[Federal Register Volume 65, Number 124 (Tuesday, June 27, 2000)]
[Notices]
[Pages 39640-39642]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-16208]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42965; File No. SR-NASD-99-74]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change as Amended by the National Association of 
Securities Dealers, Inc. Relating To an Exemption From NASD Conduct 
Rule 2710 for Closed-End Management Companies That Make Periodic 
Repurchases of Their Securities Under Rule 23c-3(b) of the Investment 
Company Act of 1940

June 20, 2000.

I. Introduction

    On December 20, 1999, the National Association of Securities 
Dealers, Inc. (``NAD'' or ``Association''), through its wholly owned 
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), filed with the 
Securities and Exchange Commission (``Commission'' or ``SEC'') a 
proposed rule change regarding an exemption from NASD Conduct Rule 2710 
(``Corporate Financing Rule'') for closed-end management companies that 
make periodic repurchases of their securities under Rule 23c-3(b) \1\ 
of the Investment Company Act of 1940 (``1940 Act'') \2\ NASD 
Regulation filed an amendment to the proposed rule change on February 
29, 2000, which amendment entirely replaced and superseded the initial 
proposal. \3\ On March 20, 2000, NASD Regulation again amended the 
proposal.\4\ The Proposed rule change, as amended, was published for 
comment in the Federal Register on April 7, 2000.\5\ The Commission 
received one comment letter on the proposal.\6\ This order grants 
approval to the proposed rule change, as amended.
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    \1\ 17 CFR 270.23c-3(b).
    \2\ 15 U.S.C. 80a-1, et seq.
    \3\ See February 28, 2000 letter and attachments from Joan C. 
Conley, Secretary, NASD Regulation to Katherine A. England, 
Assistant Director, Division of Market Regulation (``Division''), 
SEC (``Amendment No. 1''). In Amendment No. 1, NASD Regulation made 
changes to the language of the proposed new rule. Exhibits 2 through 
4 that were attached to the original filing are incorporated by 
reference in Amendment No. 1.
    \4\ See March 17, 2000 letter from Suzanne E. Rothwell, Chief 
Counsel, Corporate Financing, NASD Regulation to Katherine A. 
England, Assistant Director, Division, SEC (``Amendment No. 2''). In 
Amendment No. 2, NASD Regulation made minor, technical changes to 
the proposed new rule.
    \5\ See Securities Exchange Act Release No. 42601 (March 30, 
2000), 65 FR 18405 (SR-NASD-99-74).
    \6\ See April 27, 2000 letter from Kathy D. Ireland, Associate 
Counsel, Investment Company Institute (``ICI''), to Jonathan G. 
Katz, Secretary, SEC (``ICI Letter'').
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II. Description of the Proposal

    NASD Regulation proposes to amend the Corporate Financing Rule and 
NASD Conduct Rule 2830 to exempt public offerings by closed-end 
investment management companies that make periodic tender offers for 
their securities in compliance with Rule 23c-3(b) \7\ of the 1940 Act 
\8\ from the filing requirements and limitations on underwriting 
compensation of the Corporate Financing Rule and, instead, subject such 
offerings to the sales charge limitations of NASD Conduct Rule 2830.
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    \7\ 17 CFR 270.23c-3(b).
    \8\ 15 U.S.C. 80a-1, et seq.
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    The Corporate Financing Rule regulates the underwriting terms and 
other arrangements of public offerings of securities. Subparagraph 
(b)(8)(C) of the Corporate Financing Rule provides that securities of 
investment companies registered under the 1940 Act \9\ are exempt from 
filing and compliance with the Corporate Financing Rule, unless the 
offerings is of securities of a management company defined as a 
``closed-end'' company in Section 5(a)(2) of the 1940 Act \10\ 
(``closed-end funds'').\11\ Thus, closed-end funds are subject to the 
filing requirements, filing fees, and regulations of the Corporate 
Financing Rule. Open-end investment companies (``open-end funds'') are 
exempt from filing with NASD Regulation under the Corporate Financing 
Rule. Instead, open-end funds' sales charges are regulated under NASD 
Conduct Rule 2830.
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    \9\ Id.
    \10\ 15 U.S.C. 80a-5(a)(2).
    \11\ Section 5(a)(1) of the 1940 Act defines ``open-end 
company'' as ``a management company which is offering for sale or 
has outstanding any redeemable security for which it is the 
issuer.'' Section 5(a)(2) of the 1940 Act defines ``closed-end 
company'' as ``any management company other than an open-end 
company.''15 U.S.C. 80a-5(a)(1) and (2).
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    Closed-end funds are subject to the core provisions of the 1940 Act 
\12\ that also apply to open-end funds, including prohibitions on 
affiliated transactions, obligations requiring shareholder approval of 
advisory contracts, anti-pyramiding restrictions, and board composition 
requirements. However, such funds are not subject to other 1940 Act 
\13\ restrictions applicable to open-end funds, including certain 
limitations on leverage and certain obligations pertaining to the 
liquidity of investments.
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    \12\ 15 U.S.C. 80a-1, et seq.
    \13\ Id.
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    The NASD has applied the Corporate Financing Rule and its 
predecessor rule to members' sales of the securities of closed-end 
funds on the basis that

[[Page 39641]]

closed-end fund offerings are structured and marketed in a manner that 
is more similar to and competitive with corporate securities offerings 
than to open-end funds. At the time the Corporate Financing Rule was 
adopted, closed-end funds conducted offerings of a fixed number of 
common shares at specified times; priced their shares periodically; 
limited sales compensation of broker/dealers to a discount from a fixed 
offering price; generally did not repurchase their securities directly 
from shareholders; and generally listed their securities on a 
securities market.
    Certain closed-end funds, commonly known as ``interval funds,'' 
however, engage in continuous offerings of their securities under Rule 
415(a)(1)(xi) \14\ under the Securities Act of 1933; \15\ price their 
shares daily; pay broker/dealers initial and continuing compensation 
that meets the sales charge limitations of NASD Conduct Rule 2830; do 
not list their securities on a securities market; and conduct periodic 
repurchases in compliance with Rule 23c-3(b) \16\ of the 1940 Act.\17\ 
Rule 23c-3(b)(2)(i) \18\ requires that the interval fund establish as a 
fundamental policy, changeable only by a majority vote of the 
outstanding voting securities of the company, that it will make 
periodic repurchase offers. Because the shares of interval funds are 
not redeemable on a daily basis, they are classified as ``closed-end'' 
under the 1940 Act.\19\
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    \14\ 17 CFR 230.415(a)(1)(xi).
    \15\ 15 U.S.C. 77a, et seq.
    \16\ 17 CFR 270.23c-3(b).
    \17\ 15 U.S.C. 80a-1, et seq.
    \18\ 17 CFR 270.23c-3(b)(2)(i).
    \19\ 15 U.S.C. 80a-1, et seq.
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    In Notice to Members 98-81 (October, 1998), NASD Regulation 
requested public comment on whether any of the NASD's rules are 
obsolete. One commenter, the ICI, proposed exempting interval funds 
from regulation by the Corporate Financing Rule. In addition, the 
Corporate Financing Department has received a rulemaking petition 
requesting an exemption from the Corporate Financing Rule for interval 
funds. NASD Regulation believes that the distribution of interval fund 
shares is conducted and financed in a manner more similar to that used 
by open-end funds than the method used by traditional closed-end funds. 
Therefore, the calculation of members' compensation for the 
distribution of interval fund shares is more properly regulated by 
provision (d) of NASD Conduct Rule 2830 (provision (d) hereinafter, the 
``Sales Charge Rule''), rather than by the limitations on underwriting 
compensation in the Corporate Financing Rule.
    Consequently, NASD Regulation proposes to amend the Corporate 
Financing Rule and NASD Conduct Rule 2830 to exempt interval funds from 
the filing requirements, filing fees, and regulations of the Corporate 
Financing Rule and, instead, to subject them to NASD Conduct Rule 2830, 
which regulates the distribution and sales charges of open-end 
funds.\20\ The proposed amendment to the Corporate Financing Rule would 
amend subparagraph (b)(8)(C) to provide that closed-end fund offerings 
are exempt if the fund makes periodic repurchase offers pursuant to 
Rule 23c-3(b) \21\ and it offers its shares on a continuous basis 
pursuant to Rule 415(a)(1)(xi) \22\ under the Securities Act of 1993. 
\23\ Closed-end funds that do not meet these requirements will continue 
to be subject to the Corporate Financing Rule. The proposed amendment 
to NASD Conduct Rule 2830 would amend paragraph (d) and (j) to provide 
that interval funds are subject to the provisions regulating sales 
charges and the repurchases of fund securities.\24\
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    \20\ Interval funds are distinguished from other hybrid closed-
end funds that make periodic self-tenders in compliance with Rule 
13e-4 and Schedule 13E-4 under the Securities Exchange Act of 1934 
(``tender offer funds'') (``Exchange Act''). See 17 CFR 240.13e-4 
and 17 CFR 240.13e-101, et seq., 15 U.S.C. 78a, et seq. Such tender 
offer funds are not required to establish as a fundamental policy 
that they will make periodic repurchases, as required by Rule 23c-
3(b)(2)(i) under the 1940 Act. 17 CFR 270.23c-3(b)(2)(i), 15 U.S.C. 
80a-1, et seq. The rule change proposed herein would not exempt 
tender offer funds from the Corporate Financing Rule. However, NASD 
Regulation will consider individual requests for exemption under the 
NASD Rule 9600 series from the requirements of the Corporate 
Financing Rule for such tender offer funds. See Exemption granted 
October 29, 1999 under ``Corporate Financing Rule--Rule 2710'' at 
www.nasd.com.
    \21\ 17 CFR 270.23c-3(b).
    \22\ 17 CFR 270.415(a)(1)(xi).
    \23\ 15 U.S.C. 77a, et seq.
    \24\ An interval fund that has received a ``no objections'' 
opinion from the Corporate Financing Department based upon 
representations that underwriting compensation will not exceed a 
certain amount will become subject to the Sales Charge Rule upon 
effectiveness of the proposed amendments, provided that the 
compensation limit has not already been met or exceeded. Any 
interval fund that has reached the applicable compensation limit 
under the Corporate Financing Rule shall remain subject to the 
requirements of the Rule until the fund files a post-effective 
amendment with the Commission registering additional securities.
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III. Summary of Comments

    The Commission received one comment letter on the proposal from the 
ICI.\25\ While the ICI is generally supportive of the proposal, the ICI 
believes that the proposal does not go far enough in two respects. 
First, the ICI recommends that the exemption from Corporate Financing 
Rule be expanded to include funds that make periodic self-tenders in 
compliance with Rule 13e-4 \26\ and Schedule 13E-4 \27\ under the 
Exchange Act.\28\ The ICI believes that tender offer funds are 
substantially similar to the interval funds that fall within the scope 
of the proposal, in that funds making repurchases of shares outside of 
Rule 23c-3 \29\ also need to replenish their assets through sales of 
additional shares to offset the effects of repurchases, and therefore 
may wish to compensate broker-dealers in the same manner as interval 
funds relying on Rule 23c-3.\30\ The ICI believes, therefore, it is 
irrelevant whether funds are required to have a fundamental policy to 
conduct self-tender offers, and that the proposal should be expanded to 
include tender offer funds.\31\
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    \25\ See footnote, 4, supra.
    \26\ 17 CFR 240.13e-4.
    \27\ 17 CFR 240.13e-101. Although the ICI refers to Schedule 
13E-4 in its comment letter, the Commission notes that Schedule 13E-
4 was removed and reserved, effective January 24, 2000. See 
Securities Act Release No. 7760 (October 22, 1999), 64 FR 61408 
(November 10, 1999). The information is now contained in new 
Schedule TO, 17 CFR 240.14d-100.
    \28\ 15 U.S.C. 78a, et seq.
    \29\ 17 CFR 270.23c-3
    \30\ Id.
    \31\ See ICI Letter at page 2.
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    Second, the ICI notes that the proposal, as written, applies only 
to interval funds that offer their shares on a continuous basis 
pursuant to SEC Rule 415(a)(1)(xi).\32\ The ICI states, however, that 
SEC Rule 415(a)(1)(xi) \33\ permits interval funds to offer shares 
under the ``shelf registration'' provisions of the Act on either a 
continuous or delayed basis. To ensure consistency with SEC Rule 
415(a)(1)(xi),\34\ the ICI believes the proposal should be modified to 
include interval funds that offer their shares on a delayed basis. The 
ICI maintains that interval funds that make offerings on a delayed 
basis are also more similar to open-end funds than closed-end funds, 
and therefore should be treated as open-end funds.\35\
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    \32\ 17 CFR 230.415(a)(1)(xi).
    \33\ Id.
    \34\ Id.
    \35\ See ICI Letter on page 2.
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    In responding to the ICI's comments, NASD Regulation stated that 
its proposed requirement that the exemption be made available only for 
those closed-end funds that issue securities on a continuous basis 
specifically excluding those interval funds that offer their shares on 
a delayed or periodic basis, was intended to ensure that the fund's 
manner of financing the distribution of shares

[[Page 39642]]

would be more similar to the manner of financing the distribution of 
shares of mutual funds that offer shares on a continuous basis.\36\ 
Additionally, NASD Regulation noted that closed-end funds that offer 
their shares on a periodic basis may decide to finance the distribution 
in a manner more similar to corporate offerings than the broker/dealer 
compensation methods used by mutual funds.\37\ For these reasons, NASD 
Regulation does not believe that the ICI's suggested expansion of the 
scope of the proposal is warranted.
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    \36\ See May 15, 2000 letter from Suzanne E. Rothwell, Chief 
Counsel, Corporate Financing, NASD Regulation to Katherine A. 
England, Assistant Director, Division, SEC (``NASD Regulation 
Letter'').
    \37\ Id.
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    Additionally, NASD Regulation noted that, although some tender 
offer funds offer their shares continuously and periodically self-
tender, these funds do not, as a matter of fundamental policy, 
establish that they will make periodic repurchases.\38\ NASD Regulation 
explained that the discretion whether to make periodic repurchases 
allows a tender offer fund the flexibility to determine if it needs to 
continuously offer shares to replenish fund assets. Were a tender offer 
fund to decide to offer shares periodically, however, NASD Regulation 
notes that such a fund could compensate broker/dealers in the same 
manner as corporate issuers.\39\ For these reasons, NASD Regulation doe 
not propose to amend the proposal to extend the exemption to tender 
offer funds.
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    \38\ Id.
    \39\ Id.
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IV. Discussion

    The Commission has reviewed carefully the NASD's proposed rule 
change and finds, for the reasons set forth below, the proposal is 
consistent with the requirements of the Exchange Act and the rules and 
regulations thereunder applicable to a registered securities 
association, and in particular, with the requirements of Section 
15A(b)(6) of the Exchange Act.\40\
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    \40\ 15 U.S.C. 78o-3(b)(6).
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    Section 15A(b)(6) of the Exchange Act \41\ requires that rules of a 
registered securities association be designed to prevent fraudulent and 
manipulative acts and practices, promote just and equitable principles 
of trade, and, in general, protect investors and the public interest. 
The proposal would require that certain closed-end funds known as 
``interval funds'' be regulated by NASD Conduct Rule 2830(d), rather 
than by the limitations on underwriting compensation in the Corporate 
Financing Rule. The Commission agrees that interval funds, because 
their manner of financing the distribution of shares are more similar 
to that of open-end funds, are more properly regulated by NASD Conduct 
Rule 2830, which regulates the distribution and sales charges of open-
end funds. The proposal is narrowly construed, in that the amendment to 
subparagraph (b)(8)(C) of the Corporate Financing Rule would restricted 
to closed-end funds that make periodic repurchase offers pursuant to 
Rule 23c-3(b) \42\ and offer shares on a continuous basis pursuant to 
Rule 415(a)(1)(xi) \43\ under the Securities Act of 1933.\44\ Closed-
end funds that do not meet these requirements will continue to be 
subject to the Corporate Financing Rule. The Commission finds that 
allowing the requested exemption for funds that meet these limited 
criteria is consistent with the public interest and beneficial to 
investors because the distribution of interval fund shares is conducted 
and financed in a manner more similar to that used by open-end 
management investment companies, which are regulated by NASD Conduct 
Rule 2830(d).
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    \41\ Id.
    \42\ 17 CFR 270.23c-3(b).
    \43\ 17 CFR 230.415(a)(1)(xi).
    \44\ 15 U.S.C. 77a et seq.
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    The Commission has considered carefully the comments raised by the 
ICI, and is not persuaded that the scope of the proposal should be 
expanded to include interval funds that offer their shares on a 
periodic basis, nor that the proposed exemption should be made 
available to closed-end funds that operate as tender offer funds. The 
Commission finds that the proposal is reasonably designed to ensure 
that the exemption applies only to funds whose manner of financing the 
distribution of shares is more similar to that of mutual funds that 
offer shares on a continuous basis. The Commission is concerned that 
tender offer funds and interval funds that offer their shares 
periodically are marketed, and their distribution financed, in a manner 
more akin to corporate issuers that are subject to the Corporate 
Financing Rule. The Commission therefore believes that the exemption 
should not be expanded at this time to exempt these funds from the 
requirements of this rule. The Commission notes, however, that NASD 
Regulation stated that it prefers to gain experience regarding the 
financing structures of tender offer funds through the exemptive 
process under the Rule 9600 series, and therefore it will consider 
individual requests for exemption from the requirements of the 
Corporate Financing Rule for these types of funds.\45\
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    \45\ See NASD Regulation Letter at page 2.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\46\ that the proposed rule change (SR-NASD-99-74), as amended, is 
hereby approved.
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    \46\ 15 U.S.C. 78s(b)(2).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\47\
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    \47\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-16208 Filed 6-26-00; 8:45 am]
BILLING CODE 8010-01-M