[Federal Register Volume 62, Number 132 (Thursday, July 10, 1997)]
[Notices]
[Pages 37105-37108]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-18090]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38812; File No. SR-NASD-97-29]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Granting Approval to Proposed Rule Change and
Amendments No. 1 and No. 2 Thereto Relating to Prohibition on Members
Receiving any Payment To Publish a Quotation, Make a Market in an
Issuer's Securities or Submit an Application to Make a Market in an
Issuer's Securities
July 3, 1997.
On April 18, 1997, 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 prohibit members from
receiving any payment to publish a quotation, make a market in an
issuer's securities or submit an application to make a market in an
issuer's securities. On May 19, 1997 and May 21, 1997, the NASD
submitted two amendments (``Amendment No. 1'' and
[[Page 37106]]
``Amendment No. 2''), respectively, to the proposed rule change.\3\
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\1\ 15 U.S.C. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In Amendment No. 1, the NASD made technical corrections to
the text of the rule, provided an explanation for not expressly
prohibiting member-to-member payments for making a market, and added
an explanatory footnote concerning the rule's coverage. Letter from
Alden Adkins, Vice President and General Counsel, NASD Regulation,
to Elaine Darroch, Attorney, Division of Market Regulation, SEC (May
16, 1997). Amendment No. 2 corrected a minor omission in Amendment
No. 1. Letter from Alden Adkins, Vice President and General Counsel,
NASD Regulation, to Elaine Darroch, Attorney, Division of Market
Regulation, SEC (May 19, 1997).
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The proposed rule change and Amendments No. 1 and No. 2 thereto
were published for comment in Securities Exchange Act Release No. 38670
(May 22, 1997), 62 FR 29382 (May 30, 1997). No comments were received
on the proposal. This order approves the proposed rule change.
I. Introduction
It has been a longstanding policy and position of the NASD that a
broker-dealer is prohibited from receiving compensation or other
payments from an issuer for quoting, making a market in an issuer's
securities or for covering the member's out-of-pocket expenses for
making a market, or for submitting an application to make a market in
an issuer's securities. As stated in Notice to Members 75-16 (February
20, 1975), such payments may be viewed as a conflict of interest since
they may influence the member's decision as to whether to quote or make
a market in a security and, thereafter, the prices that the member
would quote.
On October 27, 1994, the United States Court of Appeals, Tenth
Circuit, reversed, in part, an SEC decision in the matter of General
Bond & Share Co. (``General Bond'').\4\ The NASD had held that General
Bond had, among other things, violated Article III, Section 1 of the
Association's Rules of Fair Practice (currently NASD Rule 2110) by
accepting payments from issuers in return for listing itself as a
market maker for the securities in the National Quotation Bureau, Inc.
(``NQB'') Pink Sheets (``Pink Sheets''). The NASD position was based on
NASD policy as articulated to the members in Notice to Members 75-16
(February 20, 1975). The SEC, in affirming the NASD decision, agreed
with the NASD that this conduct was inappropriate and in violation of
NASD rules.\5\
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\4\ General Bond & Share Co. v. Securities and Exchange
Commission, 39 F. 3d 1451 (10th Cir. 1994).
\5\ In the Matter of General Bond & Share Co., Securities
Exchange Act Release No. 32291 (May 11, 1993), 54 SEC Docket 129.
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The Tenth Circuit decision held that the NASD rules at the time did
not prohibit a member firm from accepting issuer-paid compensation for
making a market in a security.\6\ Although the NASD had previously
stated that such specific conduct was prohibited, the Court held that
the NASD was required by statute to submit a filing with the SEC
amending NASD rules in this respect. The NASD is proposing this rule to
clarify the application of NASD rules to situations involving the
acceptance of compensation for market making activities.
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\6\ The Court reversed the SEC's finding of violation that
related to the firm's acceptance of issuer-paid compensation, but
sustained all of the SEC's other findings of violation by General
Bond. General Bond, 39 F.3d at 1458, 1461.
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II. Description of the Proposal
The NASD proposes to add Rule 2460 to prohibit receipt by a broker-
dealer of ``any payment or other consideration'' from a prohibited
party for publishing a quotation, acting as a market maker, or
submitting an application in connection therewith. It is intended to
cover any form of payment in cash, non-cash items, or securities. The
term ``consideration'' would include, for example, granting or offering
of securities products on terms more favorable than those granted or
offered to the public. This term would include the granting of options
in any security, where the options are exercisable at a price that is
discounted from the prevailing market price. The rule also would cover
the purchase of securities by a member from a prohibited party at a
discount from the prevailing market. Such payments are intended to be
prohibited because they may, as discussed in Notice to Members 75-16,
create a conflict of interest that would influence the member to enter
a quotation or make a market in a security.
The proposed rule prohibits payments that are made ``for publishing
a quotation, acting as a market maker in a security, or submitting an
application in connection therewith.'' This language would apply the
prohibitions of the rule to the entry of a quotation in a security,
making a market in a security, and the entry of a quotation or the
quotation of a security at a particular price.\7\ The definition of
``quotation'' is drawn from Rule 15c2-11 of the Act\8\ and includes
indications of interest.\9\ The proposed rule also specifies that a
member may not impose a fee or accept a payment for submitting an
application to enter quotations or make a market in an issuer's
securities, e.g., a NASD Form 211 application to enter a quotation in
the OTC Bulletin Board or NQB Pink Sheets.
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\7\ NASD Notice to Member 75-16 states that questionable
payments to a market marker have the potential to influence the
member's ``* * * decision to make a market and thereafter, perhaps,
the prices it would quote.'' NASD Notice to Members, supra note 5.
\8\ 17 CFR 240.15c2-11(e)(3)
\9\ The proposed rule would apply to any situation in which
member broker-dealer quotations are published in any interdealer
quotation system, or any publication or electronic communication
network or device which is used by brokers or dealers to make known
to others their interest in transactions in any security, including
offers to buy and sell at a stated price or otherwise, or
invitations or offers to buy or sell. See Amendments No. 1 and No.
2, supra note 3.
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The proposed rule would apply to payments by an issuer, an
affiliate of the issuer, or a promoter, whether received directly or
indirectly through another party. Whether a person is considered an
affiliate would be determined under the provisions of NASD Rule 2720
that relate to the existence of a control relationship between an
issuer and a member. For purposes of NASD Rule 2720, the term
``affiliate'' shall mean ``a company which controls, is controlled by
or is under common control with a member.'' In addition, the term
``affiliate'' is also presumed under certain circumstances in which a
member or company is presumed to control, or presumed to be under
common control, when the respective entities beneficially own ten
percent or more of the outstanding voting securities of the other
entity.\10\
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\10\ See NASD Rule 2720(b)(1)(B) (i), (ii) and (iii).
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The concept of ``promoter'' is broadly defined to encompass all
persons other than the issuer and its affiliates who would have an
interest in influencing a member to make a market in a security. Thus,
the definition includes not only the organizer of the issuer's
business, but also any director, employee, consultant, account, or
attorney of the issuer. In addition, certain categories of
securityholders are also within the definition, since these persons are
considered to have an interest greater than that of the average
securityholder in ensuring the existence of an active market. The
categories in the definition, however, are intended to be illustrative
only, and the proposed rule would prohibit payments by any similar
person with an interest in promoting the entry of quotations or market
making in the issuer's securities.
The proposed rule change does not specifically cover member-to-
member payments in the express language of the proposed rule.\11\ The
reason for the exclusion of member-to-member conduct in the express
language of the rule are as follows. This member-to-
[[Page 37107]]
member conduct arguably is already covered by other provisions of the
proposed rule, provisions of another proposed Conduct Rule, and an
existing Conduct Rule.\12\ First, the definition of a promoter could
apply to payments by one member to another member to publish a quote,
make a market, or file an application therewith for a particular
security for the purpose of promoting interest in a particular
security.\13\ In addition, such payments may also fall within the scope
of proposed conduct rule interpretation IM-2110-5 (SR-NASD-97-37),\14\
which would prohibit certain anticompetitive conduct of member broker-
dealers. In particular, the proposed rule interpretation would prohibit
certain ``coordinated'' activity among member broker-dealers regarding
prices (including quotations), trades, or trade reports. Thus, certain
coordinated efforts in publishing quotations or setting prices may be
subject to the provisions of the proposed rule. Furthermore, member-to-
member payments in some cases may also be covered by NASD Conduct Rule
2110 as conduct that is inconsistent with high standards of commercial
honor and just and equitable principles of trade. In addition, member-
to-member payments not specifically prohibited under the provisions
above may involve legitimate broker-dealer activity for which
exemptions from the proposed rule would have to be crafted. Crafting
appropriate exemptions would complicate the proposed rule unnecessarily
in light of the absence of a history of abusive conduct in member-to-
member payments.
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\11\ See Amendment No. 1, supra note 3.
\12\Id.
\13\Id.
\14\ Securities Exchange Act Release No. 38715 (June 4, 1997),
62 FR 31845 (June 11, 1997) (notice of proposed rule change (SR-
NASD-97-37)).
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The proposed rule also is intended to prohibit indirect payments by
the issuers, affiliates, or promoters through other members. Thus,
members may not accept payments from other members that originate from
an issuer, affiliate, or promoter of the issuer.
In addition, the proposed rule contains a general exception that
permits payments to a member by prohibited persons for ``bona fide
services.'' Such bona fide services are intended to include, but not be
limited to, investment banking services, including traditional
underwriting compensation and fees. The proposed rule contains a
further exemption for reimbursement of fees imposed by the SEC and the
states, and listing fees imposed by self-regulatory organizations. Such
fees have been generally considered costs of the issuer, even when paid
by a broker-dealer.
The proposed rule is intended to apply a fair practice standard to
a particular course of conduct of a member as described below. In
addition, however, the action of a member in charging an issuer a fee
for making a market, or accepting an unsolicited payment from an issuer
where the member makes a market in the issuer's securities, could also
subject the member to violations of the antifraud provisions of federal
securities laws and NASD Rule 2120.\15\ Further, the payment by an
issuer to a market maker to facilitate market making activities also
may cause the member to contribute to violations of Section 5 of the
Securities Act of 1933.\16\
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\15\ Rule 2120 prohibits members from effecting transactions in,
or inducing the purchase or sale of, any security by means of any
manipulative, deceptive, or other fraudulent device or contrivance.
\16\ The insertion of quotations for a security in an
interdealer quotation system in exchange for a payment by an issuer
may result in a violation of Section 5 of the Securities Act of 1933
based on the issuer's interest in facilitating the subsequent sale.
This ``second sale'' theory was articulated by the SEC and upheld by
the court in SEC v. Harwyn Industries, Inc., 326 F. Supp. 943
(S.D.N.Y. 1971). See Letter from Kenneth S. Spirer, Attorney,
Division of Market Regulation, SEC, to Jack Rubens, Monroe
Securities, Inc. (May 4, 1973).
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The proposed rule as originally proposed for public comment \17\
included a third exception,\18\ which was intended to encourage members
to conduct an initial Rule 15c2-11 review \19\ of the issuer and the
security by permitting reimbursement of the member's reasonable out-of-
pocket expenses related to this review. The third exception was
eliminated from the proposed rule due to concerns that such payments
could violate Section 17(b) of the Securities Act of 1933 \20\ and
could be used inappropriately to avoid the limitations of the proposed
rule.
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\17\ NASD Notice to Members 96-83 (December 1996).
\18\ The third exception to the original proposed rule stated:
(b) The provisions of paragraph (a) shall not preclude a member from
accepting: * * * (3) reimbursement of reasonable out-of-pocket
expenses on an accountable basis, not including the member's
overhead, in connection with the member's initial review process in
determining whether to agree to publish a quotation or to act as a
market maker in a particular security.
\19\ Rule 15c2-11 imposes an ``affirmative review'' obligation
on a broker-dealer to form a reasonable belief that the information
submitted in connection with an application to enter a quotation is
accurate in all material respects and that the sources of the
information are reliable. See Securities Exchange Act Release No.
29094 (April 17, 1991), 56 FR 19148 (April 25, 1991).
\20\ Section 17(b) of the Securities Act of 1933 explicitly
makes it unlawful for any person receiving consideration, directly
or indirectly from an issuer, to publish or circulate any material
which describes such issuer's securities without fully disclosing
the receipt of such consideration, whether past or prospective, and
the amount thereof.
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III. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities association, and, in
particular, with the requirements of Section 15A(b) of the Act.\21\
Among other things, Section 15A(b)(6) of the Act requires that the
rules of a national securities association be designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, and in general, to protect investors and
the public. The Commission believes that the proposed rule change in
designed to prevent fraudulent and manipulative acts, to promote just
and equitable principles of trade, and to protect investors and the
public.\22\
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\21\ 15 U.S.C. Sec. 78f(b).
\22\ In approving this rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. Sec. 78c(f).
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Specifically, the Commission finds that the rule preserves the
integrity of the marketplace by ensuring that quotations accurately
reflect a broker-dealer's interest in buying or selling a security. The
decision by a firm to make a market in a given security and the
question of price generally are dependent on a number of factors,
including, among others, supply and demand, the firm's expectations
toward the market, its current inventory position, and exposure to risk
and competition. This decision should not be influenced by payments to
the member from issuers or promoters. Public investors expect broker-
dealers' quotations to be based on the factors described above. If
payments to broker-dealers by promoters and issuers were permitted,
investors would not be able to ascertain which quotations in the
marketplace are based on actual interest and which quotations are
supported by issuers or promoters. This structure would harm investor
confidence in the overall integrity of the marketplace. The Commission
finds that the proposed rule supports a longstanding policy and
position of the NASD \23\ and establishes a clear standard of fair
practice for member firms.
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\23\ NASD Notice to Members 75-16 (February 20, 1975). See also
Letter from Kenneth S. Spirer, Attorney, Division of market
Regulation, SEC, to Mr. Jack Rubens, Monroe Securities, Inc. (May 4,
1973) (regarding acceptance of a fee or service charge from issuers
in connection with making a market).
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[[Page 37108]]
The Commission notes that the rule does not specifically prohibit
member-to-member payments to make a market. Nevertheless, the
Commission agrees with the NASD that the definition of a promoter in
NASD Rule 2460 being approved today, is broad enough to cover payments
by one member to another member to publish a quote, make a market, or
file an application therewith for a particular security for the purpose
of promoting an interest in a particular security. In addition, another
proposed rule, IM-2110-5 (SR-NASD-97-37),\24\ would prohibit certain
anticompetitive conduct of broker-dealers. In particular, the rule
would prohibit certain ``coordinated'' activity among member broker-
dealers regarding prices (including quotations), trades, or trade
reports. Thus, certain coordinated efforts in publishing quotations or
setting prices may be subject to the provisions of the proposed rule.
The Commission notes that the NASD was concerned that if all member-to-
member payments were prohibited, then activity which involved
legitimate broker-dealer activity would have to become subject to an
exemption. The Commission agrees with the NASD that crafting
appropriate exemptions would complicate the rule unnecessarily, when
other provisions of the rule and other proposed rules cover the
prohibited conduct.
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\24\ Securities Exchange Act Release No. 38715 (June 4, 1997),
62 FR 31854 (June 11, 1997) (notice of proposed rule change (SR-
NASD-97-37)).
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\25\ that the proposed rule change (SR-NASD-97-29) is approved.
\25\ 15 U.S.C. Sec. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\26\
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\26\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-18090 Filed 7-9-97; 8:45 am]
BILLING CODE 8010-01-M