[Federal Register Volume 68, Number 250 (Wednesday, December 31, 2003)]
[Notices]
[Pages 75684-75701]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-32183]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48989; File No. SR-NASD-00-04]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendments Nos. 6, 7, 8, 9, and 10 by the National Association of 
Securities Dealers, Inc. Relating to Its Corporate Financing Rule

December 23, 2003.

I. Introduction

    On January 21, 2000, the National Association of Securities 
Dealers, Inc. (``NASD'') filed with the Securities and Exchange 
Commission (``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change amending NASD Conduct Rule 2710. 
NASD filed Amendments Nos. 1,\3\ 2,\4\ and 3 \5\ to the proposed rule 
change on March 6, 2000, March 21, 2000, and March 30, 2000, 
respectively. The proposed rule change was published for comment in the 
Federal Register on April 11, 2000.\6\ The Commission received 14 
comments.\7\ NASD filed Amendment No. 4 on December 11, 2000.\8\ NASD 
filed Amendment No. 5 on February 4, 2001,\9\ which was published for 
comment in the Federal Register on March 14, 2001.\10\ The Commission 
received eight comments.\11\ NASD filed Amendment Nos. 6,\12\ 7,\13\ 
8,\14\ 9,\15\ and 10 \16\ on November 19, 2001, and April

[[Page 75685]]

3, 2002, April 14, 2003, April 29, 2003, and June 2, 2003, 
respectively. This order issues notice of, and grants accelerated 
approval to, the filing as modified by Amendment Nos. 6, 7, 8, 9, and 
10.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter from Suzanne E. Rothwell, Chief Counsel, Corporate 
Financing, NASD Regulation, Inc. (``NASD Regulation''), to Katherine 
A. England, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated March 3, 2000 (``Amendment No. 
1'').
    \4\ Letter from Suzanne E. Rothwell, Chief Counsel, Corporate 
Financing, NASD Regulation, to Katherine A. England, Assistant 
Director, Division, Commission, dated March 20, 2000 (``Amendment 
No. 2'').
    \5\ Letter from Suzanne E. Rothwell, Chief Counsel, Corporate 
Financing, NASD Regulation, to Katherine A. England, Assistant 
Director, Division, Commission, dated March 29, 2000 (``Amendment 
No. 3'').
    \6\ See Securities Exchange Act Release No. 42619 (April 4, 
2000), 65 FR 19409 (``initial notice'').
    \7\ These comments, and NASD Regulation's response, are 
discussed in the release cited in footnote 9.
    \8\ Amendment No. 4, filed December 11, 2000, amends the 
original filing as modified by Amendment Nos. 1, 2, and 3 in 
response to comments.
    \9\ NASD submitted a new Form 19b-4, which replaced and 
superseded all previous versions of the proposed rule change in 
their entirety.
    \10\ See Securities Exchange Act Release No. 44044 (March 6, 
2001), 66 FR 14949.
    \11\ These comments, and the amendments proposed by NASD 
Regulation in response, are summarized in Section III. of this 
order.
    \12\ NASD submitted a new Form 19b-4, which replaced and 
superseded all previous versions of the proposed rule change in 
their entirety.
    \13\ Letter from Gary L. Goldsholle, Associate General Counsel, 
NASD Regulation, to Katherine A. England, Assistant Director, 
Division, Commission, dated April 3, 2002 (``Amendment No. 7''). 
Amendment No. 7 makes certain technical corrections to the rule text 
as it appears in Amendment No. 6, such as correcting the numbering 
of certain paragraphs in the rule text. As such, it is not subject 
to notice and comment.
    \14\ Letter from Gary L. Goldsholle, Associate General Counsel, 
NASD, to Katherine A. England, Assistant Director, Division, 
Commission, dated April 11, 2003 (``Amendment No. 8''). Among other 
things, Amendment No. 8: (i) Amends the definition of ``item of 
value'' in proposed Rule 2710(c)(3)(B) to exclude derivative 
instruments and certain other transactions; (ii) amends proposed 
NASD Rule 2710(a) to define ``fair price;'' (iii) modifies the 
requirement in proposed NASD Rule 2710(b)(6)(A)(iv) such that 
information initially filed in connection with debt securities and 
derivative instruments acquired or entered into for a ``fair price'' 
may be limited to a brief description of the transaction and a 
representation that the transaction was, or, if the pricing terms 
have not been set will, be entered into for a ``fair price;'' (iv) 
amends the lock-up requirements in proposed Rule 2710(g)(2) to 
exempt certain debt securities and derivative instruments; and (v) 
changes references in the rules from ``the Association'' to 
``NASD.''
    \15\ Letter from Therese Woods, Deputy Director, Corporate 
Financing, NASD, to Katherine A. England, Assistant Director, 
Division, Commission, dated April 25, 2003 (``Amendment No. 9''). 
Amendment No. 9 makes technical corrections to the proposed rule 
text and amends proposed Rule 2710(b)(6)(A)(iv)(b) to state: 
``information initially filed in connection with debt securities and 
derivative instruments acquired or entered into for ``fair price'' 
as defined in subsection (a)(9), but not excluded from items of 
value under subsection (c)(3)(B)(vi) or (vii), may be limited to a 
brief description of the transaction (additional information may be 
required in the review process) and a representation by the member 
that a registered principal or senior manager on behalf of the 
member has determined that the transaction was (or if the pricing 
terms have not been set) will be entered into at a fair price as 
defined in subsection (a)(9);''.
    \16\ Letter from Therese Woods, Deputy Director, Corporate 
Financing, NASD, to Katherine A. England, Assistant Director, 
Division, Commission, dated May 28, 2003 (``Amendment No. 10''). 
First, Amendment No. 10 makes technical corrections to the proposed 
rule text and revises the definition of ``fair price'' in proposed 
Rule 2710(a)(9) to include a cross reference to subsection (e)(5) 
and to clarify that a derivative instrument or other security 
received for acting as a private placement agent for the issuer for 
providing or arranging a loan, credit facility, merger, acquisition, 
or any other service, is not included within the definition of 
``fair price.'' Second, Amendment No. 10 adds subsection (a)(10) to 
Rule 2710, regarding required filing dates. Third, Amendment No. 10 
adds the following language to proposed Rule 2710(b)(6)(A)(iv)(b): 
``provided, however, that information filed in connection with debt 
securities and derivative instruments acquired or entered into for a 
``fair price'' as defined in subsection (a)(9) may be limited as 
described in subsection (b)(6)(A)(iv)b.'' Fourth, Amendment No. 10 
adds the following language to the beginning of the first sentence 
of proposed Rule 2710(g): ``In any public equity offering, other 
than a public equity offering by an issuer that can meet the 
requirements in subparagraphs (b)(7)(C)(i) or (ii), any * * *.'' 
Fifth, Amendment No. 10 adds new subparagraph (e)(5) to Rule 2710, 
regarding valuation of items of value acquired in connection with a 
fair price derivative or debt transaction.
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II. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    In response to comments to Amendment No. 5, NASD is proposing 
additional amendments to Rules 2710 and 2720 of the NASD's Conduct 
Rules. Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets. The text of 
the proposed rule change is marked to show additions and deletions from 
the NASD Corporate Financing Rule as it currently exists. The 
discussion section of this notice, however, focuses on the changes made 
in Amendment Nos. 6 through 10. For an explanation of the original 
filing, see the initial notice cited in footnote 6.
* * * * *

2710. Corporate Financing Rule--Underwriting Terms and Arrangements

(a) Definitions
    For purposes of this Rule, the following terms shall have the 
meanings stated below. The definitions in Rule 2720 are incorporated 
herein by reference.
(1) Issuer
    The issuer of the securities offered to the public, any selling 
security holders offering securities to the public, any affiliate of 
the issuer or selling security holder, and the officers or general 
partners, directors, employees and security holders thereof[;].
(2) Net Offering Proceeds
    Offering proceeds less all expenses of issuance and 
distribution[;].
(3) Offering Proceeds
    Public offering price of all securities offered to the public, not 
including securities subject to any overallotment option, securities to 
be received by the underwriter and related persons, or securities 
underlying other securities[;].
(4) Participating Member(s)
    Any NASD member that is participating in a public offering, any 
associated person of the member, any members of their immediate family, 
and any affiliate of the member.
[(4)](5) Participation or Participating in a Public Offering
    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[; and].
[(5)](6) Underwriter and Related Persons
    [Includes underwriters,] Consists of underwriter's counsel, 
financial consultants and advisors, finders, [members of the selling or 
distribution group,] any participating member [participating in the 
public offering], and any [and all] other persons [associated with or] 
related to any participating member [and members of the immediate 
family of any of the aforementioned persons].

(7) Listed Securities

    Securities meeting the listing standards to trade on the national 
securities exchanges identified in SEC Rule 146, markets registered 
with the SEC under Section 6 of the Exchange Act, and any offshore 
market that is a ``designated offshore securities market'' under Rule 
902(b) of SEC Regulation S.

(8) Derivative Instruments

    A derivative instrument is any ``eligible OTC derivative 
instrument'' as defined in SEC Rule 3b-13(a)(1), (2) and (3).

(9) Fair Price

    A derivative instrument or non-convertible or non-exchangeable debt 
security has been acquired or entered into at a fair price for purposes 
of subparagraphs (b)(6)(A)(iv), (c)(3)(B)(vi) and (vii), and (e)(5) if 
the underwriters and related persons have priced the debt security or 
derivative instrument in good faith; on an arm's length, commercially 
reasonable basis; and in accordance with pricing methods and models and 
procedures used in the ordinary course of their business for pricing 
similar transactions. A derivative instrument or other security 
received for acting as a private placement agent for the issuer, for 
providing or arranging a loan, credit facility, merger, acquisition or 
any other service, including underwriting services, is not included 
within this ``fair price'' definition.

(10) Required Filing Date

    The required filing date shall be the dates provided in 
subparagraph (b)(4), and for a public offering exempt from filing under 
subparagraph (b)(7), the required filing date for purposes of 
subparagraph (d) and (g) shall be the date the public offering would 
have been required to be filed with the NASD but for the exemption.
(b) Filing Requirements
    (1)-(3) No change.
(4) Requirement for Filing
    (A) Unless filed by the issuer, the managing underwriter, or 
another member, a member that anticipates participating in a public 
offering of securities subject to this Rule shall file with [the 
Association] NASD the documents and information with respect to the 
offering specified in subparagraphs (5) and (6) below:
    (i) no later than one business day after [the filing of] any such 
documents are filed with or submitted to:
    [(i)]a. [with] the Commission; or
    [(ii)]b. [with the] any state securities commission or other 
regulatory authority; or
    [(iii) with any other regulatory authority; or]
    [(iv)](ii) if not filed with or submitted to any regulatory 
authority, at least fifteen [(15)] business days prior to the 
anticipated [offering] date on which offers will commence.
    (B) No [offering] sales of securities subject to this Rule shall 
commence unless:
    (i) the documents and information specified in subparagraphs (5) 
and (6) below have been filed with and reviewed by [the Association] 
NASD; and
    (ii) No change.
    (C) No change.
    (5) No change.
(6) Information Required To Be Filed
    (A) Any person filing documents with the NASD that are required to 
be filed

[[Page 75686]]

under paragraph (b)(4) above shall provide the following information 
with respect to the offering through [the Association's] NASD's 
electronic filing system:
    (i)-(ii) No change.
    (iii) a statement of the association or affiliation with any member 
of any officer[,] or director of the issuer, of any [or security 
holder] beneficial owner of [the issuer in an initial public offering 
of equity securities, and with respect to any other offering provide 
such information with respect to any officer, director or security 
holder of five percent] 5% or more of any class of the issuer's 
securities, and of any beneficial owner of the issuer's unregistered 
equity securities that were acquired during the 180-day period 
immediately preceding the required filing date of the public offering, 
except for purchases described in subparagraph (c)(3)(B)(iv) below. 
This statement must identify [to include]:
    a. [the identity of] the person;
    b. [the identity of] the member and whether such member is 
participating in any capacity in the public offering; and
    c. the number of equity securities or the face value of debt 
securities owned by such person, the date such securities were 
acquired, and the price paid for such securities.
    (iv) [a statement addressing the factors in subparagraphs (c)(4)(C) 
and (D), where applicable;]
    [(v)] a detailed explanation of any other arrangement entered into 
during the [12-month] 180-day period immediately preceding the required 
filing date of the public offering, which arrangement provides for the 
receipt of any item of value [and/]or the transfer of any warrants, 
options, or other securities from the issuer to the underwriter and 
related persons, provided however: [; and]
    a. information regarding debt securities and derivative instruments 
not considered an item of value under subsection (c)(3)(B)(vi) and 
(vii) is not required to be filed; and
    b. information initially filed in connection with debt securities 
and derivative instruments acquired or entered into for a ``fair 
price'' as defined in subsection (a)(9), but not excluded from items of 
value under subsection (c)(3)(B)(vi) or (vii), may be limited to a 
brief description of the transaction (additional information may be 
required in the review process) and a representation by the member that 
a registered principal or senior manager on behalf of the member has 
determined that the transaction was or (if the pricing terms have not 
been set) will be entered into at a fair price as defined in subsection 
(a)(9).
    (v) a statement demonstrating compliance with all of the criteria 
of an exception from underwriting compensation in subparagraph (d)(5) 
below, when applicable; and
    (vi) a detailed explanation and any documents related to:
    a. the modification of any information or representation previously 
provided to the NASD or of any item of underwriting compensation, 
including the information required in subparagraph (b)(6)(A)(iii) above 
with respect to any securities of the issuer acquired subsequent to the 
required filing date and prior to the effectiveness or commencement of 
the offering[,] ; or
    b. any new arrangement that provides for the receipt of any 
additional item of value by any participating member subsequent to the 
[review and approval of such compensation] issuance of an opinion of no 
objections to the underwriting terms and arrangements by [the 
Association] NASD and within 90 days immediately following the date of 
effectiveness or commencement of sales of the public offering, 
provided, however, that information filed in connection with debt 
securities and derivative instruments acquired or entered into for a 
``fair price'' as defined in subsection (a)(9) may be limited as 
described in subsection (b)(6)(A)(iv)b.
    (vii) any other information required to be filed under this Rule.
    (B) No change.
    (7)-(11) No change.
(c) Underwriting Compensation and Arrangements
(1) General
    No member or person associated with a member shall participate in 
any manner in any public offering of securities in which the 
underwriting or other terms or arrangements in connection with or 
relating to the distribution of the securities, or the terms and 
conditions related thereto, are unfair or unreasonable.
(2) Amount of Underwriting Compensation
    (A) No member or person associated with a member shall receive an 
amount of underwriting compensation in connection with a public 
offering [which] that is unfair or unreasonable and no member or person 
associated with a member shall underwrite or participate in a public 
offering of securities if the underwriting compensation in connection 
with the public offering is unfair or unreasonable.
    (B)-(D) No change.
    (E) The maximum amount of compensation (stated as a percentage of 
the dollar amount of the offering proceeds) [which] that is considered 
fair and reasonable generally will vary directly with the amount of 
risk to be assumed by [the underwriter and related persons] 
participating members and inversely with the dollar amount of the 
offering proceeds.
(3) Items of [Compensation] Value
    (A) For purposes of determining the amount of underwriting 
compensation received or to be received by the underwriter and related 
persons pursuant to subparagraph (c)(2) above, the following items and 
all other items of value received or to be received by the underwriter 
and related persons in connection with or related to the distribution 
of the public offering, as determined pursuant to [sub]paragraph [(4)] 
(d) below shall be included:
    (i)-(iii) No change.
    (iv) finder's fees, whether in the form of cash, securities or any 
other item of value;
    (v) wholesaler's fees;
    (vi) financial consulting and advisory fees, whether in the form of 
cash, securities, or any other item of value;
    (vii) common or preferred stock, options, warrants, and other 
equity securities, including debt securities convertible to or 
exchangeable for equity securities, [including securities] received [as 
underwriting compensation, for example]:
    a. [in connection with a] for acting as private placement agent [of 
securities] for the issuer;
    b. for providing or arranging a loan, credit facility, [bridge 
financing] merger or acquisition services, or any other service for the 
issuer;
    [c. as a finder's fee;]
    [d. for consulting services to the issuer; and]
    [e.]c. [securities purchased] as an investment in a private 
placement made by the issuer; or
    d. at the time of the public offering.
    (viii) special sales incentive items [in compliance with 
subparagraph (6)(B)(xi)];
    (ix) any right of first refusal provided to [the underwriter and 
related persons] any participating member to underwrite or participate 
in future public offerings, private placements or other financings, 
which will have a compensation value of 1% of the offering proceeds or 
that dollar amount contractually agreed to by the issuer and 
underwriter to waive or terminate the right of first refusal;
    (x) No change.
    (xi) commissions, expense reimbursements, or other compensation to 
be received by the underwriter and related persons as a result of the

[[Page 75687]]

exercise or conversion, within twelve [(12)] months following the 
effective date of the offering, of warrants, options, convertible 
securities, or similar securities distributed as part of the public 
offering;
    (xii) fees of a qualified independent underwriter; and
    (xiii) compensation, including expense reimbursements, previously 
paid [in the six (6) months prior to the initial or amended filing of 
the prospectus or similar documents] to any member in connection with a 
[or person associated with a member for a] proposed public offering 
that was not completed[.], unless the member does not participate in 
the revised public offering.
    (B) Notwithstanding subparagraph (c)(3)(A) above, the following 
shall not be considered an item of value:
    (i) [E] expenses customarily borne by an issuer, such as printing 
costs; SEC, ``blue sky'' and other registration fees; [the Association] 
NASD filing fees; and accountant's fees, [shall be excluded from 
underwriter's compensation] whether or not paid through [an 
underwriter] a participating member;
    (ii) cash compensation for acting as placement agent for a private 
placement or for providing a loan, credit facility, or for services in 
connection with a merger/acquisition;
    (iii) listed securities purchased in public market transactions;
    (iv) securities acquired through any stock bonus, pension, or 
profit-sharing plan that qualifies under Section 401 of the Internal 
Revenue Code;
    (v) securities acquired by an investment company registered under 
the Investment Company Act of 1940;
    (vi) non-convertible or non-exchangeable debt securities acquired 
for a fair price in the ordinary course of business in transactions 
unrelated to the public offering; and
    (vii) derivative instruments entered into for a fair price in the 
ordinary course of business in a transaction unrelated to the public 
offering.
[(4)](d) Determination of Whether [Compensation Is Received in 
Connection with the Offering] Items of Value Are Included in 
Underwriting Compensation
[(A)](1) Pre-Offering Compensation
    All items of value received [or to be received] and all 
arrangements entered into for the future receipt of an item of value by 
the underwriter and related persons during the [twelve (12) month] 
period commencing 180 days immediately preceding the required filing 
date of the registration statement or similar document pursuant to 
subparagraph (b)(4) above[, and at the time of and subsequent to] until 
the date of effectiveness or commencement of sales of the public 
offering[,] will be [examined to determine whether such items of value 
are] considered to be underwriting compensation in connection with the 
public offering [and, if received during the six (6) month period 
immediately preceding the filing of the registration statement or 
similar document, will be presumed to be underwriting compensation 
received in connection with the offering, provided, however, that such 
presumption may be rebutted on the basis of information satisfactory to 
the Association to support a finding that the receipt of an item is not 
in connection with the offering and shall not include cash discounts or 
commissions received in connection with a prior distribution of the 
issuer's securities].

(2) Undisclosed and Post-Offering Compensation

    All items of value received and all arrangements entered into for 
the future receipt of an item of value by any participating member that 
are not disclosed to the NASD prior to the date of effectiveness or 
commencement of sales of a public offering, including items of value 
received subsequent to the public offering, are subject to post-
offering review to determine whether such items of value are, in fact, 
underwriting compensation for the public offering.
    [(B) Items of value received by an underwriter and related person 
more than twelve (12) months immediately preceding the date of filing 
of the registration statement or similar document will be presumed not 
to be underwriting compensation. However, items received prior to such 
twelve (12) month period may be included as underwriting compensation 
on the basis of information to support a finding that receipt of the 
item is in connection with the offering.]
    [(C) For purposes of determining whether any item of value received 
or to be received by the underwriter and related persons is in 
connection with or related to the distribution of the public offering, 
the following factors, as well as any other relevant factors and 
circumstances, shall be considered:]
    [(i) the length of time between the date of filing of the 
registration statement or similar document and:]
    [a. the date of the receipt of the item of value;]
    [b. the date of any contractual agreement for services for which 
the item of value was or is to be received; and]
    [c. the date the performance of the service commenced, with a 
shorter period of time tending to indicate that the item is received in 
connection with the offering;]
    [(ii) the details of the services provided or to be provided for 
which the item of value was or is to be received;]
    [(iii) the relationship between the services provided or to be 
provided for which the item of value was or is to be received and:]
    [a. the nature of the item of value;]
    [b. the compensation value of the item; and]
    [c. the proposed public offering;]
    [(iv) the presence or absence of arm's length bargaining or the 
existence of any affiliate relationship between the issuer and the 
recipient of the item of value, with the absence of arm's length 
bargaining or the presence of any affiliation tending to indicate that 
the item of value is received in connection with the offering.]
    [(D) For purposes of determining whether securities received or to 
be received by the underwriter and related persons are in connection 
with or related to the distribution of the public offering, the factors 
in subparagraph (C) above and the following factors shall be 
considered:]
    [(i) any disparity between the price paid and the offering price or 
the market price, if a bona fide independent market exists at the time 
of acquisition, with a greater disparity tending to indicate that the 
securities constitute compensation;]
    [(ii) the amount of risk assumed by the recipient of the 
securities, as determined by:]
    [a. the restrictions on exercise and resale;]
    [b. the nature of the securities (e.g., warrant, stock, or debt); 
and]
    [c. the amount of securities, with a larger amount of readily 
marketable securities without restrictions on resale or a warrant for 
securities tending to indicate that the securities constitute 
compensation; and]
    [(iii) the relationship of the receipt of the securities to 
purchases by unrelated purchasers on similar terms at approximately the 
same time, with an absence of similar purchases tending to indicate 
that the securities constitute compensation.]
    [(E) Notwithstanding the provisions of subparagraph (3)(A)(vi) 
above, financial consulting and advisory fees may be excluded from 
underwriting compensation upon a finding by the Association, on the 
basis of information satisfactory to it, that an ongoing

[[Page 75688]]

relationship between the issuer and the underwriter and related person 
has been established at least twelve (12) months prior to the filing of 
the registration statement or similar document or that the 
relationship, if established subsequent to that time, was not entered 
into in connection with the offering, and that actual services have 
been or will be rendered which were not or will not be in connection 
with or related to the offering.]

(3) Date of Receipt of Securities

    Securities of the issuer acquired by the underwriter and related 
persons will be considered to be received for purposes of subparagraphs 
(d)(1) and (d)(5) as of the date of the:
    (A) closing of a private placement, if the securities were 
purchased in or received for arranging a private placement; or
    (B) execution of a written contract with detailed provisions for 
the receipt of securities as compensation for a loan, credit facility, 
or put option; or
    (C) transfer of beneficial ownership of the securities, if the 
securities were received as compensation for consulting or advisory 
services, merger or acquisition services, acting as a finder, or for 
any other service.

(4) Definitions

    For purposes of subparagraph (d)(5) below, the following terms will 
have the meanings stated below.
    (A) An entity:
    (i) includes a group of legal persons that either:
    a. are contractually obligated to make co-investments and have 
previously made at least one such investment; or
    b. have filed a Schedule 13D or 13G with the SEC that identifies 
the legal persons as members of a group that have agreed to act 
together for the purpose of acquiring, holding, voting or disposing of 
equity securities of an issuer in connection with a previous 
investment; and
    (ii) may make its investment or loan through a wholly owned 
subsidiary (except when the entity is a group of legal persons).
    (B) An institutional investor is any individual or legal person 
that has at least $50 million invested in securities in the aggregate 
in its portfolio or under management, including investments held by its 
wholly owned subsidiaries; provided that no participating members 
direct or otherwise manage the institutional investor's investments or 
have an equity interest in the institutional investor, either 
individually or in the aggregate, that exceeds 5% for a publicly owned 
entity or 1% for a nonpublic entity.
    (C) A bank or insurance company is only the regulated entity, not 
its subsidiaries or other affiliates.
    (D) A right of preemption means the right of a shareholder to 
acquire additional securities in the same company in order to avoid 
dilution when additional securities are issued, pursuant to:
    (i) any option, shareholder agreement, or other contractual right 
entered into at the time of a purchase of securities;
    (ii) the terms of the security purchased;
    (iii) the issuer's charter or by-laws; or
    (iv) the domestic law of a foreign jurisdiction that regulates the 
issuance of the securities.
    (E) ``Total equity securities'' means the aggregate of the total 
shares of:
    (i) common stock outstanding of the issuer; and
    (ii) common stock of the issuer underlying all convertible 
securities outstanding that convert without the payment of any 
additional consideration.

(5) Exceptions From Underwriting Compensation

    Notwithstanding subparagraph (d)(1) above, the following items of 
value are excluded from underwriting compensation (but are subject to 
the lock-up restriction in subparagraph (g)(1) below), provided that 
the member does not condition its participation in the public offering 
on an acquisition of securities under an exception and any securities 
purchased are purchased at the same price and with the same terms as 
the securities purchased by all other investors.
    (A) Purchases and Loans by Certain Entities--Securities of the 
issuer purchased in a private placement or received as compensation for 
a loan or credit facility before the required filing date of the public 
offering pursuant to subparagraph (b)(4) above by certain entities if:
    (i) each entity:
    a. either:
    1. manages capital contributions or commitments of $100 million or 
more, at least $75 million of which has been contributed or committed 
by persons that are not participating members;
    2. manages capital contributions or commitments of $25 million or 
more, at least 75% of which has been contributed or committed by 
persons that are not participating members;
    3. is an insurance company as defined in Section 2(a)(13) of the 
Securities Act or is a foreign insurance company that has been granted 
an exemption under this Rule; or
    4. is a bank as defined in Section 3(a)(6) of the Act or is a 
foreign bank that has been granted an exemption under this Rule; and
    b. is a separate and distinct legal person from any member and is 
not registered as a broker/dealer;
    c. makes investments or loans subject to the evaluation of 
individuals who have a contractual or fiduciary duty to select 
investments and loans based on the risks and rewards to the entity and 
not based on opportunities for the member to earn investment banking 
revenues;
    d. does not participate directly in investment banking fees 
received by any participating member for underwriting public offerings; 
and
    e. has been primarily engaged in the business of making investments 
in or loans to other companies; and
    (ii) all entities related to each member in acquisitions that 
qualify for this exception do not acquire more than 25% of the issuer's 
total equity securities during the review period in subparagraph 
(d)(1), calculated immediately following the transaction.
    (B) Investments In and Loans to Certain Issuers--Securities of the 
issuer purchased in a private placement or received as compensation for 
a loan or credit facility before the required filing date of the public 
offering pursuant to subparagraph (b)(4) above by certain entities if:
    (i) each entity:
    a. manages capital contributions or commitments of at least $50 
million;
    b. is a separate and distinct legal person from any member and is 
not registered as a broker/dealer;
    c. does not participate directly in investment banking fees 
received by the member for underwriting public offerings; and
    d. has been primarily engaged in the business of making investments 
in or loans to other companies; and
    (ii) institutional investors beneficially own at least 33% of the 
issuer's total equity securities, calculated immediately prior to the 
transaction;
    (iii) the transaction was approved by a majority of the issuer's 
board of directors and a majority of any institutional investors, or 
the designees of institutional investors, that are board members; and
    (iv) all entities related to each member in acquisitions that 
qualify for this exception do not acquire more than 25% of the issuer's 
total equity securities, calculated immediately following the 
transaction.
    (C) Private Placements With Institutional Investors--Securities of 
the issuer purchased in, or received as

[[Page 75689]]

placement agent compensation for, a private placement before the 
required filing date of the public offering pursuant to subparagraph 
(b)(4) above if:
    (i) institutional investors purchase at least 51% of the ``total 
offering'' (comprised of the total number of securities sold in the 
private placement and received or to be received as placement agent 
compensation by any member);
    (ii) an institutional investor was the lead negotiator or, if the 
terms were not negotiated, was the lead investor with the issuer to 
establish or approve the terms of the private placement; and
    (iii) underwriters and related persons did not, in the aggregate, 
purchase or receive as placement agent compensation more than 20% of 
the ``total offering'' (excluding purchases by any entity qualified 
under subparagraph (d)(5)(A) above).
    (D) Acquisitions and Conversions to Prevent Dilution--Securities of 
the issuer if:
    (i) the securities were acquired as the result of:
    a. a right of preemption that was granted in connection with 
securities that were purchased either:
     1. in a private placement and the securities are not deemed by the 
NASD to be underwriting compensation; or
    2. from a public offering or the public market; or
    b. a stock-split or a pro-rata rights or similar offering; or
    c. the conversion of securities that have not been deemed by the 
NASD to be underwriting compensation; and
    (ii) the only terms of the purchased securities that are different 
from the terms of securities purchased by other investors are pre-
existing contractual rights that were granted in connection with a 
prior purchase;
    (iii) the opportunity to purchase in a rights offering or pursuant 
to a right of preemption, or to receive additional securities as the 
result of a stock-split or conversion was provided to all similarly 
situated securityholders; and
    (iv) the amount of securities purchased or received did not 
increase the recipient's percentage ownership of the same generic class 
of securities of the issuer or of the class of securities underlying a 
convertible security calculated immediately prior to the investment, 
except in the case of conversions and passive increases that result 
from another investor's failure to exercise its own rights.
    (E) Purchases Based On a Prior Investment History--Purchases of 
securities of the issuer if:
    (i) the amount of securities purchased did not increase the 
purchaser's percentage ownership of the same generic class of 
securities of the issuer or of the class of securities underlying a 
convertible security calculated immediately prior to the investment; 
and
    (ii) an initial purchase of securities of the issuer was made at 
least two years and a second purchase was made more than 180 days 
before the required filing date of the public offering pursuant to 
subparagraph (b)(4) above.
[(5)](e) Valuation of Non-Cash Compensation
    For purposes of determining the value to be assigned to securities 
received as underwriting compensation, the following criteria and 
procedures shall be applied[:].
    [(A) No underwriter and related person may receive a security or a 
warrant for a security as compensation in connection with the 
distribution of a public offering that is different than the security 
to be offered to the public unless the security received as 
compensation has a bona fide independent market, provided, however, 
that: (i) in exceptional and unusual circumstances, upon good cause 
shown, such arrangement may be permitted by the Association; and (ii) 
in an offering of units, the underwriter and related persons may only 
receive a warrant for the unit offered to the public where the unit is 
the same as the public unit and the terms are no more favorable than 
the terms of the public unit.]

(1) Limitation on Securities Received Upon Exercise or Conversion of 
Another Security

    An underwriter and related person may not receive a security 
(including securities in a unit), a warrant for a security, or a 
security convertible into another security as underwriting compensation 
in connection with a public offering unless:
    (A) the security received or the security underlying the warrant or 
convertible security received is identical to the security offered to 
the public or to a security with a bona fide independent market; or
    (B) the security can be accurately valued, as required by 
subparagraph (f)(2)(I) below.
[(B)](2) Valuation of Securities That Do Not Have an Exercise or 
Conversion Price
    [s] Securities that [are not options, warrants or convertible 
securities] do not have an exercise or conversion price shall have a 
compensation value [be valued on the basis of] based on:
    [(i)] (A) the difference between [the per security cost and]:
    (i) either the market price per security on the date of 
acquisition, [where a] or, if no bona fide independent market exists 
for the security, [or] the [proposed (and actual)] public offering 
price per security; and
    (ii) the per security cost;
    [(ii)] (B) multiplied by the number of securities received or to be 
received as underwriting compensation;
    [(iii)] (C) divided by the offering proceeds; and
    [(iv)] (D) multiplied by one hundred [(100)].

(3) Valuation of Securities That Have an Exercise or Conversion Price

    [(C) o] Options, warrants or convertible securities that have an 
exercise or conversion price (``warrants'') shall [be valued on the 
basis of] have a compensation value based on the following formula:
    [(i)] (A) the [proposed (and actual)] public offering price per 
security multiplied by .65 [(65%)];
    [(ii)] (B) minus the [difference between] resultant of the exercise 
or conversion price per [security] warrant [and] less either:
    (i) the market price per security on the date of acquisition, where 
a bona fide independent market exists for the security, or
    (ii) the [proposed (and actual)] public offering price per 
security;
    [(iii)] (C) divided by two [(2)];
    [(iv)] (D) multiplied by the number of securities underlying the 
warrants[, options, and convertible securities received or to be 
received as underwriting compensation];
    [(v)] (E) less the total price paid for the [securities] warrants;
    [(vi)] (F) divided by the offering proceeds; and
    [(vii)] (G) multiplied by one hundred [(100).];
    (H) provided, however, that, notwithstanding subparagraph (e)(4) 
below, such warrants shall have a compensation value of at least .2% of 
the offering proceeds for each amount of securities that is up to 1% of 
the securities being offered to the public (excluding securities 
subject to an overallotment option).
    (4) Valuation Discount for Securities With a Longer Resale 
Restriction
    [(D) a lower value equal to 80% and 60% of the calculated value 
shall be assigned if securities, and where relevant, underlying 
securities, are or will be restricted from sale, transfer, assignment 
or other disposition for a

[[Page 75690]]

period of one and two years, respectively, beyond the one-year period 
of restriction required by subparagraph (7)(A)(i) below.]
    A lower value equal to 10% of the calculated value shall be 
deducted for each 180-day period that the securities or underlying 
securities are restricted from sale or other disposition beyond the 
180-day period of the lock-up restriction required by subparagraph 
(g)(1) below. The transfers permitted during the lock-up restriction by 
subparagraphs (g)(2)(A)(iii)-(iv) are not available for such 
securities.
    (5) Valuation of Items of Value Acquired in Connection with a Fair 
Price Derivative or Debt Transaction
    Any debt or derivative transaction acquired or entered into at a 
``fair price'' as defined in subsection (a)(9) and item of value 
received in or receivable in the settlement, exercise or other terms of 
such debt or derivative transaction shall not have a compensation value 
for purposes of determining underwriting compensation. If the actual 
price for the debt or derivative security is not a fair price, 
compensation will be calculated pursuant to this subsection (e) or 
based on the difference between the fair price and the actual price.
[(6)] (f) Unreasonable Terms and Arrangements
[(A)] (1) General
    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 Association] NASD.
[(B)] (2) Prohibited Arrangements
    Without limiting the foregoing, the following terms and 
arrangements, when proposed in connection with [the distribution of] a 
public offering of securities, shall be unfair and unreasonable[:].
    [(i)] (A) [a]Any accountable expense allowance granted by an issuer 
to the underwriter and related persons [which] that includes payment 
for general overhead, salaries, supplies, or similar expenses of the 
underwriter incurred in the normal conduct of business[;].
    [(ii)] (B) [a]Any non-accountable expense allowance in excess of 
[three (3) percent;] 3% of offering proceeds.
    [(iii)] (C) [a]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, except a reasonable advance against out-of-pocket accountable 
expenses actually anticipated to be incurred by the underwriter and 
related persons, which advance is reimbursed to the issuer to the 
extent not actually incurred[;].
    [(iv)] (D) [t]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] that 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 shall not be presumed 
to be unfair or unreasonable under normal circumstances[;].
    [(v)] (E) [a]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, except that a member 
may demonstrate on the basis of information satisfactory to [the 
Association] NASD that an arrangement of more than two [(2)] years is 
not unfair or unreasonable under the circumstances.
    [(vi)] (F) [a]Any right of first refusal provided to the 
underwriter or related persons to underwrite or participate in future 
public offerings, private placements or other financings [which] that:
    [a.] (i) has a duration of more than three [(3)] years from the 
[effective] date of effectiveness or commencement of sales of the 
public offering; or
    [b.] (ii) has more than one opportunity to waive or terminate the 
right of first refusal in consideration of any payment or fee[;].
    [(vii)] (G) [a]Any payment or fee to waive or terminate a right of 
first refusal regarding future public offerings, private placements or 
other financings provided to the underwriter and related persons 
[which] that:
    [a.](i) has a value in excess of the greater of [one percent (] 1% 
[)] of the offering proceeds in the public offering where the right of 
first refusal was granted (or an amount in excess of [one percent] 1% 
if additional compensation is available under the compensation 
guideline of the original offering) or [five percent (] 5% [)] of the 
underwriting discount or commission paid in connection with the future 
financing (including any overallotment option that may be exercised), 
regardless of whether the payment or fee is negotiated at the time of 
or subsequent to the original public offering; or
    [b.](ii) is not paid in cash[;].
    [(viii)](H) The terms or the exercise of the terms of an agreement 
for the receipt by the underwriter and related persons of underwriting 
compensation consisting of any option, warrant or convertible security 
[which] that:
    [a.](i) is exercisable or convertible more than five [(5)] years 
from the effective date of the offering;
    [b. is exerciseable or convertible at a price below either the 
public offering price of the underlying security or, if a bona fide 
independent market exists for the security or the underlying security, 
the market price at the time of receipt;]
    [c.](ii) is not in compliance with subparagraph [(5)(A)] (e)(1) 
above;
    [d.](iii) has more than one demand registration right at the 
issuer's expense;
    [e.](iv) has a demand registration right with a duration of more 
than five [(5)] years from the [effective] date of effectiveness or the 
commencement of sales of the public offering;
    [f.](v) has a piggyback registration right with a duration of more 
than seven [(7)] years from the [effective] date of effectiveness or 
the commencement of sales of the public offering;
    [g.](vi) has anti-dilution terms [designed to provide] that allow 
the underwriter and related persons [with disproportionate rights, 
privileges and economic benefits which are not provided to the 
purchasers of the securities offered to the public (or the public 
shareholders, if in compliance with subparagraph (5)(A) above)] to 
receive more shares or to exercise at a lower price than originally 
agreed upon at the time of the public offering, when the public 
shareholders have not been proportionally affected by a stock split, 
stock dividend, or other similar event; or
    [h.](vii) has anti-dilution terms [designed to provide for the 
receipt or accrual of] that allow the underwriter and related persons 
to receive or accrue cash dividends prior to the exercise or conversion 
of the security[; or].
    [i. is convertible or exercisable or otherwise is on terms more 
favorable than the terms of the securities being offered to the 
public;]
    [(ix)](I) [t]The receipt by the underwriter and related persons of 
any item of compensation for which a value

[[Page 75691]]

cannot be determined at the time of the offering[;].
    [(x)](J) [w]When proposed in connection with the distribution of a 
public offering of securities on a ``firm commitment'' basis, any over 
allotment option providing for the over allotment of more than [fifteen 
(15) percent] 15% of the amount of securities being offered, computed 
excluding any securities offered pursuant to the over allotment 
option[;].
    [(xi) stock numerical limitation. The receipt by the underwriter 
and related persons of securities which constitute underwriting 
compensation in an aggregate amount greater than ten (10) percent of 
the number or dollar amount of securities being offered to the public, 
which is calculated to exclude:]
    [a. any securities deemed to constitute underwriting compensation;]
    [b. any securities issued pursuant to an overallotment option;]
    [c. in the case of a ``best efforts'' offering, any securities not 
actually sold; and]
    [d. any securities underlying warrants, options, or convertible 
securities which are part of the proposed offering, except where 
acquired as part of a unit;]
    [(xii)](K) [t]The receipt by a member or person associated with a 
member, pursuant to an agreement entered into at any time before or 
after the effective date of a public offering of warrants, options, 
convertible securities or units containing such securities, of any 
compensation or expense reimbursement in connection with the exercise 
or conversion of any such warrant, option, or convertible security in 
any of the following circumstances:
    [a.](i) the market price of the security into which the warrant, 
option, or convertible security is exercisable or convertible is lower 
than the exercise or conversion price;
    [b.](ii) the warrant, option, or convertible security is held in a 
discretionary account at the time of exercise or conversion, except 
where prior specific written approval for exercise or conversion is 
received from the customer;
    [c.](iii) the arrangements whereby compensation is to be paid are 
not disclosed:
    [1.]a. in the prospectus or offering circular by which the 
warrants, options, or convertible securities are offered to the public, 
if such arrangements are contemplated or any agreement exists as to 
such arrangements at that time, and
    [2.]b. in the prospectus or offering circular provided to security 
holders at the time of exercise or conversion; or
    [d.](iv) the exercise or conversion of the warrants, options or 
convertible securities is not solicited by the underwriter or related 
person, provided however, that any request for exercise or conversion 
will be presumed to be unsolicited unless the customer states in 
writing that the transaction was solicited and designates in writing 
the broker/dealer to receive compensation for the exercise or 
conversion[;].
    [(xiii)](L) [f]For a member to participate with an issuer in the 
public distribution of a non-underwritten issue of securities if the 
issuer hires persons primarily for the purpose of distributing or 
assisting in the distribution of the issue, or for the purpose of 
assisting in any way in connection with the underwriting, except to the 
extent in compliance with 17 C.F.R. 240.3a4-1 and applicable state law.
    [(xiv)](M) [f]For a member or person associated with a member to 
participate in a public offering of real estate investment trust 
securities, as defined in Rule 2340(c)(4), unless the trustee will 
disclose in each annual report distributed to investors pursuant 
Section 13(a) of the Act a per share estimated value of the trust 
securities, the method by which it was developed, and the date of the 
data used to develop the estimated value.
    [(C) In the event that the underwriter and related persons receive 
securities deemed to be underwriting compensation in an amount 
constituting unfair and unreasonable compensation pursuant to the stock 
numerical limitation in subparagraph (B)(ix) above, the recipient shall 
return any excess securities to the issuer or the source from which 
received at cost and without recourse, except that in exceptional and 
unusual circumstances, upon good cause shown, a different arrangement 
may be permitted.]
    [(7)](g) Lock-Up Restriction[s] on Securities
    [(A) No member or person associated with a member shall participate 
in any public offering which does not comply with the following 
requirements:]
    [(i) securities deemed to be underwriting compensation shall not be 
sold, transferred, assigned, pledged or hypothecated by any person, 
except as provided in subparagraph (B) below, for a period of (a) one 
year following the effective date of the offering. However, securities 
deemed to be underwriting compensation may be transferred to any member 
participating in the offering and the bona fide officers or partners 
thereof and securities which are convertible into other types of 
securities or which may be exercised for the purchase of other 
securities may be so transferred, converted or exercised if all 
securities so transferred or received remain subject to the 
restrictions specified herein for the remainder of the initially 
applicable time period;]
    [(ii) certificates or similar instruments representing securities 
restricted pursuant to subparagraph (i) above shall bear an appropriate 
legend describing the restriction and stating the time period for which 
the restriction is operative; and]
    [(iii) securities to be received by a member as underwriting 
compensation shall only be issued to a member participating in the 
offering and the bona fide officers or partners thereof.]

(1) Lock-Up Restriction

    In any public equity offering, other than a public equity offering 
by an issuer that can meet the requirements in subparagraphs 
(b)(7)(C)(i) or (ii) any common or preferred stock, options, warrants, 
and other equity securities of the issuer, including debt securities 
convertible to or exchangeable for equity securities of the issuer, 
that are unregistered and acquired by an underwriter and related person 
during 180 days prior to the required filing date, or acquired after 
the filing of the registration statement and deemed to be underwriting 
compensation by the NASD, and securities excluded from underwriting 
compensation pursuant to subparagraph (d)(5) above, shall not be sold 
during the offering, or sold, transferred, assigned, pledged, or 
hypothecated, or be the subject of any hedging, short sale, derivative, 
put, or call transaction that would result in the effective economic 
disposition of the securities by any person for a period of 180 days 
immediately following the date of effectiveness or commencement of 
sales of the public offering, except as provided in subparagraph (g)(2) 
below.

(2) Exceptions to Lock-Up Restriction

    [(B) The provisions of subparagraph (A) notwithstanding:]
    Notwithstanding subparagraph (g)(1) above, the following shall not 
be prohibited:
    (A) the transfer of any security:
    (i) by operation of law or by reason of reorganization of the 
issuer [shall not be prohibited.];
    (ii) to any member participating in the offering and the officers 
or partners thereof, if all securities so transferred remain subject to 
the lock-up restriction in subparagraph (g)(1) above for the remainder 
of the time period;
    [(C) Venture capital restrictions. When a member participates in 
the initial public offering of an issuer's securities, such member or 
any officer,

[[Page 75692]]

director, general partner, controlling shareholder or subsidiary of the 
member or subsidiary of such controlling shareholder or a member of the 
immediate family of such persons, who beneficially owns any securities 
of said issuer at the time of filing of the offering, shall not sell 
such securities during the offering or sell, transfer, assign or 
hypothecate such securities for ninety (90) days following the 
effective date of the offering unless:]
    [(i) the price at which the issue is to be distributed to the 
public is established at a price no higher than that recommended by a 
qualified independent underwriter who does not beneficially own 5% or 
more of the outstanding voting securities of the issuer, who shall also 
participate in the preparation of the registration statement and the 
prospectus, offering circular, or similar document and who shall 
exercise the usual standards of ``due diligence'' in respect thereto; 
or]
    [(ii)] (iii) if the aggregate amount of [such] securities of the 
issuer held by [such a member and its related persons enumerated above 
would] the underwriter or related person do not exceed 1% of the 
securities being offered[.];
    (iv) that is beneficially owned on a pro-rata basis by all equity 
owners of an investment fund, provided that no participating member 
manages or otherwise directs investments by the fund, and participating 
members in the aggregate do not own more than 10% of the equity in the 
fund;
    (v) that is not an item of value under subparagraphs (c)(3)(B)(iv)-
(vii) above;
    (vi) that is eligible for the limited filing requirement in 
subparagraph (b)(6)(A)(iv)b and has not been deemed to be underwriting 
compensation under the Rule;
    (vii) that was previously but is no longer subject to the lock-up 
restriction in subparagraph (g)(1) above in connection with a prior 
public offering (or a lock-up restriction in the predecessor rule), 
provided that if the prior restricted period has not been completed, 
the security will continue to be subject to such prior restriction 
until it is completed; or
    (viii) that was acquired subsequent to the issuer's initial public 
offering in a transaction exempt from registration under SEC Rule 144A; 
or
    (B) the exercise or conversion of any security, if all securities 
received remain subject to the lock-up restriction in subparagraph 
(g)(1) above for the remainder of the time period.
[(8)] (h) [Conflicts of Interest] Proceeds Directed to a Member[:]

(1) Compliance With Rule 2720

    No member shall participate in a public offering of an issuer's 
securities where more than [ten (10) percent] 10% of the net offering 
proceeds, not including underwriting compensation, are intended to be 
paid to [members participating in the distribution of the offering or 
associated or affiliated persons of such members, or members of the 
immediate family of such persons] participating members, unless the 
price at which an equity issue or the yield at which a debt issue is to 
be distributed to the public is established pursuant to Rule 
2720(c)(3).
[(A)] (2) Disclosure
    All offerings included within the scope of [this] subparagraph 
[(8)] (h)(1) shall disclose in the underwriting or plan of distribution 
section of the registration statement, offering circular or other 
similar document that the offering is being made pursuant to the 
provisions of this subparagraph and, where applicable, the name of the 
member acting as qualified independent underwriter, and that such 
member is assuming the responsibilities of acting as a qualified 
independent underwriter in pricing the offering and conducting due 
diligence.
[(B)] (3) Exception From Compliance
    The provisions of [this] subparagraphs [(8)] (h)(1) and (2) shall 
not apply to:
    [(i)] (A) an offering otherwise subject to the provisions of Rule 
2720;
    [(ii)] (B) an offering of securities exempt from registration with 
the Commission under Section 3(a)(4) of the Securities Act of 1933;
    [(iii)] (C) an offering of a real estate investment trust as 
defined in Section 856 of the Internal Revenue Code; or
    [(iv)] (D) an offering of securities subject to Rule 2810, unless 
the net offering proceeds are intended to be paid to the above persons 
for the purpose of repaying loans, advances or other types of financing 
utilized to acquire an interest in a pre-existing company.
[(d)] (i) Non-Cash Compensation
(1) Definitions
    The terms ``compensation,'' ``non-cash compensation'' and 
``offeror'' as used in this Section (d) of this Rule shall have the 
following meanings:
    (A) ``Compensation'' shall mean cash compensation and non-cash 
compensation.
    (B) ``Non-cash compensation'' shall mean any form of compensation 
received in connection with the sale and distribution of securities 
that is not cash compensation, including but not limited to 
merchandise, gifts and prizes, travel expenses, meals and lodging.
    (C) ``Offeror'' shall mean an issuer, an adviser to an issuer, an 
underwriter and any affiliated person of such entities.
(2) Restrictions on Non-Cash Compensation
    In connection with the sale and distribution of a public offering 
of securities, no member or person associated with a member shall 
directly or indirectly accept or make payments or offers of payments of 
any non-cash compensation, except as provided in this provision. Non-
cash compensation arrangements are limited to the following:
    (A) Gifts that do not exceed an annual amount per person fixed 
periodically by the Board of Governors \17\ and are not preconditioned 
on achievement of a sales target.
---------------------------------------------------------------------------

    \17\ The current annual amount fixed by the Board of Governors 
is $100.
---------------------------------------------------------------------------

    (B) An occasional meal, a ticket to a sporting event or the 
theater, or comparable entertainment which is neither so frequent nor 
so extensive as to raise any question of propriety and is not 
preconditioned on achievement of a sales target.
    (C) Payment or reimbursement by offerors in connection with 
meetings held by an offeror or by a member for the purpose of training 
or education of associated persons of a member, provided that:
    (i) associated persons obtain the member's prior approval to attend 
the meeting and attendance by a member's associated persons is not 
conditioned by the member on the achievement of a sales target or any 
other incentives pursuant to a non-cash compensation arrangement 
permitted by subparagraph (d)(2)(D);
    (ii) the location is appropriate to the purpose of the meeting, 
which shall mean an office of the issuer or affiliate thereof, the 
office of the member, or a facility located in the vicinity of such 
office, or a regional location with respect to regional meetings;
    (iii) the payment or reimbursement is not applied to the expenses 
of guests of the associated person; and
    (iv) the payment or reimbursement by the issuer or affiliate of the 
issuer is not conditioned by the issuer or an affiliate of the issuer 
on the achievement of a sales target or any other non-cash compensation 
arrangement permitted by subparagraph (d)(2)(D).
    (D) Non-cash compensation arrangements between a member and its

[[Page 75693]]

associated persons or a company that controls a member company and the 
member's associated persons, provided that no unaffiliated non-member 
company or other unaffiliated member directly or indirectly 
participates in the member's or non-member's organization of a 
permissible non-cash compensation arrangement; and
    (E) Contributions by a non-member company or other member to a non-
cash compensation arrangement between a member and its associated 
persons, provided that the arrangement meets the criteria in 
subparagraph (d)(2)(D).
    A member shall maintain records of all non-cash compensation 
received by the member or its associated persons in arrangements 
permitted by subparagraphs (d)(2)(C)-(E). The records shall include: 
the names of the offerors, non-members or other members making the non-
cash compensation contributions; the names of the associated persons 
participating in the arrangements; the nature and value of non-cash 
compensation received; the location of training and education meetings; 
and any other information that proves compliance by the member and its 
associated persons with subparagraph (d)(2)(C)-(E).
[e] (j) Exemptions
    Pursuant to the Rule 9600 Series, the [Association may exempt a 
member or person associated with a member from the provisions of this 
Rule] appropriate NASD staff, for good cause shown after taking into 
consideration all relevant factors, may conditionally or 
unconditionally grant an exemption from any provision of this Rule to 
the extent that such exemption is consistent with the purposes of the 
Rule, the protection of investors, and the public interest.

2720. Distribution of Securities of Members and Affiliates--Conflicts 
of Interest

(a) General
    No Change.
(b) Definitions
    (1)-(8) No Change.
    (9) Immediate family--the parents, mother-in-law, father-in-law, 
[husband or wife] spouse, brother or sister, brother-in-law or sister-
in-law, son-in-law or daughter-in-law, and children of an employee or 
associated person of a member, except any person other than the spouse 
and children who does not live in the same household as, have a 
business relationship with, provide material support to, or receive 
material support from, the employee or associated person of a member. 
In addition, the immediate family includes [or] any other person who 
[is supported, directly or indirectly, to a material extent by] either 
lives in the same household as, provides material support to, or 
receives material support from, an employee [of,] or associated person 
[associated, with] of a member.
* * * * *

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

    In its filing with the Commission, 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. 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
    In January 2000, NASD filed with the SEC proposed amendments to the 
Corporate Financing Rule (``Rule'') to modernize and simplify the Rule 
(``original proposal''). The SEC published the original proposal for 
comment on April 11, 2000 \18\ and received 14 comment letters.\19\ In 
January 2001, NASD submitted Amendment No. 5 to the original proposal 
to respond to the comments (``amended proposal''). The SEC published 
the amended proposal for comment on March 14, 2001\20\ and received 8 
comment letters \21\ described later in this Section. Amendment Nos. 6 
through 10 respond to the comments received.
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    \18\ See supra note 6.
    \19\ As stated previously, these comment letters are discussed 
in the release cited in note.
    \20\ See supra note 10.
    \21\ Letters from Edward M. Alterman, Fried, Frank, Harris 
Shriver & Jacobson (``Fried Frank''), dated April 4, 2001; Goldman 
Sachs & Co. (``Goldman''), dated April 6, 2001; Michael T. Edsall, 
Kirkland & Ellis (Kirkland''), dated April 4, 2001; Christine Walsh, 
First Vice President and Co-Head of Investment Banking Counsel 
Corporate and Institutional Client Group, Merrill Lynch 
(``Merrill''), dated April 12, 2001; John Faulkner, Managing 
Director, Morgan Stanley Dean Witter (``Morgan''), dated April 10, 
2001; Stuart J. Kaswell, General Counsel and Senior Vice President, 
Securities Industry Association (``SIA''), dated April 6, 2001; 
Linda DeRenzo, Testa, Hurwitz & Thibeault (``Testa''), dated April 
3, 2001; and Morris N. Simkin, Winston & Strawn (``Winston''), dated 
February 27, 2001.
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    The Corporate Financing Rule regulates underwriting compensation 
and prohibits unfair arrangements in connection with public offerings 
of securities. The Rule requires members to submit registration 
statements for public offerings and other supplemental information to 
the Corporate Financing Department (``Department'') for review. In 
January 2000, NASD proposed comprehensive amendments to the Rule to 
modernize the Rule so that it would better reflect the various 
financial activities of multi-service firms.
    The Commission has twice published for comment the proposed 
amendments. Commenters praised NASD for its decision to bring clarity 
and consistency to the application of the Rule. They also believed that 
the Rule should accommodate bona fide advisory and investment 
activities of NASD members while continuing to protect issuers and 
investors from unfair or unreasonable underwriting activities.
    The original proposal contained an objective standard that members 
and the Department could follow to determine whether any ``item of 
value,'' such as fees and securities received by underwriters and their 
affiliates should be included in the calculation of underwriting 
compensation under the Rule. Under this standard, all items of value 
received by participating members within the 180 day period before the 
filing of a registration statement and up to the time of the offering's 
effectiveness or commencement of sales (the ``Review Period'') would be 
included, unless the items were received in a transaction that met 
certain exceptions contained in the Rule. The exceptions are intended 
to distinguish securities and other items of value acquired as 
consideration for underwriting services from securities and other items 
of value acquired as consideration for venture capital investments and 
other financial services.
    In the original proposal, securities acquired during the 90 days 
before the registration statement was filed would have been counted as 
compensation per se, notwithstanding whether their acquisition 
otherwise would meet an exception. Industry commenters strongly opposed 
the 90-day per se requirement and recommended the adoption of several 
alternative exceptions. They also recommended that the Department 
retain some flexibility under the Rule to make case-by-case 
determinations regarding whether certain items of value should be 
deemed to be underwriting compensation.

[[Page 75694]]

    The amended proposal eliminates the 90-day per se requirement and 
adds the following:
    [sbull] A 10% limitation on acquisitions of securities that meet 
the exception for ``purchases and loans by certain entities'' in 
paragraph (d)(5)(A) of Rule 2710 (``Exception 1'') and the exception 
for ``investments in and loans to certain issuers'' in paragraph 
(d)(5)(B) of Rule 2710 (``Exception 2'');
    [sbull] A provision that excludes listed securities from being 
deemed an ``item of value;'
    [sbull] The addition of insurance companies and banks as qualifying 
entities in Exception 1;
    [sbull] An exception for securities received in connection with 
financial consulting and advisory arrangements, if the arrangement is 
detailed in a written agreement executed at least 12 months before 
filing; and,
    [sbull] Tightened lock-up restrictions that prohibit derivative 
transactions that result in the effective economic disposition of 
locked-up shares.
    The following is a description of proposed amendments to the 
amended proposal to which the Commission is granting accelerated 
approval. As noted previously, the Commission has published the filing 
for comment on two prior occasions.\22\ All of the proposed changes 
from the amended proposal are in response to the comments on Amendment 
No. 5, except as indicated for non-substantive and conforming changes 
to the Rule. NASD also describes several suggestions made by the 
commenters that it does not support because they would not improve the 
Rule or would be inconsistent with its purposes.
---------------------------------------------------------------------------

    \22\ See supra notes 6 and 10.
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1. Lock-Up Restrictions
    The current Corporate Financing Rule imposes a one-year lock-up on 
securities deemed to be underwriting compensation. Securities of an 
issuer that are not deemed to be underwriting compensation, but are 
held by members of the underwriting syndicate in an IPO, are subject to 
a 90-day ``venture capital'' lock-up. The lock-up provisions in the 
Rule are intended primarily to protect the aftermarket in a new 
security from the potential for manipulation. The lock-up provisions as 
proposed to be amended also should ensure that securities acquired 
during the Review Period by an underwriter or related person that are 
not deemed to be compensation because they were acquired in 
transactions that meet one of the five proposed exceptions, were 
acquired and held as an investment in the issuer.
    The original proposal replaced the one-year and 90-day lock-up 
provisions with a single 180-day lock-up. According to NASD, the 180-
day lock-up is consistent with the industry practice to impose a 180-
day lock-up on securities of the issuer held by its officers, directors 
and other insiders. The amended proposal further tightens the lock-up 
provision by prohibiting certain derivative transactions. NASD believes 
that this change should ensure that securities subject to the lock-up 
are held as an investment and minimize the opportunity for underwriters 
and related persons to realize a quick profit from cheap stock and 
warrants acquired from the issuer or its nominees during the Review 
Period.
    Commenters (Goldman, Fried Frank, SIA and Testa) suggested changing 
language in the amended proposal that could be read to prevent members 
from participating in public offerings in which their affiliates or 
associated persons are selling security-holders. They also commented 
that the lock-up restrictions are too broad and recommended that the 
restrictions apply only to securities deemed to be underwriter 
compensation related to initial public offerings.
    In response to these comments, NASD proposes to revise the language 
in the proposed amendments to clarify that members may participate in 
public offerings in which the members, their affiliates or associated 
persons are offering their shares or are selling security-holders of 
another issuer. NASD intended for the Rule to permit such 
participation, but the draft rule language was not clear on this point. 
The proposed amendments also would limit the 180-day lock-up to equity 
or convertible-to-equity securities and certain derivatives 
(``unregistered equity securities'') held by underwriters and related 
persons and acquired during the Review Period. NASD also proposes 
additional exceptions from the lock-up requirements in NASD Rule 
2710(g)(2) to provide that debt securities and derivative instruments 
(1) that are not items of value, or (2) that are eligible for the 
limited filing requirement in NASD Rule 2710(b)(6)(A)(iv) and have not 
been deemed to be underwriting compensation by the Department under the 
Rule will not be locked up.
    The proposed amendments retain the lock-up provision in connection 
with secondary offerings. Nevertheless, NASD believes that it is 
unusual for members and their affiliates to acquire privately placed, 
unregistered securities of issuers conducting secondary offerings, 
except pursuant to Rule 144A transactions. The proposed amendments 
would provide an exception from the lock-up restrictions for Rule 144A 
securities acquired after the completion of an issuer's IPO.
2. 10% Limitation
    The original and amended proposals contained an objective standard 
that members and the Department would use to determine whether any 
``item of value,'' such as fees and securities, received by 
underwriters and their affiliates must be included in the calculation 
of underwriting compensation under the Rule. Under this standard, all 
items of value received by a participating member during the Review 
Period would be included, unless the items were received in a 
transaction that met one of the enumerated exceptions contained in the 
proposal.
    Exceptions 1 and 2 except from underwriting compensation, 
securities received as consideration for certain investments and loans 
by entities that are affiliates of members. These entities must meet 
certain capital and other requirements that are designed to ensure that 
they are engaged in bona fide businesses providing loans to, or venture 
capital investments in, other companies. The amended proposal also 
provided that the total amount of securities received by all entities 
related to a member in transactions meeting the requirements in 
Exceptions 1 and 2 may not exceed 10% of the issuer's total equity 
securities, calculated immediately following the transaction.
    Some commenters (Fried Frank, Goldman, Kirkland, SIA and Testa) 
asserted that the 10% limitation undermined the usefulness of the 
exceptions and was unnecessary because the other requirements in the 
exceptions ensure that the transactions are bona fide investments or 
loans. NASD proposed to retain the limitation in Exceptions 1 and 2, 
but raise the threshold to 25%. NASD states that other conditions of 
the exceptions help to ensure that the transaction is a bona fide 
investment or loan, but a 25% limitation is a reasonable additional 
protection against the potential for overreaching and unfair 
arrangements. The 25% limitation would apply only to transactions that 
qualify for the particular exception. If, for example, a member 
receives unregistered equity securities as placement agent compensation 
in a transaction that qualifies under the third exception, those 
securities would not count toward the 25% limitation on the amount of 
securities that could be acquired by an

[[Page 75695]]

affiliated entity in a transaction that qualifies under Exception 1 or 
2.
    Exception 1 would apply the 25% threshold to all securities 
acquired during the Review Period, while Exception 2 would apply the 
25% threshold to each acquisition of securities under that exception. 
Exception 1 is available for private placements and loans in which the 
only parties are the member's affiliate and the issuer. Accordingly, 
under Exception 1 a member's affiliate could structure a single 
financing as a series of transactions, each of which enable it to 
acquire no more than 25% of the issuer's total equity securities, but 
in combination would bring the affiliate's acquisitions well over the 
25% level. By contrast, because the issuer's board of directors must 
approve each transaction in Exception 2, the amount of equity an issuer 
must provide as consideration for a particular mezzanine level 
financing would be certain and discrete. Consequently, Exception 1 
would apply the 25% threshold to all securities acquired during the 
Review Period, while Exception 2 would apply the threshold on a 
transaction by transaction basis.
3. Entity Definition
    A. New Partnerships. Exceptions 1 and 2 require entities to meet 
certain capital requirements and to be engaged in the business of 
making investments in or loans to other companies. Some commenters 
(Goldman and SIA) pointed out that many sponsors routinely carry out 
investment programs through a series of similar funds, although each 
individual fund may not meet the capital requirements in the 
exceptions. Other commenters (Fried Frank and Morgan) noted that a fund 
whose first investment is in the issuer would not be able to establish 
that it is engaged in the business of making investments and loans and 
thus it could not qualify for the exceptions, even though the fund is 
part of the investment program. These commenters recommended that NASD 
amend the Rule to treat as one entity all funds in a series of funds 
that are created to engage in the same business as prior funds in the 
series. The fund's capital and operating history thus would reflect 
those of the entire investment program for purposes of these 
exceptions. NASD does not support this change because it would 
introduce a highly subjective consideration (i.e., whether a fund is 
part of an investment program) and would undermine the requirements 
that a qualifying entity demonstrate through its operating history that 
it is a bona fide business, and that it alone meets the capital 
standards in the exception.
    B. Group of Legal Persons. The definition of ``entity'' for 
purposes of Exceptions 1 and 2 includes ``a group of legal persons'' 
that are contractually obligated to make co-investments and have 
previously made at least one such investment. This provision permits a 
group of entities to combine their capital for purposes of the 
exceptions, and thus permits certain joint ventures and partnerships 
that would not otherwise be deemed entities to take advantage of the 
exceptions. Some commenters recommended that the definition be broader 
and include: (1) entities that have entered into a co-investment 
agreement, but have not yet made a co-investment; or (2) entities that 
do not have a co-investment agreement, but have made previous co-
investments. Given the potential abuse that could arise from an 
illegitimate ``grouping'' of different entities, the proposed 
amendments preserve the requirements of both a co-investment history 
and an agreement.
    C. Bank and Insurance Company Subsidiaries. The amended proposal 
added insurance companies and banks as qualifying entities in Exception 
1. These entities are separately regulated and engage in a line of 
business that is distinct from the underwriting business. Commenters 
(Goldman and SIA) suggested that because the definition of ``entity'' 
includes a wholly owned subsidiary of a qualifying entity, subsidiaries 
of banks and insurance companies could enjoy a competitive advantage 
over broker/dealer subsidiaries if they were not required to meet the 
capitalization requirements. The proposed amendments clarify that in 
order to qualify for the exception, subsidiaries and affiliates of 
banks and insurance companies that are not themselves regulated banks 
and insurance companies must separately meet the requirements in 
Exception 1.
4. Institutional Investor Definition
    Rule 2710(d)(4)(B) defines ``institutional investor'' for purposes 
of Exception 2 and the exception for ``private placements with 
institutional investors'' in paragraph (d)(5)(C) of Rule 2710 
(``Exception 3''). Under the amended proposal, no participating member 
could have any equity interest or management responsibility in an 
entity intending to qualify as an ``institutional investor.'' One 
commenter (Fried Frank) suggested that NASD amend the definition of 
``institutional investor'' to permit some part of the equity interest 
in the entity to be held by participating members. The commenter claims 
that the application is otherwise too restrictive, especially with 
regard to widely held institutional entities like publicly owned 
companies or mutual funds.
    In response to the comment, NASD proposes to amend the definition 
of ``institutional investor'' to permit a member to qualify for the 
exceptions so long as it holds no more than 5% of a publicly owned 
entity and no more than 1% of a non-public entity, such as a hedge 
fund.
5. Private Placements With Institutional Investors
    Exception 3 addresses private placements in which: (1) 
Institutional investors acquire at least 51% of the total offering of 
the issuer's securities; (2) an institutional investor is the lead 
negotiator or lead investor with the issuer and establishes the terms 
of the private placement; and (3) underwriters and related persons do 
not acquire more than 20% of the total offering. Some commenters (Fried 
Frank and Goldman) claimed that it should be presumed that 
institutional investors participated in the negotiation of the 
transaction to the extent necessary to protect their interests if they 
acquire as much as 51% of an offering of privately placed securities, 
and that the ``lead negotiator'' or ``lead investor'' requirement is 
unnecessary. Some commenters further asserted that the 20% limitation 
is too low.
    NASD does not propose any change to these provisions. NASD agrees 
that institutional investors generally will protect their interests, 
but the requirement that an unaffiliated institutional investor lead 
the negotiation or serve as lead investor is designed to prevent the 
potential overreaching that could occur if a member that is 
underwriting an issuer's public offering or its affiliate sets the 
price and terms of a private placement undertaken during the Review 
Period. Because the 20% limitation permits participating members to 
acquire only a relatively small portion of the issuer's equity in a 
private placement compared to the unaffiliated institutional investors, 
NASD views the limitation as reasonably designed to minimize the 
incentive for participating members to pressure an issuer to conduct 
the private placement for the member's benefit.
6. Transactions Completed Before Filing
    Exceptions 1-3 require that the issuer's securities be acquired in 
transactions that occur before the required filing date of the public 
offering. Commenters (Fried Frank, Merrill, Morgan) suggested that, in 
view

[[Page 75696]]

of other safeguards built into the exceptions, this requirement should 
be deleted. Because an issuer's ability to negotiate at arm's length to 
raise capital directly from participating members may be particularly 
compromised once the members are actively engaged in soliciting 
investors in the public offering on behalf of the issuer, NASD believes 
it is appropriate to limit the exceptions to transactions that occur 
before filing a registration statement.
7. Preemptive Rights and Anti Dilution Rights
    The exception for ``acquisitions and conversions to prevent 
dilution'' in paragraph (d)(5)(D) of Rule 2710 (``Exception 4'') would 
not apply to any purchase or acquisition that increases the 
participating member's percentage ownership of the same generic class 
of securities of the issuer. Some commenters (Fried Frank, Goldman, 
Merrill, Morgan and SIA) suggested that NASD revise Exception 4 to 
permit passive increases in ownership that may be the result of another 
investor's failure to exercise its own preemptive rights. NASD has 
revised the proposed amendments to make this change.
8. Purchases Based on a Prior Investment History
    The exception for ``purchases based on a prior investment history'' 
in paragraph (d)(5)(E) of Rule 2710 (``Exception 5'') would provide an 
exception for acquisitions made in private placements during the Review 
Period by participating members in order to prevent dilution of a long-
standing equity interest in the issuer. In order to be eligible for the 
exception, the investor must have made at least two prior purchases of 
the issuer's securities: One investment must have been made at least 24 
calendar months before the required filing date and another more than 
180 days before the required filing date. Commenters (Merrill, Morgan, 
SIA) suggested various shorter time period requirements for the initial 
acquisitions that would broaden the availability of the exception. NASD 
included Exception 5 in response to comments on the original proposal. 
The time periods correspond roughly to investments the Department has 
recognized in the course of its filing reviews as typical of early 
round financing by long-term venture capital investors in start-up 
companies in the late 1990's and 2000. According to NASD, the trend in 
the current market environment is that these time periods are being 
extended, not shortened. NASD believes that the proposed time periods 
are consistent with the purposes of, and other protections in, 
Exception 5.
9. Financial Consulting and Advisory Arrangements
    The exception for ``financial consulting and advisory 
arrangements'' in paragraph (d)(5)(F) of Rule 2710 (``Exception 6'') 
addresses securities acquired in connection with financial consulting 
and advisory services. Codifying an exception for the receipt of 
securities as consideration for these services is in contrast to the 
proposed treatment of cash paid in connection with financial consulting 
and advisory services, which the Department proposed to continue to 
evaluate on a case-by-case basis to determine whether fees were in fact 
received in connection with underwriting services. A commenter (Fried 
Frank) suggested that the Department continue to evaluate whether the 
receipt of securities paid in connection with these services is 
underwriting compensation on a case-by-case basis, rather than relying 
solely on the proposed exception. NASD agrees that these arrangements 
are so fact specific that in many cases they do not fit well into the 
codified exception. Accordingly, the proposed amendments delete the 
codified exception. The Department will continue to analyze the receipt 
of both cash and securities in connection with financial consulting and 
advisory services based on the particular facts and circumstances in 
the arrangements.
10. Listed Securities
    The amended proposal excluded from ``items of value,'' listed 
securities of the issuer that are purchased in public market 
transactions. Commenters (Fried Frank, Goldman and SIA) suggest that 
the exclusion is too narrow and should instead extend to securities 
that are freely trading or acquired in transactions with persons 
unaffiliated with the issuer. Alternatively, one commenter (SIA) 
suggested that the definition of listed securities should be amended to 
specify the markets and exchanges on which securities may be listed to 
qualify for the exception. NASD has amended the Rule to specify 
eligible markets and exchanges. NASD believes that expanding the 
definition to include all freely trading securities or those acquired 
from unaffiliated persons would create unacceptable opportunities to 
evade the Rule and consequently NASD has not adopted the change.
11. When Securities Are Considered Received
    The original and amended proposals provided that securities will be 
considered ``received'' as of the date of the closing of the private 
placement, not at the date a commitment letter is signed. One commenter 
(Fried Frank) suggested that one relevant date should be the date on 
which the buyer is unconditionally bound to purchase. The Department 
made several, ultimately unsuccessful attempts to review commitment 
letters and work with counsel to determine whether market-out and other 
termination clauses typically found in commitment letters render them 
binding contracts. The date of closing a private placement, when 
beneficial ownership is transferred, continues to be the best and most 
reliable indicator of when securities are received. Consequently, NASD 
has not made the recommended change.
12. Items of Value Received After Completion of an Offering
    The amended proposal would require members to file information with 
the Department regarding the receipt of items of value by participating 
members during the 90 day period following the effective date of a 
registration statement. One commenter (Fried Frank) asserted that the 
provision would be too burdensome. NASD believes that the information 
is necessary to prevent fraudulent conduct and that the provision is a 
reasonable, narrowly defined mechanism to ensure that members comply 
with the Rule.
13. Non-Qualified Employee Benefit Plans
    The amended proposal would have excluded from items of value 
securities acquired through certain plans that qualify under Section 
401 of the Internal Revenue Code. Commenters (Fried Frank and Goldman) 
suggested that the provision be expanded to include securities received 
under non-qualified employee benefit plans. Under such a revision, the 
Department staff would be required to investigate and analyze who owns 
the assets, directs the trading and exercises control in the various 
non-qualified plans. NASD is not confident that the Department would 
always be provided with all necessary information on a timely basis 
from which it could conclude that a particular plan is not, for 
example, substantially an investment vehicle for employees in the 
investment banking or syndicate departments, or their relatives or 
nominees. Consequently, NASD has not made the recommended change.

[[Page 75697]]

14. Non-Cash Compensation
    One commenter (Winston) suggested that the Rule be amended so that 
its treatment of non-cash compensation conforms to the requirements in 
the rules regulating investment company sales charges and variable 
annuities. The proposed amendments do not address this issue. NASD 
currently is working on rule amendments that would address the issue 
comprehensively under both the Corporate Financing Rule and NASD 
Conduct Rule 2810 (Direct Participation Programs).
15. Certain Derivative Securities
    NASD also proposes additional amendments to the definition of 
``item of value'' so that it does not have the unintended effect of 
capturing within ``underwriting compensation'' certain derivative and 
other instruments that are entered into by members or related persons 
in the ordinary course of business. As proposed, the definition of 
``items of value'' would include derivative instruments and certain 
other transactions that were not intended to be included in the 
compensation provisions. Accordingly, NASD proposes to add subsections 
(c)(3)(B)(vi) and (vii) to NASD Rule 2710, which provide that 
nonconvertible or non-exchangeable debt securities and derivative 
instruments acquired or entered into: (i) for a fair price; (ii) in the 
ordinary course of business; and (iii) in transactions unrelated to the 
public offering; are not ``items of value'' under the Rule. Because 
they are not items of value, they would also be excluded from the lock-
up requirements in the Rule, as discussed above. In addition, any 
securities received in settlement of the derivative entered into at a 
fair price would not have any compensation value.
    The term ``fair price'' would be defined in NASD Rule 2710(a)(9) to 
require that the underwriters and related persons have priced the non-
convertible or non-exchangeable debt security or derivative instrument 
in good faith, on an arm's length basis, in a commercially reasonable 
manner, and in accordance with pricing methods and models and 
procedures used in the ordinary course of their business for pricing 
similar transactions. This ``fair price'' definition is intended to 
distinguish covered debt and derivative transactions from a transaction 
in which the benefit to the underwriter or related person is related to 
the underwriting or similar services provided to the issuer. The 
proposed definition would exclude a derivative instrument or other 
security received for acting as a private placement agent for the 
issuer, for providing or arranging a loan, credit facility, merger, 
acquisition or any other service, including underwriting services.
    As stated above, proposed NASD Rule 2710(c)(3)(B)(vi) and (vii) 
would require that the non-convertible or non-exchangeable debt 
securities and derivative instruments be acquired or entered into ``in 
transactions unrelated to the public offering.'' Generally, if a 
transaction occurring within the review period is negotiated by 
personnel in a member's investment banking department, it would not be 
considered to be ``unrelated to the public offering.'' An exception to 
this general principle would be a put option or other derivative 
instrument that is entered into by an issuer with an underwriter or 
related person, in connection with a publicly disclosed share 
repurchase program. The public disclosure and transparent nature of the 
repurchase program distinguish the derivative transaction in support of 
the program from other privately negotiated transactions between the 
investment bankers and the issuer during the review period.
    NASD determined not to define the term ``in the ordinary course of 
business'' for purposes of Rule 2710(c)(3)(B)(vi) and (vii). Whether a 
debt or derivative transaction between an issuer and an underwriter or 
related person is part of regular business services provided by the 
member to its clients or whether it is a customized transaction that is 
being offered in connection with a public offering depends on the 
particular facts and circumstances.
    Under the proposed Rule, information regarding debt and derivative 
transactions that do not meet the ``in the ordinary course of business 
in transactions unrelated to the public offering'' requirement of Rule 
2710(c)(3)(B)(vi) and (vii) would be required to be filed if the 
related public offering is subject to the filing requirements of the 
Rule. NASD proposes to amend the filing requirement in NASD Rule 
2710(b)(6)(A)(iv), such that information initially filed in connection 
with debt securities and derivative instruments acquired or entered 
into for a ``fair price'' as defined in NASD Rule 2710(a)(9), but not 
excluded from items of value, may be limited to a brief description of 
the transaction and a representation that the transaction was (or if 
the pricing terms have not been set) will be entered into at a fair 
price as defined in NASD Rule 2710(a)(9). The required information 
would have to be submitted only with respect to the particular public 
offering to which a particular non-convertible or non-exchangeable debt 
security or derivative instrument relates. The Department would 
evaluate the information submitted in the same case-by-case manner that 
it will review financial consulting and advisory arrangements under the 
Rule.

IV. Commission Findings and Order Granting Accelerated Approval to 
Proposed Rule Change

    The Commission finds that the proposed rule change is consistent 
with the Act and the rules and regulations thereunder applicable to a 
national securities association. In particular, the Commission finds 
that the proposed rule change is consistent with Section 15A(b)(6) of 
the Act,\23\ which requires that an Association's rules be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and to protect investors and the 
public interest.\24\ The Commission believes that the proposed rule 
change should permit members to provide legitimate capital-raising 
services to issuers, while adopting restrictions that are designed to 
minimize the opportunity for abusive practices by members.
---------------------------------------------------------------------------

    \23\ 15 U.S.C. 78o-3(b)(6).
    \24\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
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    Current NASD Rule 2710 requires the terms of an underwriting to be 
fair and reasonable. Under the current Rule, any item of value, 
including certain securities of the issuer, acquired by the underwriter 
and related persons during the 12-month period before the filing date 
of a proposed public offering is examined by the Department to 
determine whether it was acquired ``in connection with the public 
offering'' and, therefore, is deemed to be underwriting compensation. 
The Rule presumes that any such item of value acquired during the six-
month period before filing is underwriting compensation, but this 
presumption may be rebutted by the member based on information 
satisfactory to the Department. The proposed rule change replaces the 
current subjective standard with an objective standard under which all 
items of value received by an underwriter or related person during the 
180 days before the required filing date of the registration statement 
or similar document will be considered to be underwriting compensation 
in connection with a public offering. Items

[[Page 75698]]

of value that are not disclosed to NASD, and items of value that are 
received subsequent to the public offering, would be subject to post-
offering review to determine whether they were underwriting 
compensation for the public offering. The proposed rule also contains 
five exceptions from the general rule that an ``item of value'' is 
deemed to be underwriting compensation. The Commission believes that 
replacing the subjective test with an objective, bright-line test 
should provide greater clarity and predictability regarding whether 
equity securities of the issuer and other items of value acquired by 
the underwriter and related persons constitute underwriting 
compensation. In addition, it should permit the NASD to better use its 
resources.

A. Six-Month Pre-Offering Test

    As stated above, the proposed rule change replaces the current 
subjective standard with an objective standard under which all items of 
value received by an underwriter or related person during the 180-day 
period before the required filing date of the registration statement or 
similar document will be considered to be underwriting compensation in 
connection with a public offering. Under the current Rule, the 
Department examines all items of value acquired by the underwriter and 
related persons during the 12-month period before the filing date of a 
proposed public offering. The Commission believes that a bright-line 
test should provide greater clarity and predictability concerning 
application of the Rule to specific transactions. Consequently, members 
and their venture capital and lending affiliates should find it easier 
to determine at the time of a private placement or other financing 
whether their investment will be treated as underwriting compensation 
when the subsequent public offering is filed with the Department for 
review. The Commission also believes that shortening the time-frame 
from one year to six months is reasonable and reflects the NASD's 
experience that a longer time frame has generally been unnecessary to 
minimize the opportunity for abusive practices by members. The 
Commission also notes that commenters generally supported shortening 
the look-back period to 180 days.
    Several commenters requested that the Rule be amended to provide 
that the 180-day review period be measured from the date that the 
preliminary prospectus is circulated, particularly because certain 
issuers file early with the SEC. According to NASD, members typically 
provide significant underwriting services in connection with the 
preparation and filing of a registration statement or other offering 
document. These underwriting activities are likely to have commenced 
during the 180-day period preceding the filing date. Consequently, the 
NASD is not going to amend the rule. The Commission believes it is 
reasonable for the NASD to measure the review period from the required 
filing date, rather than the date the preliminary prospectus is 
circulated.

B. Undisclosed and Post-Offering Compensation

    The original proposal would have required the staff to examine 
items of value received by underwriters and related persons during the 
90-day period immediately following the effective date of a public 
offering to determine whether they constitute underwriting 
compensation. Commenters expressed concern that the provision may 
subject members to disciplinary actions based upon the unknown 
activities by unaffiliated entities included in the definition of 
``underwriter and related person.''
    In response to the concerns of commenters, NASD narrowed the scope 
of the rule. As amended, proposed Rule 2710(d)(2) would provide that 
all items of value received and all arrangements entered into for the 
future receipt of an item of value by a participating member that are 
not disclosed to NASD before the date of effectiveness or the 
commencement of sales of a public offering (including items of value 
received after the public offering), are subject to post-offering 
review to determine whether such items of value are additional 
underwriting compensation for the public offering. In addition, 
subparagraph (b)(6)(vi)(b) would require the filing of any new 
arrangement that provides for receipt of an additional item of value 
subsequent to the issuance of an opinion of no objections to the 
underwriting arrangements by NASD and during the 90-day period 
following the date of effectiveness or commencement of the public 
offering. These provisions will enable NASD staff to consider whether 
items of value received after the public offering need to be included 
as underwriting compensation in order to avoid circumvention of the 
Rule.

C. Items of Value

    Current Rule 2710(c)(3)(A) sets forth the items of value that are 
to be included in the calculation of underwriting compensation. NASD 
proposed to make non-substantive amendments to the description of the 
types of equity securities that are included. In addition, in response 
to comments, NASD is proposing several changes to Rule 2710(c)(3)(B), 
which sets forth exclusions from ``items of value.'' The proposal would 
expand this section by adding: (i) Cash compensation for acting as 
placement agent for a private placement or for providing a loan, credit 
facility, or for services in connection with a merger/acquisition; (ii) 
listed securities purchased in public market transactions; (iii) 
securities acquired through any stock bonus, pension, or profit-sharing 
plan that qualifies under Section 401 of the Internal Revenue Code; (v) 
securities acquired by an investment company registered under the 
Investment Company Act of 1940; (vi) non-convertible or non-
exchangeable debt securities acquired for a fair price in the ordinary 
course of business in transactions unrelated to the public offering; 
and (vii) derivative instruments (and any securities received in 
settlement thereof) entered into for a fair price in the ordinary 
course of business in a transaction unrelated to the public offering.
    The Commission believes that the proposal codifies exclusions for 
``items of value'' that should not raise concerns about abuse and 
overreaching. As noted above, securities received in settlement of a 
derivative entered into at a fair price would not be considered an item 
of value. The Commission believes that it is reasonable to exempt any 
securities received in settlement of a derivative entered into at a 
fair price because the derivative transaction itself is not considered 
to be an item of value and, thus, the securities received in settlement 
(like any cash received in settlement in the case of a cash-settled 
derivative) would not represent any additional value.
    Some commenters suggested that the exclusion for listed securities 
that are purchased in public market transactions is too narrow and 
should instead extend to securities that are freely trading or acquired 
in transactions with persons not affiliated with the issuer. Another 
commenter suggested that the definition of listed securities should be 
amended to specify the markets and exchanges on which securities may be 
listed to qualify for the exception. NASD has amended the Rule to 
specify eligible markets and exchanges. NASD believes that expanding 
the definition to include all freely trading securities or those 
acquired from unaffiliated persons would create unacceptable 
opportunities to evade the Rule. The Commission agrees.

[[Page 75699]]

D. Exceptions to the General Rule

    The proposed rule change provides five exceptions from the general 
rule that items of value received within 180 days of the required 
filing date of a registration statement or similar document will be 
considered to be underwriting compensation.
1. Purchases and Loans by Certain Entities
    The first exception in subparagraph (d)(5)(A) is intended for 
acquisitions of the issuer's securities by certain entities that 
routinely make investments in or provide loans or credit facilities to 
other companies. The exception would be available to an entity that: 
(i) Manages capital contributions or commitments of $100 million or 
more, at least $75 million of which has been contributed or committed 
by persons that are not participating members; (ii) manages capital 
contributions or commitments of $25 million or more, at least 75% of 
which has been contributed or committed by persons that are not 
participating members; (iii) is an insurance company as defined under 
Section 2(a)(13) of the Securities Act of 1933, or a foreign insurance 
company that has been given an exemption; or (iv) is a bank as defined 
in Section 3(a)(6) of the Act or is a foreign bank that has been 
granted an exemption. In addition to those requirements, the entity 
must: (i) Be a separate and distinct legal person from any member and 
not be registered as a broker-dealer; (ii) make investments or loans 
subject to the evaluation of individuals who have a contractual or 
fiduciary duty to select investments and loans based on risks and 
rewards, not on opportunities for the member to earn investment banking 
revenues; (iii) not participate directly in investment banking fees 
received by any participating member for underwriting public offerings; 
and (iv) have been primarily engaged in the business of making 
investments in or loans to other companies. Finally, all entities 
related to each member in acquisitions that qualify for this exemption 
cannot acquire more than 25% of the issuer's total equity securities 
during the review period.
    The Commission believes that the proposed exceptions accommodate 
bona fide acquisitions by entities that regularly make venture capital 
investments. The Commission also believes that the limitations of the 
exception, such as the capital under management requirement, and the 
25% acquisition limit, are reasonably designed to minimize the 
opportunity for abusive practices. The Commission notes that the 
acquisition limitation was previously proposed to be 10% of the 
issuer's total securities. In response to the concerns of commenters, 
NASD has proposed to raise this limit to 25%. The Commission believes 
that the other conditions of the exception should help to ensure that 
the transactions are bona fide investments or loans, and the 25% 
limitation is sufficient as a reasonable additional protection against 
overreaching and unfair arrangements.
2. Investments in and Loans to Certain Issuers
    The second exception in subparagraph (d)(5)(B) is intended for 
acquisitions of securities of issuers that have significant 
institutional investor involvement in their corporate governance. 
Securities of the issuer purchased in a private placement or received 
as compensation for a loan or credit facility would be exempt if each 
entity: (i) Manages capital contributions or commitments of at least 
$50 million; (ii) is a separate and distinct legal person from any 
member and is not registered as a broker/dealer; (iii) does not 
participate directly in investment banking fees received by the member 
for underwriting public offerings; and (iv) has been primarily engaged 
in the business of making investments in or loans to other companies. 
The following additional requirements would apply: (i) Institutional 
investors must beneficially own at least 33% of the issuer's total 
equity securities, calculated immediately before the transaction; (ii) 
the transaction was approved by a majority of the issuer's board of 
directors and a majority of any institutional investors, or the 
designees of institutional investors, that are board members; and (iii) 
all entities related to each member in acquisitions that qualify for 
this exception do not acquire more than 25% of the issuer's total 
equity securities, calculated immediately following the transaction.
    The Commission believes this exception is reasonable and should 
permit bona fide investments in issuers with significant institutional 
investor involvement in their corporate governance. The Commission 
believes that the limitations of this exception, such as the 
requirement of substantial involvement of institutional investors, 
should minimize the potential for overreaching and abuse. As stated 
above, the Commission notes that the acquisition limitation was 
previously proposed to be 10% of the issuer's total securities. In 
response to the concerns of commenters, NASD has proposed to raise this 
limit to 25%. The Commission believes that the other conditions of the 
exception should help to ensure that the transactions are bona fide 
investments or loans, and the 25% limitation is sufficient as a 
reasonable additional protection against overreaching and abuse.
a. Definition of ``Entity''
    Exceptions 1 and 2 require entities to meet certain capital 
requirements and to be engaged in the business of making investments in 
or loans to other companies. Some commenters recommended that NASD 
amend the Rule to treat as one entity all funds in a series of funds 
that are created to engage in the same business as prior funds in the 
series. NASD determined not to adopt the suggested amendment because it 
believed that it would introduce a highly subjective consideration 
(i.e., whether a fund is part of an investment program) and would 
undermine the requirement that a qualifying entity demonstrate through 
its operating history that it is a bona fide business, and that it 
alone meets the capital standards in the exception. The Commission 
believes that the proposed definition of ``entity'' is an objective 
standard that should be more easily administered by the Department than 
the standard suggested by comments. The Commission also believes that 
it is reasonable for the NASD to retain the requirement that each 
qualifying entity demonstrate through its operating history that it is 
a bona fide business.
    In addition, the definition of ``entity'' for purposes of 
exceptions 1 and 2 includes ``a group of legal persons'' that are 
contractually obligated to make co-investments and have previously made 
at least one such investment. Some commenters recommended that the 
definition be broader and include: (1) Entities that have entered into 
a co-investment agreement, but have not yet made a co-investment; or 
(2) entities that do not have a co-investment agreement, but have made 
previous co-investments. NASD determined not to make this change 
because of the potential abuse that could arise from an illegitimate 
``grouping'' of different entities; the proposed rule preserves the 
requirements of both a co-investment history and an agreement. The 
Commission believes that the proposed definition is reasonable and 
should minimize any potential for abuse.
3. Private Placements With Institutional Investors
    Exception 3 would permit acquisitions in private placements that 
have significant institutional investor participation. This exception 
would permit private placements in which: (1)

[[Page 75700]]

Institutional investors acquire at least 51% of the total offering of 
the issuer's securities; (2) an institutional investor is the lead 
negotiator or lead investor with the issuer and establishes the terms 
of the private placement; and (3) underwriters and related persons do 
not acquire more than 20% of the total offering. Some commenters 
claimed that it should be presumed that institutional investors 
participated in the negotiation of the transaction to the extent 
necessary to protect their interests if they acquire as much as 51% of 
an offering of privately placed securities, and that the ``lead 
negotiator'' or ``lead investor'' requirement is unnecessary. Some 
commenters further asserted that the 20% limitation is too low.
    NASD did not propose any changes in response to these comments. The 
Commission believes that the 20% limitation and the requirement that an 
unaffiliated institutional investor lead the negotiation or serve as 
lead investor are reasonable limitations designed to prevent the 
potential for overreaching that could occur if a member that is 
underwriting an issuer's public offering or its affiliate sets the 
price and terms of a private placement undertaken during the Review 
Period.
a. Definition of ``Institutional Investor''
    For purposes of exceptions 2 and 3, ``institutional investor'' is 
defined as any individual or legal person that has at least $50 million 
invested in securities in the aggregate in its portfolio or under 
management, including investments held by its wholly owned 
subsidiaries; provided that no participating members direct or 
otherwise manage the institutional investor's investments or have an 
equity interest in the institutional investor, either individually or 
in the aggregate, that exceeds 5% for a publicly owned entity or 1% for 
a nonpublic entity. Under a previous version of the proposal, no 
participating member could have any equity interest or management 
responsibility in an entity intending to qualify as an ``institutional 
investor.'' Commenters stated that the definition of ``institutional 
investor'' should be amended to permit some part of the equity interest 
in the entity to be held by participating members. Other commenters 
stated that equity interest should not be the determinative factor, but 
rather control. In response to comments, NASD decided to amend the 
definition to allow an equity interest in the institutional investor, 
either individually or in the aggregate, of up to 5% for a publicly 
owned entity or 1% for a nonpublic entity. The Commisison believes that 
this limitation is reasonable and should help to ensure that only 
institutional investors that are independent of the influence of 
members will count for purposes of exceptions 2 and 3.
4. Acquisitions and Conversions To Prevent Dilution
    Under the proposal, securities of the issuer would be excluded from 
underwriting compensation if the securities were acquired as the result 
of: (i) A qualifying right of preemption or a stock-split or a pro-rata 
rights or similar offering, or (ii) the conversion of securities that 
have not been deemed by NASD to be underwriting compensation. In 
addition, the only terms of the purchased securities that could be 
different from the terms of securities purchased by other investors 
would be pre-existing contractual rights that were granted in 
connection with a prior purchase. Further, the opportunity to purchase 
must have been provided to all similarly situated securityholders. 
Finally, the amount of securities purchased or received must not have 
increased the recipient's percentage ownership of the same generic 
class of securities of the issuer, except in the case of conversions 
and passive increases that result from another investor's failure to 
exercise its own rights.
    Under a previous version of the proposal, this exception would not 
have applied to any purchase or acquisition that increased the 
participating member's percentage ownership of the same generic class 
of securities of the issuer. In response to comments, NASD revised the 
exception to permit passive increases in ownership that may be the 
result of another investor's failure to exercise its own preemptive 
rights.
    The Commission agrees with NASD that this exception does not raise 
concerns about overreaching and abusive practices that the Rule was 
designed to address because purchases pursuant to a right of preemption 
are based on a purchase right granted to the purchaser in a prior 
investment and thus, the acquisition is not compensation for a 
subsequent public offering. The Commission further believes that the 
limitations of the exception should help to ensure that only securities 
acquired pursuant to a valid right of preemption will be eligible to be 
excluded from the underwriting exception. The Commission also believes 
that it is reasonable to permit passive increases in ownership that may 
be the result of another investor's failure to exercise its own 
preemptive rights. The Commission notes that shareholders frequently 
must decide whether to exercise their preemptive rights without knowing 
whether other shareholders will do the same. Consequently, without an 
exception for passive increases, it would be virtually impossible to 
determine in advance whether shares acquired pursuant to a right of 
preemption would be deemed underwriting compensation.
5. Purchases Based on a Prior Investment History
    This exception would exempt acquisitions made in private placements 
during the Review Period by participating members in order to prevent 
dilution of a long-standing equity interest in the issuer. In order to 
be eligible for the exception, the investor must have made at least two 
prior purchases of the issuer's securities: one investment must be made 
at least 24 calendar months before the required filing date and another 
more than 180 days before the required filing date. Commenters 
suggested various shorter time period requirements for the initial 
acquisitions that would broaden the availability of the exception. NASD 
included this exemption in response to comments on the original 
proposal. NASD has stated that the time periods correspond roughly to 
investments the Department has recognized in the course of its filing 
reviews as typical of early round financing by long-term venture 
capital investors in start-up companies in the late 1990's and 2000. 
The Commission believes that this exemption is reasonable and would 
codify NASD's historic practice of exempting such securities from 
underwriting compensation. In addition, the Commission believes that 
the proposed time periods are reasonable in that they reflect NASD's 
experience with such acquisitions.
6. Financial Consulting and Advisory Arrangements
    Prior versions of the proposal contained an exemption that 
addressed securities acquired in connection with financial consulting 
and advisory services. A commenter suggested that the Department 
continue to evaluate whether the receipt of securities paid in 
connection with these services are underwriting compensation on a case-
by-case basis, rather than solely relying on the proposed exception. 
NASD determined that these arrangements are so fact specific that in 
many cases they do not fit well into a codified exception and, thus, 
proposed to delete this exception. Consequently, the Department would 
continue to analyze the receipt of both cash and securities in 
connection with financial consulting

[[Page 75701]]

and advisory services based on the particular facts and circumstances 
in the arrangements. The Commission believes that it is within NASD's 
discretion to delete this exception and to continue to review such 
acquisitions based on the particular facts and circumstances.

E. Lock-Up Restriction

    Under the proposal, common or preferred stock, options, warrants, 
and other equity securities of the issuer that are unregistered and 
acquired by an underwriter and related person within 180 days before 
the filing of the registration statement, or acquired after the filing 
of the registration statement and deemed to be compensation by NASD, 
would be subject to a 180-day lock-up. The proposed lock-up also would 
prohibit certain derivative transactions.\25\ In addition, the proposal 
contains several exceptions to the lock-up restriction for transfers of 
securities, including, but not limited to, transfers of securities that 
are not considered to be an item of value, transfers by operation of 
law or reorganization of the issuer, and transfers of securities that 
were previously, but no longer are, subject to a lock-up restriction in 
connection with a prior public offering.
---------------------------------------------------------------------------

    \25\ However, as discussed above, debt securities and derivative 
instruments (1) that are not items of value, or (2) that are 
eligible for the limited filing requirement in NASD Rule 
2710(b)(6)(A)(iv) and have not been deemed to be underwriting 
compensation by the Department under the Rule will not be subject to 
the lock-up.
---------------------------------------------------------------------------

    Under the original version of the proposal, a 180-day lock-up 
restriction would have applied to all equity securities of the issuer 
that are held by any underwriter and related person at the time of 
effectiveness of the public offering, unless the securities or 
transaction complied with an exception. In response to comments, NASD 
determined to limit the 180-day lock-up to unregistered equity or 
convertible-to-equity securities and certain derivatives held by 
underwriters and related persons and acquired during the Review Period. 
Despite contrary views of commenters, NASD determined to retain the 
lock-up provision in connection with secondary offerings. However, the 
proposal would provide an exception from the lock-up restrictions for 
Rule 144A securities acquired after the completion of the issuer's IPO. 
In addition, in response to comments, NASD is proposing to amend the 
proposed rule change to clarify that members may participate in public 
offerings in which the members, their affiliates or associated persons 
are offering their shares or are selling security-holders of another 
issuer. NASD has stated that it intended to permit such participation, 
but the prior version of the proposal was unclear.
    The Commission believes that the proposed lock-up restrictions, and 
exceptions thereto, are reasonably designed to protect the aftermarket 
in a new security from the potential for fraud and manipulation that 
exists when a member is an underwriter, actively trades the securities, 
and is a selling security-holder. The Commission further believes that 
the proposed prohibition against any hedging, short sale, derivative, 
put, or call transaction that would result in the effective economic 
disposition of the securities should help to prevent circumvention of 
the lock-up restrictions.

F. Exemptive Authority

    Under the proposal, the NASD has retained the ability to grant 
exemptions from any provision of the Rule, if such exemption is 
consistent with the purposes of the Rule, the protection of investors, 
and the public interest. The Commission believes that this exemptive 
authority is reasonable and should give NASD the authority to exempt 
transactions that, although covered by the Rule, the Rule was not 
intended to address.
    The Commission finds good cause for accelerating approval of 
Amendment Nos. 6, 7, 8, 9, and 10. The Commission notes that the 
proposed rule change has been previously published twice for 
comment.\26\ Amendment Nos. 6 through 10 respond to the concerns 
previously raised by commenters and make certain technical corrections 
to the proposed rule change. Accordingly, the Commission finds that 
good cause exists, consistent with Sections 15A(b)(6) of the Act,\27\ 
and Section 19(b)(2) of the Act \28\ to accelerate approval of 
Amendment Nos. 6 through 10 to the proposed rule change prior to the 
thirtieth day after publication in the Federal Register.
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    \26\ See supra notes 6 and 10.
    \27\ 15 U.S.C. 78o-3(b)(6).
    \28\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 6 through 10, including whether the 
amendments are consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street NW, Washington, DC 
20549-0609. Comments may also be submitted electronically at the 
following e-mail address: [email protected]. All comment letters 
should refer to File No. SR-NASD-00-04. This file number should be 
included on the subject line if e-mail is used. To help the Commission 
process and review comments more efficiently, comments should be sent 
in hard copy or by e-mail but not by both methods.
    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. Copies of such filing will also be 
available for inspection and copying at the principal office of NASD. 
All submissions should refer to File No. SR-NASD-00-04 and should be 
submitted by January 21, 2004.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\29\ that the proposed rule change (SR-NASD-00-04), as amended, is 
approved, and Amendment Nos. 6 through 10 are approved on an 
accelerated basis.
---------------------------------------------------------------------------

    \29\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\30\
---------------------------------------------------------------------------

    \30\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-32183 Filed 12-30-03; 8:45 am]
BILLING CODE 8010-01-P