[Federal Register Volume 63, Number 100 (Tuesday, May 26, 1998)]
[Notices]
[Pages 28535-28540]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-13850]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40001; File No. SR-NASD-97-95]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change By the National Association of Securities Dealers, 
Inc. Relating to Amendments to the Free-Riding and Withholding 
Interpretation

May 18, 1998.

I. Introduction

    On December 23, 1997,\1\ the National Association of Securities 
Dealers Regulation, Inc. (``NASD Regulation'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') a 
proposed rule change pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act''),\2\ and Rule 194-b thereunder.\3\ Notice 
of the proposal appeared in the Federal Register on February 11, 
1998.\4\ The Commission received one comment letter regarding the 
proposal.\5\ The

[[Page 28536]]

commenter generally supported the proposed rule change with some 
modifications.\6\
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    \1\ On March 12, 1998, NASD Regulation filed Amendment No. 1 to 
the proposal. Amendment No. 1 revised Paragraph (b)(9)(A)(ii) to 
include the shares of a member's parent that are publicly traded on 
an exchange or Nasdaq in the exemption granted for shares of members 
traded on an exchange or Nasdaq. Section III of this approval order 
contains a further discussion of this amendment. In brief, the 
technical amendment was necessary to reflect the fact that members 
are often part of a holding company structure wherein the parent of 
the member is the entity that actually trades on an exchange or 
Nasdaq. Amendment No. 1 also corrected a drafting error in the 
original proposal's Paragraph (d) of IM-2110-1 to clarify that both 
employees and directors may take advantage of an exemption for 
issuer directed securities programs. Because this amendment is 
technical the statute does not require that it be published for 
comment.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240-19b-4.
    \4\ Securities Exchange Act Release No. 39620 (February 4, 
1998), 63 FR 7026 (February 11, 1998).
    \5\ See letter from Sullivan & Cromwell to Jonathan G. Katz, 
Secretary, SEC, dated March 13, 1998.
    \6\ On April 9, 1998. NASD Regulation filed Amendment No. 2 to 
the proposal. See letter to Katherine A. England, Assistant 
Director, Division of Market Regulation. Amendment No. 2 responds to 
the comment letter submitted by Sullivan and Cromwell regarding the 
proposed rule change. NASD Regulation's response to the comment 
letter is discussed in detail in Section III of this approval order. 
Because this amendment is technical the statute does not require 
that it be published for comment.
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    The proposal amends Interpretative Material IM-2110-1 and Rule 2720 
to revise certain aspects of the Free-Riding and Withholding 
Interpretation (``Interpretation''). The purpose of the Interpretation 
is to protect the integrity of the public offering system by ensuring 
that members make a bona fide public distribution of ``hot issue'' 
securities and do not withhold such securities for their own benefit or 
use the securities to reward other persons who are in a position to 
direct future business to the member. Hot issues are defined by the 
Interpretation as securities of a public offering that trade at a 
premium in the secondary market whenever such trading commences.
    The Interpretation prohibits members from retaining the securities 
of hot issues in their own accounts and prohibits members from 
allocating such securities to directors, officers, employees and 
associated persons of such members and other broker-dealers. It also 
restricts member sales of hot issue securities to the accounts of 
specified categories of persons, including, among others, senior 
officers of banks, insurance companies, registered investment 
companies, registered investment advisory firms and any other person 
with such organizations whose activities influence or include the 
buying and selling of securities. These basic prohibitions and 
restrictions are also made applicable to sales by members of hot issue 
securities to accounts in which any such persons may have a beneficial 
interest and, with some exceptions, to members of the immediate family 
of those persons restricted by the Interpretation.
    In March 1997, the NASD Regulation Board of Directors (``Board''), 
acting upon recommendation from the National Business Conduct Committee 
(``NBCC'') \7\ considered various amendments to the Interpretation. The 
Board submitted a series of proposed rule amendments to the membership 
for comment in Notice to Members 97-30. NASD Regulation received 22 
comment letters in response to Notice to Members 97-30. As described 
below, the proposal has been amended in response to these comments.
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    \7\ The name of this committee has been changed to National 
Adjudicatory Council. See Securities Exchange Act Release No. 39470 
(December 19, 1997), 62 FR 67927 (December 30, 1997).
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II. Summary Description of the Proposed Rule Change

A. Exemptive Authority

    Previously, there has not been a provision in the Interpretation 
itself to allow the NBCC, the Board, or NASD Regulation staff to grant 
exemptive relief. In the past, the NBCC, relying on the NASD By-Law's 
grant of authority to the Board and its Committees, granted exemptions 
in certain unique circumstances. NASD Rule 9600 delegates exemptive 
authority in the Interpretation to the Office of General Counsel. The 
Interpretation previously provided for exemption relief solely in cases 
involving sales of issuer-directed securities to non-employee-director 
restricted persons pursuant to Paragraph (d)(2) of the Interpretation.
    As revised, the Interpretation authorizes NASD Regulation staff, 
upon written request and taking into consideration all relevant 
factors, to provide an exemption either unconditionally or on specified 
terms from any or all of the provisions of the Interpretation, 
consistent with the purposes of the Interpretation, the protection of 
investors and the public interest. The proposed rule revisions also 
provide that persons may appeal decisions of NASD Regulation staff to 
the National Adjudicatory Council.

B. Treatment of Direct and Indirect Owner of Broker-Dealers

    In 1994, the Interpretation's definition of ``associated person'' 
was amended to exempt certain passive investors in broker-dealers.\8\ 
Among other things, the rule amendments approved in the instant filing 
address two limitations from the previous amendments. First, the 
definition of associated person as previously provided in the 
Interpretation did not include non-natural persons that have an 
ownership interest in or have contributed capital to a broker-dealer. 
Secondly, the Interpretation did not affirmatively specify any 
ownership levels at which a natural person becomes an associated person 
by reason of his or her ownership interest in a broker-dealer. Rather, 
the Interpretation only specified when a natural person is not an 
associated person.
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    \8\ Securities Exchange Act Release No. 35059 (December 7, 
1994), 59 FR 64455, 64457 (December 14, 1994).
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    In Notice to Members 97-30, NASD Regulation proposed creating a new 
definition of ``restricted person.'' Among other things, commenters 
advised the NASD that this approach would result in confusion because 
the term ``restricted person'' was already used throughout the 
Interpretation. Commenters also observed that when the proposed 
restricted persons provisions were read with other sections of the 
Interpretation, the Interpretation would appear to be so broad as to 
preclude purchases by any entity that owns 10 percent or more of a 
broker-dealer or any account in which such entity has a beneficial 
interest.
    Having considered the potential problems with creating a new 
definition of ``restricted person,'' to clarify the application of the 
Interpretation to natural and non-natural persons, the Interpretation 
has been revised by NASD Regulation to create a new Paragraph (b)(9) of 
IM 2110-1. Paragraph (b)(9)(A) would exempt from the Interpretation's 
prohibitions purchases by any person who directly or indirectly owns 
any class of equity securities of, or who has made a contribution of 
capital to, a member, and whose ownership or capital interest is 
passive and is less than 10 percent of the equity or capital of a 
member, as long as such person purchases hot issues from a person other 
than the member in which it has such passive ownership and such person 
is not in a position by virtue of its passive ownership interest to 
direct the allocation of hot issues.
    Alternatively, a second exemption embodied in Paragraph (b)(9)(A) 
would exclude purchases by any person who directly or indirectly owns 
any class of equity securities of, or who has made a contribution of 
capital to, a member, and whose ownership or capital interest is 
passive and is less than 10 percent of the equity or capital of a 
member, as long as such member's shares, or shares of a parent of such 
member, are traded on an exchange or Nasdaq.
    In response to commenters' concerns that the rule revisions 
proposed in Notice to Members 97-30 would prohibit sales of hot issues 
to all entities within many insurance companies that own a broker-
dealer, Paragraph (b)(9)(B) of the proposal exempts sales of hot issues 
to any account established for the benefit of bona fide public 
customers of a person restricted pursuant to Paragraph (b)(9). This 
exception expressly notes that such accounts would include, but are not 
limited to, an insurance company's general or separate accounts.

[[Page 28537]]

    Finally, Paragraph (b)(9)(C) retains the indirect ownership 
provisions originally proposed in Notice to Members 97-30. 
Specifically, it provides that any person with an equity ownership or 
capital interest in an entity that maintains an investment in a member 
shall be deemed to have a percentage interest of the entity of the 
member multiplied by the percentage interest of such person in such 
entity.

C. Exception to the Public Offering Definition

    Heretofore, debt offerings have been included in the 
Interpretation's definition of ``public offering.'' The proposed rule 
change would provide an exception from the Interpretation for debt 
securities other than debt securities convertible into common or 
preferred stock. This exclusion is based upon the rationale that such 
offerings do not raise the same issues as equity offerings inasmuch as 
the price for a particular debt security generally fluctuates based on 
interest rate movements rather than demand factors. The definition of 
public offering also would except financing instrument-backed 
securities that are rated by a nationally recognized statistical rating 
organization in one of the four highest generic rating categories. 
Lastly, NASD Regulation has reconsidered its earlier position and, in 
response to comment letters received regarding Notice to Members 97-30, 
revised the term public offering so as to exclude secondary offerings 
by an issuer whose securities are actively traded securities. The 
modified Interpretation defines actively traded securities to include 
securities that have a worldwide average daily trading volume value of 
at least $1 million and are issued by an issuer whose common equity 
securities have a public float value of at least $150 million.

D. Foreign Mutual Funds

    Purchases of shares of investment companies registered under the 
Investment Company Act of 1940 were previously exempt from the 
Interpretation based upon the rationale that the interest of any one 
restricted person in an investment company ordinarily is de minimis and 
because ownership of investment company shares generally is subject to 
frequent turnover. The proposed rule revisions would extend this 
rationale to the purchase of shares of foreign investment companies and 
thus exempt such shares from the Interpretation, subject to 
verification procedures designed, among other things, to ensure that 
the company is listed on a foreign exchange or authorized for sale to 
the policy by a foreign regulatory authority.

E. Issuer-Directed Share Exemption

    In Notice to Members 97-30, NASD Regulation stated that persons 
have requested that the language of Paragraph (d) of the Interpretation 
be modified to clarify that the exemption is available to employees of 
the issuer who are materially supported by a restricted person and both 
employees and non-employee directors. Based upon the comments received 
and its own initiative to clarify and streamline the issuer-directed 
securities provisions more generally, the proposed rule change modifies 
Paragraph (d) of the Interpretation to permit persons associated with a 
member and their immediate family members to purchase hot issues. The 
amendments clarify that the exemptions apply to employees and directors 
of a parent or subsidiary of the issuer, consistent with NASD 
Regulation's past practice.

F. Accounts for Qualified Plans Under the Employment Retirement Income 
Security Act (``ERISA'')

    The Interpretation has not previously expressly addressed the 
status of qualified employee benefit plans under ERISA. In direct 
response to the requests of commenters, the proposed rule change 
clarifies the status of such accounts. To that end, the proposal 
incorporates within the Interpretation itself a prior NBCC 
interpretation governing the matter. As a general rule, NASD Regulation 
believes qualified ERISA plans should not be deemed an ``investment 
partnership or corporation'' and should not be considered a 
``restricted account'' for purposes of the Interpretation. The proposed 
amendments to the Interpretation provide guidance, however, in 
determining the factual circumstances wherein a qualified ERISA plan 
could be deemed restricted.

III. Comments Letters Received and Amendment No. 2 to the Proposal

    As noted above, the Commission received one comment letter from 
Sullivan and Cromwell. Amendment No. 2 to the filing responds to the 
comment letter and, as discussed below, amends the proposal to address 
issues raised by the Sullivan and Cromwell letter.

A. Investment Grade Securities

    The proposed rule change exempts from the Interpretation debt 
securities (other than debt securities convertible into common or 
preferred stock) and financing instrument backed-securities that are 
rated by a nationally recognized statistical rating organization in one 
of its four highest generic rating categories. Sullivan and Cromwell 
recommends that NASD Regulation exempt ``investment grade preferred 
securities,'' (i.e., preferred equities) from the Interpretation based 
upon its understanding that prices for such securities are principally 
based on prevailing interest rates and that many investors view 
investment grade preferred securities of different issuers as being 
largely fungible.
    NASD Regulation does not agree with Sullivan and Cromwell that 
``investment grade preferred securities'' should be excluded from the 
Interpretation, because NASD Regulation does not believe that the 
prices of investment grade preferred securities are based on interest 
rate movements to the same extent as investment grade debt. NASD 
Regulation believes that demand-side factors play an important role in 
the price of many preferred securities. In addition, preferred 
securities generally differ from investment grade debt in that they are 
rarely collateralized. Moreover, purchasers of preferred securities 
often look to the issuer's business and management in determining 
whether to purchase the security. For these reasons, NASD Regulation 
believes that ``investment grade preferred securities'' should not be 
excluded from the Interpretation. Amendment No. 2 to the filing states, 
however, that NASD Regulation will evaluate the impact of excluding 
investment grade debt and investment grade financing-backed securities 
from the Interpretation and will consider in the future whether 
preferred equities should also be excluded.

B. Paragraph (b)(9) and Direct/Indirect Owners of Broker-Dealers

    In Paragraph (b)(9) of the proposed rule change, NASD Regulation 
prohibits members from selling hot issues to any person or to a member 
of the immediate family of such person who owns or has contributed 
capital to a broker-dealer, other than solely a limited business 
broker-dealer as defined in Paragraph (c) of the Interpretation, or the 
account in which any such person has a beneficial interest, with 
certain exceptions for ownership interest of less than 10%. 
Importantly, however, Paragraph (b)(9) exempts sales to the account of 
a restricted person that is established for the benefit of bona fide 
public customers.
    The Sullivan & Cromwell letter makes a number of particularized 
comments, which are discussed in detail below. The thrust of Sullivan & 
Cromwell

[[Page 28538]]

comments is that Paragraph (b)(9) should be revised to apply only to 
institutions that are ``principally engaged in the broker-dealer 
business.'' In responding to the suggestion, NASD Regulation notes that 
it has rejected this argument many times and continues to believe that 
such a narrow approach is inconsistent with the scope and intent of the 
Interpretation. As reiterated in Amendment No. 2 to the filing, NASD 
Regulation is of the opinion that the proposed revisions by Sullivan 
and Cromwell would leave open a substantial possibility of reciprocal 
self-dealing among broker-dealer and owners of broker-dealers.
    NASD Regulation notes that the Interpretation protects the 
integrity of the public offering process by ensuring that members make 
a bona fide public distribution at the public offering price of hot 
issue securities and do not withhold such securities for their own 
benefit or use such securities to reward other persons in the financial 
services business who are in a position to direct future business to 
the member. NASD Regulation believes the Interpretation also ensures 
that members of the securities industry do not take advantage of their 
inside position in the industry to the detriment of public investors. 
In light of the foregoing rationales, NASD Regulation believes that 
persons who own a significant percentage of a broker-dealer, i.e., 10% 
or more, should be restricted under the Interpretation.
    NASD Regulation notes that it has provided an exemption from the 
interpretation for persons that own 10% or more of a broker-dealer by 
permitting such persons to purchase hot issues for the benefit of bona 
fide public customers, or for an ERISA account pursuant to Paragraph 
(f)(3). NASD Regulation does not believe that permitting such persons 
to purchase hot issues for proprietary accounts, even if such hot 
issues directly or indirectly benefit some public shareholder, is 
consistent with the purposes of the Interpretation.
1. Banks and Industrial Companies with Broker-Dealer Subsidiaries and 
Affiliates
    Sullivan and Cromwell states in its letter that it is concerned 
that the proposed rule change would affect the public offering market 
by making hot issues unavailable to many institutional customers, and 
in particular, banks with broker-dealer subsidiaries and affiliates. 
Sullivan and Cromwell observes that proposed Paragraph (b)(9) generally 
would prohibit the sale of hot issues to banks with broker-dealer 
subsidiaries and affiliates. To the extent that these banks purchase 
hot issues on a proprietary basis, NASD Regulation believes that the 
Interpretation should apply. NASD Regulation notes, however, that banks 
with broker-dealer subsidiaries and affiliates may purchase hot issues 
on behalf of bona fide public customers, pursuant to the exemption set 
forth in Paragraph (b)(9).
    The proposed rule change also would prohibit industrial companies 
that own broker-dealers, such as General Electric Company (``GE'') and 
Ford Motor Company (``Ford'') from purchasing hot issues for their own 
account. Here again, NASD Regulation believes that this is the correct 
result. However, companies such as GE and Ford would be able to 
purchase hot issues for an account in which they have a beneficial 
interest, provided that such account is established for the benefit of 
bona fide public customers.
2. Accounts Established for the Benefit of Bona Fide Public Customers
    As stated above, Paragraph (b)(a) of the proposed rule change 
contains an exemption for sales to the account of any person restricted 
under this subparagraph that is established for the benefit of bona 
fide public customer. Specifically, Paragraph (b)(9) states that such 
accounts would include ``insurance company general and separate 
accounts.'' NASD Regulation included these examples because it 
understood that investments from such accounts are passed on directly 
to policy holders, i.e., bona fide public customers.
    The Sullivan and Cromwell letter suggests that the exemption for 
accounts established for the benefit of bona fide public customers 
applies solely to life insurance companies. As explained by NASD 
Regulation, it was not intended that the exemption described in 
Paragraph (b)(9) apply solely to life insurance companies. NASD 
Regulation intended that the exemption apply across all industries. 
Accordingly, Paragraph (b)(9)(B) of the proposed rule change has been 
amended. The revised language is set forth below. Additions to the 
provision are italicized. Language to be deleted appears in brackets.

This prohibition shall not apply to sales to the account of any 
person restricted under this paragraph established for the benefit 
of bona fide public customers, including [an] insurance company 
general [or] , separate and investment accounts and bank trust 
accounts.

3. Shares of a Member Traded as Part of a Holding Company
    As originally proposed, Paragraph (b)(9) of the proposed rule 
change would exempt any person who owns any class of equity securities 
of, or who has made a contribution of capital to, a member, and whose 
ownership or capital interest is passive and is less than 10% of the 
equity or capital of a member, so long as such member's shares are 
publicly traded on an exchange or Nasdaq. Sullivan & Cromwell states 
that this exemption does not properly reflect the fact that many of the 
largest broker-dealers are subsidiaries of publicly traded holding 
companies and are not themselves publicly traded. NASD Regulation 
previously addressed this issue in Amendment No. 1 to the filing. 
Amendment No. 1 revises paragraph (b)(9)(A)(ii) to include within the 
exemption shares of a parent of a member firm that are publicly traded 
on an exchange or Nasdaq.
4. Immediate Family Members
    Paragraph (b)(9) applies to ``any person, or to a member of the 
immediate family of such person.'' Sullivan and Cromwell states that 
Paragraph (b)(9) would require a member, for example Merrill Lynch, to 
confirm not only that its customer does not own any Merrill Lynch 
Parent stock, but also that none of his or her immediate family members 
owns any such stock. Sullivan and Cromwell also states that Paragraph 
(b)(9) does not exempt immediate family members who are not materially 
supported by the restricted person, as does Paragraph (b)(2) of the 
Interpretation. Sullivan and Cromwell maintains that it would be almost 
impossible for a broker-dealer owned by a publicly traded holding 
company to comply with Paragraph (b)(9) since, on its face, it would 
require the broker-dealer to obtain complete information regarding the 
securities portfolios of each of its customers' immediate family 
members. Proposed Paragraph (b)(9), however, is implicated only by 
persons who own 10% or more of a member. Nevertheless, NASD Regulation 
believes that the provisions regarding the immediate family members of 
restricted persons under proposed Paragraph (b)(9) should not be more 
restrictive than the provisions in Paragraph (b)(2), which pertain to 
associated persons of a member. NASD Regulation has therefore amended 
Paragraph (b)(9) so as to exclude immediate family members who are not 
materially supported by restricted persons. Revised

[[Page 28539]]

Paragraph (b)(9) is set forth below. New language is italicized.

Sell any of the securities to any person, or to a member of the 
immediate family of such person who is supported directly or 
indirectly to a material extent by such person, * * *.
5. Miscellaneous Changes to Paragraph (b)(9)
    Pursuant to Amendment No. 2, NASD Regulation also corrected an 
inadvertent clerical error in Paragraph (b)(9)(C) of the proposed rule 
change that was identified by the Sullivan and Cromwell comment later. 
The missing language set forth below was contained in the proposed rule 
change as published in NASD Notice to Members 97-30, but was omitted 
from the rule filing. New language is italicized. Revised Paragraph 
(b)(9)(C) has been amended to read as follows:

For purposes of this paragraph, any person with an equity ownership 
or capital interest in an entity that maintains an investment in a 
member shall be deemed to have a percentage interest in the member 
equal to the percentage interest of the entity in the member 
multiplied by the percentage interest of such person in such entity.

C. Foreign Investment Companies

    Paragraphs (f) and (1)(6) of the proposed rule change would exempt 
foreign investment companies i.e., foreign mutual funds, organized 
under the laws of the foreign jurisdiction, that have provided to the 
member a written certification prepared by counsel or an independent 
certified public accountant, which states that: (1) The fund has 100 or 
more investors; (2) the fund is listed on a foreign exchange or 
authorized for sale to the public by a foreign regulatory authority, 
(3) no more than 5% of the fund assets are to be invested in the hot 
issue securities being offered, and (4) any person owning more than 5% 
of the shares of the fund is not a restricted person.
    Sullivan and Cromwell states that while it agrees that an exemption 
should be provided for foreign investment companies, it opposes any 
requirement that NASD members obtain written certification from an 
attorney or accountant. Sullivan and Cromwell proposes instead that 
NASD Regulation exempt foreign investment companies based upon their 
``status'' under foreign regulatory regimes, for example, any fund 
qualified for sale under the European Union's Directive on Undertakings 
for Collective Investment in Transferable Securities.
    In response to comments received regarding Notice to Members 97-30, 
and to alleviate the burdens associated with the written certification 
requirement, NASD Regulation modified proposed Paragraph (1)(6) to 
permit foreign, and not just U.S., attorneys and accountants to provide 
written certifications. NASD Regulation continues to believe, however, 
that written certifications are an appropriate method of determining 
whether a particular foreign investment company meets the criteria for 
exemption from the Interpretation and does not agree that this 
requirement should be eliminated.
    Sullivan and Cromwell states in its comment letter that if written 
certifications are to be required, it recommends two changes. First 
Sullivan and Cromwell states that foreign investment companies, like 
registered investment companies, do not investigate the status of their 
shareholders and thus will be unable to comply with the requirement to 
certify that ``any person owning more than 5% of the shares of the fund 
is not a person described in Paragraphs (b)(1), (2), (3), or (4) of the 
Rule.''
    NASD Regulation considered this issue in proposing the exemption 
for foreign investment companies but concluded that the concerns of the 
Interpretation that restricted persons do not indirectly purchase hot 
issues through foreign investment companies were paramount. 
Accordingly, if a foreign investment company is owned more than 5% by a 
person, an attorney or accountant must certify that such person is not 
a restricted person under the Interpretation. The attorney or 
accountant providing the written certification required pursuant to 
paragraph (1)(6) may rely upon information supplied by the foreign 
investment company and any shareholder that owns more than 5% of the 
foreign investment company. NASD Regulation is of the opinion that the 
shareholder is likely to cooperate with any request by the foreign 
investment company, or its counsel or accountant, regarding the 
shareholder's status under the Interpretation since the shareholder's 
cooperation may enhance the foreign investment company's investment 
opportunities by permitting it to invest in hot issues. As a practical 
matter, however, the requirement to determine whether a more than 5% 
shareholder is a restricted person is unlikely to affect many foreign 
investment companies because, as Sullivan and Cromwell concedes in its 
comment letter, each foreign investment company must have at least 100 
shareholders and, consequently, it is unlikely that the interest of any 
one person will exceed the 5% threshold.
    Second, Sullivan and Cromwell states that, as drafted, Paragraph 
(1)(6) of the Interpretation would require a member firm to obtain a 
written certification prior to each hot issue sale to a foreign 
investment company. Sullivan and Cromwell views this as unduly 
burdensome and recommends that NASD Regulation revise Paragraph (1)(6) 
to be consistent with Paragraph (f)(2), which states that ``a written 
representation shall be deemed to be current if it is based upon the 
status of the account as of a date more than 18 months prior to the 
date of the transaction.'' NASD Regulation agrees that members should 
not be required to obtain a written certification before each 
transaction and will adopt the same standard in effect for 
certifications made pursuant to Paragraph (f)(2). Accordingly, the 
final sentence of Paragraph (f)(2) of the Interpretation shall be 
amended as set forth below. New language is italicized.

For purposes of this paragraph (f) and the certification required 
pursuant to paragraph (1)(6). a list or written representation shall 
be deemed to be current if it is based upon the status of the 
account as of a date not more than 18 months prior to the date of 
the transaction.

    In addition to responding to the Sullivan and Cromwell 
observations, Amendment No. 2 corrected proposed Paragraph (1)(6)(D) to 
make the paragraph clearer and more consistent with other parts of the 
Interpretation. The revised paragraph is set forth below. New language 
is italicized. Language to be deleted from the paragraph appears in 
brackets.

Any person owning more than 5% of the share of the fund is not a 
restricted person as described in paragraph (b)(1), (2), (3), [or] 
(4) or (9) of the [Rule] interpretation.

D. Secondary Distributions

    The proposed rule change exempts from the Interpretation secondary 
distributions by an issuer whose securities are actively-traded 
securities. Sullivan and Cromwell supports the decision to exempt 
secondary offerings but objects to the provision in the definition of 
``actively-traded securities'' that excludes securities issued by the 
distribution participant or an affiliate of the distribution 
participant. NASD Regulation's proposed rule change to exempt secondary 
offerings was drafted to track the exemption for actively-traded 
securities set forth in the SEC's Regulation M. In adopting the 
exemption for secondary distributions, NASD Regulation was focusing on 
the average daily trading value and public float value provisions of 
Regulation M exempt securities. NASD Regulation agrees with Sullivan 
and Cromwell concerning secondary offerings of

[[Page 28540]]

members or affiliates of members and proposes revising the definition 
of `'actively-traded securities'' to extend the exemption to securities 
issued by a distribution participant or an affiliate of the 
distribution participant. Paragraph (1)(7)(A), as amended, is set forth 
below. Language to be deleted from the paragraph appears in brackets.

Actively-traded securities means securities that have an ADTV value 
of at least $1 million and are issued by an issuer whose common 
equity securities have a public float value of at least $150 
million[; provided, however, that such securities are not issued by 
the distribution participant or an affiliate of the distribution 
participant].

    Finally, Sullivan Cromwell notes that Paragraph (l)(1) refers to 
secondary distributions ``by an issuer.'' Sullivan and Cromwell asks 
whether secondary distributions by an existing security holder are 
subject to the Interpretation. If not, Sullivan and Cromwell recommends 
amending the text of proposed Paragraph (l)(1) to extend the exemption 
to such distributions. NASD Regulation did not intend to exclude from 
the exemption secondary offerings by security holders. Accordingly, it 
has revised Paragraph (l)(1) as set forth below. New language is 
italicized. Language to be deleted from the paragraph appears in 
brackets.

The term public offering shall exclude secondary distributions by an 
issuer or any security holder of the issuer, of [whose securities 
are] actively-traded securities.

IV. Conclusion

    The Commission has carefully considered the comments set forth in 
the Sullivan and Cromwell letter. As discussed in detail above, the 
NASD Regulation has made a number of technical amendments to the 
proposal in response to the Sullivan and Cromwell letter, which the 
Commission believes are consistent with the spirit of the 
Interpretation. Indeed, the Commission believes the changes to the 
proposal which were made pursuant to Amendment No. 1 and No. 2 will 
facilitate the ability of NASD member firms to comply with the 
Interpretation, because the amendments further clarify the intent of 
the proposed rule change. For example, in response to the Sullivan and 
Cromwell letter, the Interpretation was amended to clarify that the 
exemption in paragraph (b)(9)(B) for sales to the accounts of 
restricted persons established for the benefit of bona fide public 
customers was intended to apply across all industries, as opposed to 
life insurance companies exclusively. Similarly, Amendment No. 1 to the 
proposal facilitates member firm compliance by amending the paragraph 
(b)(9)(A)(ii) exemption for shares of a member traded on an exchange or 
Nasdaq to include an exemption for shares of a member traded as a part 
of a holding company. This amendment fosters member firm compliance 
with the Interpretation by recognizing that many of the largest broker-
dealers are subsidiaries of publicly traded holding companies and are 
not themselves publicly traded.
    NASD Regulation has determined not to revise the proposal in 
response to Sullivan and Cromwell's suggestion that paragraph (b)(9) of 
the Interpretation, which with certain exceptions, prohibits sales of 
hit issue securities to any person who owns or has contributed capital 
to a broker-dealer, be revised such that it only applies to 
institutions engaged ``principally in the broker-dealer business.'' The 
Commission agrees with NASD Regulation that such an amendment is 
inconsistent with the scope and intent of the proposal, because the 
modification would leave open a substantial possibility of self-dealing 
between broker-dealers and owners of broker-dealers. Accordingly, the 
Commission believes NASD Regulation has a sound investor protection 
basis for its decision not to narrow the scope of paragraph (b)(9) of 
the Interpretation as requested by Sullivan and Cromwell.
    The Commission believes the proposed rule change, as amended, is 
consistent with the provisions of section 15(A)(b)(6) of the Act,\9\ 
which provides in pertinent part that the rules of a national 
securities association be designed to prevent fraudulent and 
manipulative acts, promote just and equitable principles of trade and 
protect investors and the public interest. Specifically, the proposal 
preserves public confidence in the fairness of the investment banking 
and securities business by ensuring that members of the investment 
banking community do not unfairly benefit from public offerings by 
virtue of their positions as insiders, to the detriment of public 
investors. Preservation of investor confidence in the fairness of the 
markets is critical to the continued participation of all classes of 
securities marked participants. The Commission believes, moreover, that 
the proposed rule change is consistent with section 15A(b)((9) \10\ in 
that it will alleviate certain inequities caused by the Interpretation, 
which imposed burdens on competition not necessary or appropriate in 
furtherance of the purposes of the Act.
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    \9\ 15 U.S.C. 78o-3.
    \10\ 15 U.S.C. 78o-3.
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    In approving this proposal, the Commission notes that it is has 
considered the proposal's impact on efficiency, competition, and 
capital formation.\11\ The Commission believes the proposal will 
facilitate the capital raising process by removing restrictions and 
compliance burdens imposed by the Interpretation with respect to 
certain transactions where application of the Interpretation does not 
enhance investor protection or the public interest. For example, the 
proposal excludes from the definition of public offering secondary 
offerings by an issuer whose securities are actively traded securities. 
At the same time, the Interpretation continues to apply to those 
securities allocations that pose a risk of undercutting the 
Interpretation's objective of ensuring a bona fide distribution of hot 
issue securities to the public.
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    \11\ 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) \12\ of the 
Act, that the proposed rule change SR-NASD-97-95 be and hereby is 
approved.

    \12\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-13850 Filed 5-22-98; 8:45 am]
BILLING CODE 8010-01-M