.
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    Subparagraph (b)(3)(A)(ii) permits a member to include an estimated 
value provided by an independent source engaged by the member. Thus, 
when a member is obligated to include an estimated value for DPP/REIT 
securities on customer account statements under subparagraph (b)(1), 
the member may include valuations from both an independent source and 
an annual/periodic report, if the member determines to do so.
    In considering this mandatory obligation, NASD Regulation 
determined that there are circumstances where the member should be 
required to refrain from using an estimated value that the member 
believes is inappropriate. Therefore, proposed subparagraph (b)(1) 
provides that a member shall not include an estimated value of the 
securities on the account statement if the member believes that the 
estimated value was inaccurate as of the date of the valuation or is no 
longer accurate due to a material change in the operations or assets of 
the program. With respect to the latter phrase, the assets of a real 
estate limited partnership would be considered to be impaired, for 
example, where the lessee fails to perform under the lease. Similarly, 
the sale of a property would be considered a material change because 
the sale reduces the value of the program.
    In the second circumstance, under subparagraph (b)(2) of the 
proposed rule change, if a general securities member or its affiliate 
acts as a fiduciary in connection with partnership or trust securities 
which are held in retirement accounts and is disclosing individual

[[Page 15948]]

DPP/REIT estimated values to retirement account holders,\7\ then the 
member must disclose the same valuations on the statements of all other 
customers owning such securities. NASD Regulation believes that when a 
member or its affiliate acts as a fiduciary for retirement accounts and 
provides individual DPP/REIT security values to its retirement account 
customers, other customers of the broker/dealer should receive the same 
values being provided to retirement account customers. NASD Regulation 
states that the requirement to disclose the ERISA or IRS valuation to 
other customers would not conflict with the fiduciary and custodial 
obligations imposed by the Department of Labor and the IRS.
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    \7\ According to NASD Regulation, the Employee Retirement Income 
Securities Act (``ERISA'') and Internal Revenue Service (``IRS'') 
regulations require, at least annually, that a retirement account 
fiduciary provide to the account holder a statement of the total 
value of all the assets in the account.
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    However, according to NASD Regulation, neither the Department of 
Labor (which administers ERISA regulations) or the IRS (which 
administers IRA and other retirement products) specifically requires 
fiduciaries to provide individual values for any assets held in the 
retirement account. Therefore, if the general securities member acting 
as a fiduciary does not provide individual values for the DPP and REIT 
securities in the retirement account, proposed new subparagraph (b)(5), 
discussed more fully below, provides an exception from the requirement 
to disclose individual values for assets held in a retirement 
account.\8\
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    \8\ The adoption of such an exception does not represent a view 
that the proposed requirement to provide individual ERISA/IRA 
valuations to other customers of the broker-dealer will discourage 
members from providing such individual valuations. To the contrary, 
fiduciaries increasingly are providing individual values for each 
asset in a retirement account in order to permit the account holder 
to make withdrawals where the account holder has reached the age 
when ERISA/IRS regulations require annual mandatory withdrawals that 
do not exceed a percentage-of-assets limitation.
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Appropriate Source for Estimated Values--Subparagraph (b)(3)(A)

    Proposed subparagraph (b)(3)(A) of NASD Rule 2340 requires that, 
where DPP and/or REIT securities are listed on a customer account 
statement with an estimated value, such values shall be: (1) Provided 
by an independent source engaged by the member; or (2) from a valuation 
provided in an annual report distributed to investors or in a periodic 
report that must be filed with the SEC (discussed more fully above). A 
member may use an estimated value from either or both of these sources. 
Under proposed subparagraph (b)(3)(A)(iv), a member may develop an 
estimated value for the DPP/REIT securities only when a valuation by an 
independent source or from an SEC annual or periodic report is not 
available.
    Subparagraph (b)(3)(A)(i) requires that any value provided must be 
developed from data which is as of a date no more than 18 months prior 
to the date the customer account statement is issued. NASD Regulation 
believes that this requirement is appropriate because an estimated 
value, accurate upon its first use on a customer account statement, may 
become stale due to length of time or occurrence of subsequent events 
(such as the sale of a major asset of the partnership). NASD Regulation 
believes that the 18-month standard provides sufficient time for the 
member and for an independent valuation source to develop an estimated 
value for DPP/REIT securities based on the audited financials contained 
in the Form 10-K of the DPP or REIT that is filed by March 30 and is 
based on financial statements dated December 31 of the prior year.
    Accordingly, the 18-month standard will allow a member to continue 
to use a valuation based, for example, on the December 31, 1995, 
financials during April, May, and June 1997, while a new estimated 
value based on the December 31, 1996, financials is being developed. In 
developing an objective standard, NASD Regulation considered whether 
investors would be disadvantaged if an event occurred that would render 
an estimated value disclosed on customer account statements obsolete 
during the 18-month period. As set forth above, it is the 
responsibility of the member to not include an estimated value on the 
account statement that the member believes was inaccurate at the time 
it was developed or is no longer accurate as a result of a material 
change in the operations or assets of the program or trust.

Segregation of DPP/REIT Securities--Subparagraphs (b)(3)(B) and (b)(6)

    Subparagraph (b)(3)(B) requires that an estimated value provided 
for DPP/REIT securities on a customer's account statement be segregated 
from other securities into a separate location on the customer account 
statement. NASD Regulation believes that investment in non-publicly 
traded DPP and REIT securities and the estimated values that may be 
disclosed for those securities regarding their performance differ 
sufficiently from the prices of other securities that customers will 
benefit from having the DPP/REIT securities grouped together. In 
addition, NASD Regulation believes that the segregation of these 
securities into a separate location on the customer account statement 
should also lessen the possibility of misleading customers regarding 
the estimated values for DPP/REIT securities since the valuations will 
be distinguished from listed securities and accompanied by cautionary 
disclosures.
    Subparagraph (b)(6) of the proposed rule change provides that DPP/
REIT securities listed on customer account statements without an 
estimated value shall also be segregated. Thus, the requirement to 
segregate DPP/REIT securities will apply regardless of whether the 
security is listed with or without an estimated value.

Disclosure of the Source of the Estimated Value--Subparagraph 
(b)(3)(B)(i)

    Proposed subparagraph (b)(3)(B)(i) requires members to provide a 
brief and easily-understood statement relating to the source of the 
estimated value, provided that the member informs the customer of how 
to obtain a more complete and detailed explanation of the methodology. 
The provision includes two examples of such a brief statement: (1) 
``the value represents an estimate of the investor's interest in the 
assets owned by the DPP or REIT;'' or (2) ``the value . . . represents 
an estimate of the value of the investor's DPP and/or REIT 
securities.'' Another example of acceptable disclosure is that the 
estimated value is ``an estimate of value provided to (member's name) 
by an independent valuation service on an annual basis based on 
information available to the service on (date).''
    An example of the disclosure a member may use to inform the 
customer of how to obtain a more complete explanation of the valuation 
methodology is: ``A general description of the methodology used by the 
independent valuation service to determine its estimate of value is 
available by telephoning (telephone number).''

Disclosure of Nature of DPP/REIT Securities--Subparagraph (b)(3)(B)(ii)

    Proposed subparagraph (b)(3)(B)(ii) requires disclosure in close 
proximity to the location of the DPP/REIT securities on the account 
statement that DPP securities generally are illiquid securities and the 
estimated value disclosed may not be realizable if the customer seeks 
to liquidate the security. NASD Regulation considers the requisite 
disclosure to be sufficiently proximate if it is located on the same

[[Page 15949]]

page where the DPP and/or REIT securities are listed.

Aggregation of Estimated Values for DPP/REIT Securities with the Value 
of Other Securities in Sub-Totals and in the Total Account Value--
Subparagraphs (b)(4) (A) and (B)

    Proposed subparagraph (b)(4)(A) prohibits a general securities 
member who discloses an estimated value for a DPP and/or REIT security 
on a customer account statement from aggregating the estimated value of 
the DPP/REIT securities with the value of any other securities in any 
sub-total on the statement. Proposed subparagraph (b)(4)(B) allows a 
member to include the estimated value of the DPP/REIT securities in the 
total account value on the statement if the member provides disclosure 
in close proximity to the total account value of the sub-total for DPP/
REIT securities and of the illiquid nature of the securities, as 
required by subparagraph (b)(3)(B)(ii), as discussed above. NASD 
Regulation considers ``close proximity'' to require that the sub-total 
for DPP/REIT securities and the cautionary disclosure appear on the 
same page as the total account value.

Use of Purchase Price--Subparagraph (b)(4)(C)

    Proposed subparagraph (b)(4)(C) prohibits members from using the 
original purchase price of a DPP or REIT security on a customer account 
statement as the estimated value unless the valuation of the DPP or 
REIT by another method indicates the same dollar amount as the original 
issue price. Thus, regardless of the mandatory obligations in proposed 
subparagraphs (b)(1) and (b)(2) to disclose an estimated value for DPP/
REIT securities under certain circumstances, the member may not use the 
original purchase price as the required estimated value (unless the 
valuation of the DPP or REIT by another method indicates the same 
dollar amount as the original issue price).

Retirement Account Statements With No Individual Values--Subparagraph 
(b)(5)

    Proposed subparagraph (b)(5) states that if a retirement account 
statement prepared in accordance with ERISA and IRS regulations 
includes an aggregate value of the assets held in the account, but does 
not provide individual values for any of the assets, then the member 
must disclose on the account statement only that DPP and/or REIT 
securities included in the account are generally illiquid securities. 
As a result of the exception provided in subparagraph (b)(5) from 
subparagraphs (b) (1)-(4), the member may include the value of DPP/REIT 
securities in the total account value. NASD Regulation believes that 
since individual values are not provided for any of the assets in the 
retirement account, the other provisions that would, in particular, 
require disclosures along with the display of the total account value, 
are unnecessary.

Required Disclosure for Unpriced Securities--Subparagraph (b)(6)

    When a member discloses no valuation for DPP/REIT securities on a 
customer account statement, proposed subparagraph (b)(6) requires the 
member to segregate the DPP/REIT securities on the account statement 
and include disclosures that DPP/REIT securities are generally illiquid 
securities, that the value of the security may be different from its 
purchase price, and, if applicable, that accurate valuation information 
is not available.

Implementation of Proposed Rule Change

    In order to provide members (or their service organizations) with 
sufficient time to modify their computer systems to comply with the 
proposed rule change, NASD Regulation is requesting that the proposed 
rule change become effective six months after Commission approval. 
During that time, NASD Regulation will issue a Notice to Members 
announcing the Commission's approval of the proposed rule change and 
the anticipated effective date. In addition, the staff of the Corporate 
Financing Department will respond to inquiries by members and their 
service organizations regarding compliance with the proposed rule 
change. To the extent that interpretive issues arise during this period 
that are generally applicable to those members that are subject to the 
proposed rule change, the Association will issue a Notice to Members to 
clarify for all members the application of the rule change.
    (b) NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\9\ 
which require that the Association adopt and amend its rules to promote 
just and equitable principles of trade and generally provide for the 
protection of customers and the public interest, in that the proposed 
rule change significantly improves disclosure to public customers on 
their account statements of information concerning the value and 
performance of securities issued by non-publicly traded DPPs and REITs 
in which such customers have invested, while providing safeguards for 
both member firms and public customers against the publication of 
inaccurate, and therefore misleading, values for such securities.
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    \9\ 15 U.S.C. Sec. 78o-3.
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation 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 94-96 (December 1994). Thirty-nine comments were received in 
response thereto from 36 commenters. A copy of the Notice to Members is 
attached as Exhibit 2 to the rule filing. A copy of the comment letters 
received in response thereto are attached as Exhibit 3 to the rule 
filing. Thirty of the 36 commentators generally favored NASD 
Regulation's effort to provide regulatory guidance regarding the 
disclosure of partnership valuations on customer account statements, 
although every letter contained suggested revisions. Six commenters 
were opposed to the adoption of the proposed rule change.
    Notice to Members 94-96 published an original version of the 
proposed rule change which required that customer account statements:

    1. Segregate DPP securities from other securities on the account 
statement;
    2. If illiquid DPP securities are listed without a price, 
include disclosure that accurate pricing information is not 
available because the value of the security is not determinable 
until the liquidation of the partnership and no secondary market 
exists;
    3. If DPP securities are listed with a price:
    a. Not aggregate the value of the DPP securities with the value 
of any other securities on the statement or include the value of the 
DPP securities in the customer account net worth calculation; and
    b. Include disclosure of the methodology used for obtaining the 
valuation; and
    c. Include disclosure that DPP securities generally are illiquid 
securities and that the price listed may not be realizable if the 
customer seeks to liquidate the security.

Scope and Definitions

    NASD Regulation agreed with the views of commenters that the 
regulatory concerns surrounding the value of DPP securities should 
extend only to unlisted DPPs and REITs, since an investment in Nasdaq 
or exchange-listed securities provides investors with some measure of 
liquidity and market

[[Page 15950]]

values.\10\ Accordingly, NASD Regulation revised its proposal to adopt 
a definition of DPP and REIT securities in new subparagraphs (c) (3) 
and (4) of NASD Rule 2340 that excludes securities listed on a national 
securities exchange or the Nasdaq Stock Market, as well as securities 
that are in a depository and settle regular way. NASD Regulation also 
determined to except from the definition of DPP securities any program 
registered as a commodity pool, since those programs offer investors a 
security that is redeemable by the issuer, at the customer's option at 
regular intervals and at ascertainable values.
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    \10\ NASD Regulation expanded the proposal published for comment 
in Notice to Members 94-96 to include non-publicly traded REIT 
securities (which are not included in the Association's definition 
of DPP security) in order to ensure similarity of treatment under 
NASD Rules for these products.
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Prices versus Estimated Values

    NASD Regulation amended the proposal published for comment to 
eliminate the word ``price'' and insert the phrase ``estimated value'' 
throughout the revised rule. Commenters stated that a ``price'' carried 
on a customer account statement gives the appearance to the investor 
that the security can be liquidated for an amount that is roughly 
equivalent to the price set forth on the customer's account statement. 
However, except in the case of those DPPs/REITs which are publicly 
listed and traded, estimated values of DPP/REIT securities are not 
likely to be realizable if a customer seeks to liquidate his or her 
investment.

Requirements to Place Estimated Values on Customer Account Statements 
and Guidance on Appropriate Sources of Valuations--Subparagraphs (b) 
(1) and (2)

    The provisions of the proposal published for comment that provide 
guidance for the disclosure of DPP securities with an estimated value 
on customer account statements received the most comments. The 
commenters generally believed that investors should be provided with a 
value for their DPP securities. However, they differed as to the value 
to be disclosed, with the greatest amount of comment focused on 
valuation methodologies (whether net asset value or securitized value) 
and their source (i.e., whether generated by the member or obtained 
from the general partners or third-party independent evaluators).
    NASD Regulation agrees with the sentiment expressed in a majority 
of the comment letters and with the views of correspondence received 
from the House Subcommittee, i.e., that investors in non-publicly 
traded partnerships and trusts should know how their investments are 
performing. However, NASD Regulation believes that there are practical 
problems to requiring that all members provide disclosure of the 
estimated values of all DPP and REIT securities held by their 
customers. A member that was not part of the underwriting syndicate for 
the initial public offering would not have conducted due diligence. 
Therefore, the member would not have the usual ongoing relationship 
with the general partner or trust advisor that would permit the member 
to assess the reliability and validity of an estimated value provided 
by the general partner/trust advisor or any other source. In 
particular, when a customer's DPP/REIT securities are transferred to a 
broker-dealer after acquiring them through another member, NASD 
Regulation determined that it would be an inappropriate burden for the 
member to be required to provide estimated values for the many 
different partnerships and trusts held by its customers if the member 
did not participate in the initial public offering of the DPP or REIT.
    NASD Regulation determined that members should be required to 
provide customers who have DPP or REIT securities in their general 
securities accounts with estimated values under two specific 
circumstances: (1) when the member participated in the underwriting of 
the initial or, although rare, follow-on public offering of the 
partnership or trust securities and had the opportunity to conduct due 
diligence and develop a relationship with the sponsor or general 
partner; and (2) when the member or its affiliate acts as a fiduciary 
in connection with partnership or trust securities which are held in 
retirement accounts and are disclosing individual DPP/REIT security 
values to retirement account holder.\11\ NASD Regulation has revised 
the proposal published for comment in the Notice to Members to reflect 
these requirements by adopting new subparagraphs (b)(1) and (b)(2) of 
NASD Rule 2340.
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    \11\ ERISA and IRS regulations require, at least annually, that 
a retirement account fiduciary provide to the account holder a value 
for the aggregate of all the assets in the account. However, as 
noted in footnote eight, other ERISA/IRS regulations requiring 
mandatory annual withdrawals by the account holder place pressure on 
a member acting as a fiduciary to provide individual values for each 
asset in a retirement account.
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    However, to address concerns that the proposed rule change would 
require members to provide estimated values for DPP/REIT securities 
held in a retirement account, although neither the Department of Labor 
(which administers ERISA Regulations) or the IRS (which administers 
IRA, and other retirement type products) specifically require 
fiduciaries to provide individual values for DPP/REIT securities and 
any other assets held in the retirement account, NASD Regulation 
proposed new subparagraph (b)(5) to provide an exception from the 
requirement to disclose individual values if the member only provides 
an aggregate value for the entire retirement account. See discussion 
below of subparagraph (b)(5).

Appropriate Source for Estimated Values--Subparagraph (b)(3)(A)

    Commenters expressed concern that the proposal published for 
comment did not provide guidance on the different sources of an 
estimated value considered appropriate by the Association. Accordingly, 
NASD Regulation has amended its original proposal to include a 
provision in subparagraph (b)(3)(A) of NASD Rule 2340 that will require 
the member's estimated value for DPP or REIT securities to be provided 
by an independent source engaged by the member, or be from a valuation 
in the DPP's or REIT's annual report distributed to investors, or from 
a periodic report filed with the SEC by the DPP or REIT. The member may 
develop a value for the DPP or REIT only if a valuation by an 
independent source or from an annual or SEC periodic report is not 
available.

Prohibition on Using Stale Data--Subparagraph (b)(3)(A)(i)

    Many commenters stated that an estimated value, accurate upon its 
first use on a customer account statement, may become stale or 
inaccurate due to lengthy time or subsequent events (such as the sale 
of a major asset of the partnership). NASD Regulation agrees that an 
estimated value based on stale information eventually becomes 
sufficiently misleading to investors to constitute a fraud. Therefore, 
NASD Regulation has amended its original proposal to include a 
provision in subparagraph (b)(3)(A)(i) of NASD Rule 2340 that will 
preclude members from disclosing an estimated value if the financial 
statements and other underlying data used to determine that value are 
of a date more than 18 months prior to the date the account statement 
is issued. In addition, proposed subparagraph (b)(2) provides an 
exception to the mandatory requirement that a member that participated 
in the

[[Page 15951]]

distribution of a DPP or REIT security provide an estimated value for 
such securities on its customers' account statements where the member 
believes that the estimated value was inaccurate as of the date of the 
valuation or is no longer accurate as a result of a material change in 
the operations or assets of the program or trust.

Segregation of DPP/REIT Securities--Subparagraphs (b)(3)(B) and (b)(6)

    NASD Regulation considered and ultimately rejected the views of 
several commenters who objected to the requirement that DPP and REIT 
securities be segregated from other securities into a separate location 
on the customer account statement. NASD Regulation believes that 
investments in non-publicly traded DPP and REIT securities and the 
estimated values which may be disclosed regarding their performance 
differ sufficiently from the prices of other securities that customers 
will benefit from having the securities grouped together for ease of 
presentation and review.
    In addition, NASD Regulation believes that the segregation of DPPs 
and REITs into a separate location on the customer account statement 
should lessen the possibility of misleading customers regarding values 
since they will be distinguished from listed securities. NASD 
Regulation also determined that the requirement to segregate DPP/REIT 
securities should apply regardless of whether the security is listed 
with or without an estimated value. Therefore, proposed subparagraphs 
(b)(3)(B) and (b)(6) set forth the requirement to segregate DPP and 
REIT securities.

Use of Purchase Price--Subparagraph (b)(4)(C)

    In response to the correspondence of the SEC, NASD Regulation 
amended the proposal published for comment to add a new provision in 
subparagraph (b)(4)(C) prohibiting members from using the original 
purchase price of a DPP or REIT security on a customer account 
statement as the estimated value. NASD Regulation provided additional 
language to clarify that the same dollar value of the purchase price 
may be used when a valuation methodology results in the estimated value 
and purchase price being equivalent.

Required Disclosure for Unpriced Securities--Subparagraph (b)(6)

    In response to comments, NASD Regulation amended the proposal 
published for comment to require the following disclosure on the 
account statement where a member provides no valuation for a DPP or 
REIT: that DPP and/or REIT securities generally are illiquid 
securities; the value of the security may be different than its 
purchase price; and, if applicable, that accurate valuation information 
is not available. This disclosure replaces the provision in the 
proposal published for comment that would have required a statement 
that the value of the DPP security is not available until the 
liquidation of the partnership and that no active secondary market 
exists.

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 reason 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, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, DC 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-97-12 and should be 
submitted by April 24, 1997.

    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. 97-8470 Filed 4-2-97; 8:45 am]
BILLING CODE 8010-01-M