[Federal Register Volume 69, Number 242 (Friday, December 17, 2004)]
[Proposed Rules]
[Pages 75774-75795]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-27434]



[[Page 75773]]

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Part III





Securities and Exchange Commission





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17 CFR Parts 228, 229 et al.



Amendments to Regulation M: Anti-Manipulation Rules Concerning 
Securities Offerings; Proposed Rule

  Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / 
Proposed Rules  

[[Page 75774]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 228, 229, 230, 240 and 242

[Release Nos. 33-8511; 34-50831; IC-26691; File No. S7-41-04]
RIN 3235-AF54


Amendments to Regulation M: Anti-Manipulation Rules Concerning 
Securities Offerings

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (Commission) is 
proposing amendments to Regulation M under the Securities Exchange Act 
of 1934 (Exchange Act), which governs the activities of underwriters, 
issuers, selling security holders, and others in connection with 
offerings of securities. The proposed amendments are intended to 
prohibit certain activities by underwriters and other distribution 
participants that can undermine the integrity and fairness of the 
offering process, particularly with respect to allocations of offered 
securities. The proposal also seeks to enhance the transparency of 
syndicate covering bids, which may affect the aftermarket price and 
trading of an offered security, and prohibit the use of penalty bids. 
The amendments also are intended to update certain definitional and 
operational provisions in light of market developments since Regulation 
M's adoption. As a consequence of these proposed amendments to 
Regulation M, we are also recommending corresponding changes to 
disclosure rules under the Securities Act of 1933 (``Securities Act'') 
as well as changes to certain recordkeeping rules under the Exchange 
Act.

DATES: Comments should be received on or before February 15, 2005.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-41-04 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.

All submissions should refer to File Number S7-41-04. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for public inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW., Washington, 
DC 20549. All comments received will be posted without change; we do 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: James Brigagliano, Assistant Director, 
Joan Collopy, Special Counsel, Elizabeth Sandoe, Special Counsel, Liza 
Orr, Special Counsel, Elizabeth Marino, Attorney, or Denise Landers, 
Attorney Fellow, Office of Trading Practices and Processing, Division 
of Market Regulation, at (202) 942-0772, at the Securities Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is requesting public comment 
on proposed amendments to Regulation M [17 CFR 242.100, 242.101, 
242.102, and 242.104], proposed rule 106 to the Regulation and Rule 
17a-2 [17 CFR 240.17a-2] under the Exchange Act.

I. Introduction

    Manipulation interferes with the securities markets' fundamental 
function as an independent pricing mechanism and undermines the 
markets' integrity and fairness. Under the securities laws, Congress 
granted the Commission broad authority to combat manipulative conduct. 
The Commission, in turn, has recognized that special opportunities and 
incentives for manipulation arise in securities offerings and has 
determined that certain offerings require specific regulation.\1\ 
Consequently, the Commission has focused its regulation on market 
activities that could artificially facilitate an offering.
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    \1\ The primary focus of Regulation M, and its predecessor Rule 
10b-6, is (1) offerings that raise manipulative concerns, defined as 
distributions; (2) persons who are likely to engage in manipulative 
activity; and (3) the activities that likely could raise or support 
the security's price. Securities Exchange Act Release No. 33924 
(April 19, 1994), 59 FR 21681, 21684 (``Regulation M Concept 
Release'') (stating that a person contemplating or making a 
distribution has an obvious incentive to artificially influence the 
price of the securities in order to facilitate the distribution or 
increase its profitability and citing Bruns, Nordeman & Co., 40 SEC 
652, 660 n.11 (1961)); Securities Exchange Act Release No. 38067 
(December 20, 1996), 62 FR 520 (January 3, 1997) (``Regulation M 
Adopting Release'').
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    Because price integrity is essential during a securities offering, 
the Commission adopted rules to proscribe and regulate activities that 
offering participants could use to manipulate the price of the offered 
security. The anti-manipulation rules were first codified in 1955,\2\ 
and today, Regulation M incorporates these provisions.\3\ Regulation M, 
among other things, prohibits issuers, selling security holders, 
underwriters, broker-dealers, and other distribution participants \4\ 
from directly or indirectly bidding for, purchasing, or attempting to 
induce any person to bid for or purchase any security that is the 
subject of the distribution during the applicable restricted period.\5\ 
Regulation M proscribes activities that may increase a security's 
offering price, and so increase the offering proceeds; or may stabilize 
the market price of an offered security in order to avoid a price 
decline during the sales period or in the immediate aftermarket, or to 
induce or attempt to induce prospective investors to buy in the 
aftermarket.
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    \2\ Securities Exchange Act Release No. 5194 (July 5, 1955), 20 
FR 5075.
    \3\ Regulation M replaced former Rules 10b-6, 10b-6A, 10b-7, 
10b-8, and 10b-21. See Regulation M Adopting Release, 62 FR at 520. 
Rules 101, 102, and 103 of Regulation M apply to distributions of 
securities, defined as an offering of securities, whether or not 
subject to registration under the Securities Act that are 
distinguished from ordinary trading by the magnitude of the offering 
and the presence of special selling efforts and selling methods. 
Rule 104 of Regulation M applies to offerings of securities, which 
generally encompasses all methods of offering and selling securities 
to investors. Regulation M Adopting Release, 62 FR at 535, n. 116. 
Rule 105 applies to offerings registered under the Securities Act, 
except offerings that are not firm commitment underwritings. 17 CFR 
242.100 through 105.
    \4\ Under Regulation M, ``distribution participant'' is defined 
as an underwriter, prospective underwriter, broker, dealer, or other 
person who has agreed to participate or is participating in a 
distribution. 17 CFR 242.100(b).
    \5\ See supra note 3 for the definition of distribution. 17 CFR 
242.100(b).
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    Although the general antifraud and anti-manipulation provisions of 
the federal securities laws (e.g., Section 17(a) of the Securities Act, 
and Sections 9(a), 10(b), and 15(c) of the Exchange Act \6\ and Rule 
10b-5 under the

[[Page 75775]]

Exchange Act \7\) apply to all securities transactions, Regulation M 
takes a prophylactic approach and is focused on particular activities 
in connection with securities offerings.\8\ Rather than addressing 
manipulation after the fact, Regulation M seeks to prevent it by 
generally precluding certain persons from engaging in specified market 
activities. Also, unlike the more general anti-manipulation provisions, 
Regulation M does not require the Commission to prove in an enforcement 
action that distribution participants have a manipulative intent or 
purpose. As a prophylactic, anti-manipulation measure, Regulation M is 
designed to prohibit activities that could artificially influence the 
market for the offered security, including, for example, supporting the 
offering price by creating the exaggerated perception of scarcity of 
the offered security or creating the misleading appearance of active 
trading in the market for the security.
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    \6\ 15 U.S.C. 77q(a); 15 U.S.C. 78i(a), 78j(b), and 78(o)(c).
    \7\ 17 CFR 240.10b-5.
    \8\ See Regulation M Concept Release, 59 FR at 21687 (noting 
purpose of the anti-manipulation rules is to limit the scope of 
market activity during securities offerings in order to 
prophylactically prevent manipulation).
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    Regulation M consists of six rules. Rule 100 contains definitions 
of terms under Regulation M. Rule 101 governs the activities of 
underwriters and other persons participating in a distribution of 
securities and their affiliated purchasers.\9\ Rule 102 governs the 
activities of the issuer, selling security holders and their affiliated 
purchasers. Rule 103 describes the conditions for permissible 
``passive'' market making during the restricted period for a 
distribution of a Nasdaq security. Rule 104 governs stabilization, 
syndicate short covering activity, and penalty bids. Rule 105 prohibits 
covering short sales with offered securities purchased from an 
underwriter, broker, or dealer participating in an offering. Since 
Regulation M's adoption in 1996, the Commission has examined 
underwriting practices and aftermarket activities. In recent years, 
anti-manipulation regulation has been extensively and intensively 
scrutinized, with a particular focus on initial public offerings 
(``IPOs'').\10\ Recent Commission \11\ and SRO \12\ actions and private 
litigation \13\ have addressed certain misconduct in connection with 
IPOs.
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    \9\ 17 CFR 242.101. An affiliated purchaser generally means a 
person acting, directly or indirectly, in concert with a 
distribution participant, issuer or selling security holder in 
connection with the acquisition or distribution of any covered 
security or an affiliate of a distribution participant, issuer or 
selling security holder, that directly or indirectly, controls the 
purchases of any covered security by a distribution participant, 
issuer, or selling security holder, whose purchases are controlled 
by or under common control with any such person. See 17 CFR 
242.100(b).
    \10\ See, e.g., NYSE/NASD IPO Advisory Committee, Report and 
Recommendations (http://www.nyse.com/pdfs/iporeport.pdf) (May 2003) 
(IPO Blue Ribbon Report); NASD Notice to Members 03-79 (December 
2003) (adopting NASD Rule 2790 to prohibit sales of new issues to 
any account in which a restricted member has a beneficial interest); 
NASD Notice to Members 03-72 (November 2003) (proposing additional 
amendments to NASD Rule 2712 Governing Allocations and Distributions 
of Shares in IPOs (SR-NASD-2003-140)); NASD Notice to Members 97-34 
(June 1997) (launching initial public offering tracking system by 
The Depository Trust Company to monitor flipping).
    \11\ See, e.g., SEC v. J.P. Morgan Securities, Inc., No. 03 Civ. 
02028 (D.D.C. 2003), Complaint, (alleging violations of Regulation 
M); SEC v. Robertson Stephens, Inc., Final Judgment of Permanent 
Injunction and Other Relief Against Robertson Stephens, Inc., 03 
Civ. 0027 (RL) (D.D.C. 2003), Complaint ]] 1, 5 (alleging violations 
of NASD Conduct Rules 2110 and 2330 and Section 17(a) of the 
Exchange Act and Rule 17a-3(a)(6) thereunder for improperly sharing 
customer profits by allocating ``hot'' IPO shares to customers and 
receiving in return shares of customer profits via excessive 
commissions or markdowns); SEC v. Credit Suisse First Boston Corp., 
No. 1:02 CV 00090, 2002 WL 479836 (D.D.C. 2002), Complaint, ]] 1, 6 
(alleging violations of NASD Conduct Rules 2110 and 2330 and Section 
17(a) under the Exchange Act and Rule 17a-3(a)(6) thereunder, for 
encouraging customers to channel profits from hot IPOs via excessive 
brokerage commissions); In the Matter of Michael J. Markowski, 
Securities Exchange Act Release No. 44086 (March 20, 2001) (finding 
a Rule 10b-6 violation when a broker-dealer firm instructed its 
brokers to solicit aftermarket orders during the distribution).
    \12\ See NASD Notice to Members 4-50 (July 2004) (announcing 
Bear Stearns & Co., Inc., Deutsche Bank Securities Inc., and Morgan 
Stanley & Co., Inc. were censured for engaging in improper IPO 
allocation practices and profit-sharing with customers by charging 
excessive commissions on listed agency trades within one day of 
allocating IPO shares to those customers). See also supra note 10, 
and accompanying text (detailing recent NASD actions to address the 
IPO allocation process).
    \13\ See In re Initial Public Offering Securities Litigation, 
241 F. Supp. 2d 281 (S.D.N.Y. 2003) (denying defendant underwriters' 
motion to dismiss in case involving multiple allocating underwriters 
charged with market manipulation for requiring customers to engage 
in tie-in agreements and to pay undisclosed excessive compensation 
in order to receive allocations of IPO stock). See also In re 
Initial Public Offering Antitrust Litigation, 287 F. Supp. 2d 497 
(S.D.N.Y. 2003) (finding that investors could not pursue antitrust 
claims against underwriters whom they alleged conspired to inflate 
aftermarket prices under doctrine of implied immunity); Friedman v. 
Salomon Smith Barney, Inc., 313 F.3d 796, 801 (2nd Cir. 2002) 
(finding that underwriters and brokers are immune from antitrust 
liability for price stabilization practices in the aftermarket since 
it is the exclusive jurisdiction of the Securities and Exchange 
Commission).
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    On the basis of these developments, today we are proposing 
revisions to Regulation M and the addition of a new rule.\14\ Our 
proposals would:
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    \14\ The Commission staff previously addressed manipulative 
conduct related to tie-in arrangements and solicitations for 
aftermarket purchases of an offered security in violation of 
Regulation M. See Division of Market Regulation: Staff Legal 
Bulletin No. 10 ``Prohibited Solicitations and `Tie-in' Agreements 
for Aftermarket Purchases'' (August 25, 2000) (Staff Legal Bulletin 
10). Although the aforementioned conduct would violate Regulation M 
or other provisions of the federal securities laws, or both, 
proposed Rule 106 would expressly prohibit the full array of 
fraudulent and manipulative conduct related to allocations of 
offered shares.
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     Amend Rule 100's definition of ``restricted period'' with 
respect to IPOs and to expressly reflect the Commission's long-standing 
application of the definition in the context of mergers, acquisitions, 
and exchange offers;
     Amend Rule 101's ``de minimis exception'' to require 
recordkeeping;
     Amend Rules 100, 101, and 102 to update the average daily 
trading volume (ADTV) value and public float value qualifying 
thresholds for purposes of the ``restricted period'' definition and the 
``actively-traded'' securities and ``actively-traded'' reference 
securities exceptions;
     Amend Rule 104 to require disclosure of syndicate covering 
bids and to prohibit penalty bids;
     Amend Rule 104(j)(2) to include reference securities in 
the exception for transactions in securities eligible for resale under 
Rule 144A; and
     Adopt new Rule 106 to expressly prohibit conditioning the 
award of allocations of offered securities on the receipt of 
consideration in addition to the stated offering consideration.

As a consequence of these proposals, we are also recommending 
amendments to Rule 481 and Item 508 of Regulations S-K and S-B under 
the Securities Act concerning disclosure, and Rules 17a-2 and 17a-4 
with respect to recordkeeping. We solicit specific comment on our 
approach and the specific proposals. We encourage commenters to present 
data on our proposals and any suggested alternative approaches.

II. Discussion of Proposed Amendments to Regulation M

A. Rule 100(b)

1. ``Restricted Period'' for IPOs
    The Commission is proposing to amend the definition of ``restricted 
period'' in Rule 100(b) with respect to IPOs.\15\ Specifically, the 
Commission is

[[Page 75776]]

proposing new paragraph (4) to the definition to provide that the 
restricted period for an IPO would extend from the earlier of: (1) The 
period beginning at the time an issuer reaches an understanding with a 
broker-dealer that is to act as an underwriter, or such time that a 
person becomes a distribution participant; or (2) if there is no 
underwriter, the period beginning at the time the registration 
statement is filed with the Commission or other offering document is 
first circulated to potential investors, or such time that a person 
becomes a distribution participant, and would conclude when the 
distribution is completed.\16\
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    \15\ 17 CFR 242.100(b) states that restricted period means: (1) 
For any security with an ADTV value of $100,000 or more of an issuer 
whose common equity securities have a public float value of $25 
million or more, the period beginning on the later of one business 
day prior to the determination of the offering price or such time 
that a person becomes a distribution participant, and ending upon 
such person's completion of participation in the distribution; and 
(2) For all other securities, the period beginning on the later of 
five business days prior to the determination of the offering price 
or such time that a person becomes a distribution participant, and 
ending upon such person's completion of participation in the 
distribution. (3) In the case of a distribution involving a merger, 
acquisition, or exchange offer, the period beginning on the day 
proxy solicitation or offering materials are first disseminated to 
security holders, and ending upon the completion of the 
distribution.
    \16\ A distribution is generally considered completed when the 
securities in the distribution have been distributed or acquired for 
investment, e.g., when an underwriter's participation has been 
distributed and any stabilization arrangements and trading 
restrictions in connection with the distribution have been 
terminated. 17 CFR 242.100(b). Provided, however, that an 
underwriter's participation will not be deemed to have been 
completed if a syndicate overallotment option is exercised in an 
amount that exceeds the net syndicate short position at the time of 
such exercise. Id. For a selling group member that is not part of 
the underwriting syndicate, its participation is completed when the 
selling group member has sold its entire allotment.
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    As defined in Rule 100(b), ``restricted period'' is the time period 
during which covered persons must refrain from directly or indirectly 
bidding for, purchasing, or attempting to induce any person from 
bidding for, or purchasing a covered security.\17\ The length of the 
restricted period is based on the liquidity of a security's trading 
market, specifically the value of the average daily trading volume 
(``ADTV'')\18\ of the security and the value of the public float \19\ 
of the issuer.\20\ If a covered security has an ADTV value of $100,000 
or more and a public float value of $25 million or more, then the 
restricted period begins on the later of one business day prior to the 
determination of the offering price, or such time that a person becomes 
a distribution participant (``one-day security'').\21\ If a covered 
security's ADTV and public float values are less than $100,000 and $25 
million respectively, then the restricted period commences on the later 
of five business days prior to the determination of the offering price 
or such time that a person becomes a distribution participant (``five-
day security'').\22\ The restricted period generally ends, for all 
securities, upon such person's completion of participation in the 
distribution.\23\ However, distribution participants and their 
affiliated purchasers are not subject to a restricted period for a 
covered security that has an ADTV value of at least $1 million and a 
public float value of at least $150 million (``actively-traded 
securities'').\24\ Issuers, selling security holders, and their 
affiliated purchasers are not subject to a restricted period with 
respect to reference securities that have an ADTV value of at least $1 
million and a public float value of at least $150 million.\25\
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    \17\ A covered security is defined as ``any security that is the 
subject of the distribution, or any reference security.'' A 
reference security is defined as a ``security into which a security 
that is the subject of a distribution (`subject security') may be 
converted, exchanged, or exercised or which, under the terms of the 
subject security, may in whole or in significant part determine the 
value of the subject security. 17 CFR 242.100(b).
    \18\ ADTV is defined as the worldwide average daily trading 
volume during the two full calendar months immediately preceding, or 
any 60 consecutive calendar days ending within the 10 calendar days 
preceding, the filing of the registration statement; or, if there is 
no registration statement or if the distribution involves the sale 
of securities on a delayed basis pursuant to 230.415 of this 
chapter, two full calendar months immediately preceding, or any 
consecutive 60 calendar days ending within the 10 calendar days 
preceding, the determination of the offering price. 17 CFR 
242.100(b).
    \19\ Rule100(b) provides that ``public float value shall be 
determined in the manner set forth on the front page of Form 10-K 
even if the issuer of such securities is not required to file Form 
10-K * * *.'' 17 CFR 242.100(b).
    \20\ However, if the distribution involves a corporate action, 
current subparagraph (3) of the restricted period governs the 
commencement of the restricted period. This is the day that proxy 
solicitation or offering materials are mailed. Additionally, current 
paragraphs (1) and (2) of the restricted period definition would 
apply to any valuation or election period in connection with the 
corporate action.
    \21\ 17 CFR 242.100(b) definition of restricted period, 
subparagraph (1).
    \22\ 17 CFR 242.100(b) definition of restricted period, 
subparagraph (2).
    \23\ See supra note 15.
    \24\ 17 CFR 242.101(c)(1) (providing an exception for actively-
traded covered securities if the distribution participant or its 
affiliated purchasers did not issue the security). We note, however, 
that there is no actively-traded securities exception for IPOs 
because they have no trading market.
    \25\ 17 CFR 242.102(d)(1) (providing an exception for actively-
traded reference securities if the issuer or its affiliated 
purchasers did not issue the reference security). Rule 102 did not 
except all actively-traded reference securities, because the 
Commission determined that issuers and selling security holders have 
a high stake in the proceeds of an offering (and thus, an incentive 
to manipulate), and so, should not be able to trade in their 
securities, whether or not they are actively-traded. Regulation M 
Adopting Release, 62 FR at 531.
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    The restricted period provides a defined period of time during 
which the effects of a distribution participant's bids, purchases, or 
attempts to induce bids or purchases on the market price for a security 
may dissipate. It therefore allows other market participants to observe 
trading in the offered security unaffected by the activity of persons 
with an incentive to facilitate the distribution. With a one or five-
day restricted period, investors and market participants should observe 
prices in the offered security that result from the natural forces of 
supply and demand.
    A recent enforcement case alleged that a broker-dealer, prior to 
the pricing of IPOs, induced and attempted to induce investors to make 
aftermarket bids or purchases.\26\ Inducements and attempts to induce 
aftermarket bids or purchases by distribution participants in order to 
facilitate a securities distribution interfere with the securities 
markets' function as an independent pricing mechanism and undermine the 
integrity of the capital raising process.\27\ The activity often 
creates the exaggerated perception to investors of scarcity of IPO 
stock and can affect the pricing of the offering.
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    \26\ See SEC v. J.P. Morgan Securities, Inc., supra note 11.
    \27\ Regulation M's proscription of attempts to induce bids and 
purchases are not intended to interfere with legitimate book-
building. The determination as to whether an activity or 
communication constitutes legitimate book-building or an attempt to 
induce a bid or purchase in violation of Regulation M depends on the 
particular facts and circumstances surrounding such activity or 
communication.
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    The restricted period definition references trading market 
information, i.e., ADTV and public float, and provides two restricted 
periods based on these thresholds. Paragraph (2) of the definition 
provides that ``for all other securities'' that do not satisfy the ADTV 
and public float levels in paragraph (1) of the definition, the 
restricted period is five days. Currently, the absence of a trading 
market for IPOs has meant that the five-day restricted period applies 
to IPOs.
    In the case of IPOs, however, the market influences underlying the 
one and five-day restricted periods do not apply. There is no trading 
market that would provide an independent pricing mechanism for 
prospective investors to evaluate the IPO price set by underwriters. 
Therefore, any inducement activity by underwriters and other 
distribution participants can have long-lasting effects.
    Attempts to induce aftermarket bids or purchases that occur earlier 
than five days before IPO pricing can affect the pricing of an 
offering. Thus, the Commission believes that current Rule 100's 
application to IPOs that results in a restricted period that commences 
five

[[Page 75777]]

days prior to pricing an IPO is inadequate to address potentially 
manipulative conduct because attempts to induce aftermarket bids and 
purchases are inappropriate at any time prior to the pricing and 
distribution of an IPO.
    In order to combat manipulative abuses in connection with IPOs, the 
Commission is proposing new paragraph (4) to the definition of 
restricted period to specify that in the case of an IPO, the restricted 
period generally begins the earlier of: when the issuer reaches an 
understanding with the broker-dealer that is to act as its underwriter, 
or such time that a person becomes a distribution participant; or if 
there is no underwriter, when the registration statement is filed with 
the Commission or other offering document is first circulated to 
potential investors, or such time that a person becomes a distribution 
participant.\28\ Additionally, the Commission is proposing to define 
IPO in Rule 100(b) to mean an issuer's first offering of a security to 
the public in the United States, and if prior to the offering the 
issuer's equity securities do not have a public float value, and the 
IPO would be an issuer's first offering of an equity security to the 
public in the United States. We propose to use this definition of IPO 
so that if an issuer's first offering of a security in the United 
States is debt, then both that debt offering and the issuer's first 
offering of an equity security in the United States would fall within 
this proposed definition of IPO. However, if an offered equity security 
already has a trading market either domestically or abroad for which 
ADTV and public float values may be calculated, then the equity 
offering would not be an IPO, and either a one or five-day restricted 
period would apply based on the ADTV and public float values. We also 
note that the actively-traded security or reference security exception 
would not apply to IPOs.
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    \28\ An underwriter is defined as a person who has agreed with 
an issuer or selling security holder: (1) To purchase securities for 
distribution; or (2) to distribute securities for or on behalf of 
such issuer or selling security holder; or (3) to manage or 
supervise a distribution of securities for or on behalf of such 
issuer or selling security holder. 17 CFR 242.100(b).
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    Q. Is there a different restricted period that should apply to IPOs 
that would more appropriately restrict potentially manipulative 
activity? Should the restricted period for IPOs begin earlier than 
proposed? Should the restricted period begin with the filing of the 
registration statement (or with the first circulation of an offering 
document to potential investors) for all IPOs, including IPOs that have 
an underwriter? Please provide specific reasons and information to 
support an alternative recommendation. Please provide empirical data, 
when possible, and cite to economic studies, if any, to support any 
alternative approaches.
2. Amendments to Rule 100(b)--``Restricted Period'' for Corporate 
Actions \29\
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    \29\ Restricted period means in the case of a distribution 
involving a merger, acquisition, or exchange offer, the period 
beginning on the day proxy solicitation or offering materials are 
first disseminated to security holders, and ending upon the 
completion of the distribution. 17 CFR 242.100(b).
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    The Commission has a long-standing interpretation under both 
Regulation M and its predecessor, Rule 10b-6, that the restricted 
period for mergers, acquisitions, and exchange offers includes 
valuation and election periods.\30\ Valuation periods refer to time 
periods when the offered security's market price is a factor in 
determining the consideration paid in a corporate action.\31\ Election 
periods refer to time periods when shareholders have the right to elect 
among various forms of consideration.\32\ These periods have been 
considered by the Commission to be included in the restricted period 
because they are deemed part of the distribution, and valuation and 
election periods are price-sensitive times during which the incentive 
for interested persons to manipulate is high. Currently, the Rule 
100(b) definition of restricted period for mergers, acquisitions, and 
exchange offers refers to ``the period beginning on the day proxy 
solicitation or offering materials are first disseminated to security 
holders * * *'' but the rule text itself does not explicitly refer to 
valuation and election periods.\33\
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    \30\ See Regulation M Adopting Release, 62 FR at 527 (stating 
that consistent with interpretations under Rule 10b-6, a restricted 
period under Regulation M would commence one or five days before the 
commencement of a valuation period, i.e., a period where the market 
price of the offered security would be a factor for determining the 
consideration paid in a merger, acquisition or exchange offer, and 
continue for the duration of such period), citing Securities 
Exchange Act Release No. 19565 (March 14, 1983), 48 FR 10628, 10638 
(stating that ``any period during which the market price of the 
offered security was a factor in determining the consideration to be 
paid pursuant to the merger (`valuation period') * * * the issuer 
was required to cease bidding for or purchasing the security five 
business days prior to and for the duration of the valuation period. 
A similar restriction was applied to any period during which the 
target company shareholders had the right to elect among various 
forms of consideration offered in connection with [a] merger 
(`election period').''). See also Division of Market Regulation 
Staff Legal Bulletin No. 9: Frequently Asked Questions About 
Regulation M (revised April 12, 2002) available at http://www.sec.gov/interps/legal/mrslb9.htm (stating ``the restricted 
period includes the valuation period as well. For instance, if the 
valuation period occurs outside of the proxy solicitation period, an 
additional restricted period would commence one or five business 
days prior to the commencement of the valuation period and continue 
until the valuation period ends.'').
    \31\ See supra note 30.
    \32\ See supra note 30.
    \33\ 17 CFR 242.100(b).
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    Notwithstanding the long-standing interpretation, the staff 
occasionally receives inquiries about restricted periods concerning 
valuation and election periods in corporate actions. Therefore, we 
believe that expressly stating this interpretation in the rule would be 
beneficial. Accordingly, we propose to amend the definition of the 
restricted period in Rule 100(b) to include valuation and election 
periods and to add definitions for these terms.
    Q. We seek specific comment concerning the proposal to incorporate 
the interpretation concerning election and valuation periods into the 
text of the restricted period definition.

B. Rule 100 Restricted Period Definition and Rules 101 and 102 
Actively-Traded Security Exception: ADTV and Public Float Value 
Thresholds

    As discussed earlier, Rules 101 and 102 of Regulation M prohibit 
certain persons from making bids or purchases during restricted 
periods, as defined in Rule 100(b). The applicable restricted period 
begins either one or five days before determining the offering price 
(or other applicable event) and is determined on the security's ADTV 
value and the issuer's public float value.\34\ Securities that have an 
ADTV value of at least $100,000 of an issuer whose common equity 
securities have a public float value of at least $25 million have a 
restricted period that commences one day prior to the day of the 
pricing of the offering and for securities falling below those 
thresholds a five-day restricted period applies.\35\ The Commission 
additionally determined to except actively-traded securities from the 
provisions of Rule 101, when such securities are not issued by the 
distribution participant or an affiliate thereof.\36\ Similarly, 
actively-traded reference securities are excepted from the provisions 
of Rule 102 when such securities are not issued by the issuer, or any 
affiliate of the issuer, of the security in distribution.\37\ Actively-

[[Page 75778]]

traded securities and reference securities are those with an ADTV value 
of at least $1 million and are issued by an issuer whose common equity 
securities have a public float value of at least $150 million.\38\ In 
effect, these actively-traded securities and reference securities have 
no restricted period.\39\ As discussed below, we now propose to 
increase the thresholds for the applicable restricted periods for the 
actively-traded securities and actively-traded reference securities 
exceptions in order to adjust for inflation since the time of 
Regulation M's adoption in 1996.
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    \34\ See supra Section II.A. for a discussion of restricted 
periods and corresponding ADTV and public float value thresholds.
    \35\ 17 CFR 242.100(b).
    \36\ 17 CFR 242.101(c)(1). Cf., Rule 100(b) definition of 
restricted period. 17 CFR 242.100(b). See also supra note 24.
    \37\ 17 CFR 242.102(d)(1). A reference security is a security 
into which a security that is the subject of a distribution 
(``subject security'') may be converted, exchanged, or exercised or 
which, under the terms of the subject security, may in whole or in 
significant part determine the value of the subject security. 17 CFR 
242.100(b). See also supra note 25.
    \38\ 17 CFR 242.100(b). When Regulation M was adopted, the 
Commission believed the two-part ADTV and public float standard 
appropriately distinguished which securities were more difficult to 
manipulate. The Commission reasoned that the use of a trading volume 
standard alone would permit securities experiencing an unusual 
short-term volume increase in trading to be excepted from the 
restrictions of Rules 101 and 102. To avoid this result, the 
Commission added a public float component to the test, so that 
securities with an unusual increase in trading volume, but with a 
relatively small public float value, would be subject to the 
restricted periods under Rules 101 and 102. Regulation M Adopting 
Release, 62 FR at 527.
    \39\ It should be noted, however, that actively-traded 
securities and reference securities are not excepted from Rule 104 
of Regulation M. 17 CFR 242.104.
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    In excepting actively-traded securities from Rule 101 and actively-
traded reference securities from Rule 102, the Commission believed that 
it was reasonable to rely on market mechanisms to curb the manipulative 
activity addressed by Regulation M.\40\ In particular, the Commission 
reasoned that as the value of trading volume increased, it became less 
likely that a person could, cost-effectively, manipulate the price of 
the security.\41\ Also, the Commission considered that actively-traded 
securities are followed widely by the investment community, and any 
aberrations in the price of an actively-traded stock would be observed 
by the investment community and corrected.\42\ In addition, actively-
traded securities are listed and traded on exchanges or other organized 
markets, and so are relatively transparent and subject to 
surveillance.\43\
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    \40\ Regulation M Adopting Release, 62 FR at 527.
    \41\ Id.
    \42\ Id.
    \43\ Id.
---------------------------------------------------------------------------

    The restricted period threshold levels were intended to apply only 
to those securities where the potential for manipulation was relatively 
limited and which would allow the effects of the market activities of 
distribution participants and issuers to dissipate.\44\ Similarly, the 
Commission believed that the threshold values for the actively-traded 
security exception from Rule 101 and actively-traded reference security 
exception from Rule 102 would except securities as to which the 
potential for a successful manipulation is relatively limited.\45\ The 
Commission is proposing to increase these threshold levels for the 
restricted period and actively-traded security and reference security 
exceptions to adjust for the effect of inflation. Since Regulation M 
was adopted in 1996, the value of the dollar has decreased due to 
inflation and has resulted in the ADTV and public float value 
thresholds becoming less restrictive than when Regulation M was 
initially adopted. As a result, more issuers' securities would now 
qualify for the restricted periods and for the actively-traded security 
exceptions and the lower thresholds may except from Regulation M's 
prohibitions securities that may be more susceptible to manipulation 
than we contemplated at adoption.\46\ Part of this increase in the 
number of actively-traded securities and securities qualifying for a 
one- or five-day restricted period, is due to inflation's effect on the 
value of the dollar.
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    \44\ See discussion supra Section II.A.
    \45\ Regulation M Adopting Release, 62 FR at 527. The Commission 
observed that the exception would not compromise investor protection 
because the general antifraud and anti-manipulation provisions would 
continue to apply to offerings of actively-traded securities. Thus, 
distribution participants (and their affiliated purchasers) would 
continue to be prohibited from influencing the price of such 
securities to facilitate the distribution. Securities Exchange Act 
Release No. 37094 (April 11, 1996), 61 FR 17108, 17112 (April 18, 
1996) (``Regulation M Proposing Release'').
    \46\ When we adopted Regulation M, the Commission estimated 
(based on 1995 data) a total of 4,255 securities would either have a 
one- or five-day restricted period, with 2,693 one-day securities 
and 1,562 five-day securities respectively. Additionally, 1,901 
securities would qualify for the actively-traded security exception. 
Regulation M Adopting Release, 62 FR at 525, n. 37 (based on an 
analysis of NYSE, Amex and Nasdaq-listed securities). Today, based 
on 2003 data, approximately 4,667 securities would either have a 
one- or five-day restricted period, with 2,035 securities one-day 
securities and 2,632 securities five-day securities and 2,352 
securities would qualify for the actively-traded security exception. 
These estimates are based on computations performed by the Office of 
Economic Analysis (``OEA''), July 8, 2004, using the CRSP database.
---------------------------------------------------------------------------

    Because ADTV and public float value are measured in dollars, the 
general change in the value of the dollar since Regulation M's adoption 
has eroded the restrictiveness of the Regulation's threshold values. We 
believe that the level of restrictiveness we employed in 1996 for 
actively-traded securities remains an appropriate threshold, and 
therefore, in order to make the thresholds for the restricted period 
and actively-traded securities and reference securities current, the 
Commission is proposing to increase the ADTV and public float value 
thresholds to account for the decline in the value of the dollar that 
has occurred since 1996 (i.e., adjust the values by the change in the 
Consumer Price Index (``CPI'')). Between 1996 and 2004, the CPI, a 
general measure for the change in the value of the dollar, rose 
approximately 20 percent.\47\ The adjustment of the thresholds to 
reflect the current dollar value should simply reset the thresholds to 
the level of restrictiveness intended when Regulation M was adopted. As 
such, the adjusted thresholds should capture approximately the same 
type of issuers, with similar market liquidity and investment community 
following, as originally contemplated to be excepted when Regulation M 
was adopted.\48\ Thus adjusting the thresholds would express in today's 
dollar value terms the same type of issuer meant to be excepted in 
1996.
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    \47\ The change in CPI is the percentage change in Urban CPI 
measured from July 1996 to July 2004, based on calculations 
performed by OEA.
    \48\ Adjusting the ADTV and public float value thresholds 
upwards for actively-traded securities by 20% would yield 2,353 
issuers, or approximately 31% of all issuers would qualify as 
actively-traded securities. Based on calculations performed by OEA, 
in 1996 approximately 2,338 issuers were deemed actively-traded 
securities, which represented 27% of all issuers.
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    We propose to amend the Rule 100(b) definition of restricted 
period, the Rule 101(c)(1) exception for actively-traded securities, 
and the Rule 102(d)(1) exception for actively-traded reference 
securities to reflect an adjustment to the ADTV and public float values 
for the change in CPI. Specifically we propose to adjust the one-day 
restricted period to require at least $120,000 for ADTV value and $30 
million for public float value, and to adjust the actively-traded 
security and reference security thresholds to require at least $1.2 
million for ADTV value and $180 million for public float value, which 
reflects the change in the CPI Index from 1996 to 2004.
    Q. Should the current thresholds for actively-traded securities, as 
well as the thresholds for one and five-day restricted periods, be 
adjusted by a factor other than CPI? If so, what factor should be used? 
Should the Commission consider adjusting these threshold values for 
this rise in the value of the market since Regulation M was adopted in 
1996, for example, by the change in the S&P 500 or Dow Jones Industrial 
Average? Commenters should provide specific reasons and data in support 
of their statements and any

[[Page 75779]]

alternative measure for adjusting the ADTV and public float values 
suggested.
    Q. Do ADTV and public float values provide an appropriate measure 
on which to base the actively-traded exception? That is, do these 
trading volume and public float criteria adequately identify a 
security's liquidity and depth? Are these criteria sufficient to 
identify securities that are more difficult to manipulate? Should other 
criteria in addition to, or in lieu of, ADTV and public float value be 
used? If so, please provide specific comment on other criteria and 
reasons to support your recommendation.
    Q. Are the current actively-traded securities exception and one and 
five-day restricted periods under Regulation M set at appropriate 
threshold levels? That is, do the current ADTV value and public float 
value thresholds for actively-traded securities and for one and five-
day restricted periods adequately balance the goal of maintaining 
market liquidity with the mandate to protect investors from 
manipulation? If not, what threshold levels would? Commenters should 
provide specific reasons and data in support of their statements and 
any alternative thresholds suggested.

C. Rule 101(b)(7)--De Minimis Exception

    The de minimis exception in Rule 101(b)(7) is intended to excuse 
from Rule 101's trading prohibitions small, inadvertent transactions 
that would not impact the market.\49\ It excepts purchases and 
unaccepted bids during the restricted period that total less than 2% of 
the distributed security's ADTV only if the person making the bid or 
purchase maintains and enforces written policies and procedures 
reasonably designed to achieve compliance with Regulation M. Moreover, 
a firm is expected to ``review its policies and procedures and modify 
them as appropriate'' in order to qualify for the exception.\50\ 
Repeated reliance on this exception by distribution participants or 
their affiliated persons raises concerns about whether the transactions 
were ``inadvertent'' and the adequacy and effectiveness of a firm's 
compliance policies and procedures.\51\
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    \49\ 17 CFR 242.101(b)(7).
    \50\ Regulation M Adopting Release, 62 FR at 530.
    \51\ Regulation M Adopting Release, 62 FR at 530 (stating that 
``[t]he Commission notes that repeated reliance on the exception 
would raise questions about the adequacy and effectiveness of a 
firm's procedures'').
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    From time to time, firms relying on this exception have informed 
the Commission's staff of an inadvertent bid or purchase that occurred 
during the restricted period. However, other firms similarly relying 
upon the exception may not inform the Commission's staff of that 
activity. Consequently, the Commission cannot know with a high degree 
of certainty how often the exception is used, whether certain firms 
repeatedly rely on it, or whether firms have adequate and effective 
procedures qualifying them for the exception.
    Thus, the Commission is proposing to modify Rule 101(b)(7) to 
require firms to create a separate record of each bid or purchase that 
is made in reliance on the de minimis exception, including among other 
things, that brokers and dealers specify the subject security, the day 
the restricted period commenced, the ADTV, and the bids or purchases 
that otherwise would violate Regulation M, including time, price, 
quantity, and market. Brokers and dealers would be required to maintain 
these records pursuant to proposed Exchange Act Rule 17a-4(b)(13). We 
believe this requirement would more easily allow Commission and SRO 
examiners to uncover patterns of abuse or policies and procedures that 
are not reasonably designed to achieve compliance with the rule.
    Q. Is the proposed amendment an effective and efficient manner in 
which to guard against repeated reliance on the exception and promote 
effective compliance policies and procedures? Please provide any 
alternatives.
    Q. Are there other aspects of the de minimis exception that the 
Commission should consider changing? For example, is the 2% ADTV 
threshold appropriate or should it be raised or lowered? Please provide 
data supporting your comment.

D. Rule 104--Syndicate Covering and Penalty Bids

    We propose to amend Rule 104 of Regulation M to require any person 
communicating a bid that is for the purpose of effecting a syndicate 
covering transaction (``syndicate covering bids'') to identify or 
designate the bid as such wherever it is communicated and to prohibit 
the use of penalty bids.\52\ ``Congress granted the Commission broad 
rulemaking authority to combat manipulative abuses in whatever form 
they might take.''\53\ Congress also delegated to the Commission 
exclusive regulatory authority over price stabilization practices 
(i.e., syndicate covering transactions and penalty bids) in Section 
9(a)(6) of the Exchange Act.\54\ ``In exercising its authority, the 
Commission [through Regulation M and its predecessor Rule 10b-6] has 
focused on the market activities of persons participating in a 
securities offering, and determined that securities offerings present 
special opportunities and incentives for manipulation that require 
specific regulatory attention.''\55\ The objective of Regulation M is 
to preclude manipulative conduct by persons with an interest in the 
outcome of an offering and activity that undermines the integrity of 
the markets by interfering with the market's function as an independent 
pricing mechanism. Security offerings are particularly susceptible to 
manipulative abuse because persons, such as underwriters, who stand to 
profit from such offerings have special incentives to manipulate in 
order to facilitate the offerings.
---------------------------------------------------------------------------

    \52\ 17 CFR 242.104. Rule 104 permits underwriters and syndicate 
members, in order to facilitate an offering, to conduct stabilizing 
and other aftermarket activities in compliance with the Rule's 
conditions. Unlike Rules 101 and 102, which apply only to 
distributions, Rule 104 is broader in that it applies to security 
offerings. See Regulation M Adopting Release, 62 FR at 535, n. 116 
and supra note 3.
    \53\ See Regulation M Adopting Release, 62 FR at 520.
    \54\ See Friedman v. Salomon Smith Barney, Inc., 2000 U.S. Dist. 
LEXIS 17785 (S.D.N.Y. 2000), aff'd 313 F.3d 796 (2d Cir. N.Y. 2002) 
(dismissing plaintiffs' claims on the basis that the defendants' use 
of penalty bids and other price stabilization practices used to 
combat flipping were subject to regulation by the Commission under 
Section 9(a)(6) of the Exchange Act and, therefore, immune from 
anti-trust attack).
    \55\ Regulation M Adopting Release, 62 FR at 520.
---------------------------------------------------------------------------

    Syndicate covering transactions occur when the managing underwriter 
places a bid or effects a purchase on behalf of the underwriting 
syndicate in order to reduce a syndicate short position created in 
connection with the offering.\56\ Penalty bids are a means by which the 
managing underwriter may impose a financial penalty on syndicate 
members whose customers sell offering shares in the immediate 
aftermarket.\57\ Syndicate covering transactions and penalty bids may 
have the effect of stabilizing the market price in connection with an 
offering, by preventing or retarding a decline in the market price of 
the offered security once aftermarket trading commences.\58\
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    \56\ A syndicate covering transaction is the placing of any bid 
or the effecting of any purchase on behalf of the sole distributor 
or the underwriting syndicate or group to reduce a short position 
created in connection with the offering. 17 CFR 242.100(b).
    \57\ A penalty bid is an arrangement that permits the managing 
underwriter to reclaim a selling concession from a syndicate member 
in connection with an offering when the securities originally sold 
by the syndicate member are purchased in syndicate covering 
transactions. 17 CFR 242.100(b).
    \58\ ``Stabilizing'' means ``the placing of any bid, or the 
effecting of any purchase, for the purpose of pegging, fixing, or 
maintaining the price of a security.'' 17 CFR 242.100(b). When 
adopting Regulation M, the Commission noted that ``syndicate short 
covering transactions and the imposition of penalty bids by 
underwriters are activities that can facilitate an offering in a 
manner similar to stabilization.'' Regulation M Adopting Release, 62 
FR at 537. Before Rules 10b-6 and 10b-7 were adopted, the Commission 
considered syndicate covering transactions to be a means of 
facilitating the distribution by supporting the market price of an 
offered security. Exchange Act Release No. 3506 (November 16, 1943), 
11 FR 10965 (describing the conditions under which syndicate 
covering transactions may facilitate an offering). Stabilization, 
and syndicate covering transactions, are permitted only to prevent 
or retard a decline in the market price, and may not be used to 
raise the market price, or create a false or misleading appearance 
of either active trading in a security or with respect to the 
trading market for the offered security. Id. See also Proposed 
Rules: Stabilizing to Facilitate a Distribution, Securities Exchange 
Act Release No. 28732 (January 3, 1991), 56 FR 814.

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[[Page 75780]]

    To enhance the transparency of syndicate covering transactions, we 
are proposing to amend paragraph (h)(2) of Rule 104 to require 
identification or designation of syndicate covering bids, analagous to 
the identification of stabilizing bids.\59\ Specifically, the proposal 
would require a managing underwriter or other person communicating a 
bid that is for the purpose of effecting a syndicate covering 
transaction to identify or designate the bid as such wherever it is 
communicated.\60\ The proposal also would prohibit the use of penalty 
bids, as discussed below.
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    \59\ 17 CFR 242.104(h)(1). Consistent with the current 
disclosure requirement for stabilizing bids, the NASD requires 
market makers intending to initiate stabilizing bids to provide it 
with prior notice. See NASD Rule 4614. Stabilizing bids are then 
identified by a symbol on the Nasdaq quotation display. Id. In this 
way, the person engaged in stabilization satisfies the requirement 
to inform the market and the person to whom the bid is made of the 
stabilizing purpose of the bid by notifying the NASD. See Regulation 
M Adopting Release, 62 FR at 537. On the exchanges, underwriters 
must notify the exchange and provide disclosure to the recipient of 
the bid, i.e., the specialist. See NYSE Rule 392; Regulation M 
Adopting Release, 62 FR at 537.
    \60\ Rule 104(h)(2) would continue to require prior notice to 
the self-regulatory organization with direct authority over the 
principal market in the United States for the security for which the 
syndicate covering transaction is effected. 17 CFR 242.104(h)(2).
---------------------------------------------------------------------------

1. Overview of the Current Rule 104
    Rule 104 governs stabilization,\61\ syndicate covering 
transactions,\62\ and penalty bids.\63\ For stabilizing bids, the rule 
currently requires prior notification to the market on which such bids 
are effected and to the person with whom the bid is entered, but for 
syndicate covering transactions and penalty bids, only requires prior 
notification to the relevant SRO.\64\ In the typical offering, the 
syndicate agreement allows the managing underwriter to ``oversell'' the 
offering, i.e., establish a short position beyond the number of shares 
to which the underwriting commitment relates. The underwriting 
agreement with the issuer often provides for an ``overallotment 
option'' whereby the syndicate can purchase additional shares from the 
issuer or selling shareholders in order to cover its short 
position.\65\ To the extent that the syndicate short position is in 
excess of the overallotment option, the syndicate is said to have taken 
an ``uncovered'' short position.\66\ The syndicate short position, up 
to the amount of the overallotment option, may be covered by exercising 
the option or by purchasing shares in the market once secondary trading 
begins. Shares purchased in the market by or on behalf of the syndicate 
must be used to reduce the size of the syndicate short position. 
Therefore, the overallotment option may be exercised only to the extent 
required to cover the ``net'' short position.\67\ Shares needed to 
cover the uncovered short position must be purchased in the market.\68\
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    \61\ See supra note 58.
    \62\ See supra note 56.
    \63\ See supra note 57.
    \64\ 17 CFR 242.104(h)(1)-(2). For a discussion of Regulation 
M's notice requirement for stabilizing bids, see Regulation M 
Adopting Release, 62 FR at 537.
    \65\ ``Underwriters frequently receive an overallotment option 
(``Green Shoe''), which is the right, but not the obligation, to 
purchase securities from the issuer in addition to those initially 
underwritten by the syndicate, which may constitute up to 15% of the 
initial underwritten amount. Because the overallotment option may be 
insufficient to cover the entire syndicate short position, that 
portion in excess of the overallotment option must be covered 
through purchases in the secondary market.'' Regulation M Proposing 
Release, 61 FR at 17124, n. 86.
    \66\ The creation of an uncovered short position in connection 
with an offering is permissible activity that facilitates the 
offering, and is different from the delivery obligations related to 
``uncovered short selling'' of securities in the secondary market 
that is discussed in the Regulation SHO Adopting Release. See 
Securities Exchange Act Release No. 50103 (July 28, 2004), 69 FR 
48008 (August 6, 2004).
    \67\ If an underwriter were to exercise the Overallotment Option 
in an amount exceeding the net syndicate short position, under 
Regulation M and former Rule 10b-6, an underwriter's participation 
in the distribution would not be deemed completed and purchases made 
prior to the exercise of the option may violate Regulation M. See 
Regulation M Adopting Release, 62 FR at 522-23; Securities Exchange 
Act Release No. 19565 (March 4, 1983), 48 FR 10628, 10640. 
Underwriters and issuers also would have to consider any prospectus 
disclosure issues this may raise. See infra note 69.
    \68\ See generally, Loss, L and Seligman, J., Securities 
Regulation, 3d Section 2-A-2 (2004).
---------------------------------------------------------------------------

    Currently, issuers are required to inform investors that the 
syndicate may effect stabilizing and syndicate covering transactions, 
or impose penalty bids, in connection with the securities offering by 
providing a general description of possible stabilization, syndicate 
covering transactions and penalty bids in the Plan of Distribution or 
Underwriting section of the prospectus, if an underwriter intends to 
engage in any of these activities.\69\ Generally, this disclosure is 
included in prospectuses for firm commitment offerings, regardless of 
whether the underwriters intend to or, in fact, stabilize the 
offering.\70\
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    \69\ Items 508(l) and 508(j) of Regulations S-K and S-B [17 CFR 
229.508(l) and 228.508(j)]. Securities Act Rule 481(d) [17 CFR 
230.481(d)] requires this disclosure in registration statements 
prepared on a form available solely to investment companies 
registered under the Investment Company Act of 1940 or in a 
Securities Act registration statement for a company that has elected 
to be regulated as a business development company under Sections 55 
through 65 of the Investment Company Act [15 U.S.C. 80a-54--80a-64].
    \70\ The Division of Corporation Finance has issued interpretive 
guidance indicating that the Staff will issue comments if the 
disclosure regarding applicable short sale transaction does not 
address the following material points: (1) The potential for 
underwriter short sales in connection with the offering; (2) a 
description of short sales and uncovered short sales; (3) an 
explanation of when an uncovered short sale position will be 
created; (4) how underwriters close out covered short sales and 
uncovered short sale positions; (5) how underwriters determine the 
method for closing out covered short sale positions; and (6) the 
potential effects of underwriters' short sales and transactions to 
cover those short sales. See ``Current Issues and Rulemaking 
Projects,'' Nov. 14, 2000, Section VIII.A.3.c, at http://www.sec.gov. The guidance includes examples of language that issuers 
may use to provide the required disclosure.
---------------------------------------------------------------------------

2. Current Syndicate Practices
    Underwriters assume a large measure of the risk that an offering 
may not be successful, and so have manipulative incentives to varying 
degrees throughout the offering process. The point in time when 
underwriters no longer have manipulative incentive or purpose to 
facilitate an offering cannot be identified with precision.\71\ But the 
Commission has recognized that these incentives can continue into the 
aftermarket when syndicate covering transactions and penalty bids 
occur.\72\
    The creation of a syndicate short position and the subsequent 
purchasing activity to cover the position can impact the offering and 
the aftermarket price. The potential ``buying power'' of the short 
position can allow the syndicate to price the offering more 
aggressively because its syndicate short covering can support the 
aftermarket at prices around or above the offering price, thereby 
validating the offering price. Purchasers in the offering also may 
conclude that the trading activity in the aftermarket validates the 
offering price, and therefore may be more inclined to retain the shares 
purchased in the offering

[[Page 75781]]

rather than sell the shares to realize a gain or avoid a loss.
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    \71\ See Regulation M Proposing Release, 61 FR at 17124.
    \72\ Id. at 17124-17125.
---------------------------------------------------------------------------

    When we adopted Regulation M, we specifically recognized that 
underwriters frequently engage in syndicate covering transactions, and 
noted that these transactions can facilitate an offering in a manner 
similar to stabilization.\73\ Currently, Rule 104 addresses the risk 
that stabilization will create a false or misleading appearance with 
respect to the trading market for the offered security by imposing 
pricing, disclosure, and other conditions on this activity.\74\ Among 
other things, the Commission considered the contemporaneous disclosure 
that stabilization is occurring to be beneficial to market 
participants, because this information is important to their decisions 
to buy or sell the security.
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    \73\ See Regulation M Adopting Release, 62 FR at 537.
    \74\ Regulation M Adopting Release, 62 FR at 535. While Rules 
101 and 102 primarily protect investors in the offering, the 
disclosure of the stabilizing bid's purpose under Rule 104 and the 
proposal regarding syndicate covering bids will benefit investors in 
the aftermarket of an offered security, as well as investors in the 
offering itself.
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    Syndicate covering transactions are regulated quite differently 
under Rule 104, in large measure because the Commission had 
insufficient information about syndicate covering transactions when 
Regulation M was adopted.\75\ We stated, however, that we could 
reconsider whether additional regulation was warranted.\76\ Since that 
time, our staff has been reviewing syndicate covering transactions and 
other aftermarket practices. The staff has learned that in the U.S. 
syndicate covering transactions have replaced (in terms of frequency of 
use) stabilization as a means to support post-offering market 
prices.\77\ Syndicate covering transactions may be preferred by 
managing underwriters primarily because they are not subject to the 
price and other conditions that apply to stabilization under Rule 104, 
and in particular the contemporaneous market disclosure of the bidding 
and purchasing activity.\78\ However, the lack of transparency of 
syndicate covering transactions has the potential to create a false or 
misleading appearance with respect to the trading market for the 
offered security. Because syndicate covering transactions are not 
required to be disclosed to the market, investors (i.e., those who 
purchased in the offering, as well as those who purchased in the 
aftermarket) are not informed about when the syndicate is actually 
making syndicate covering purchases in the market. As a result, 
investors have no way of knowing whether, and to what extent, the 
market price of the offered security may be supported by syndicate 
covering activity. Of note, once the managing underwriter has covered 
the syndicate's short position and ceases such purchasing in the 
aftermarket, there is often a significant decline in the security's 
price.\79\ As a result, syndicate covering transactions can, and 
studies show that they do, enable underwriters to support the 
aftermarket price of the offered security at levels that they may not 
obtain in the absence of their activity, thereby interfering with free 
market forces.\80\ Finally, the investing public who buy the offered 
shares in the aftermarket at syndicate-influenced prices unknowingly 
bear the risk of a significant subsequent decline in the security's 
price.\81\
---------------------------------------------------------------------------

    \75\ See Regulation M Adopting Release, 62 FR at 537. Instead, 
the Commission required SRO notification and recordkeeping of 
syndicate covering transactions. In so doing, the Commission 
believed that SRO notification of syndicate covering transactions 
would serve to apprise regulators of their possible market effects, 
while the new recordkeeping requirements would assist the Commission 
in assessing whether further regulation was warranted. Id. at 537-
538; Regulation M Proposing Release, 61 FR at 17125.
    \76\ Regulation M Proposing Release, 61 FR at 17125.
    \77\ See, e.g., Ekkehart Boehmer and Raymond P.H. Fishe, 
``Underwriter Short Covering in the IPO Aftermarket: A Clinical 
Study,'' 10 Journal of Corporate Finance, at 575-594 (September 
2004) (finding that short covering trades are often used as a 
substitute for Rule 104 stabilization in that they serve the same 
purpose without the disclosure obligation associated with Rule 104 
trades); Reena Aggarwal, ``Stabilization Activities by Underwriters 
After Initial Public Offerings,'' 55 Journal of Finance 1075, 1079 
(June 2000) (finding that underwriters do not stabilize through 
stabilizing bids, but by overselling the issue and covering this 
short position by purchasing shares in the aftermarket).
    \78\ Id.
    \79\ See, e.g., Reena Aggarwal, ``Stabilization Activities by 
Underwriters After Initial Public Offerings,'' 55 Journal of Finance 
1075-1103 (June 2000) (noting that price levels decrease immediately 
after the underwriters' ``stabilizing'' activities cease); Kathleen 
Weiss Hanley, A. Arun Kumar, and Paul J. Seguin, ``Price 
Stabilization in the Market for New Issues,'' 34 Journal of 
Financial Economics, 177-197 (October 1993).
    \80\ See, e.g., Ekkehart Boehmer and Raymond P.H. Fishe, Who 
Ends up Short From Underwriter Short Covering? A Detailed Case 
Analysis of Underwriter Stabilization in a Large IPO, at 32-34 
(March 28, 2001) (finding that short covering trades can slow down 
price declines and that short covering reduces the price impact of a 
sell by more than 70%).
    \81\ See, e.g., supra note 79. Underwriters have an incentive to 
artificially influence aftermarket activity because they have 
underwritten the risk of the offering, and a poor aftermarket 
performance could result in reputational harm and subsequent 
financial loss.
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3. Proposal for Syndicate Covering Transactions
    As discussed above, stabilization and syndicate covering 
transactions can both be used to facilitate an offering by supporting 
the market price of the offered security, Rule 104 currently regulates 
these activities differently. While both stabilization and syndicate 
covering transactions support the price in the aftermarket of an 
offered security, they do operate differently. Stabilizing bids and 
purchases are conducted only by the managing underwriter who places 
bids at prices prescribed by Rule 104 to peg, fix, or stabilize the 
market price for the security. In contrast, the managing underwriter 
places syndicate short covering bids in the market, typically when the 
security is trading below the offering price, in order to deliver 
securities sold short in the offering, i.e., cover the syndicate short 
position. This bidding and purchasing activity can also support the 
market price for the securities. Therefore, to address the disparate 
treatment of activities that similarly impact the aftermarket trading 
of an offered security, the Commission is proposing that Rule 104 be 
amended to require disclosure of syndicate covering bids. In 
particular, we propose to amend Rule 104(h)(2) to require any person 
communicating a bid for the purpose of effecting a syndicate covering 
transaction to identify or designate the bid as such wherever it is 
communicated.\82\
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    \82\ Rule 104(h)(2) would continue to require prior notice to 
the self-regulatory organization with direct authority over the 
principal market in the United States for the security for which the 
syndicate covering transaction is effected. 17 CFR 242.104(h)(2). 
Because Rule 104 already requires underwriters to make disclosures 
with respect to stabilizing bids, we believe it will not require 
significant effort or technical changes (to internal systems and 
procedures) on the part of underwriters or other syndicate members 
in order to comply with the proposed disclosure for syndicate 
covering bids. See text accompanying supra note 60. Moreover, while 
the burden would be on the underwriter or other person displaying or 
transmitting a syndicate covering bid to satisfy the proposed 
disclosure requirements, we anticipate that the SROs will make 
changes to their existing rules and procedures to assist their 
members in complying with these requirements. For example, a special 
symbol or identifier could be used to identify the bid as a 
syndicate covering bid. The Commission staff will coordinate with 
the SROs to develop procedures to provide wide notice of such bids 
to the markets. Moreover, we are soliciting comment from the 
industry as to whether the Commission should require broader 
dissemination of the fact that an underwriter is engaged in 
syndicate covering transactions (e.g., by requiring the underwriter 
to publish a press release or issue some notice to the market), 
especially in cases where syndicate covering bids are not currently 
displayed to the market.
---------------------------------------------------------------------------

    We believe that requiring syndicate covering bids to be identified 
or designated in this way would help protect investors by providing 
contemporaneous information about the potential market impact of 
syndicate

[[Page 75782]]

bidding and purchasing activity.\83\ The proposal also would regulate 
consistently activities that are similar in terms of their market 
impact. While the Commission recognizes that stabilization and 
syndicate covering transactions both have the effect of supporting the 
market price of a security, these activities do operate differently, 
and so we are not, at this time, proposing to apply to syndicate 
covering bids the type of specific price, counter-party disclosure, or 
other limitations that now apply to stabilizing. Instead, the 
Commission will continue to monitor such transactions, and consider 
whether any additional regulation of syndicate covering transactions in 
the future is appropriate.
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    \83\ Regulation M Adopting Release, 62 FR at 537.
---------------------------------------------------------------------------

    Q. Does the manner in which a managing underwriter effects 
syndicate short covering bids and purchases present issues for 
complying with the above notification and disclosure proposals? That 
is, would compliance with the proposal be complicated by the fact that 
managing underwriters may be purchasing for accounts other than the 
syndicate concurrently with making syndicate short covering bids and 
purchases? Please provide specific details of underwriter practices in 
this regard and suggest what modifications, if any, should be made to 
the proposal to address these concerns.
    Q. What, if any, burdens would be imposed by the proposed 
disclosure? For example, would there be any difficulty in identifying 
or designating a bid as a syndicate covering bid (i.e., by attaching a 
symbol or modifier to the bid) wherever it is communicated?
    Q. Should the Commission consider, in addition to the proposed 
disclosure, revising Rule 104 to require a general notification to the 
market (e.g., through a press release, a website posting, or an 
administrative message sent over the Tape) that syndicate covering 
activity has commenced (and another notification when syndicate 
covering activity has ceased)?
    Q. Should the Commission consider revising Rule 104 to require 
disclosure, such as disclosure in a press release, of either or both of 
the following information: (1) That the underwriting syndicate has an 
uncovered short position in the offered security; and (2) the size of 
the syndicate uncovered short position. We seek specific comment 
concerning this alternative, or any other alternatives, the Commission 
should consider in regulating syndicate covering transactions. We also 
seek specific comment and empirical data regarding the current use of 
syndicate covering transactions and other aftermarket activities by 
underwriters in connection with securities offerings.
    Q. Should the Commission require SROs to develop a mechanism for 
their members to comply with the Rule 104 proposal? Should the 
Commission consider using a different mechanism other than identifying 
or designating the bid itself, such as a press release or other 
notification mechanism? Should the SROs develop a mechanism on their 
own?
    Q. Should the Commission impose specific price or other conditions 
on syndicate short covering bids or purchases in the aftermarket? If 
so, please provide specific comment on what conditions would be 
appropriate to apply and provide reasons for your recommendations.
    Q. Should the Commission consider making the disclosure 
requirements for stabilization bids the same as the proposed 
requirements for syndicate covering bids? That is, should we also amend 
Rule 104(h)(1) to require that any person communicating a bid that is 
for the purpose of stabilizing identify or designate the bid as a 
stabilizing bid wherever it is communicated?
    Q. Are there differences between stabilization and syndicate 
covering that would require different kinds of disclosure or other 
regulation for syndicate short covering? If so, please identify these 
differences and make recommendations about the way in which the 
proposed disclosure requirement should be modified?
4. Penalty Bids
    Penalty bids are a contractual term in underwriting agreements that 
allow the lead underwriter to reclaim a selling concession paid to a 
syndicate member if that member's customers sell their allocated shares 
in the immediate aftermarket.\84\ Penalty bid provisions are assessed 
at the election of the managing underwriter, and are not assessed in 
all offerings. We understand that penalty bids are rarely assessed, and 
are assessed most often in connection with offerings for which there is 
relatively low demand to help prevent triggering or exacerbating a 
market price decline through investor sales of IPO shares.\85\ Based on 
discussions between the staff and securities industry representatives, 
we also understand that syndicate managers justify the use of penalty 
bids by claiming that if the securities are sold within a short period 
of time, i.e., flipped, the syndicate member has not earned its 
commission (i.e., for selling shares to long-term investors) and the 
syndicate is entitled to reclaim the associated selling concessions via 
the penalty bid provision.
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    \84\ 17 CFR 242.100(b). The immediate sale by an IPO purchaser 
is often referred to as ``flipping.'' See, e.g., Raymond P.H. Fishe, 
``How Stock Flippers Affect IPO Pricing and Stabilization,'' Journal 
of Financial and Quantitative Analysis, Vol. 37, No. 2 (June 2002).
    \85\ See, e.g., Reena Aggarwal, ``Allocation of IPOs and 
Flipping Activity,'' 68 Journal of Financial Economics 111-135 
(April 2003) (finding that penalty bids are assessed in only 13% of 
offerings and amount to a small percentage of the total spread).
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    Penalty bids raise three troublesome issues. First, because Rule 
104 does not require the assessment of a penalty bid to be disclosed to 
the market, penalty bids can function as an undisclosed form of 
stabilization by discouraging immediate sales of IPO securities that 
would otherwise lower a stock's market price. Second, we understand 
that some sales representatives may fear losing a sales commission if 
their customers sell their IPO shares.\86\ The salesperson's concern 
may result in improper interference with a customer's right to sell 
securities when the customer chooses to do so. Third, there is evidence 
that the assessment of penalty bids at the syndicate level results in 
discriminatory effects on the syndicate member's customers. In 
particular, we understand that institutional salespersons are not 
penalized when their institutional customers flip their shares, but 
retail salespersons often are penalized.\87\ While internal 
compensation matters are not the focus of our proposed rule amendment, 
we are mindful that the pressure of a penalty bid assessment by a 
managing underwriter can result in discriminatory and improper conduct 
by a firm and its salespeople towards its customers.\88\
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    \86\ See, e.g., M. Siconolfi and P. McGeehan, ``Flip Side: Wall 
Street Brokers Press Small Investors To Hold IPO Shares--Big 
Institutions Can Cash Out Quickly; the `Little Guy' Can't Without 
Penalties--Rife With Double Standards?'', The Wall Street Journal, 
at A.1 (June 26, 1998).
    \87\ Id. See also W. Wilhelm, Jr., ``Secondary Market Price 
Stabilization in Initial Public Offerings,'' 12 Journal of Applied 
Corporate Finance, 78-85 (January 1999) (finding that the 
suppression of small-quantity orders by penalty bids, particularly 
during the first few days of trading, bears most heavily on retail 
investors receiving IPO allocations).
    \88\ We also are aware that, even where penalty bids are not 
imposed, some firms pressure their sales representatives to 
discourage customers from selling when a stock's price declines, 
unrelated to the recovery of any selling concessions. We understand 
that the NASD and the NYSE are currently in the process of 
rulemaking designed to address this specific concern. See File Nos. 
SR-NASD-2003-140 and SR-NYSE-2004-12 (publication pending).
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    Because we believe the likelihood of harm through the use of 
penalty bids is

[[Page 75783]]

significant, we propose that Rule 104 be amended to prohibit the use of 
such bids. In particular, we propose to add a new subparagraph under 
the Rule, which would state, ``it shall be unlawful to impose or assess 
any penalty bid in connection with an offering,'' and to eliminate the 
existing references to penalty bids in subparagraph (2) of the Rule. We 
also propose that Rule 17a-2(c) of the Exchange Act (which imposes 
certain record keeping and notification requirements) and Rule 481(d) 
(which requires certain information be included in a prospectus) and 
Item 508(l) of Regulations S-K and S-B (which imposes certain 
disclosure requirements for the ``plan of distribution'' section of a 
prospectus) be amended to eliminate all references pertaining to 
penalty bids. While we considered requiring disclosure of penalty bids 
by sales representatives to customers, we do not believe that such 
disclosure would address the conflicts that arise with respect to their 
use. We also believe that such direct disclosure could be confusing or 
intimidating, and ultimately have an even greater chilling effect on 
those investors who wish to sell their shares in the aftermarket. We 
also understand that penalty bids are rarely assessed, so our proposal 
to eliminate their use should not have a great effect on the practices 
of most broker-dealers.
    Q. Should the Commission consider, as an alternative, requiring 
syndicate members to disclose to their customers who seek to sell their 
IPO shares that the firm or sales representatives could have its 
selling concession reclaimed if the customer sells its IPO shares and 
that this raises a conflict of interest for the firm and its 
salespersons? Should we require disclosure of any other anti-flipping 
policies that the firm has in place that may affect an investor's 
decision to purchase or sell IPO shares? \89\
---------------------------------------------------------------------------

    \89\ For example, a firm may have a policy or practice of 
excluding clients from future IPOs if they flip shares, irrespective 
of whether a penalty bid is assessed.
---------------------------------------------------------------------------

    Q. Are there other aftermarket practices or policies that create 
conflicts of interest that should be prohibited or subject to increased 
disclosure? There may be other practices that investors should be made 
aware of, or other conduct that raises the same type of concerns as 
discussed above. For example, should the Commission prohibit firms from 
imposing anti-flipping policies that discriminate against retail 
investors, such as rescinding sales commissions for retail sales, or 
excluding retail customers (but not institutional customers) from 
future IPO allocations for quickly selling their IPO shares, or require 
disclosure of their policies? If so, please provide specific details 
regarding such practices or policies and suggest approaches to regulate 
such practices.
5. Rule 104--Exception for Transactions in Rule 144A Securities
    Rule 104(j)(2) generally excepts from Rule 104 transactions in Rule 
144A securities offered and sold in the U.S., provided they are sold 
either to qualified institutional buyers in a transaction exempt from 
registration under the Securities Act or to non U.S. persons in 
Regulation S offerings that are made concurrently with a Rule 144A 
offering.\90\ When we adopted Regulation M, the exception under Rule 
104 was intended to be identical to the exception for Rule 144A 
securities under Rules 101 and 102.\91\ We therefore propose to add the 
words ``or any reference security'' to Rule 104(j)(2) in order to make 
this subparagraph consistent with the same exception under Rules 101 
(b)(10) and 102(b)(7) for transactions in Rule 144A securities.
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    \90\ 17 CFR 242.104(j)(2). See also Regulation M Adopting 
Release, 62 FR at 536.
    \91\ Regulation M Adopting Release, 62 FR at 536, n. 119.
---------------------------------------------------------------------------

    Q. The Commission seeks specific comment concerning the proposal to 
add the omitted language ``or any reference security'' to Rule 
104(j)(2).

E. New Rule 106

    The Commission is proposing new Rule 106 of Regulation M to 
expressly prohibit distribution participants, issuers, and their 
affiliated purchasers, directly or indirectly, from demanding, 
soliciting, attempting to induce, or accepting from their customers any 
consideration in addition to the stated offering price of the 
security.\92\ This new rule would expressly prohibit certain abuses 
that occurred in connection with IPOs, particularly those in the late 
1990's and in other ``hot issue'' periods, such as conditioning or 
``tying'' an allocation of shares in a ``hot issue'' on an 
understanding that the customer would buy shares in another, usually 
``cold,'' offering,\93\ or on paying excessive commissions to the 
underwriter.\94\ This proposal would also prohibit issuers, 
underwriters, broker-dealers, and other distribution participants from 
accepting an offer from a prospective purchaser to pay additional 
consideration in order to obtain an allocation of offered shares.
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    \92\ This proposal would apply to any distribution of 
securities, i.e., a public offering or private placement, and would 
apply equally to initial and secondary offerings.
    \93\ An IPO is considered to be a ``cold'' offering when there 
is weak investor interest in the IPO shares. An IPO is considered to 
be a ``hot'' offering when investor demand significantly exceeds the 
supply of securities in the offering. Shares in hot offerings often 
trade at substantial premiums to the offering price.
    \94\ The Commission has stated that such activity involves 
possible violations of the antifraud and anti-manipulation 
provisions of the federal securities laws. See Securities Exchange 
Act Release No. 9824 (October 16, 1972), 37 FR 22796 (October 25, 
1972) (1972 Interpretive Release). SEC v. Credit Suisse First Boston 
Corp., No. 1:02 CV 00090, 2002 WL 479836 (D.D.C. 2002), Complaint ]] 
1, 6 (alleging violations of NASD Conduct Rules 2110 and 2330 and 
Section 17(a) under the Exchange Act and Rule 17a-3(a)(6) 
thereunder, for encouraging customers to channel profits from hot 
IPOs via excessive brokerage commissions in order to receive such 
hot shares).
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1. Background
    The Commission has long considered tying the award of allocations 
of offered shares to additional consideration to be fraudulent and 
manipulative, and such practices have always been actionable under 
Section 17(a) of the Securities Act and Section 10(b) and Rule 10b-5 of 
the Exchange Act.\95\ In addition, some forms of tie-ins are already 
prohibited by Regulation M \96\ and SRO rules.\97\

[[Page 75784]]

Underwriters' or issuer's demands for consideration in addition to the 
stated offering price have several pernicious effects. These activities 
can contribute to a false impression of scarcity in the offered shares. 
This, in turn, can stimulate and distort the offering and aftermarket 
prices by creating the impression that any unfulfilled demand for the 
offered shares may only be satisfied in the aftermarket.\98\ Moreover, 
such activities create the impression that the underwriters have 
``rigged the game'' and only the market participants who know they are 
expected, and are willing, to pay the additional consideration are able 
to participate in IPOs.
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    \95\ See supra notes 6-7 and accompanying text. See also C. 
James Padgett, 52 SEC 1257 (1997), aff'd sub. nom, Sullivan v. SEC, 
159 F.3d 637 (D.C. Cir. 1998) (finding underwriters violated Section 
17(a) of the Securities Act and Section 10(b) of the Exchange Act 
and Rule 10b-5 thereunder by requiring that IPO purchasers sell 
their shares back to the firm at the beginning of aftermarket 
trading). See also 15 U.S.C. 77q (making unlawful fraudulent conduct 
in the offer or sale of any security or security-based swap 
agreement by means of interstate commerce); 15 U.S.C. 78(j)(b) and 
17 CFR.240.10b-5 (making it unlawful for any person to ``employ any 
device, scheme, or artifice to defraud'' or to ``engage in any act, 
practice, or course of business which operates or would operate as a 
fraud or deceit upon any person''). A ``tie-in agreement'' in the 
securities offering context generally refers to requiring either 
implicitly or explicitly that customers give consideration in 
addition to the stated offering price of any security in order to 
obtain an allocation of the offered shares. Securities Exchange Act 
Release No. 10636 (February 11, 1974), 39 FR 7806 (February 28, 
1974) (``1974 Rule 10b-20 Proposing Release''); Securities Exchange 
Act Release No. 11328 (April 2, 1975), 40 FR 16090 (April 9, 1975) 
(``1975 Rule 10b-20 Proposing Release''). These arrangements can 
also violate other provisions of the securities laws and SRO rules. 
SEC v. Credit Suisse First Boston Corp., No. 1:02 CV 00090, 2002 WL 
479836 (D.D.C. 2002).
    \96\ Securities Exchange Act Release No. 6536 (April 24, 1961) 
(reminding dealers that requiring customers to make purchases in the 
aftermarket for the offered security in exchange for allocations of 
that security violates the anti-manipulation rules including Rule 
10b-6, the predecessor to Regulation M); Staff Legal Bulletin No. 10 
(August 25, 2000), available at http://www.sec.gov/interps/legal/slbmr10.htm.
    \97\ See NASD Conduct Rule 2710 (2004) (requiring disclosure to 
the NASD of all relevant aspects of the offering including accurate 
disclosure of underwriting compensation); NASD Conduct Rule 2330 
(2003) (prohibiting member firms from sharing profits with customer 
accounts); NASD Conduct Rule 2120 (2003) (prohibiting members from 
using manipulation, deception or fraud to induce or effect 
transactions in offered securities); NASD Conduct Rule 2310-2 (2002) 
(requiring fair dealing in all relationships with customers); 15 
U.S.C. 78q(a) (requiring broker dealers to make and keep records of 
terms and conditions of all purchases and sales of securities); NASD 
Conduct Rule 2210 (2001) (establishing professional standard of 
conduct required of NASD members); NASD Conduct Rule 2110 (1996) 
(requiring that members observe ``high standards of commercial honor 
and just and equitable principles of trade''); 17 CFR 240.10b-5.
    \98\ See 1974 Rule 10b-20 Proposing Release, 39 FR at 7806 
(describing how broker inducements for allocating offered shares: 
(1) encourages participation in cold offerings by investors with a 
view toward immediate resale of the security; (2) obscures actual 
demand for the offering making an assessment by investors of true 
demand difficult thus artificially affecting the offering price; and 
(3) stimulates demand for the offering and forces investors who 
could not participate to buy in the aftermarket).
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    In 1974 and 1975, in order to broadly and explicitly address such 
manipulative conduct, the Commission proposed Rule 10b-20 to prohibit 
broker-dealers and others from (explicitly or implicitly) demanding 
from their customers any payment or consideration, including a 
requirement to purchase other securities, in addition to the security's 
disclosed offering price.\99\ This proposal would have prohibited, for 
example, conditioning or ``tying'' an allocation of shares in a hot 
issue on an agreement to buy shares in another offering or in the 
aftermarket of another offering, for which there may be a lack of 
investor demand (i.e., cold offerings).\100\ When underwriters allocate 
shares in ``hot offerings'' to customers who agree to make aftermarket 
purchases in ``cold offerings,'' the purchasers in the cold offerings 
are deceived as to the true demand for that offering.\101\ Proposed 
Rule 10b-20 also would have prohibited underwriters from requiring 
customers to pay excessive commissions or agreeing to profit sharing 
arrangements with distribution participants in order to receive 
allocations of IPO shares. The proposal also broadly prohibited any 
kind of arrangement where the customer would be required to perform any 
act, or refrain from any conduct, effect another transaction or refrain 
therefrom, other than what was disclosed in the registration statement 
or offering circular in order to receive an allocation.\102\ The 
Commission withdrew the proposal in 1988, in part due to the passage of 
time since its proposal, and because the Commission believed that such 
agreements already could be reached under the existing antifraud and 
anti-manipulation provisions of the federal securities laws.\103\
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    \99\ As proposed in 1975, Rule 10b-20 would have applied to 
offerings registered under the Securities Act or on Form 1-A. 1975 
Rule 10b-20 Proposing Release, 40 FR 16090. As originally proposed 
in 1974, Rule 10b-20 would have applied to any securities offering 
utilizing jurisdictional means. 1974 Rule 10b-20 Proposing Release, 
39 FR at 7806.
    \100\ See 1974 Rule 10b-20 Proposing Release (citing Securities 
Exchange Act Release No. 9824 (October 16, 1972), 37 FR 22796 
(October 25, 1972) (``1972 Interpretive Release'') (noting that 
allocating customers shares of hot IPOs in exchange for customer 
purchases of cold IPOs violates the antifraud and anti-manipulation 
provisions of the Exchange Act).
    \101\ See 1974 Rule 10b-20 Proposing Release, 39 FR at 7806.
    \102\ 1975 Rule 10b-20 Proposing Release, 40 FR at 16091-16092.
    \103\ See Securities Exchange Act Release No. 26182 (October 14, 
1988), 53 FR 41206. See also C. James Padgett, 52 SEC 1257 (1997), 
aff'd sub. nom, Sullivan v. SEC, 159 F.3d 637 (DC Cir. 1998) 
(finding underwriters violated Section 17(a) of the Securities Act 
and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by 
requiring that IPO purchasers sell their shares back to the firm at 
the beginning of aftermarket trading). Of note, the Commission 
determined that these tie-in agreements created a materially false 
impression of the extent of aftermarket activity. As such, the 
arrangement operated as a fraud upon the market and defrauded 
aftermarket purchasers. Id. at n. 53.
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    During periods of high demand for new IPOs, such as occurred in the 
late 1990s, some underwriters induced or required customers who wished 
to receive ``hot'' IPO allocations to provide additional consideration 
to obtain an allocation of IPO shares. For example, the Commission has 
alleged that underwriters required or induced customers to pay 
excessive commissions \104\ on transactions in other securities, to 
purchase ``cold'' IPO shares,\105\ and to make purchases in the 
aftermarket \106\ of the offered security.
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    \104\ See SEC v. Credit Suisse First Boston Corp., No. 1:02 CV 
00090, 2002 WL 479836 (D.D.C. 2002), Complaint ]] 1, 6 (alleging 
violations of NASD Conduct Rules 2110 and 2330 and Section 17(a) 
under the Exchange Act and Rule 17a-3(a)(6) thereunder, for 
encouraging customers to channel profits from hot IPOs via excessive 
brokerage commissions). CSFB encouraged its retail customers to pay 
excessive commissions in correlation to the profit (sometimes up to 
65%) they made in flipping their IPO shares through the purchases of 
off-setting trades in order to receive IPO allocations. Id. at ]] 
17-25, 42-43. See also SEC v. Robertson Stephens, Inc., Final 
Judgment of Permanent Injunction and Other Relief Against Robertson 
Stephens, Inc., 03 Civ. 0027 (RL) (D.D.C. 2003), Complaint ]] 1, 5 
(alleging violations of NASD Conduct Rules 2110 and 2330 and Section 
17(a) of the Exchange Act and Rule 17a-3(a)(6) thereunder for 
improperly sharing customer profits by allocating ``hot'' IPO shares 
to customers and receiving in return shares of customer profits via 
excessive commissions or markdowns). Robertson Stephens is alleged 
to have ranked customers according to customers' total commission 
dollars and used that ranking system to encourage customers to 
increase their commissions in order to receive IPO allocations. Id. 
at ]] 14-26 . It was expected that a portion of the profits a 
customer made on an allocation would be filtered back to the firm by 
way of excessive commission business. Id. at ]] 29-33. The NASD has 
also taken related actions involving payments of excessive 
commissions in exchange for IPO allocations. See NASD Notice to 
Members 4-50 (July 2004) (announcing that Bear Stearns & Co., Inc., 
Deutsche Bank Securities, Inc., and Morgan Stanley & Co., Inc. were 
censured for engaging in improper profit sharing with customers 
through the use of excessive commissions).
    \105\ See SEC v. J.P. Morgan Securities, Inc. at supra note 26 
and accompanying text.
    \106\ Id.
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    Given the widespread nature of these abuses concerning underwriters 
inducing or accepting additional compensation from customers for 
allocations,\107\ as demonstrated by enforcement actions and studies, 
we believe that an express Commission rule that complements the current 
provisions of Regulation M would be beneficial. Although this conduct 
may be actionable, for example, under current Regulation M, the general 
antifraud and anti-manipulation provisions of the federal securities 
laws, as well as SRO rules, we believe that a prophylactic rule 
specifically addressing the full range of misconduct that we observed 
in this context is necessary to preserve the integrity of the 
securities offering process and to protect investors.
---------------------------------------------------------------------------

    \107\ See Report of the Special Study of the Securities Markets 
of the Securities and Exchange Commission, H.R. Doc. No. 88-95, pt. 
1 at 555-56 (1 Sess. 1963) (noting that underwriters used 
manipulative tactics in order to increase issues to the level of 
``hot'' offerings and create a ``pop'' in the offering price); 
Report of the Securities and Exchange Commission Concerning the Hot 
Issues Markets (August 1984) at 37-38 (noting existence of 
manipulative tie-in agreements during the hot issues market between 
1980 and 1983); SEC v. Credit Suisse First Boston Corp., No. 1:02 CV 
00090, 2002 WL 479836 (D.D.C. 2002), Complaint ]] 29-45 (noting that 
violative conduct was not isolated but rather business as usual and 
pervasive). Brokers expected customers to pay CSFB for having 
granted them ``hot'' IPO allocations, considering such allocations 
quick profits on which they (the underwriters) deserved something in 
return. Id. at ] 36. See also SEC v. Robertson Stephens, Inc., Final 
Judgment of Permanent Injunction and Other Relief Against Robertson 
Stephens, Inc., 03 Civ. 0027 (RL) (D.D.C. 2003), Complaint ]] 23-28 
(pressuring customers to increase their commissions in order to 
receive allocations by use of their ``ranking system'').

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[[Page 75785]]

2. Proposal
    Proposed new Rule 106 of Regulation M would explicitly prohibit 
distribution participants, including underwriters, and issuers and 
their affiliates, directly or indirectly, from demanding, soliciting, 
or attempting to induce, or accepting an offer from their customers of 
any payment or other consideration in addition to the security's stated 
consideration. For example, this rule would prohibit distribution 
participants, issuers and their affiliated persons, in connection with 
allocating an offered security, from inducing, soliciting, requiring or 
otherwise accepting an offer from a potential purchaser to purchase any 
other security to be sold or proposed to be offered or sold by such 
person. Similarly, Rule 106 would also prohibit distribution 
participants, issuers and their affiliated persons, in connection with 
allocating an offered security, from inducing, soliciting, requiring 
(or accepting an offer from) prospective customers to effect any other 
transaction or refrain from any of the foregoing, other than as stated 
in the registration statement or applicable offering document for the 
offer and sale of such offered security. Rule 106 would apply to any 
distribution of securities, whether a public offering or private 
placement of securities, and would apply to initial as well as 
secondary offerings.\108\
    Rule 106 would complement the current provisions of Regulation M. 
Like Regulation M, the proposed rule is intended to protect the 
integrity of the offering process. Presently, the focus of Regulation M 
is on the protection of the integrity of the pricing of an offering by 
prohibiting distribution participants and issuers from bidding for, or 
purchasing, the offered securities in the market, or attempting to 
induce others to do so. Rule 106 would address a broad range of conduct 
by distribution participants and issuers that can stimulate the market 
for the offered shares (thereby distorting the offering price and the 
aftermarket). It also would address conduct that can operate as a fraud 
on prospective purchasers of IPOs, who are unaware of the underwriters' 
additional requirement for receiving an allocation.
---------------------------------------------------------------------------

    \108\ See supra note 3 for the definition of distribution. 17 
CFR 242.100(b).
---------------------------------------------------------------------------

    We note, however, that the proposed rule is not intended to 
interfere with legitimate customer relationships. For example, this 
provision is not intended to prohibit a firm from allocating IPO shares 
to a customer because the customer has separately retained the firm for 
other services, when the customer has not paid excessive compensation 
in relation to those services. On balance, we believe a comprehensive 
rule specifically directed at the types of impermissible conduct 
discussed herein is warranted. Such conduct, which often recurs during 
``hot issues'' periods, undermines the fundamental function of the 
securities markets as an independent pricing mechanism and erodes 
investor confidence in the securities offering process generally. 
Having a prophylactic rule that expressly addresses the conduct 
discussed above would therefore prevent potential misconduct in the 
future as well as enhance the Commission's enforcement capabilities.
    Q. Is the language of the rule sufficient to address the full scope 
of manipulative conduct involved in the offering process, including the 
conduct discussed above? If it does not, how should the language be 
changed? What types of conduct should or should not be included within 
the rule? Please provide specific examples and any suggested 
alternative language.
    Q. Commenters are asked to discuss whether the proposed language 
adequately protects legitimate customer relationships or might 
potentially interfere with these relationships. If the language does 
interfere with such relationships, please explain how and provide 
specific examples and recommendations.
    Q. Although firms are required to create and maintain records of 
customer orders, should firms also be required to create and maintain 
records of indications of interest and the basis for IPO allocations? 
To what extent do firms already create and maintain records indicating 
that information? How burdensome would such a recordkeeping requirement 
be?
    Q. Should the Commission consider prohibiting allocations of 
initial public offering shares to persons based solely on their status? 
For example, should a person be prohibited from receiving initial 
public offering shares because of his or her status as CEO of a public 
or nonpublic company?\109\
---------------------------------------------------------------------------

    \109\ See IPO Blue Ribbon Report, Recommendation 9.
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III. General Request for Comment

    Any interested person wishing to submit written comments on any 
aspect of the proposed rules discussed in this release, as well as on 
other matters that may have an impact on the proposals contained 
herein, is requested to do so. Commenters should provide empirical data 
to support their views. The Commission also requests general comment on 
the following:
    Rule 103 of Regulation M describes the conditions for permissible 
passive market making during the restricted period for a distribution 
of a Nasdaq security.\110\ Passive market making was included in 
Regulation M to alleviate special liquidity problems that could exist 
for a Nasdaq security in distribution, if distribution participants or 
their affiliates who are Nasdaq market makers were required to withdraw 
from making a market during the restricted period.\111\ The Commission 
is not proposing to amend Rule 103 at this time. However, as part our 
effort to comprehensively monitor the operation of Regulation M, we 
seek comment about Rule 103.
---------------------------------------------------------------------------

    \110\ 17 CFR 242.103.
    \111\ See Regulation M Adopting Release, 62 FR at 534.
---------------------------------------------------------------------------

    Q. Have the structural changes to the Nasdaq market since 
Regulation M's adoption affected the operation of Rule 103? Does Rule 
103 continue to be necessary? If so, why? If not, why not?
    Q. Does the existence of multiple sources of liquidity for Nasdaq 
securities, such as electronic communications networks (ECNs), 
alleviate the liquidity concerns Rule 103 was meant to address? If so, 
how? If not, why not?

IV. Paperwork Reduction Act

    Certain provisions of the proposed amendments to Regulation M 
contain ``collection of information'' requirements within the meaning 
of the Paperwork Reduction Act of 1995 (PRA);\112\ the Commission has 
submitted information to the Office of Management and Budget (OMB) for 
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The 
Commission is revising the currently approved collection of information 
titled ``Regulation M'' under OMB control number 3235-0465. An agency 
may not conduct or sponsor, and a person is not required to respond to, 
a collection of information unless it displays a currently valid 
control number.
---------------------------------------------------------------------------

    \112\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

A. Summary of Collections of Information

1. Proposed Amendments to Rule 101(b)(7)\113\
---------------------------------------------------------------------------

    \113\ We have also proposed conforming changes to Rule 17a-
4(b)(13) but the paperwork burden derives from the substance of the 
proposed amendments to Rule 101(b)(7) discussed herein.
---------------------------------------------------------------------------

    The proposed amendments to Rule 101(b)(7) of Regulation M would 
require

[[Page 75786]]

distribution participants and their affiliated purchasers to maintain 
records of their reliance on the de minimis transactions exception from 
Rule 101 of Regulation M. Currently, Rule 101(b)(7) excepts from the 
rule's prohibitions purchases and unaccepted bids made by distribution 
participants and their affiliates during the restricted period that 
total less than 2% of the distributed security's ADTV only if the 
person making the bid or purchase maintains and enforces written 
policies and procedures reasonably designed to achieve compliance with 
Regulation M. When Regulation M was adopted, the Commission stated a 
firm is expected to ``review its policies and procedures and modify 
them as appropriate'' in order to qualify for the exception.\114\ While 
broker-dealers are currently required under Rule 17a-3 under the 
Exchange Act to make and keep records of the terms of each brokerage 
order and each purchase and sale of a security for a period of three 
years, the proposed amendments to Rule 101(b)(7) would be a new 
collection of information because it would require firms to maintain a 
separate written record of information about each bid or purchase that 
is made in reliance on the de minimis exception. Like Rule 17a-3, the 
proposed amendment to Rule 101(b)(7) would require these records be 
maintained for a period of three years.
---------------------------------------------------------------------------

    \114\ Securities Exchange Act Release No. 38067 (December 20, 
1996), 62 FR 520, 530.
---------------------------------------------------------------------------

2. Proposed Amendments to Rule 104
    The proposed amendments to Rule 104 of Regulation M would require 
any person communicating a bid for the purpose of effecting a syndicate 
covering transaction to identify or designate the syndicate covering 
bid as such wherever it is communicated. Rule 104 currently requires 
that any person effecting a syndicate covering transaction shall 
provide prior notice to the self-regulatory organization with direct 
authority over the principal market in the United States for the 
security for which the syndicate covering transaction is effected. We 
believe the identifying or designating the bid as a syndicate covering 
bid, would be an additional collection of information because the 
proposal would require entities to disclose syndicate covering bids.

B. Need for and Proposed Use of the Collection of Information

    The information that would be required to be collected under the 
proposed amendments to Rules 101(b)(7) and 104 of Regulation M is 
necessary to prevent fraudulent, manipulative and deceptive acts by 
issuers, broker-dealers and others. The purpose of the proposed 
amendment to Rule 101(b)(7) is to have a record that would allow 
Commission and SRO examiners to review distribution participants' 
compliance with Rule 101 and to provide a basis for potentially 
uncovering patterns of abuse or policies and procedures that are not 
reasonably designed to achieve compliance with the regulation. The 
purpose of the proposed amendments to Rule 104 is to improve the 
transparency of syndicate covering bids through contemporaneous 
identification of the bid to the market where it is communicated in 
order to: (1) Protect the integrity of the trading market by providing 
investors, both in the offering and in the aftermarket, with 
contemporaneous information about actual syndicate purchasing activity, 
(2) preclude the manipulative effects of such bids, and (3) prevent the 
investing public from unknowingly bearing the cost of undisclosed 
syndicate covering activities.

C. Respondents

1. Proposed Amendments to Rule 101(b)(7)
    The proposed amendments to Rules 101(b)(7) would require those 
distribution participants, and their affiliated purchasers who rely on 
the Rule 101 exception for de minimis transactions to make and keep 
records of the bids or purchases made in reliance on the de minimis 
exception. Therefore, the proposed amendments would apply to all 
distribution participants and their affiliated purchasers who rely on 
the exception in connection with follow-on, i.e., secondary, 
distributions of securities other than those qualifying for the 
actively-traded securities exception under Rule 101 (i.e., securities 
that have at least $1 million ADTV value and $150 million public float 
value). The Commission's Office of Economic Analysis (``OEA'') 
estimates that there are approximately 6,562 active broker-dealers 
registered with the Commission, of which 614 engage in 
underwriting.\115\ Based on OEA's review of offerings in 2003, we 
estimate there are approximately 64 offerings annually of securities 
other than actively-traded securities.\116\ Based on the staff's 
discussions with broker-dealers concerning their practices and 
experience with the de minimis transaction exception, we estimate that 
of the 614 brokers who engage in underwriting would utilize the de 
minimis transaction exception once every two years.
---------------------------------------------------------------------------

    \115\ This number is based on OEA's review of 2003 FOCUS Report 
filings reflecting registered broker-dealers. This number does not 
include broker-dealers that are delinquent on FOCUS Report filings.
    \116\ This number is based on information provided by the SEC's 
Office of Economic Analysis.
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2. Proposed Amendments to Rule 104
    Proposed amendments to Rule 104 will require distribution 
participants, such as managing underwriters, who are communicating a 
syndicate covering bid, to identify or designate the bid as a syndicate 
covering bid wherever it is communicated. Syndicate covering 
transactions typically are effected by a managing underwriter on behalf 
of the syndicate. Managing underwriters do not utilize syndicate 
covering transactions in all offerings. Rather, syndicate covering 
transactions generally occur in connection with IPOs. Further, only a 
fraction of all IPOs, typically those IPOs where supply exceeds 
investor demand for the offered security, are facilitated by the 
managing underwriter by means of syndicate covering transactions. The 
number of IPOs conducted per year is also dependent on general economic 
conditions, e.g., the business cycle. As noted above, OEA estimates 
that approximately 614 active broker-dealers registered with the 
Commission engage in underwriting. The staff estimates that there were 
88 equity IPOs in 2003, and that all such IPOs involved a managing 
underwriter.\117\ Based on the staff's review of syndicate covering 
practices in a sample of offerings in one year, the staff believes that 
approximately 53% (or 47 offerings) of such IPOs were facilitated by 
syndicate covering transactions.
---------------------------------------------------------------------------

    \117\ This number is based on information provided to the 
Commission staff by OEA.
---------------------------------------------------------------------------

D. Total Annual Reporting and Recordkeeping Burden

1. Proposed Amendments to Rule 101(b)(7)
    The proposed amendments to Rule 101(b)(7) of Regulation M would 
require all distribution participants and affiliated purchasers who 
rely on the de minimis exception to maintain a record of each bid or 
purchase made in reliance of the exception. We believe that 
distribution participants already make records of the type of 
information required in the proposed amendment to Rule 101(b)(7) since 
broker-dealers must record the terms of bids and transactions they 
effect under Rule 17a-3 and keep such records for 3 years. However, the 
proposal would require

[[Page 75787]]

that a record of the de minimis bids and purchases be kept separately. 
Thus, we believe the proposed amendments would impose an additional 
collection of information by requiring distribution participants to 
maintain the records separately.
    Based on the staff's review of broker practices with respect to 
record keeping and their reliance on the de minimis transaction 
exception, we understand that the de minimis exception is rarely 
utilized by distribution participants and that it would take each 
broker approximately 20 minutes to create and maintain files for all de 
minimis bids and purchases made per offering. Based on the staff's 
review of broker-dealer experiences, we assume that one syndicate 
member per offering would rely on the de minimis exception once every 2 
years (or 0.5 times per year). We estimate that the total estimated 
annual hour burden per year is 10.7 burden hours (the product of one 
syndicate member per offering, 64 offerings involving non-actively 
traded securities, 0.5 reliances per year, and 20 minutes recordkeeping 
per offering). We also estimate the paperwork compliance for the 
proposed amendments for each distribution participant per offering is 
approximately 10 minutes per year (the product of one syndicate member 
per offering, 0.5 reliances per year, and 20 minutes recordkeeping per 
offering). With respect to the proposed amendments to Rule 101(b)(7), 
we estimate that the broker-dealers bear 100% of the burden of 
preparation internally since the broker-dealers relayed to the staff 
that they would create and maintain such files internally.
2. Proposed Amendments to Rule 104
    The proposed amendments to Rule 104 of Regulation M would require 
managing underwriters to identify or designate syndicate covering bids 
as such wherever communicated and to provide notice of its intention to 
engage in short covering to the SRO with direct authority over the 
principal market in the United States for the security for which the 
syndicate covering bid was made.
    Managing underwriters do not utilize syndicate covering 
transactions in all offerings. Rather, syndicate covering transactions 
generally occur in connection with IPOs. Further, only a fraction of 
all IPOs, typically those IPOs where supply exceeds demand for the 
security, are facilitated by the managing underwriter by means of 
syndicate covering transactions. The number of IPOs conducted per year 
is also dependent on general economic conditions, e.g., the business 
cycle. We estimate that approximately 614 active broker-dealers 
registered with the Commission engage in underwriting. In 2003, we 
estimate that there were 88 equity IPOs of which approximately 53% (or 
47 offerings) involved a managing underwriting effecting syndicate 
covering transactions. We assume for purposes of this analysis that 
each offering had one managing underwriter. The staff reviewed the 
number of syndicate covering transactions made in a sample of offerings 
in a particular year and based upon that data, the staff believes that 
on average approximately 22 syndicate covering bids occur for each IPO 
that involves syndicate short covering.
    It was determined at the time of Regulation M's adoption that in 
instances where such disclosure was required for stabilizing bids that 
it would require 15 minutes per bid.\118\ We are requiring only 
identification of the syndicate covering bids in addition to that which 
is already required under Rule 104 and we believe this will impose only 
nominal costs and time upon the syndicate manager or other person 
communicating the syndicate covering bid.
---------------------------------------------------------------------------

    \118\ 62 FR at 542.
---------------------------------------------------------------------------

    Based on the number of IPOs in 2003 that involved syndicate short 
covering and the average number of short covering bids per offering, 
the annual number of syndicate short covering bids was 1034 (the 
product of 47 offerings, and 22 syndicate covering bids per offering). 
We estimate that identifying or designating each syndicate bid would 
take approximately 15 minutes. Thus, the total estimated annual hour 
burden per year is 258.5 burden hours (the product of 1034 syndicate 
covering bids and 15 minutes per bid). As stated above, typically the 
managing underwriter communicates the syndicate covering bid. 
Therefore, we also estimate that the paperwork compliance for the 
proposed rules for each managing underwriter is approximately 5.5 
annual burden hours per offering (258.5 burden hours/47 offerings). 
With respect to the proposed Rule 104 amendments, we estimate that the 
syndicate member bears 100% of the burden of preparation internally 
because the managing underwriter communicates the syndicate covering 
bids on behalf of the syndicate.

E. Collection of Information Is Mandatory

1. Proposed Amendments to Rule 101(b)(7)
    The collection of information is mandatory if a distribution 
participant or its affiliated purchasers wish to rely on the de minimis 
transactions exception from Rule 101 of Regulation M.
2. Proposed Amendments to Rule 104
    The collection of information is mandatory for all persons 
communicating a bid that is for the purpose of effecting a syndicate 
covering transaction.

F. Confidentiality

1. Proposed Amendments to Rule 101(b)(7)
    The collection of information under the proposed amendments to Rule 
101(b)(7) would be provided to Commission and SRO examiners, but not 
subject to public availability.
2. Proposed Amendments to Rule 104
    The collection of information under the proposed amendments to Rule 
104 would be communicated and displayed publicly.

G. Record Retention Period

1. Proposed Amendments to Rule 101(b)(7)
    The proposed amendments to Rule 101(b)(7) would require a broker or 
dealer to preserve the records required under the rule in accordance 
with proposed Rule 17a-4(b)(13). Rule 17a-4(b)(13) would require 
distribution participants and their affiliated purchasers to create and 
maintain separate written records of each bid or purchase made in 
reliance on the de minimis exception for a period of three years, the 
first two years in an accessible place.
2. Proposed Amendments to Rule 104
    The proposed amendments to Rule 104 do not contain any 
recordkeeping requirements.

H. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to: (1) Evaluate whether the proposed collection of 
information is necessary for the proper performance of the functions of 
the agency, including whether the information shall have practical 
utility; (2) evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collection of information; (3) determine whether

[[Page 75788]]

there are ways to enhance the quality, utility, and clarity of the 
information to be collected; and (4) evaluate whether there are ways to 
minimize the burden of the collection of information on those who are 
to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-41-04. 
Requests for materials submitted to OMB by the Commission with regard 
to this collection of information should be in writing, refer to File 
No. S7-41-04, and be submitted to the Securities and Exchange 
Commission, Records Management, Office of Filings and Information 
Services, 450 5th Street, NW., Washington, DC 20549. OMB is required to 
make a decision concerning the collections of information between 30 
and 60 days after publication. Consequently, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

V. Consideration of Proposed Amendments to Regulation M's Costs and 
Benefits \119\
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    \119\ The Commission is also proposing certain conforming 
changes to Rules 17a-2, 17a-4, 104(j)(2) under the Exchange Act, and 
Rule 481 and Item 508 under the Securities Act. The costs and 
benefits, however, arise from the substance of the proposed 
amendments in the rule changes discussed herein.
---------------------------------------------------------------------------

    The Commission is considering the costs and benefits of the 
proposed amendments to Regulation M and new Rule 106 thereunder. The 
Commission is sensitive to these costs and benefits, and requests data 
to quantify the costs and the value of the benefits provided, and 
encourages commenters to discuss any additional costs or benefits 
beyond those discussed here. In particular, the Commission requests 
comment on the potential costs for any modification to both computer 
systems and surveillance mechanisms and for information gathering, 
management, and recordkeeping systems or procedures, as well as any 
potential costs or benefits resulting from the proposals for 
registrants, issuers, investors, broker-dealers, other securities 
industry professionals, regulators and others. Commenters should 
provide analysis and data to support their views on the costs and 
benefits associated with the proposed amendments.

A. Proposed Amendments to Rule 100: Definition of Restricted Period and 
IPO

1. Benefits
    We believe that the proposed amendments to Rule 100 of Regulation M 
would clarify what is considered to be an IPO under the regulation and 
when a restricted period under Rule 101 and 102 begins for IPOs, 
thereby facilitating compliance by distribution participants, issuers, 
their affiliates and others. By explicitly defining IPO we are helping 
to ensure that the extended restricted period will apply to an issuer's 
initial offerings of debt and equity, as well as clarifying when the 
extended restricted period would be applicable to issuers whose 
securities already trade on foreign markets. Similarly, we propose to 
amend the definition of restricted period to incorporate a long-
standing interpretation under Regulation M, that is, to expressly 
describe the applicable restricted period for corporate actions such as 
valuation and election periods. We also propose to define these terms 
in Rule 100. By amending the definition of the restricted period to 
explicitly define the applicable restricted period for IPOs and for 
election and valuation periods, we would provide certainty to the 
issuers, distribution participants, their affiliates and others, as to 
when exactly the restricted period begins and ends. In addition, a 
defined restricted period for IPOs and explicitly defining the 
restricted period for valuation and election periods would help to 
combat manipulative abuses that may occur prior to an IPO and during 
price sensitive valuation and election periods and that have been the 
subject of recent enforcement actions. By prohibiting inducements, bids 
or purchases well in advance of IPO pricing the proposed amendment 
would allow the securities markets to function as independent pricing 
mechanisms by reflecting true demand for the security and improve the 
integrity of the capital raising process. Prohibiting such activity 
would also reduce the investors' perception of scarcity of IPO stock, 
which affects the pricing of and aftermarket trading in the IPO 
security.
2. Costs
    The proposed amendment would expand the restricted period for an 
IPO so that such period would generally commence from earlier of (i) 
the time that an issuer reaches an understanding with the broker-dealer 
that the broker-dealer is to act as its underwriter or (ii) the time a 
registration statement is filed with the Commission or other offering 
document is first circulated to potential investors. This proposed 
expansion of the IPO restricted period, were it adopted, would capture 
in a prophylactic rule, conduct that is already actionable under the 
antifraud and anti-manipulation provisions of the federal securities 
laws. We note that the amendment applies only to IPOs which are a small 
portion of all offerings. Similarly, we propose to expressly describe 
the applicable restricted period for valuation and election periods. 
This proposal is an application of a long-standing, broadly published, 
interpretation regarding the application of Regulation M in the context 
of valuation and election periods.
    We understand that distribution participants already have policies 
and procedures in place to monitor for compliance with the restricted 
periods under current Regulation M. The only incremental costs of the 
proposed restricted period for IPOs would be associated with monitoring 
for Regulation M compliance during that portion of the restricted 
period which is new--the period beginning when an issuer and broker 
dealer reach an understanding that the broker-dealer is to act an 
underwriter or when a registration statement is filed or offering 
document is circulated to potential investors until 5 days prior to 
pricing. Because there is no trading market for an IPO offered security 
prior to the pricing of offering, distribution participants should not 
incur any costs associated with monitoring for open market purchases 
during the new portion of the restricted period. However, there may be 
costs associated with training employees of distribution participants 
to understand the application of the proposed restricted period. 
However, as stated above, we believe such activity prior to an IPO is 
already prohibited by the general antifraud and anti-manipulation 
provisions of the securities laws and distribution participants and 
their employees should not engage in such conduct at any time prior to 
the distribution of the IPO. Similarly, distribution participants, 
issuers, their affiliates and others are already prohibited under 
Regulation M during election and valuation periods. As such, they 
should already have undertaken training, compliance procedures and 
monitoring to comply with the Regulation. Nonetheless, the proposals 
may require one-time changes by certain

[[Page 75789]]

distribution participants, issuers, affiliated purchasers and others. 
Thus, costs, if any, associated with training, modifying, revising 
policies and behavior and monitoring for compliance should be minimal.
    Of note, we believe that costs, if any, associated with the 
proposed amendment concerning IPOs would only be borne by distribution 
participants. Our experience indicates that distribution participants, 
rather than issuers, have engaged in inducing or attempting to induce 
persons to bid for or purchase a covered security prior to the 5-day 
IPO restricted period. The Commission believes that even if there are 
some costs generated by this proposal, such costs are minimal and are 
justified by the facilitation of investment and enhancement of investor 
confidence in the IPO capital raising process that we believe will 
result from this proposal. We are however sensitive to potential costs 
borne by industry participants and generally solicit comment on any 
costs this proposed amendment could generate and whether the proposed 
amendments impose greater costs than presently exist under the federal 
securities laws.

B. Proposed Amendments to Rules 100, 101 and 102: ADTV and Public Float 
Value Thresholds

1. Benefits
    The Commission believes the proposed adjustments to ADTV and public 
float values will reset the thresholds to their original 
restrictiveness and thereby appropriately apply the one- and five-day 
restricted period or actively-traded exception to the appropriate 
securities, thus minimizing the potential for manipulation during 
offerings. In order to make the thresholds for the restricted period 
and actively-traded securities and reference securities current, the 
Commission is proposing to increase the ADTV and public float value 
thresholds to account for the decline in the value of the dollar that 
has occurred since 1996 (i.e., adjust the values by the Consumer Price 
Index (``CPI''). Between 1996 and 2004, the CPI, a general measure for 
the change in the value of the dollar rose approximately 20 
percent.\120\ The adjustment of the thresholds to reflect the current 
dollar value should simply reset the thresholds to the level of 
restrictiveness intended when Regulation M was adopted. By resetting 
the ADTV and public float thresholds, the proposal would apply the 
actively-traded security exception and one- or five-day restricted 
period to the type of issuers and securities the Commission had 
considered appropriate at Regulation M's adoption, i.e., those with a 
relatively limited potential for manipulation.
---------------------------------------------------------------------------

    \120\ The change in CPI is the percentage change in Urban CPI 
measured from July 1996 to July 2004, based on calculations 
performed by OEA.
---------------------------------------------------------------------------

2. Costs
    The Commission believes that the adjustment to ADTV and public 
float value would not impose costs in addition to those considered when 
Regulation M was adopted since the amendments will reinstate the level 
of restrictiveness in effect at the time of Regulation M's adoption. As 
a practical matter, should the ADTV and public float values be adjusted 
as proposed, certain issuers or securities will no longer be exempt 
from Rules 101 and 102 or will be subject to a longer restricted 
period, and so issuers, distribution participants, their affiliates and 
others must modify their activities to comply with the applicable 
restricted period. This adjustment to a different restricted period 
(either one- or five-day, or none) may impose some initial costs upon 
issuers, distribution participants, their affiliates and others. The 
one- and five-day restricted periods, however, have been in place since 
1997 so issuers, distribution participants, their affiliates and others 
should already have the capabilities and policies and procedures in 
place in order to be able to impose such restrictions on issuers and 
their securities. At this time, the Commission believes this one-time 
modification by issuers, distribution participants and their 
affiliates, should be minimal. The Commission has no data on these 
costs and solicits comments as to whether the proposed amendments 
impose greater costs on issuers than the current rule.

C. Proposed Amendments to Rule 101(b)(7): De Minimis Exception

1. Benefits
    We believe the proposed amendments to Rule 101(b)(7) of Regulation 
M would enhance compliance with Regulation M and assist the Commission 
and SRO examiners in identifying patterns of abuse or policies and 
procedures that are not reasonably designed to achieve compliance with 
the rule.
2. Costs
    As discussed in the PRA, the proposed amendments to Rules 101(b)(7) 
would involve a collection of information since those distribution 
participants, and their affiliated purchasers who rely on the Rule 101 
exception for de minimis transacations would be required to make and 
keep records of the bids or purchases made in reliance on the de 
minimis exception. As discussed below, the staff estimates this annual 
burden to be 10.7 burden hours.
    Currently under Regulation M, distribution participants, their 
affiliates and others are expected to ``review [their] policies and 
procedures and modify them as appropriate'' in order to qualify for the 
de minimis exception and no additional requirement concerning policies 
and procedures is proposed at this time. Additionally, broker-dealers 
are already required under Rule 17a-3 of the Exchange Act to make and 
keep records of the terms of each brokerage order and each purchase and 
sale of a security for a period of three years. The proposed amendments 
would only require firms to maintain a separate written record of the 
terms of the bids and purchases made in reliance upon the exception 
from Rule 101 for a period of 3 years. Based on discussions with 
distribution participants about their experience with the de minimis 
exception, the Commission believes these would be infrequent violations 
requiring infrequent recordkeeping. Further, the review of the policies 
and procedures is already required under Regulation M. For purposes of 
the PRA, the staff estimates an annual burden of 10 minutes per 
distribution participant to keep separate records of their reliance on 
the exception. Therefore, the staff believes the proposed amendments 
regarding recordkeeping of de minimis violations of Regulation M would 
impose minimal costs.

D. Proposed Amendments to Rule 104: Syndicate Covering and Penalty Bids

1. Benefits
    Identification or designation of syndicate covering transactions 
would help to protect investors by providing contemporaneous 
information about the actual occurrences of syndicate purchasing 
activity. The proposal obligates managing underwriters and others 
communicating a syndicate covering bid to identify it as such wherever 
the bid is communicated. The staff believes such identification is an 
essential first step to market-wide identification of syndicate 
covering bids. Contemporaneous disclosure of the fact that 
stabilization-like activity is occurring is beneficial to the market 
and its participants, because it would allow market participants, i.e., 
both holders of offered shares and potential investors in the secondary 
market, to base their

[[Page 75790]]

investment decisions and the resulting transactions on all available 
information. This proposed amendment also would inhibit underwriters 
from pricing offerings at higher levels than otherwise may be 
obtainable in the absence of their syndicate covering activity in the 
subsequent trading market.
    The proposal to prohibit penalty bids would greatly reduce the 
pressure of a penalty bid assessment by a managing underwriter on a 
syndicate that, in turn may result in discriminatory and improper 
conduct by the syndicate member and its salespeople toward its 
customers who may wish to sell a security purchased in an offering.
2. Costs
    Proposed amendments to Rule 104 would require managing underwriters 
to identify or designate syndicate covering bids as such wherever 
communicated. For purposes of the PRA we estimated an annual burden of 
5.5 hours per year for managing underwriters to comply. The Commission 
recognizes that SROs and markets receiving designation of a syndicate 
bid from managing underwriters could incur some costs to communicate 
this information to the market. The required disclosure and designation 
of a syndicate bid, however, is similar to what is already required for 
stabilizing transactions, so the Commission anticipates that the means 
of communicating such information is already in place and operational. 
Issuers may also incur one-time costs related to modifying the 
disclosure language in the Plan of Distribution.
    Although penalty bids are infrequently used, due to their 
elimination managing underwriters and issuers will no longer have the 
option of using them and may impose minimal costs upon them. Overall, 
the staff believes the costs of complying with the Rule 104 proposals 
would be minimal and the benefits from improved transparency and 
removal of penalty bids would outweigh these costs.

E. Rule 104--Exception for Transactions in Rule 144A Securities

1. Benefits
    We believe that the proposed amendment to Rule 104(j)(2) to include 
``reference securities'' will make the subparagraph consistent with the 
same exception under Rules 101(b)(10) and 102(b)(7) for transactions in 
Rule 144A securities, as was intended when Regulation M was adopted and 
will clarify the application of the exception.
2. Costs
    The Commission preliminarily believes that including reference 
securities in the 144A exception of Rule 104 would impose minimal costs 
since it clarifies what securities are excepted and may require a one-
time adjustment by training and modifying procedures by distribution 
participants and others.

F. Proposed Rule 106: Unlawful Practices in Connection With Allocations 
of Offered Securities

1. Benefits
    We believe that proposed Rule 106 would help prevent abuses in 
awarding allocations of offered securities, particularly IPOs, that 
were common in the late 1990's and other ``hot issue'' periods. 
Underwriters'' or issuer's solicitations, inducements, demands for, or 
acceptance of, consideration in addition to the stated offering price 
have several pernicious effects. These activities by distribution 
participants can contribute to a false impression of scarcity in the 
offered shares. This, in turn, can stimulate and distort the offering 
and aftermarket price of the offered security by creating the 
impression among investors that any unfulfilled demand for the offered 
shares may only be satisfied in the aftermarket.\121\ Moreover, such 
activities create the impression that the underwriters have ``rigged 
the game'' and only the market participants who know they are expected, 
and are willing, to pay the additional consideration are able to 
participate in IPOs. Additionally, when underwriters allocate shares in 
``hot offerings'' to customers who agree to make aftermarket purchases 
in ``cold offerings,'' the purchasers in the cold offerings are 
deceived as to the true demand for that offering. The proposed rule 
would expressly preclude conduct that can operate as a fraud on 
prospective and actual purchasers of an offered security, particularly 
in IPOs. Such conduct can undermine the fundamental function of the 
securities markets as an independent pricing mechanism and erode 
investor confidence in the securities offering process generally. 
Having an express prophylactic rule that prohibits the conduct would 
emphasize to distribution participants that engaging in such activity 
is prohibited and would assist the Commission in its enforcement of the 
federal securities laws.
---------------------------------------------------------------------------

    \121\ See 1974 Rule 10b-20 Proposing Release (describing how 
broker inducements for allocating offered shares: (1) Encourages 
participation in cold offerings by investors with a view toward 
immediate resale of the security; (2) obscures actual demand for the 
offering making an assessment by investors of true demand difficult 
thus artificially affecting the offering price; and (3) stimulates 
demand for the offering and forces investors who could not 
participate to buy in the aftermarket). 1974 Rule 10b-20 Proposing 
Release, 39 FR at 7806.
---------------------------------------------------------------------------

2. Costs
    The Commission notes that the conduct the proposed rule prohibits 
is already prohibited by Regulation M or is illegal under the antifraud 
and anti-manipulation provisions of the federal securities laws, as 
well as under SRO rules, and so the new Rule 106 does not add any 
additional requirements. Rather, it expressly prohibits such conduct. A 
few distribution participants, their affiliates and others who did not 
already have adequate policies and procedures may need to make a one-
time revision and undertake corresponding training of employees. The 
Commission therefore believes that the proposed rule would impose 
minimal costs, if any, on distribution participants, issuers and their 
affiliated purchasers and would support investor protection.

VI. Consideration on Burden and Promotion of Efficiency, Competition, 
and Capital Formation

    Section 3(f) of the Exchange Act requires the Commission, whenever 
it engages in rulemaking and must consider or determine if an action is 
necessary or appropriate in the public interest, to consider whether 
the action would promote efficiency, competition, and capital 
formation.\122\ In addition, Section 23(a)(2) of the Exchange Act 
requires the Commission, when making rules under the Exchange Act, to 
consider the impact such rules would have on competition.\123\ Exchange 
Act Section 23(a)(2) prohibits the Commission from adopting any rule 
that would impose a burden on competition not necessary or appropriate 
in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \122\ 15 U.S.C. 78c(f).
    \123\ 15 U.S.C 78w(a)(2).
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed amendments 
to Regulation M are intended to improve market efficiency by providing 
greater clarity to all issuers, distribution participants and their 
affiliated purchasers as to the scope of permissible activity for 
offerings; helping to ensure that those securities excepted from the 
rules have no potential for manipulation; requiring companies to 
maintain records of inadvertent violations of Regulation M and to 
revise policies and procedures in order to prevent violating rules; and

[[Page 75791]]

providing greater transparency to the market of actual syndicate 
covering transactions. The proposed amendments are intended to promote 
transparency and prevent manipulative activity in the offering process 
and aftermarket.
    The Commission preliminarily believes that the proposed amendments 
would promote capital formation since they seek to eliminate the abuses 
in the offering process and would promote a more even playing field for 
potential investors and issuers alike. These proposed amendments would 
promote investor confidence in the offering process as well as in the 
market as a whole, which would foster capital formation.
    The Commission has considered the proposed amendments in light of 
the standards cited in Section 23(a)(2) and believes preliminarily 
that, if adopted, they would not likely impose any significant burden 
on competition not necessary or appropriate in furtherance of the 
Exchange Act. Specifically, the proposed amendments if adopted, would 
require maintenance of separate records under Rule 101(b)(7) and 
identification or designation of syndicate covering bids under Rule 
104. As discussed above, distribution participants under Rule 17a-3 
already make and keep records of all orders and purchases and sales, 
including de minimis bids and purchases, so the Commission believes the 
additional burden of keeping records separately and for three years 
would be minimal. With regard to Rule 104, the Commission recognizes 
that SROs and markets receiving the identification or designation of a 
syndicate bid from managing underwriters may incur some costs to 
communicate this information. The required designation of a syndicate 
bid, would be analogous to what is already required for stabilizing 
transactions, so the Commission anticipates that the means of 
communicating such information is already in place and operational and 
would require minimal costs to extend such designation to include 
syndicate covering bids. Additionally, in regard to the proposed 
definition of IPO and expansion of the restricted period for IPOs we 
would be expressly prohibiting conduct which can create an exaggerated 
perception to investors of scarcity of IPO stock and affect the pricing 
of the offering, both of which undermine the market's function as an 
independent pricing mechanism. The proposed amendments to Rules 100, 
101, and 102 concerning ADTV and public float values will restore the 
restricted period and actively-traded thresholds to the level 
originally contemplated at Regulation M's adoption. By expressly 
providing for valuation and election periods within the definition of 
the restricted period the Commission would codify a long-standing 
interpretation and eliminate any confusion in these contexts. The new 
Rule 106 would expressly prohibit in a prophylactic rule conduct 
related to offerings that has been the subject of recent enforcement 
actions. Since the conduct covered by proposed Rule 106 is already 
prohibited under either Regulation M or antifraud and anti-manipulation 
provisions of the federal securities laws, the staff codifying the 
illegality of such conduct within a prophylactic rule imposes minimal 
additional costs and would not impose a burden on competition.
    We preliminarily believe that the proposed amendments would promote 
competition among distribution participants as the amendments would 
level the playing field by applying clear and uniform regulation 
concerning conduct during an offering, and by improving the 
transparency of syndicate covering bids in the aftermarket.
    The Commission requests comment on whether the proposed amendments 
are expected to promote efficiency, competition, and capital formation.

VII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or (SBREFA),\124\ we must advise the Office of Management 
and Budget as to whether the proposed amendments constitute a ``major'' 
rule. Under SBREFA, a rule is considered ``major'' where, if adopted, 
it results or is likely to result in:
---------------------------------------------------------------------------

    \124\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified 
in various sections of 5 U.S.C. and as a note to 5 U.S.C. 601).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effect on competition, investment, or 
innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review. We request comment on the 
potential impact of the proposed amendments on the economy on an annual 
basis. Commenters are requested to provide empirical data and other 
factual support for their view to the extent possible.

VIII. Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (IRFA), in accordance with the provisions of the Regulatory 
Flexibility Act (RFA)\125\ regarding the proposed amendments to 
Regulation M.
---------------------------------------------------------------------------

    \125\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Reasons for the Proposed Action

    Based on our experience with the operation of Regulation M, and to 
reflect market developments since the Regulation's adoption, we propose 
to revise Regulation M's provisions. The proposed amendments, including 
amending the definition of ``restricted period,'' requiring 
recordkeeping for reliance on the de minimis transaction exception, 
updating the restricted period and ``actively-traded'' qualifying 
thresholds, requiring identification of syndicate covering bids, 
prohibiting penalty bids, and adopting a new rule to prevent 
conditioning the award of allocations of offered securities on the 
receipt of consideration in addition to the stated offering 
consideration, are designed to modernize Regulation M in light of 
recent developments while providing clear guidelines to prevent 
manipulation of the markets.
    If the proposed amendments were not adopted, the Regulation may not 
appropriately address the manipulative abuses that may occur prior to 
an IPO and that interfere with the securities markets' function as an 
independent pricing mechanism. Without adjusting the qualifying 
thresholds for the restricted periods and actively-traded exceptions we 
could be exempting from the regulations restrictions securities that 
may be subject to manipulation. Additionally, if the proposed 
amendments to Rule 101(b)(7) were not adopted, Commission and SRO 
examiners would be unable to identify possible patterns of abuse or 
improper policies and procedures that may be in place. As a result of 
not adopting the proposals contained in rules 104 and 106, investors 
may be precluded from receiving allocations, paying too high a price 
for a security or otherwise invest in an offered security (or trade in 
the aftermarket) with incomplete information as to the true demand for 
the security and the level or amount of actual syndicate covering 
activity. Similarly, if distribution participants were not required to 
disclose to the market and identify or designate when a syndicate short 
covering bid is made, prospective investors in, and holders of, offered 
shares will not know the extent

[[Page 75792]]

of syndicate covering activity at the time it occurs and may make 
investment decisions without all the necessary information about the 
offered security. Additionally, if distribution participants were not 
prohibited from demanding additional consideration from investors in 
order to obtain IPO allocations, we would be unable to prophylactically 
prevent such fraudulent activity from occurring and only reach such 
activities through the antifraud and anti-manipulation provisions of 
the federal securities laws. Moreover, if we did not explicitly define 
IPOs and the restricted period for valuation and election periods, we 
would not be able to provide certainty to the issuers, distribution 
participants and others as to the exact application of the rules.

B. Objectives

    The proposed amendments to Regulation M are designed to fulfill 
several objectives. First, the proposed amendments seek to prevent 
manipulation from occurring by precluding certain activities by 
underwriters and other distribution participants that can undermine the 
integrity and fairness of the offering process, particularly with 
respect to allocations of offered securities. Second, the proposal 
seeks to enhance the notice and disclosure of certain practices by 
distribution participants, such as syndicate covering that may affect 
the market price and trading of an offered security and to prohibit 
penalty bids. Third, the proposed amendments are designed to prohibit 
activities that could artificially influence the market for the offered 
security, including, supporting the offering price by creating the 
exaggerated perception of scarcity of the offered security or creating 
the misleading appearance of active trading in the market for the 
security. The amendments are also intended to update certain 
definitional and operational provisions in light of market developments 
since the Regulation's adoption in 1996.

C. Legal Basis

    The amendments to Regulation M are proposed pursuant to the 
authority set forth under the Securities Act, 15 U.S.C. 77a et seq., 
particularly Section 7, 17(a), 19(a), 15 U.S.C. 77g, 77q(a), and 
77s(a); the Exchange Act, 15 U.S.C. 78a et seq., particularly Sections 
2, 3, 9(a), 10, 11A(c), 12, 13, 14, 15(c), 15(g), 17(a), 23(a), and 30, 
15 U.S.C. 78b, 78c, 78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(c), 
78o(g), 78q(a), 78w(a), and 78dd-1; and the Investment Company Act, 15 
U.S.C. 80a-1 et seq., particularly Sections 23, 30, and 38, 15 U.S.C. 
80a-23, 80a-29, and 80a-37.

D. Small Entities Subject to the Rule

    Paragraph (a) of Rule 0-10 \126\ states that the term ``small 
business'' or ``small organization,'' when referring to issuers or 
affiliated purchasers, are those who on the last day of its most recent 
fiscal year had total assets of $5,000,000 or less. As of 2003, the 
Commission estimates that there were approximately 3489 issuers that 
qualified as small entities as defined above, and were subject to 
Regulation M.\127\ Paragraph (c)(1) of Rule 0-10 \128\ states that the 
term ``small business'' or ``small organization,'' when referring to a 
broker-dealer, means a broker or dealer that had total capital (net 
worth plus subordinated liabilities) of less than $500,000 on the date 
in the prior fiscal year as of which its audited financial statements 
were prepared pursuant to Sec.  240.17a-5(d); and is not affiliated 
with any person (other than a natural person) that is not a small 
business or small organization. As of 2003, the Commission estimates 
that there were approximately 905 broker dealers, 33 of which engaged 
in underwriting, that qualified as small entities as defined above, and 
were subject to Regulation M.\129\ The Commission seeks comment on the 
number of issuers and broker-dealers that were subject to Regulation M 
and the number of such issuers, broker-dealers and syndicate members 
that are small entities.
---------------------------------------------------------------------------

    \126\ 17 CFR 240.0-10(a).
    \127\ This number is based on the total number of issuers' 10-
KSB filings for the fiscal year ending 9/30/04.
    \128\ 17 CFR 240.0-10(c)(1).
    \129\ These numbers are based on OEA's review of 2003 FOCUS 
Report filings reflecting registered broker dealers. This number 
does not include broker-dealers that are delinquent on FOCUS Report 
filings.
---------------------------------------------------------------------------

E. Reporting, Recordkeeping and Other Compliance Requirements

    The proposed amendments to Regulation M would impose certain 
reporting, recordkeeping and other compliance requirements on broker-
dealers and issuers who are small entities and engage in securities 
offerings. Those distribution participants that are small entities who 
rely on the de minimis transactions exception of Regulation M will now 
be subject to recordkeeping requirements. Also, if any broker-dealers 
that are small entities undertake syndicate covering transactions they 
will be subject to the new identification and designation requirements. 
We do not believe, at this time, that any additional or specialized 
professional skills will be necessary to achieve these new 
requirements.

F. Duplicative, Overlapping or Conflicting Federal Rules

    The Commission believes that there are no federal rules that 
duplicate, overlap or conflict with, the proposed amendments.

G. Significant Alternatives

    The RFA directs the Commission to consider significant alternatives 
that would accomplish the stated objective, while minimizing any 
significant adverse impact on small issuers and broker-dealers. 
Pursuant to Section 3(a) of the RFA,\130\ the Commission considered the 
following alternatives: (1) The establishment of differing compliance 
or reporting requirements or timetables that take into account the 
resources available to small entities; (2) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the Rule for small entities; (3) the use of 
performance rather than design standards; and (4) an exemption from 
coverage of the Rule, or any part thereof, for small entities.
---------------------------------------------------------------------------

    \130\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    With respect to the proposed amendments to Regulation M, the 
Commission believes that in order to prevent manipulation and fraud in 
the offering process and trading markets, uniform rules applicable to 
all market participants (regardless of size) is necessary. The 
Commission believes that the majority of entities to whom Regulation M 
applies and the majority of syndicate members who would be affected by 
the proposed amendments are not small entities. Therefore, the 
establishment of different requirements for small entities is not 
practicable, nor in the public interest and for the protection of 
investors to do so. In addition, the proposed amendments impose minimal 
additional costs or burdens so establishing different compliance 
requirements or clarifying, consolidating, or simplifying compliance or 
reporting requirements for small entities would not be justified in 
this context. With regard to the proposed amendments to Regulation M, 
and clarification of the application of the regulation, small entities 
would not be specifically exempted, since all securities may be the 
subject of manipulation or other abuse the amendments seek to prevent. 
Regulation M imposes performance standards rather than design standards 
and would require all entities to comply with the

[[Page 75793]]

rule in order to ensure a proper application of the rule.

H. Solicitation of Comments

    The Commission encourages written comments on matters discussed in 
the IRFA. In particular, the Commission requests comments on (1) the 
number of issuers and broker-dealers that were subject to Regulation M 
and the number of such issuers, broker-dealers and syndicate members 
that are small entities; (2) the nature of any impact the proposed 
amendments would have on small entities and empirical data supporting 
the extent of the impact (commenters are asked to describe the nature 
of any impact and provide empirical data supporting the extent of the 
impact); and (3) how to quantify the number of small entities that 
would be affected by and/or how to quantify the impact of the proposed 
amendments. Such comments will be considered in the preparation of the 
Final Regulatory Flexibility Analysis, if the proposed amendments are 
adopted, and will be placed in the same public file as comments on the 
proposed amendments themselves. As discussed above, for purposes of 
SBREFA, the Commission is also requesting information regarding the 
potential impact of the proposed amendments on the economy on an annual 
basis. Commenters should provide empirical data to support their views.

IX. Statutory Basis

    The proposed amendments to Rule 17a-2 would be adopted under the 
Exchange Act, 15 U.S.C. 78a et seq., and particularly Sections 2, 3, 
9(a)(6), 10(a), 10(b), 13(e), 15(c), 17(a), and 23(a), 15 U.S.C. 78b, 
78c, 78i(a)(6), 78j(a), 78j(b), 78m(e), 78o(c), 78q(a), and 78w(a). The 
proposed amendments to Item 508(l)(1) of Regulation S-K and Item 
508(j)(1) of Regulation S-B and Rule 481 would be adopted under the 
Securities Act, 15 U.S.C. 77a et seq., particularly Sections 6, 7, 8, 
10, and 19(a), 15 U.S.C. 77f, 77g, 77h, 77j. and 77s(a); the Exchange 
Act, 15 U.S.C. 78a et seq., particularly Sections 3, 4, 10, 12, 13, 14, 
15, 16 and 23; 15 U.S.C. 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78p, and 
78w; and the Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq., 
particularly Sections 8 and 38(a), 15 U.S.C. 80a-8 and 80a-37(a). Rules 
100, 101, 102, 104, and 106 of Regulation M would be adopted under the 
Securities Act, 15 U.S.C. 77a et seq., particularly Sections 7, 17(a), 
19(a), 15 U.S.C. 77g, 77q(a), and 77s(a); the Exchange Act, 15 U.S.C. 
78a et seq., particularly Sections 2, 3, 9(a), 10, 11A(c), 12, 13, 14, 
15(c), 15(g), 17(a), 23(a), and 30, 15 U.S.C. 78b, 78c, 78i(a), 78j, 
78k-1(c), 78l, 78m, 78n, 78o(c), 78o(g), 78q(a), 78w(a), and 78dd-1; 
and the Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq., 
particularly Sections 23, 30, and 38, 15 U.S.C. 80a-23, 80a-29, and 
80a-37.

Text of Proposed Rule

List of Subjects

17 CFR Part 228

    Reporting and recordkeeping requirements, Securities, Small 
businesses.

17 CFR Parts 229, and 230

    Reporting and recordkeeping requirements, Securities.

17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.

17 CFR Part 242

    Brokers, Fraud, Reporting and recordkeeping requirements, 
Securities.

    For the reasons set forth in the preamble, the Commission proposes 
to amend Title 17, chapter II of the Code of Federal Regulations as 
follows:

PART 228--INTEGRATED DISCLOSURE SYSTEM FOR SMALL BUSINESS ISSUERS

    1. The authority citation for Part 228 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77jjj, 77nnn, 
77sss, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-29, 
80a-30, 80a-37, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350.
* * * * *


Sec.  228.508  [Amended]

    2. Section 228.508, paragraph (j)(1), second sentence, is amended 
by removing the phrase ``penalty bids,''.

PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES 
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND 
CONSERVATION ACT OF 1975--REGULATION S-K

    3. The authority citation for Part 229 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 
77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll, 
78mm, 79e, 79j, 79n, 79t, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-
31(c), 80a-37, 80a-38(a), 80a-39, 80b-11, and 7201 et seq.; and 18 
U.S.C. 1350, unless otherwise noted.
* * * * *


Sec.  229.508  [Amended]

    4. Section 229.508, paragraph (l)(1), second sentence, is amended 
by removing the phrase ``penalty bids,''.

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    5. The authority citation for Part 230 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 
77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 
78ll(d), 78mm, 79t, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-
37, unless otherwise noted.
* * * * *


Sec.  230.481  [Amended]

    6. Section 230.481, paragraph (d)(1), third sentence, is amended by 
removing the phrase ``penalty bids,''.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    7. The authority citation for Part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless 
otherwise noted.
* * * * *
    8. Amend Sec.  240.17a-2 by:
    a. Removing the authority citation following the section;
    b. Removing the phrase ``or imposes a `penalty bid,' as defined in 
Sec.  240.100 of this chapter'' in the introductory text of paragraph 
(a);
    c. Revising the introductory text of paragraph (c);
    d. Removing the phrase ``or a penalty bid has been imposed'' in 
paragraph (c)(1)(i);
    e. Removing the phrase ``, and whether any penalties were 
assessed'' in paragraph (c)(1)(ii);
    f. Adding the word ``and'' at the end of paragraph (c)(i)(iii);
    g. Removing the ``; and'' and in its place adding a period at the 
end of paragraph (c)(1)(iv); and
    h. Removing paragraph (c)(i)(v).
    The revision reads as follows:


Sec.  240.17a-2  Recordkeeping requirements relating to stabilizing 
activities.

* * * * *
    (c) Records relating to stabilizing and syndicate covering 
transactions required to be maintained by manager. Any person subject 
to this section who acts as a manager and stabilizes or effects 
syndicate covering transactions shall:
* * * * *

[[Page 75794]]

    9. Section 240.17a-4 is amended by adding paragraph (b)(13) to read 
as follows:


Sec.  240.17a-4  Records to be preserved by certain exchange members, 
broker and dealers.

* * * * *
    (b) * * *
    (13) The record(s) required to be made pursuant to Sec.  
242.101(b)(7) of this chapter.
* * * * *

PART 242--REGULATIONS M, SHO, ATS, AND AC AND CUSTOMER MARGIN 
REQUIREMENTS FOR SECURITY FUTURES

    10. The authority citation for Part 242 is revised to read as 
follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.

    11. Section 242.100 is amended by:
    a. Revising the phrase ``(Sec. Sec.  242.100--242.105 of this 
chapter)'' to read ``(Sec. Sec.  242.100 through 242.106)'' in 
paragraph (a);
    b. Revising the phrase ``(Sec. Sec.  242.100 through 242.105 of 
this chapter)'' to read ``(Sec. Sec.  242.100 through 242.106)'' in 
paragraph (b);
    c. Adding the following definitions in alphabetical order: Election 
period; Initial public offering; and Valuation period; and
    d. Revising the definition of Restricted period.
    The revision and additions read as follows.


Sec.  242.100  Preliminary note; definitions.

* * * * *
    Election period means any period during which shareholders have the 
right to elect among various forms of consideration offered in a 
distribution.
* * * * *
    Initial public offering (IPO) means:
    (1) An issuer's first offering of a security to the public in the 
United States, and
    (2) If prior thereto the issuer's equity securities do not have a 
public float value, an issuer's first offering of an equity security to 
the public in the United States.
* * * * *
    Restricted period means the period beginning:
    (1) For any security with an ADTV value of $120,000 or more of an 
issuer whose common equity securities have a public float value of $30 
million or more, the period beginning on the later of one business day 
prior to the determination of the offering price or such time that a 
person becomes a distribution participant, and ending upon such 
person's completion of participation in the distribution.
    (2) For any security with an ADTV value of less than $120,000 of an 
issuer whose common equity securities have a public float value of less 
than $30 million, the period beginning on the later of five business 
days prior to the determination of the offering price or such time that 
a person becomes a distribution participant, and ending upon such 
person's completion of participation in the distribution.
    (3) In the case of a distribution involving a merger, acquisition, 
or exchange offer:
    (i) The day proxy solicitation or offering materials are first 
disseminated to security holders and ending upon the completion of the 
distribution;
    (ii) The period one or five business days prior to the commencement 
of any valuation period and for the duration of such period (refer to 
paragraphs (1) and (2) of this definition to determine if one or five 
business days is applicable); and
    (iii) The period one or five business days prior to the 
commencement of any election period and for the duration of such period 
(refer to paragraphs (1) and (2) of this definition to determine if one 
or five business days is applicable).
    (4) In the case of a distribution involving an IPO, the earlier of:
    (i) The period beginning at the time when the issuer reaches an 
understanding with the broker-dealer that is to act as an underwriter, 
or such time that a person becomes a distribution participant, and 
ending upon the issuer's or distribution participant's completion of 
participation in the distribution; or
    (ii) The period beginning at the time the registration statement is 
filed with the Commission or other offering document is first 
circulated to potential investors, or such time that a person becomes a 
distribution participant, and ending upon the issuer's or distribution 
participant's completion of participation in the distribution.
* * * * *
    Valuation period means any period during which the market price of 
the offered security is a factor in determining the consideration to be 
paid in the distribution.
    12. Amend Sec.  242.101 by revising paragraph (b)(7) and in 
paragraph (c)(1) by revising the phrases ``$1 million'' and ``$150 
million'' to read ``$1.2 million'' and ``$180 million'' respectively.


Sec.  242.101  Activities by distribution participants.

* * * * *
    (b)(7) De minimis transactions. Purchases during the restricted 
period, other than by a passive market maker, that total less than 2% 
of the ADTV of the security being purchased, or unaccepted bids: 
Provided, however, that the person making such bid or purchase has 
maintained and enforces written policies and procedures designed to 
achieve compliance with other provisions of this section. Any person 
relying on this exception shall create a separate record specifying:
    (i) The security that is the subject of the relevant distribution;
    (ii) The day the restricted period commenced;
    (iii) The ADTV;
    (iv) The bid or purchase that occurred during the restricted 
period, including time, price, quantity, and market;
    (v) The individual who made such bid or purchase and the system 
used to make such bid or purchase;
    (vi) How and when such bid or purchase was discovered;
    (vii) The policies and procedures designed to achieve compliance 
with this section in effect at the time of such bid or purchase;
    (viii) The review of the policies and procedures performed 
following the discovery of such bid or purchase; and
    (ix) Any modifications made to those policies and procedures. A 
broker or dealer shall preserve the record specified in this paragraph 
in accordance with Sec.  240.17a-4(b)(13) of this chapter; or
* * * * *
    13. Amend Sec.  242.102, paragraph (d)(1), by revising the phrases 
``$1 million'' and ``$150 million'' to read ``$1.2 million'' and ``$180 
million'' respectively.
    14. Amend Sec.  242.103, paragraph (b)(7), by revising the phrase 
``Sec. Sec.  228.502, 228.508, 229.502, and 229.508'' to read 
``Sec. Sec.  228.508 and 229.508''.
    15. Amend Sec.  242.104 by:
    a. Revising paragraphs (a), (h)(2), and the introductory text of 
paragraph (j)(2); and
    b. In paragraph (h)(3) revise the phrase ``Item 502(d) of 
Regulation S-B (Sec.  228.502(d) of this chapter) or Item 502(d) of 
Regulation S-K (Sec.  229.502(d) of this chapter)'' to read ``Sec.  
230.481(d) of this chapter''.
    The revisions read as follows.


Sec.  242.104  Stabilizing and other activities in connection with an 
offering.

    (a) Unlawful activity. It shall be unlawful for any person, 
directly or

[[Page 75795]]

indirectly, to stabilize or to effect any syndicate covering 
transaction in connection with an offering of any security, in 
contravention of the provisions of this section. No stabilizing shall 
be effected at a price that the person stabilizing knows or has reason 
to know is in contravention of this section, or is the result of 
activity that is fraudulent, manipulative, or deceptive under the 
securities laws, or any rule or regulation thereunder. It shall be 
unlawful for any person to impose or assess a penalty bid in connection 
with an offering.
* * * * *
    (h) * * *
    (2) Any person communicating a bid that is for the purpose of 
effecting a syndicate covering transaction shall:
    (i) Identify or designate the bid as such wherever it is 
communicated; and
    (ii) Provide prior notice to the self-regulatory organization with 
direct authority over the principal market in the United Sates for the 
security for which the syndicate covering transaction is effected.
* * * * *
    (j) * * *
    (2) Transactions of Rule 144A securities. Transactions in 
securities eligible for resale under Sec.  230.144A(d)(3) of this 
chapter, or any reference security, if such securities are offered or 
sold in the United States solely to:
* * * * *
    16. Add Sec.  242.106 to read as follows:


Sec.  242.106  Allocating offered securities.

    (a) Unlawful activity. It shall be unlawful for a distribution 
participant, issuer or their affiliated purchasers, directly or 
indirectly, acting either alone or in concert with another person, to 
attempt to induce, induce, solicit, require, or accept from a potential 
purchaser of an offered security in connection with an allocation of 
the offered security, any consideration for such offered security in 
addition to that stated in the registration statement filed under the 
Securities Act of 1933 (15 U.S.C. 77a et seq.) or applicable offering 
document for the offer and sale of such offered security.
    (b) Exemptive authority. Upon written application or upon its own 
motion, the Commission may grant an exemption from the provisions of 
this section, either unconditionally or on specified terms and 
conditions, to any person or class of persons, to any transaction or 
class of transactions, or to any security or class of securities to the 
extent that such exemption is necessary or appropriate, in the public 
interest, and is consistent with the protection of investors.

    Dated: December 9, 2004.

    By the Commission.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-27434 Filed 12-16-04; 8:45 am]
BILLING CODE 8010-01-P