[Federal Register Volume 62, Number 136 (Wednesday, July 16, 1997)]
[Notices]
[Pages 38150-38156]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-18605]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38822; File No. SR-NASD-97-38]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') Relating to the Application of the NASD 
Corporate Financing Requirements To Exchange Offers, Mergers/
Acquisitions, and Other Similar Transactions

July 8, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ notice is hereby given that on May 23, 1997, the National 
Association of Securities Dealers, Inc. (``NASD'' or ``Association'') 
filed with the Securities and Exchange Commission (``Commission'' or 
``SEC'') the proposed rule change as described in Items I, II, and III 
below, which Items have been prepared by the self-regulatory 
organization. On June 19, 1997, the NASD filed Amendment No. 1 to its 
proposal.\2\ The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ In Amendment No. 1, the NASD amended Rule 2710(b)(7)(F)(i) 
to replace the phrase ``listed on The Nasdaq National Market, the 
New York Stock Exchange, or American Stock Exchange'' with 
``designated as a Nasdaq National Market security or listed on the 
New York Stock Exchange or American Stock Exchange.''
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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 Rules 2710 and 2720 of the Conduct 
Rules of the Association to clarify their applicability to exchange 
offers, merger and acquisition transactions, and other similar 
transactions. Below is the text of the proposed rule change. Proposed 
new language is italicized; proposed deletions are in brackets.
Rule 2710. Corporate Financing Rule--Underwriting Terms and 
Arrangements
(a) Definitions
* * * * *
(b) Filing Requirements
* * * * *
    (7) Offerings Exempt from Filing.
    Notwithstanding the provisions of subparagraph (1) above, documents 
and information related to the following public offerings need not be 
filed with the Association for review, unless subject to the provisions 
of Rule 2720. However, it shall be deemed a violation of this Rule or 
Rule 2810, for a member to participate in any way in such public 
offerings if the underwriting or other arrangements in connection with 
the offering are not in compliance with this Rule or Rule 2810, as 
applicable:
* * * * *
    (A)-(C)--No change.
    (D) securities offered pursuant to a redemption standby ``firm 
commitment'' underwriting arrangement registered with the Securities 
and Exchange Commission on Forms S-3, F-3 or F-10 (only with respect to 
Canadian issuers); [and]
    (E) financing instrument-backed securities which are rated by a 
nationally recognized statistical rating organization in one of its 
four (4) highest generic rating categories; and
    (F) exchange offers of securities where:
    (i) the securities to be issued or the securities of the company 
being acquired are designated as a Nasdaq National Market security or 
listed on the New York Stock Exchange or American Stock Exchange; or
    (ii) the company issuing securities qualifies to register 
securities with the Commission on registration statement Forms S-3, F-
3, or F-10, pursuant to the standards for those Forms as set forth in 
subparagraphs (c) (i) and (ii) of this paragraph.
    (8) Exempt Offerings.
    Notwithstanding the provisions of subparagraph (1) above, the 
following offerings are exempt from this Rule, Rule 2720, and Rule 
2810. Documents and information relating to the following offerings 
need not be filed for review:
    (A)-(F)--No change.
    (G) tender offers made pursuant to Regulation 14D adopted under the 
Securities Exchange Act of 1934, as amended; [and]
    (H) securities issued pursuant to a competitively bid underwriting 
arrangement meeting the requirements of the Public Utility Holding 
Company Act of 1935, as amended[.];
    (I) securities of a subsidiary or other affiliate distributed by a 
company in a spin-off or reverse spin-off or similar transaction to its 
existing securityholders exclusively as a dividend or other 
distribution; and
    (J) securities registered with the Commission in connection with a 
merger or acquisition transaction or other similar business 
combination, expect for offerings required to be filed pursuant to 
subparagraph (9)(I) below.
    (9) Offerings Required to be Filed.
    Documents and information relating to all other public offerings 
including, but not limited to, the following must be filed with the 
NASD for review:
    (A)-(F)--No change.
    (G) securities offered pursuant to Regulation A or Regulation B 
adopted under the Securities Act of 1933, as amended; [and]
    (H) exchange offers that are exempt from registration with the 
Commission under Sections 3(a)(4), 3(a)(9), 3(a)(11) of the Securities 
Act of 1933 (if a member's participation involves active solicitation 
activities) or registered with the Commission (if a member is acting as 
dealer-manager) (collectively ``exchange offers''), except for exchange 
offers exempt from filing pursuant to subparagraph (7)(F) above that 
are not subject to filing by subparagraph (9)(I) below;
    (I) any change offer, merger and acquisition transaction, or other 
similar corporate reorganization involving an issuance of securities 
that results in the direct or indirect public ownership of the member; 
and
    (J) any offerings of a similar nature that are not exempt under 
paragraphs (7) or (8) above.
* * * * *
(c) Underwriting Compensation and Arrangements
* * * * *
    (6) Unreasonable Terms and Arrangements.
    (A) No member or person associated with a member shall participate 
in any manner in a public offering of securities after any arrangement 
proposed in connection with the public offering, or the terms and 
conditions relating thereto, has been determined to be unfair or 
unreasonable pursuant to this Rule or inconsistent with any By-Law or 
any Rule or regulation of the NASD.
    (B) Without limiting the foregoing, the following terms and 
arrangements, when proposed in connection with the

[[Page 38151]]

distribution of a public offering of securities, shall be unfair and 
unreasonable:
* * * * *
    (v) any ``tail fee'' arrangement granted to the underwriter and 
related persons that has a duration of more than two (2) years from the 
date the member's services are terminated, in the event that the 
offering is not completed in accordance with the agreement between the 
issuer and the underwriter and the issuer subsequently consummates a 
similar transaction, expect that a member may demonstrate on the basis 
of information satisfactory to the NASD that an arrangement of more 
than two (2) years is not unfair or unreasonable under the 
circumstances.
    Subparagraphs (v)-(xiii) are renumber (vi)-(xiv).
 * * * * *
Rule 2720. Distribution of Securities of Members and Affiliates--
Conflicts of Interest
(a) General
    (1) No member or person associated with a member shall participate 
in the distribution of a public offering of debt or equity securities 
issued or to be issued by the member, the parent of the member, or an 
affiliate of the member and no member or parent of a member shall issue 
securities except in accordance with this Schedule.
    (2) No member or person associated with a member shall participate 
in the distribution of a public offering of debt or equity securities 
issued or to be issued by a company if the member and/or its associated 
persons, parent or affiliates have a conflict of interest with the 
company, as defined herein, except in accordance with this Schedule.
    (3) In the case of an exchange offer, merger and acquisition 
transaction, or similar corporate reorganization, this Rule shall only 
apply if the offering is described in:
    (a) Rule 2710(b)(9)(H) and the issuance of securities is by a 
member or the parent of a member; or
    (b) Rule 2710(b)(9)(I).
* * * * *
(c) Participation in Distribution of Securities of Member or Affiliate
    (1) and (2)--No change.
    (3) If a member proposes to underwrite, participate as a member of 
the underwriting syndicate or selling group, or otherwise assist in the 
distribution of a public offering of its own or an affiliate's 
securities, or of securities of a company with which it or its 
associated persons, parent or affiliates have a conflict of interest, 
one or more of the following three criteria shall be met:
    (A) The price at which an equity issue or the yield at which a debt 
issue is to be distributed to the public is established at a price no 
higher or yield no lower than that recommended by a qualified 
independent underwriter which shall also participate in the preparation 
of the registration statement and the prospectus, offering circular, or 
similar document and which shall exercise the usual standards of ``due 
diligence'' in respect thereto; provided, however, that:
    (i) An offering of securities by a member which has not been 
actively engaged in the investment banking or securities business, in 
its present form or as a predecessor broker/dealer, for at least the 
five years immediately preceding the filing of the registration 
statement shall be managed by a qualified independent underwriter; and
    (ii) The provision of this paragraph which requires that the price 
or yield of the securities be established based on the recommendation 
of a qualified independent underwriter shall not apply to an offering 
of equity or debt securities if:
    a. The securities (except for the securities of a broker/dealer or 
its parent) are issued in an exchange offer or other transaction 
relating to a recapitalization or restructuring of a company; and
    b. The member that is affiliated with the issuer or with which the 
member or its associated persons, parent or affiliates have a conflict 
of interest is not obligated to and does not provide a recommendation 
with respect to the price, yield, or exchange value of the transaction; 
or
    (iii) In any exchange offer, merger and acquisition transaction, or 
similar corporate reorganization subject to this Rule under 
subparagraph (a)(3) above, the provision of this paragraph which 
requires that the price or yield of the securities be established based 
on the recommendation of a qualified independent underwriter shall not 
apply and, instead, the exchange value of the securities being offered 
in the transaction shall not be less than that recommended by a 
qualified independent underwriter; or (B) and (C)--No change.
* * * * *
(o) Predominance of Rule 2720
    If the provisions of this Rule are inconsistent with any other 
provisions of the Association's By-Laws or Rules, or of any 
interpretation thereof, the provisions of this Rule shall prevail, 
except to the extent that subparagraph (b)(8) of Rule 2710 provides an 
exemption from this Rule for certain offerings.

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 self-regulatory organization 
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 self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statement.

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

1. Purpose
    Rule 2710 of the Conduct Rules of the NASD (``Corporate Financing 
Rule'') requires that members file with the Corporate Financing 
Department of the NASD public offerings of securities for review of the 
proposed underwriting terms and arrangements, which terms and 
arrangements must comply with that rule. Rule 2720 of the Conduct Rules 
(``Conflicts Rule'') establishes standards in addition to those in Rule 
2710 to address the conflicts-of-interest that occur in connection with 
a public offering of the securities of a member, the parent of a 
member, an affiliate of a member, or other issuer with whom the member 
has a conflict-of-interest. For an offering to be subject to filing 
under the Corporate Financing and Conflicts Rules, a member must be 
considered to be ``participating'' in the offering and the offering 
must be one that is subject to the filing requirements. Paragraph 
(a)(5) of Rule 2710 defines ``participation or participating in a 
public offering'' to include participation in the preparation of the 
offering or other documents, participation in the distribution of the 
offering on an underwritten, non-underwritten, or any other basis, 
furnishing of customer and/or broker lists for solicitation, or 
participation in any advisory or consulting capacity to the issuer 
related to the offering, but not the preparation of an appraisal in a 
savings and loan conversion or a bank offering or the preparation of a 
fairness opinion pursuant to SEC Rule 13e-3.
    With respect to offerings subject to compliance with the Rules, the 
Corporate Financing and Conflict Rules

[[Page 38152]]

apply to most ``public offerings'' of securities, which is defined in 
Rule 2720(b)(14) to include, among other things, ``offerings made 
pursuant to a merger or acquisition.'' Neither the Corporate Financing 
Rule nor the Conflicts Rule currently identifies the types of mergers 
and acquisitions subject to filing and compliance with those rules. The 
NASD has, therefore, determined to amend Rules 2710 and 2720 to clarify 
the application of the requirements of the Corporate Financing and 
Conflicts Rules to exchange offers, mergers and acquisitions, and 
similar corporate reorganizations and make other related amendments. In 
view of the increasing amount of merger and acquisition activity, the 
NASD believes that the proposed amendments to Rules 2710 and 2720 will 
provide certainty and eliminate confusion regarding their application 
to such transactions.
    With respect to the time-sensitive nature of many mergers and 
acquisitions, exchange offers, and similar corporate reorganizations 
that would become subject to filing as a result of approval of the 
proposed rule change, the NASD previously announced in Notice to 
Members 95-73 (September 1995) (``NTM 95-73'') a policy to expedite the 
review of such offerings by the Corporate Financing Department.\3\ In 
general, it is anticipated that a comment letter will be issued by the 
Corporate Financing Department of the NASD within 48 hours of receipt 
of the filing of the documents related to such a transaction, so long 
as the documentation and related information submitted meet the 
requirements set forth in subparagraphs (b) (5) and (6) of Rule 2710 
and the appropriate filing fee is included.
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    \3\ A copy of NTM 95-73 was submitted as Exhibit 2 to the NASD's 
proposal and is available for inspection and copying in the 
Commission's Public Reference Room.
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Summary of Proposed Rule Change

    The NASD is proposing to amend the Corporate Financing and 
Conflicts Rules to clarify their application to exchange offers, merger 
and acquisition transactions, and other similar corporate 
reorganizations and make other related changes. The amendments limit 
the application of the rules to narrow situations where pre-offering 
review under the Corporate Financing Rule or the application of the 
Conflicts Rule is believed necessary to protect investors. Thus, in 
general, the proposed rule change would require that an exchange offer 
be filed with the Corporate Financing Department for review only when a 
member is participating in solicitation activities related to an offer 
involving unlisted securities or securities that are exempt from SEC 
registration. However, filing of an exchange offer (where a member is 
participating in solicitation activities) will be required if the 
offering is subject to the Conflicts Rule because the offering is of 
securities of a member or its parent or the offer will result in the 
direct or indirect public ownership of a member. In addition, exchange 
offers, merger and acquisition transactions, and other similar 
corporate reorganizations will be subject to the Conflicts Rule, and 
required to be filed for review, if there is an issuance of securities 
that results in the direct or indirect public ownership of a member.

Description of Proposed Rule Change to Rule 2710

    The filing requirements of the Corporate Financing Rule subject an 
offering to compliance with that rule and, if the offering is of 
securities issued by a member, the parent of a member, an affiliate of 
a member, or an issuer with which the member has a conflict-or-interest 
(as that latter term is defined in Rule 2720), to compliance with the 
Conflicts Rule. Paragraph (b)(9) of Rule 2710 is intended to provide 
clarification of certain types of public offerings required to be filed 
with the Corporate Financing Department of the NASD for review. 
Paragraph (b)(9) is proposed to be amended to add new subparagraph (H) 
that would require the filing of exchange offers exempt from 
registration under Sections 3(a)(4), 3(a)(9), and 3(a)(11) of the 
Securities Act of 1933 (``Securities Act''), where the member engages 
in active solicitation, and exchange offers registered with the 
Commission if a member acts as a dealer manager.\4\ Active solicitation 
occurs when a member directly solicits or contacts securityholders, 
acts as a dealer manager, performs tasks that are performed by investor 
relations firms. (i.e., contacts securityholders to determine the 
action they intend to take), contacts securityholders to determine 
whether they have received the offering materials, answers unsolicited 
contacts, and participates in meetings with securityholders or their 
advisors before or after an exchange offer begins.\5\ In contrast, 
active solicitation does not encompass the delivery of a ``fairness 
opinion,'' advice as to the structure and terms of the exchange offer, 
assistance in the preparation of the offering documents to be sent to 
securityholders, nor any other functions that do not involve direct 
solicitation or direct contact with securityholders.
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    \4\ The term ``exchange offer'' is intended to refer to 
transactions where one security is issued in exchange for another 
security of the issuer or another entity, and is distinguished from 
mergers, acquisitions and other corporate reorganizations (except if 
accomplished through an exchange offer) registered on a Form S-4 or 
F-4.
    \5\ Activities by a broker/dealer that would not come within the 
concept of ``soliciting'' for purposes of Section 3(a)(9) may none-
the-less come within the concept of ``solicitation'' for purposes of 
the requirement to file an offering with NASD Regulation for review 
under Rules 2710 and 2720. See applicable SEC no-action letters on 
Section 3(a)(9). Further, the application of the filing requirements 
of Rule 2710 does not depend upon whether remuneration is paid to 
the member. Thus, regardless of whether a member is paid for 
soliciting the exchange, an exchange offer would be subject to 
filing if the member engages in solicitation activities as described 
in this rule filing.
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    The NASD is not extending the filing requirement to other public 
exchange offers exempt from registration because such offerings are 
either subject to the oversight of a bankruptcy court or of another 
Federal review authority, such as the Comptroller of the Currency or 
the Federal Deposit Insurance Corporation.\6\
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    \6\ See 15 U.S.C. Secs. 3(a)(5), 3(a)(6), 3(a)(10), and 
3(a)(12).
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    With respect to exchange offers registered on Forms S-4 or F-4, 
filing is expressly limited to those distributions where the member is 
engaged by the company to act as dealer manager and solicits consents 
on behalf of the company to the proposed reorganization and to 
otherwise facilitate the exchange of securities. In such exchange 
offers, the member generally acts as a financial advisor to help 
structure the transaction and will receive a fee, as well as 
distribution-related compensation for services rendered.
    To the extent an exchange offer exempt under Sections 3(a)(4), (9), 
and (11) of the Securities Act or registered with the SEC does not fall 
within the filing requirement in new subparagraph (b)(9)(H) to Rule 
2710 because the member is not engaging in solicitation activities or 
is not acting as dealer manager, respectively, the exchange offer is 
considered exempt from compliance with the Corporate Financing and 
Conflicts Rules because the member is not considered to be 
``participating in the offering.''
    The NASD, however, is also proposing to add new subparagraph 
(b)(7)(F) to Rule 2710 to exempt from filing exchange offers where the 
securities to be issued or the securities of the company to be acquired 
are designated as a Nasdaq National Market security or listed on the 
New York Stock Exchange (``NYSE'') or American Stock Exchange 
(``AMEX'') or where the

[[Page 38153]]

company issuing securities qualifies to register securities on SEC 
Registration Forms S-3 or F-10. It is believed that the listing 
standards of the three markets requiring independent directors of the 
Board of Directors will ensure that the independent directors of the 
acquiror or target will evaluate the offer and that sufficient 
information will be distributed to shareholders and to the markets, so 
that investors can make a decision regarding whether to sell or hold 
the securities they hold or will receive.
    The exemption for companies qualified to register securities on SEC 
registration Forms S-3, F-3, or F-10 applies to those companies that 
meet the standards for the Forms in subparagraphs (C)(i) and (ii) of 
paragraph (b)(7) of Rule 2710 in order to restrict the exemption to 
domestic companies that meet the standards for Forms S-3 and F-3 prior 
to October 21, 1992 and to Canadian-incorporated foreign private 
issuers that meet the standards for Form F-10 approved in Securities 
Exchange Act Release No. 6902 (June 21, 1991).\7\ This provision would 
require, in general, that a domestic company have a three-year history 
as a public reporting company, and be in compliance with the current 
year's periodic reporting requirements of the Act (with respect to the 
timely filing of Form 10-Qs and 10-Ks). In addition, the minimum 
required market value of a company's common stock must be as follows: 
Form S-3, $150 million (or $100 million market value of voting stock 
and three million shares annual trading volume); and Form F-3, $300 
million held world-wide. For Form F-10, Canadian private issuers must 
have (CN) $360 aggregate value of voting stock and a public float of 
(CN) $754 million.
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    \7\ See Notice to Member 93-88 (December 1993), which includes a 
copy of Forms S-3 and F-3 as those Forms existed prior to October 
21, 1992 and Form F-10 as approved by the SEC on June 21, 1991.
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    Paragraph (b)(7) of the Corporate Financing Rule, which includes 
the two filing exemptions for exchange offers discussed above, lists 
those public offerings not required to be filed for review with the 
Corporate Financing Department. However, the underwriting terms and 
arrangements of such exempt offerings must be in compliance with the 
requirements of Rule 2710 or 2810, as applicable. Moreover, any 
offering exempt from filing under paragraph (b)(7) must nonetheless be 
filed if the offering is subject to Rule 2720, the Conflicts Rule, and 
is subject to review by the Corporate Financing Department for 
compliance with Rules 2710 and 2720.\8\
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    \8\ See infra note 10.
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    Paragraph (b)(9) of the Corporate Financing Rule is also proposed 
to be amended to add new subparagraph (I) to require the filing of any 
exchange offer, merger or acquisition transaction, and similar 
corporate reorganization that involves an issuance of securities that 
results in the direct or indirect public ownership of a member.\9\ Such 
offerings would be subject to compliance with Rule 2710 and Rule 
2720.\10\ The NASD has long held the view that pre-offering review is 
vital to protect investors when the member and the issuer are in a 
control relationship that is addressed through the application of Rule 
2720. The NASD has previously clarified in Notice to Members 88-100 
(December 1988) that mergers or acquisitions involving an issuer and a 
member or its parent that result in the direct or indirect public 
ownership of a member are subject to compliance with Rule 2720, 
regardless of whether the merger or acquisition occurs subsequent to 
the issuer's initial public offering.\11\
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    \9\ This latter filing requirement does not, it is important to 
note, require the filing of exchange offers, mergers, acquisitions, 
and corporate reorganizations involving an offering of securities of 
an affiliate of a member other than a parent or of an issuer that 
otherwise has a conflict-of-interest with a member.
    \10\ Paragraph (n) of Rule 2720 provides that all offerings of 
securities included within the scope of that Rule are also subject 
to the provisions of Rule 2710, even though an exemption from filing 
may be available under Rule 2720.
    \11\ In the notice, the Association expressed its special 
concerns regarding the merger of blank check companies in the penny 
stock market with privately held holding companies of members, 
indirectly creating a publicly-held NASD member without having to 
comply with Rule 2720.
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    Paragraph (b)(8) of Rule 2710 lists those offerings that, although 
within the definition of ``public offering,'' are exempted from 
compliance with Rules 2710 and 2720. The NASD is proposing to add new 
subparagraphs (I) and (J) to paragraph (b)(8) to provide an exemption 
from filing and compliance with Rules 2710 and 2720 for:
    1. Spin-off and reverse spin-off transactions involving a 
subsidiary or affiliate of the issuer, where the securities are issued 
as a dividend or distribution to current shareholders; and
    2. Securities registered with the SEC in connection with a merger, 
acquisition, or other similar business combination, except if the 
offering would be filed under subparagraph (b)(9)(I), described above, 
because it involves a transaction that results in the direct or 
indirect public ownership of a member.

Spin-off transactions to existing securityholders as a dividend or 
other distribution do not involve an investment decision by 
shareholders and, consequently, any member acting as a financial 
advisor to the parent company is not generally involved in any public 
solicitation in connection with the transaction.\12\ Merger 
transactions and similar business combinations registered with the SEC 
generally only involve a member in providing financial advice to the 
Board of Directors of the acquiror or target, that may include an 
obligation that the member issue a fairness opinion regarding the 
acquisition price.
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    \12\ It should be noted, however, that where a spin-off that is 
followed by a traditional public offering by the spun-off company to 
raise capital, the company's initial public offering would be 
subject to the Corporate Financing Rule's filing requirements and to 
compliance with Rule 2720. The same analysis would require the 
filing of any public offering to raise capital that follows a 
merger, acquisition, exchange offer or other corporate 
reorganization that would be exempt from filing under Rule 2710 or 
exempt from compliance with Rules 2710 and 2720. In the latter case, 
the offering may nonetheless fall within another exemption from 
filing, such as the filing exemptions provided by subparagraphs 
(b)(7) (A), (C), or (D) of Rule 2710.
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    In addition, the NASD is proposing to add new subparagraph 
(c)(6)(B)(v) to Rule 2710 to provide that it is an unreasonable term 
and arrangement for a member to receive a right to receive a ``tail 
fee'' arrangement that has a duration of more than two years from the 
date the member's services are terminated, in the event an offering is 
not completed and the issuer subsequently consummates a similar 
transaction. Such arrangements are currently only provided in 
connection with exchange offers. It is believed that the real benefit 
derived by a company that grants a ``tail fee'' arrangement is the 
creativity of the strategic advice given by the member for the 
particular transaction that may include, among other things, assisting 
the company in defining objectives, performing valuation analyses, 
formulating restructuring alternatives, and structuring the offering. 
In particular, in the case of an exchange offer, a member providing 
financial advice will generally have provided considerable ongoing 
financial advisory services to the company.
    The proposed ``tail fee'' prohibition also, however, would permit a 
member to demonstrate on the basis of information satisfactory to the 
NASD that an arrangement of more than two years is not unfair or 
unreasonable under the circumstances. The ability of the staff of the 
Corporate Financing Department to grant exceptions upon request is 
intended to be used where the

[[Page 38154]]

member can demonstrate that the creativity of the strategic advice 
provided by the member has a potential benefit to the company for more 
than two years. In the case of exchange offers exempt from filing but 
subject to compliance with the Rule under subparagraph (b)(7)(F), where 
the ``tail fee'' arrangement is proposed to have a duration of longer 
than two years, a member would be required to request an opinion of the 
staff as to whether the arrangement is permissible under the Rule. In 
the case of any other offering exempt from filing under subparagraph 
(b)(7), a member is required to request an opinion of the staff as to 
whether it has an opinion of ``no objections'' as to any proposed 
``tail fee'' arrangement.
    As set forth above, although ``tail fee'' arrangements are 
currently granted only in connection with exchange offers, the 
provision is written to regulate such an arrangement in connection with 
any type of public offering subject to compliance with the Corporate 
Financing Rule. Where a ``tail fee'' arrangement is proposed in 
connection with public offerings that are not exchange offers, the NASD 
staff will consider whether such an arrangement is justified by the 
services provided by the member to the issuer. Where the member does 
not appear to have provided the type of substantial structuring and/or 
advisory services to the issuer similar to those that are described 
above, other than those services traditionally provided in connection 
with a distribution of a public offering, a proposed ``tail fee'' 
arrangement will be considered to be unfair and unreasonable on the 
basis that the arrangement would violate Rule 2110 (the Association's 
basic ethical rule) and Rule 2430 since the member is proposing to be 
paid for services that the member has not provided to the issuer. This 
position is consistent with subparagraph (c)(6)(B)(iv) of Rule 2710, 
which prohibits a member from receiving compensation in connection with 
an offering of securities that is not completed, except for 
compensation received in connection with a transaction (i.e., a merger 
transaction) that occurs in lieu of the proposed offering as a result 
of the member's efforts and the reimbursement of the member's 
reasonable out-of-pocket accountable expenses.
    In addition, the NASD has considered whether other types of fees 
and expense reimbursement arrangements that are typically negotiated 
for and received in connection with exchange offers proposed to be 
subject to compliance with Rule 2710 are inconsistent with or 
prohibited by subparagraphs (c)(6)(B)(iii) and (iv) of the Corporate 
Financing Rule. Subparagraph (c)(6)(B)(iii) of Rule 2710 currently 
prohibits as unfair and unreasonable any payment of commissions or 
reimbursement of expenses directly or indirectly to the underwriter and 
related persons prior to commencement of the public sale of the 
securities being offered, with certain limited exceptions. As set forth 
above, subparagraph (c)(6)(B)(iv) of Rule 2710 currently prohibits as 
unfair and unreasonable the payment of any compensation by an issuer to 
a member or person associated with a member in connection with an 
offering of securities which is not completed according to the terms of 
agreement between the issuer and underwriter, except those negotiated 
and paid in connection with a transaction that occurs in lieu of the 
proposed offering as a result of the efforts of the underwriter and 
related persons and provided, however, that the reimbursement of out-
of-pocket accountable expenses actually incurred by the member or 
person associated with a member is not presumed to be unfair or 
unreasonable under normal circumstances. The NASD has determined that 
it is not inconsistent with the Corporate Financing Rule for a member 
acting as financial advisor in an exchange offering to receive a ``time 
and efforts'' or similar fee for the services it renders in connection 
with an exchange offer that is not completed, where the member does not 
receive the agreed-upon success fee. In addition, it is deemed not 
inconsistent with the Corporate Financing Rule for a member to receive 
reimbursement of certain expenses, including, but not limited to, 
travel costs, document production, and legal fees of the financial 
advisor, whether or not the transaction is consummated. In NTM 95-73, 
publishing the original version of the proposed rule change for 
comment, the Association stated that these and similar types of 
reimbursement arrangements in exchange offers are not prohibited by the 
Corporate Financing Rule because such arrangements are not viewed as 
directly connected to the issuance of securities.

 Description of Proposed Rule Change to Rule 2720

    The NASD is proposing to amend the Conflicts Rule to conform the 
scope section of the Rule to the amendments to the filing requirements 
of Rule 2710 and to clarify the responsibilities of a qualified 
independent underwriter in an exchange offer subject to compliance with 
Rule 2720. Paragraph (a) of Rule 2720 is proposed to be amended to add 
new subparagraph (3) to provide that in the case of an exchange offer, 
merger and acquisition transaction, or similar corporate 
reorganization, compliance with Rule 2720 is required only if the 
offering comes within subparagraph (b)(9)(H) of Rule 2710, where the 
issuance of securities is by a member or the parent of a member or if 
the offering comes within subparagraph (b)(9)(I). As set forth above, 
proposed subparagraph (b)(9)(H) would require the filing of exchange 
offers exempt under Section 3(a)(4), 3(a)(9), and 3(a)(11) of the 
Securities Act, if the member's participation involves active 
solicitation activities, and of exchange offers registered with the 
SEC, if the member is acting as dealer manager. Thus, the exemption 
from filing for such exchange offers provided by proposed subparagraph 
(b)(7)(F), where the securities are designated as a Nasdaq National 
Market security or listed on the NYSE or AMEX or the issuer qualifies 
to register securities on Forms S-3, F-3 or F-10, is not available if 
the exchange offer is by a member or parent of a member.\13\ As further 
set forth above, proposed subparagraph (b)(9)(I) would require the 
filing of any exchange offer, merger and acquisition transaction, or 
similar corporate reorganization involving an issuance of securities 
that results in the direct or indirect public ownership of a 
member.\14\
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    \13\ See supra note 9.
    \14\ This filing requirement is consistent with the position 
announced in notice to members 88-100 (December 1988) and paragraph 
(i) of Rule 2720 which states: ``* * * if an issuer proposes to 
engage in any offering which results in the public ownership of a 
member * * * the offering shall be subject to the provisions of this 
Rule to the same extent as if the transaction had occurred prior to 
the filing of the offering.''
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    The NASD is also proposing to amend Rule 2720 to clarify the 
obligations of a qualified independent underwriter \15\ that would be 
required by subparagraph (c)(3) of Rule 2720 to perform due diligence 
with respect to the offering document and provide a recommendation with 
respect to the exchange value of an exchange offer, merger and 
acquisition transaction, or similar corporate reorganization. 
Currently, the Conflicts Rule requires

[[Page 38155]]

that the price at which an equity issue or the yield at which a debt 
issue is to be distributed to the public be established at a price no 
higher or yield no lower than that recommended by a qualified 
independent underwriter (who shall also participate in the preparation 
of the registration statement and shall exercise the usual standards of 
``due diligence'' in respect thereto). The NASD is proposing to amend 
subparagraph (c)(3)(A) of Rule 2720 by adding a new exception to state 
that in any exchange offer, merger and acquisition transaction or 
corporate reorganization subject to Rule 2720, the provision which 
requires that the price or yield of the securities be established based 
on the recommendation of a qualified independent underwriter shall not 
apply and, instead, the exchange value of the securities being offered 
in the transaction shall not be less than that recommended by a 
qualified independent underwriter. Thus, the proposed new provision 
would clarify that the obligation of the qualified independent 
underwriter is to ensure that the recipient of the exchange offer, 
which is the party intended to be protected by the participation of a 
qualified independent underwriter, shall not receive fewer of the 
securities being issued in exchange for each security held by the 
recipient than is recommended by the qualified independent underwriter.
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    \15\ A member must meet a number of requirements in order to be 
a qualified independent underwriter under subparagraph (b)(15) of 
Rule 2720, including the requirement that the member ``has agreed in 
acting as a qualified independent underwriter to undertake the legal 
responsibilities and liabilities of an underwriter under the 
Securities Act of 1933, specifically including those inherent in 
Section 11 thereof.'' Participation of a qualified independent 
underwriter is not required by Rule 2720 if the offering is of 
equity securities that meet the test of having a ``bona fide 
independent market'' or is of debt that is rated investment grade.
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    Finally, in order to make clear that the exemptions in subparagraph 
(b)(8) of Rule 2710 (that include exemptions for offerings of 
securities issued in a spin-off or in a merger registered with the SEC 
on Forms S-4 or F-4) are also exempt from Rule 2720, paragraph (o) of 
Rule 2720 is proposed to be amended to reference the exemptions from 
Rule 2720 that are provided in subparagraph (b)(8) of Rule 2710.

Implementation of the Proposed Rule Change

    The NASD has considered the impact of the proposed rule change on 
pending transactions that would be required to be filed with the 
Corporate Financing Department for review as a result of the 
application of Rule 2710 or Rule 2720 or would be subject to compliance 
with Rule 2710 even though exempt from filing. In order to provide 
timely notice to the membership of the SEC's approval of the proposed 
rule change, the NASD is proposing to make the proposed rule change 
effective on a date that is 30 calendar days after the issuance of a 
Notice to Members announcing SEC approval of the proposed rule change. 
The Notice to Members will be issued within 45 calendar days of SEC 
approval. Thus, proposed exchange offers, mergers, acquisitions, and 
similar transactions that have not commenced at the time the proposed 
rule change becomes effective will be required to be filed for review 
with the Corporate Financing Department, if subject to filing under 
Rule 2710 or Rule 2720. Further, such transactions, although exempt 
from filing under subparagraph (b)(7) of Rule 2710, will be required to 
be made in compliance with the proposed restrictions on ``tail fee'' 
arrangements and other provisions of the Corporate Financing Rule. The 
proposed restrictions on ``tail fee'' arrangements will not be 
applicable to any outstanding ``tail fee'' arrangements for an exchange 
offer, merger, acquisition, or similar transaction that has commenced 
prior to effectiveness of the proposed rule change.
2. Statutory Basis
    The NASD believes that the proposal to establish filing 
requirements for the review of exchange offers, mergers and 
acquisitions, and other corporate reorganizations under Rules 2710 and 
2720, to limit ``tail fee'' arrangements to two years, and to provide 
clarification as to the obligations of a qualified independent 
underwriter in exchange offers is consistent with the provisions of 
Section 15A(b)(6) of the Act \16\ in that the proposed rule change 
promotes just and equitable principles of trade and protects investors 
and the public interest.
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    \16\ 15 U.S.C. Sec. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Association 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 NTM 95-
73.\17\ Two comments were received in response thereto.\18\ The 
amendments published for comment would require filing when members act 
as dealer/managers of merger transactions or exchange offers registered 
with the SEC on Form S-4 or are engaged in solicitation activities in 
connection with unregistered exchange offerings or the transaction 
involves mergers/exchange offerings that are subject to Rule 2720. 
Under the proposal, exchange offers would be exempt from the filing 
requirements if the issuer of the securities is qualified to register 
on the SEC's short-form registration statements, i.e., Forms S-3, F-3 
or F-10, or the companies' securities held or to be received in 
connection with the exchange offer by the securityholder are listed on 
the Nasdaq National Market or the NYSE or AMEX. The Notice also 
proposed that ``tail fee'' arrangements in exchange offers should be 
limited to a two-year period from the termination of a member's 
services, provided that the NASD may permit longer periods in certain 
circumstances on a case-by-case basis. No amendments were proposed to 
Rule 2720.
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    \17\ NTM 95-73, supra note 3.
    \18\ Copies of the comment letters received in response thereto 
were submitted as Exhibit 3 to the NASD's proposal and are available 
for inspection and copying in the Commission's Public Reference 
Room.
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    The first commentor questioned the rationale for applying Rule 2720 
to a transaction where a company is seeking to acquire the securities 
of a target company and the member with which it is affiliated is 
either soliciting securityholders of the target company or merely 
acting as a financial advisor to the acquiring company. The commentor 
was unable to determine the exact role that a qualified independent 
underwriter would have in such a transaction and whether the qualified 
independent underwriter should be required to recommend a price at 
which the equity issue or debt offering could be distributed to the 
public. The commentor claimed that it would be extremely difficult for 
a qualified independent underwriter to make such a recommendation.
    The other commentor stated that the proposal was drafted too 
broadly and would require the filing of any merger and acquisition 
transaction by a member that provides financial advice to an affiliated 
issuer in the transaction, even if the member does not solicit proxies 
or otherwise have any direct contact with investors. The commentor 
recommended that the proposed amendments to the Corporate Financing 
Rule be revised to make clear that members are required to file 
exchange offers for review only if the member engages in ``solicitation 
activities'' and the exchange offer does not qualify for any of the 
exemptions from filing set forth in the Rule.
    To address these comments, language was added to proposed 
subparagraph (b)(9)(H) of Rule 2710 to clarify that an exchange offer 
under Sections 3(a)(4), 3(a)(9), and 3(a)(11) of the Securities Act are 
subject to filing only if the member's participation involves active 
solicitation

[[Page 38156]]

activities and an exchange offer (not a merger transaction) registered 
with the SEC is subject to filing only if there is a member acting as a 
dealer manager, thereby clarifying that filing is not required where 
the member's role in the transaction is limited to providing financial 
advice. In addition, as recommended by the second commentor, the 
provision was amended to clarify that filing is not required if the 
exchange offer comes within the exemption from filing in subparagraph 
(b)(7)(F) for listed securities and securities of an issuer that 
qualify to register on Forms S-3, F-3, or F-10. Consistent with this 
latter change, proposed subparagraph (b)(8)(J) of Rule 2710 that would 
exempt from the Rule mergers (not exchange offers) registered with the 
SEC, was also amended to clarify that such a merger is nonetheless 
subject to filing if the merger involves the securities of a member or 
the parent of a member (as provided in subparagraph (b)(9)(I)).
    Also consistent with the request of the second commentor for 
greater clarity in the operation of the filing requirements, new 
subparagraph (a)(3) was added to Rule 2720 to clarify that any exchange 
offer, merger and acquisition transaction, or similar corporate 
reorganization exempt from registration under Sections 3(a)(4), 
3(a)(9), and 3(a)(11) where the member is actively soliciting 
securityholders or registered with the SEC where a member is acting as 
dealer manager, will be required to be filed with the Corporate 
Financing Department and is subject to compliance with the requirements 
of the Rule if the issuance of securities is by a member or parent of a 
member. In addition, by reference to subparagraph (b)(9)(I) of Rule 
2710, the new subparagraph of the Conflicts Rule provides that any 
exchange offer, merger or acquisition transaction, or similar corporate 
reorganization involving an issuance of securities that results in the 
direct or indirect public ownership of a member will be required to be 
filed under Rule 2720. In order to make clear, moreover, that the 
exemption in subparagraph (b)(8) of Rule 2710 for offerings of 
securities issued in a spin-off or in a merger registered with the SEC 
are also exempt from Rule 2720, paragraph (o) of Rule 2720 is proposed 
to be amended to reference the exemptions from Rule 2720 that are 
provided in Rule 2710.
    Finally, to address the concerns of the first commentor regarding 
the role of the qualified independent underwriter in an exchange offer, 
merger and acquisition transaction, or similar corporate reorganization 
subject to the Conflicts Rule, subparagraph (c) of Rule 2720 is 
proposed to be amended to add a provision that requires that the 
exchange value of the securities being offered in the transaction not 
be less than that recommended by the qualified independent underwriter.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the 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 the 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, D.C. 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. Sec. 552, will be available for inspection and copying at 
the Commission's Public Reference Room. Copies of such filing will also 
be available for inspection and copying at the principal office of the 
Exchange. All submissions should refer to file No. SR-NASD-97-38 and 
should be submitted by August 6, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-18605 Filed 7-15-97; 8:45 am]
BILLING CODE 8010-01-M