[Federal Register Volume 64, Number 85 (Tuesday, May 4, 1999)]
[Notices]
[Pages 23889-23892]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-11146]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41337; File No. SR-NASD-99-14]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the National Association of 
Securities Dealers, Inc. Relating to the Adoption of Interpretive 
Materials Regarding Future Priced Securities

April 27, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 15, 1999,\3\ the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary, the Nasdaq Stock Market, Inc. (``Nasdaq'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the NASD. 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. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The Association originally filed the proposed rule change on 
March 8, 1999. After consultation with Commission staff, the 
Association filed Amendment No. 1 to clarify certain provisions of 
the proposed rule language. Letter to Richard Strasser, Assistant 
Director, Division of Market Regulation, Commission, from Robert E. 
Aber, Senior Vice President and General Counsel, NASD, dated April 
14, 1999 (``Amendment No. 1'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq proposes to adopt interpretive material relating to certain 
convertible securities. Below is the text of the proposed rule change. 
All text is being added.
* * * * *

IM-4300, Interpretive Material Regarding Future Priced Securities

Summary

    Future Priced Securities are private financing instruments which 
were created as an alternative means of quickly raising capital for 
issuers. The security is generally structured in the form of a 
convertible security and is often issued via a private placement. 
Issuers will typically receive all capital proceeds at the closing. The 
conversion price of the Future Priced Security is generally linked to a 
percentage discount to the market price of the underlying common stock 
at the time of conversion and accordingly the conversion rate for 
Future Priced Securities floats with the market price of the common 
stock. As such, the lower the price of the issuer's common stock at the 
time of conversion, the more shares into which the Future Priced 
Security is convertible. The delay is setting the conversion price is 
appealing to issuers who believe that their stock will achieve greater 
value after the financing is received. However, the issuance of Future 
Priced Securities may be followed by a decline in the common stock 
price, creating additional dilution to the existing holders of the 
common stock. Such a price decline allows holders to convert the Future 
Priced Security into large amounts of the issuer's common stock. As 
these shares are issued upon conversion of the Future Priced Security, 
the common stock price may tend to decline further.
    For example, an issuer may issue $10 million of convertible 
preferred stock (the Future Priced Security), which is convertible by 
the holder or holders into $10 million of common stock based on a 
conversion price of 80% of the closing price of the common stock on the 
date of conversion. If the closing price is $5 on the date of 
conversion, the Future Priced Security holders would receive 2,500,000 
shares of common stock. If, on the other hand, the closing price is $1 
on the date of conversion, the Future Priced Security holders would 
receive 12,500,000 shares of common stock.
    Unless the issuer carefully considers the terms of the securities 
in connection with several NASD Rules, the issuance of Future Priced 
Securities could result in a failure to comply with Nasdaq listing 
standards and the concomitant delisting of the issuer's securities from 
the Nasdaq Stock Market. Nasdaq'a experience has been that issuers do 
not

[[Page 23890]]

always appreciate this potential consequence. NASD Rules that bear upon 
the continued listing qualification of an issuer and that must be 
considered when issuing Future Priced Securities include:

1. the shareholder approval rules
2. the voting rights rules.
3. the bid price requirement
4. the listing of additional shares rules
5. the change in control rules
6. Nasdaq's discretionary authority rules
    It is important for issuers to clearly understand that failure to 
comply with any of these rules could result in the delisting of the 
issuer's securities.
    This notice is intended to be of assistance to companies 
considering financings involving Future Priced Securities. By adhering 
to the above requirements, issuers can avoid unintended listing 
qualifications problems. Issuers having any questions about this notice 
should contact The Nasdaq Stock Market, Office of General Counsel at 
(202) 728-8294 or Listing Qualifications Department at (202) 496-2500. 
Nasdaq will provide an issuer with a written interpretation of the 
application of NASD Rules to a specific transaction, upon request of 
the issuer.

How the Rules Apply

Shareholder Approval

    NASD Rule 4310(c)(25)(H)(i) relating to Nasdaq SmallCap issuers and 
Rule 4460(i)(1) relating to Nasdaq National Market issuers provide, in 
part:
    Each issuer shall require shareholder approval * * * prior to the 
issuance of designated securities * * * in connection with a 
transaction other than a public offering involving * * * the sale or 
issuance by the issuer of common stock (or securities convertible into 
or exercisable for common stock) equal to 20 percent or more of the 
common stock or 20 percent or more of the voting power outstanding 
before the issuance for less than the greater of book or market value 
of the stock.\4\
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    \4\ Nasdaq may make exceptions to this requirement when the 
delay in securing stockholder approval would seriously jeopardize 
the financial viability of the enterprise and reliance by the 
company on this exception is expressly approved by the Audit 
Committee or a comparable body of the Board of Directors.
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    When Nasdaq staff is unable to determine the number of shares to be 
issued in a transaction, it looks to the maximum potential issuance of 
shares to determine whether there will be an issuance of 20 percent or 
more of the common stock outstanding. In the case of Future priced 
Securities, the actual conversion price is dependent on the market 
price at the time of conversion and so the number of shares that will 
be issued is uncertain until the conversion occurs. Accordingly, staff 
will look to the maximum potential issuance of common shares at the 
time the Future Priced Security is issued. Typically, with a Future 
Priced Security, the maximum potential issuance will exceed 20 percent 
of the common stock outstanding because the Future Priced Security 
could, potentially, be converted into common stock based on a share 
price of one cent per share, or less. Further, for the purposes of this 
calculation, the lowest possible conversion price is below the book or 
market value of the stock at the time of issuance of the Future Priced 
Security. Therefore, shareholder approval must be obtained prior to the 
issuance of the Future Priced Security. Issuers should also be 
cautioned that obtaining shareholder ratification of the transaction 
after the issuance of a Future Priced Security does not satisfy the 
shareholder approval requirements.
    Some Future Priced Securities may contain features to obviate the 
need for shareholder approval by: (1) placing a cap on the number of 
shares that can be issued upon conversion, such that the holders of the 
Future Priced Security cannot, without prior shareholder approval, 
convert the security into 20 percent or more of the common stock or 
voting power outstanding before the issuance of the Future Priced 
Security;\5\ or (2) placing a floor on the conversion price, such that 
the conversion price will always be at least as high as the greater of 
book or market value of the common stock prior to the issuance of the 
Future Priced Securities. Even when a Future Priced Security contains 
these features, however, shareholder approval is still required under 
Rules 4310(c)(25)(H)(i)(b) and 4460(i)(1)(B) if the issuance will 
result in a change of control.
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    \5\ In order to obviate the need for shareholder approval 
through such an arrangement, those shares already issued in 
connection with the Future Priced Security must not be entitled to 
vote on the proposal to approve the issuance of additional shares 
upon conversion of the Future Priced Security.
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* * * * *

Voting Rights

    NASD Rule 4310(c)(21) provides:
    Voting rights of existing shareholders of publicly traded common 
stock registered under Section 12 of the Act cannot be disparately 
reduced or restricted through any corporate action or issuance.
    Rule 4460(j) and IM-4310 also provide rules relating to voting 
rights of Nasdaq issuers.
    Under the voting rights rules, an issuer cannot create a new class 
of security that votes at a higher rate than an existing class of 
securities or take any other action that has the effect of restricting 
or reducing the voting rights of an existing class of securities. The 
voting rights rules are typically implicated when the holders of the 
Future Priced Security are entitled to vote on an as-converted basis or 
when the holders of the Future Priced Security are entitled to 
representation on the Board of Directors. Staff will consider whether a 
voting rights violation exists by comparing the Future Priced Security 
holders' voting rights to their relative contribution to the company 
based on the company's overall book or market value at the time of the 
issuance of the Future Priced Security. The percentage of the overall 
vote attributable to the Future Priced Security holders and the Future 
Priced Security holders' representation on the board of directors must 
not exceed their relative contribution to the company based on the 
company's overall book or market value at the time of the issuance of 
the Future Priced Security. If the voting power or the board percentage 
exceeds that percentage interest, a violation exists because a new 
class of securities has been created that votes at a higher rate than 
an already existing class. Future Priced Securities that vote on an as-
converted basis also raise voting rights concerns because of the 
possibility that, due to a decline in the price of the underlying 
common stock, the Future Priced Security holder will have voting rights 
disproportionate to its investment in the Company.
    It is important to note that compliance with the shareholder 
approval rules prior to the issuance of a Future Priced Security does 
not affect whether the transaction is in violation of the voting rights 
rule. Furthermore, shareholders cannot otherwise agree to permit a 
voting rights violation by the issuer. Because a violation of the 
voting rights requirement can result in delisting of the issuer's 
securities from Nasdaq, careful attention must be given to this issue 
to prevent a violation of the rule.
* * * * *

The Bid Price Requirement

    NASD Rules 4310(c)(4) and 4450(a)(5) provide that for an issue to 
be eligible for continued inclusion on the Nasdaq Stock Marekt, the 
minimum bid price per share shall be $1.
    In addition, Rule 4450(b)(4), which applies only to issues 
qualifying for the Nasdaq National Market under maintenance standard 2, 
provides that for an issue to remain eligible for

[[Page 23891]]

continued inclusion in the Nasdaq National Market, the minimum bid 
price shall be $5.
    The bid price requirement establishes a minimum bid price for 
issues trading on Nasdaq. An issue is subject to delisting from Nasdaq 
if its bid price falls below $1. In addition, certain issues are 
subject to delisting from the Nasdaq National Market if their bid price 
falls below $5.
    The bid price rules must be thoroughly considered because the 
characteristics of Future Priced Securities often exert downward 
pressure on the bid price of the issuer's common stock. Specifically, 
dilution from the discounted conversion of the Future Priced Security 
may result in a significant decline in the price of the common stock. 
Furthermore, there appear to be instances where short selling has 
contributed to a substantial price decline, which, in turn, could lead 
to a failure to comply with the bid price requirement.\6\
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    \6\ If used to manipulate the price of the stock, short selling 
by the holders of the Future Priced Security is prohibited by the 
antifraud provisions of the securities laws and by NASD Rules and 
may be prohibited by the terms of the placement.
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* * * * *

Listing of Additional Shares

    NASD Rule 4310(c)(17) provides:
    The issuer shall be required to file on a form designated by Nasdaq 
notification of * * * the issuance of additional shares of any class of 
securities included in Nasdaq * * * no later than 15 calendar days 
prior to * * * the issuance of additional shares.
    Issuers should be cognizant that under this rule notification is 
required at least 15 days prior to issuing any security (including a 
Future Priced Security) convertible into shares of a class of 
securities already listed on Nasdaq. Failure to provide such notice can 
result in an issuer's removal from Nasdaq.
* * * * *

Public Interest Concerns

    NASD Rule 4300 provides:
    The Nasdaq Stock Market is entrusted with the authority to preserve 
and strengthen the quality of and public confidence in its market. The 
Nasdaq Stock Market stands for integrity and ethical business practices 
in order to enhance investor confidence, thereby contributing to the 
financial health of the economy and supporting the capital formation 
process. Nasdaq issuers, from new public companies to companies of 
international stature, by being included in Nasdaq, are publicly 
recognized as sharing these important objectives of the Nasdaq Stock 
Market.
    NASD Rule 4330(a) provides:
    Nasdaq may * * * deny inclusion or apply additional or more 
stringent criteria for the initial or continued inclusion of particular 
securities or suspend or terminate the inclusion of an otherwise 
qualified security if * * * Nasdaq deems it necessary to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, or to protect investors and the public 
interest.
    The returns on Future Priced Securities may become excessive 
compared with those of public investors in the issuer's common 
securities. In egregious situations, the use of a Future Priced 
Security may raise public interest concerns under Rules 4300 and 
4330(a). In addition to the demonstrable business purpose of the 
transaction, other factors tha Nasdaq staff will consider in 
determining whether a transaction raises public interest concerns 
include: (1) the amount raised in the transaction relative to the 
issuer's existing capital structure; (2) the dilutive effect of the 
transaction on the existing holders of common stock; (3) the risk 
undertaken by the Future Priced Security investor; (4) the relationship 
between the Future Priced Security investor and the issuer; (5) whether 
the transaction was preceded by other similar transactions; and (6) 
whether the transaction is consistent with the just and equitable 
principles of trade.
    Some Future Priced Securities may contain features that address the 
public interest concerns. These features tend to provide incentives to 
the investor to hold the security for a longer time period and limit 
the number of shares into which the Future Priced Security may be 
converted. Such features may limit the dilutive effect of the 
transaction and increase the risk undertaken by the Future Priced 
Security investor in relationship to the reward available.
* * * * *

Change of Control and Change in Financial Structure

    NASD Rule 4330(f) provides:
    Nasdaq shall require a Nasdaq SmallCap Market issuer to comply with 
all applicable requirements for initial inclusion under this Rule 4300 
Series and shall require a Nasdaq National Market issuer to comply with 
all applicable requirements for initial inclusion under the Rule 4300 
Series and Rule 4400 Series in the event that such issuer enters into a 
merger, consolidation, or other type of acquisition with a non-Nasdaq 
entity (including domestic and foreign corporations and limited 
partnerships), which results in a change of control and either a change 
in business or change in the financial structure of the Nasdaq SmallCap 
Market or Nasdaq National Market issuer.
    This provision, which applies regardless of whether the issuer 
obtains shareholder approval for the transaction, requires issuers to 
qualify under the initial inclusion standards following a merger or 
consolidation that results in a change of control if there is also a 
change in either the business or the financial structure of the 
issuer.\7\ It is important for issuers to realize that in certain 
instances, the conversion of a Future Priced Security may implicate 
this provision. For example, if there is no limit on the number of 
common shares issuable upon conversion, or if the limit is set high 
enough, the exercise of conversion rights under a Future Priced 
Security could result in a change of control in a deemed merger or 
consolidation with the holders of the Future Priced Securities. In 
addition, the issuance of the Future Priced Security and the large 
increase in the number of common shares outstanding after conversion of 
the Future Priced Security may be viewed as a change in financial 
structure. In such event, an issuer would be require to re-apply for 
initial inclusion and satisfy all initial inclusion requirements.
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    \7\ This provision is designed to address situations where a 
company attempts to obtain a ``backdoor listing'' on Nasdaq by 
merging with a Nasdaq issuer with minimal assets and/or operations.
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* * * * *

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 NASD 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 NASD has prepared summaries, set forth in Sections 
A, B, and C below, of the most significant aspects of such statements.

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

1. Purpose
    Nasdaq has seen an increase in the use of securities that convert 
into

[[Page 23892]]

common stock of the issuer based upon a below-market floating 
conversion rate (``Future Priced Securities''). In some cases, it 
appears that there may be a lack of understanding as to how these 
transactions may implicate Nasdaq rules. Accordingly, Nasdaq has 
prepared interpretive material that issuers can use when considering 
whether to issue these securities.
    Nasdaq has studied the use of Future Priced Securities by Nasdaq 
issuers. While Future Priced Securities can provide a legitimate 
mechanism for issuers to raise capital, each issuance may raise 
concerns under several Nasdaq Rules, including those rules relating to 
shareholder approval, voting rights, bid price, listing of additional 
shares, and changes in control. In addition, the use of Future Priced 
Securities may be inconsistent with the protection of investors and the 
public interest. The interpretive material is designed to alert issuers 
to the potential effect Future Priced Securities may have on the 
issuer's qualification for continued inclusion on Nasdaq.
2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act,\8\ which requires, 
among other things, that the Association's rules 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 interest. The interpretive material is designed to 
educate issuers as to how Nasdaq applies its various rules to Future 
Priced Securities in order 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 interest.
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    \8\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD 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.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The Association did not solicit or receive written comments on the 
proposed rule change.

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

    The proposed rule change will become effective upon filing pursuant 
to Section 19(b)(3)(A)(i) of the Act,\9\ and Rule 19b-4(f)(1) \10\ 
thereunder, in that it is designated by the Association as constituting 
a stated policy, practice, or interpretation with respect to the 
meaning, administration, or enforcement of an existing rule. At any 
time within 60 days of the filing of such rule change, the Commission 
may summarily abrogate such rule change if it appears to the Commission 
that such action is necessary or appropriate in the public interest, 
for the protection of investors, or otherwise in furtherance of the 
purposes of the Act.\11\
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    \9\ 15 U.S.C. 78s(b)(3)(A).
    \10\ 17 CFR 240.19b-4(f)(1).
    \11\ In reviewing this proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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-
0609. Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room in Washington, D.C. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to the File 
No. SR-NASD-99-14 and should be submitted by May 26, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-11146 Filed 5-3-99; 8:45 am]
BILLING CODE 8010-01-M