[Federal Register Volume 70, Number 49 (Tuesday, March 15, 2005)]
[Notices]
[Pages 12764-12769]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-1104]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51338; File No. SR-NASD-2003-141]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To Adopt 
an Additional Mark-Up Policy for Transactions in Debt Securities Except 
Municipal Securities

March 9, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 17, 2003, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by NASD.\3\ 
On June 29, 2004, NASD filed Amendment No. 1 to the proposed rule 
change.\4\ On February 17, 2005, NASD filed Amendment No. 2 to the 
proposed rule change.\5\ The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Commission staff made certain changes to the description of 
the proposed rule change with the consent of NASD, to enhance 
clarity and accuracy. Telephone conversation between Sharon K. 
Zackula, Associate General Counsel, Office of General Counsel, 
Regulatory Policy and Oversight, NASD, Richard Strasser, Attorney-
Fellow, and Andrew Shipe, Special Counsel, Division of Market 
Regulation, Commission, March 3, 2005.
    \4\ See letter from Barbara Z. Sweeney, Senior Vice President 
and Corporate Secretary, NASD, to Katherine England, Assistant 
Director, Division of Market Regulation, Commission, dated June 29, 
2004.
    \5\ See Form 19b-4, filed February 17, 2005. Amendment No. 2 
replaced the previous filings in their entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to adopt a second interpretation, proposed IM-
2440-2, to Rule 2440 to provide additional mark-up guidance for 
transactions in debt securities except municipal securities. Below is 
the text of the proposed rule change. Proposed new language is in 
italics. Text in bold would appear in italics in the Rule as published 
in the NASD Manual.
* * * * *

IM-2440-1. Mark-Up Policy

* * * * *

IM-2440-2. Additional Mark-Up Policy for Transactions in Debt 
Securities, Except Municipal Securities \1\

    \1\The Interpretation does not apply to transactions in municipal 
securities. Single terms in parentheses within sentences, such as the 
terms ``(sales)'' and ``(to)'' in the phrase, ``contemporaneous dealer 
purchases (sales) in the security in question from (to) institutional 
accounts,'' refer to scenarios where a member is charging a customer a 
mark-down.

    IM-2440-1 applies to debt securities transactions, and this IM-
2440-2 supplements the guidance provided in IM-2440-1.
    A dealer that is acting in a principal capacity in a transaction 
with a customer and is charging a mark-up or mark-down must mark-up or 
mark-down the transaction from the prevailing market price. 
Presumptively for purposes of this IM-2440-2, the prevailing market 
price for a debt security is established by referring to the dealer's 
contemporaneous cost as incurred, or contemporaneous proceeds as 
obtained, consistent with NASD pricing rules. (See, e.g., Rule 2320).
    When the dealer is selling the security to a customer, 
countervailing evidence of the prevailing market price may be 
considered only where the dealer made no contemporaneous purchases in 
the security or can show that in the particular circumstances the 
dealer's contemporaneous cost is not indicative of the prevailing 
market price. When the dealer is buying the security from a customer, 
countervailing evidence of the prevailing market price may be 
considered only where the dealer made no contemporaneous sales in the 
security or can show that in the particular circumstances the dealer's 
contemporaneous proceeds are not indicative of the prevailing market 
price.
    A dealer that effects a transaction in debt securities with a 
customer and identifies the prevailing market price using a measure 
other than the dealer's own contemporaneous cost or proceeds must be 
prepared to provide evidence that is sufficient to overcome the 
presumption that the dealer's contemporaneous cost or proceeds provide 
the best measure of the prevailing market price. A dealer may be able 
to show that its contemporaneous cost or proceeds are not indicative of 
prevailing market price, and thus overcome the presumption, in 
instances where (i) interest rates or the credit quality of the 
security changed significantly after the dealer's contemporaneous 
trades, or (ii) the dealer's contemporaneous trade was with an 
institutional account with which the dealer regularly effects 
transactions in the same or a ``similar'' security, as defined below, 
and in the case of a sale to such account, was executed at a price 
higher than the then prevailing market price, or, in the case of a 
purchase from such account, was executed at a price lower than the then 
prevailing market price, and the execution price was away from the 
prevailing market price because of the size and risk of the transaction 
(a ``Specified Institutional Trade''). In the case of a Specified 
Institutional Trade, when a dealer seeks to overcome the presumption 
that the dealer's contemporaneous cost or proceeds provide the best 
measure of the prevailing market price, the dealer must provide 
evidence of the then prevailing market price by referring exclusively 
to inter-dealer trades in the same security executed contemporaneously 
with the dealer's Specified Institutional Trade.
    In instances other than those pertaining to a Specified 
Institutional Trade, where the dealer has presented evidence that is 
sufficient to overcome the presumption that the dealer's 
contemporaneous cost or proceeds provide the best measure of the

[[Page 12765]]

prevailing market price, or where interest rates or the credit quality 
of the security changed significantly after the dealer's 
contemporaneous trades, the most important or first pricing factor that 
should be taken into consideration in establishing prevailing market 
price for a mark-up or a mark-down is prices of any contemporaneous 
inter-dealer transactions in the security in question. In the absence 
of inter-dealer transactions, the second factor that should be taken 
into consideration in establishing the prevailing market prices for 
mark-ups (mark-downs) to customers is prices of contemporaneous dealer 
purchases (sales) in the security in question from (to) institutional 
accounts with which any dealer regularly effects transactions in the 
same security. For actively traded securities, contemporaneous bid 
(offer) quotations for the security in question made through an inter-
dealer mechanism, through which transactions generally occur at the 
displayed quotations, may be used in the absence of inter-dealer or 
institutional transactions (described in the preceding sentence) in 
determining prevailing market price for customer mark-ups (mark-downs).
    In the event that, in particular circumstances, the above factors 
are not available, other factors that may be taken into consideration 
for the purpose of establishing the price from which a customer mark-up 
(mark down) may be calculated, include but are not limited to:
     Prices of contemporaneous inter-dealer transactions in a 
``similar'' security, as defined below, or prices of contemporaneous 
dealer purchase (sale) transactions in a ``similar'' security with 
institutional accounts with which any dealer regularly effects 
transactions in the ``similar'' security with respect to customer mark-
ups (mark-downs);
     Yields calculated from prices of contemporaneous inter-
dealer transactions in ``similar'' securities;
     Yields calculated from prices of contemporaneous purchase 
(sale) transactions with institutional accounts with which any dealer 
regularly effects transactions in ``similar'' securities with respect 
to customer mark-ups (mark-downs); and
     Yields calculated from validated contemporaneous inter-
dealer bid (offer) quotations in ``similar'' securities for customer 
mark-ups (mark-downs).
    The relative weight one may attribute to these other factors 
depends on the facts and circumstances surrounding the comparison 
transaction, such as its size, whether the dealer in the comparison 
transaction was on the same side of the market as the dealer is in the 
subject transaction, the timeliness of the information, and, with 
respect to the final factor listed above, the relative spread of the 
quotations in the similar security to the quotations in the subject 
security.
    Finally, if information concerning the prevailing market price of 
the subject security cannot be obtained by applying any of the above 
factors, NASD or its members may consider as a factor in assessing the 
prevailing market price of a debt security the prices or yields derived 
from economic models (e.g., discounted cash flow models) that take into 
account measures such as credit quality, interest rates, industry 
sector, time to maturity, call provisions and any other embedded 
options, coupon rate, and face value; and consider all applicable 
pricing terms and conventions (e.g., coupon frequency and accrual 
methods). Such models currently may be in use by bond dealers or may be 
specifically developed by regulators for surveillance purposes.
    Because the ultimate evidentiary issue is the prevailing market 
price, isolated transactions or isolated quotations generally will have 
little or no weight or relevance in establishing prevailing market 
price. For example, in considering yields of ``similar'' securities, 
except in extraordinary circumstances, members may not rely exclusively 
on isolated transactions or a limited number of transactions that are 
not fairly representative of the yields of transactions in ``similar'' 
securities taken as a whole.
    A ``similar'' security should be sufficiently similar to the 
subject security that it would serve as a reasonable alternative 
investment to the investor. At a minimum, the security or securities 
should be sufficiently similar that a market yield for the subject 
security can be fairly estimated from the yields of the ``similar'' 
security or securities. Where a security has several components, 
appropriate consideration may also be given to the prices or yields of 
the various components of the security.
    The degree to which a security is ``similar,'' as that term is used 
in this Interpretation, to the subject security may be determined by 
factors that include but are not limited to the following;
    (a) Credit quality considerations, such as whether the security is 
issued by the same or similar entity, bears the same or similar credit 
rating, or is supported by a similarly strong guarantee or collateral 
as the subject security (to the extent securities of other issuers are 
designated as ``similar'' securities, significant recent information of 
either issuer that is not yet incorporated in credit ratings should be 
considered (e.g., changes to ratings outlooks));
    (b) The extent to which the spread (i.e., the spread over U.S. 
Treasury securities of a similar duration) at which the ``similar'' 
security trades is comparable to the spread at which the subject 
security trades;
    (c) General structural characteristics and provisions of the issue, 
such as coupon, maturity, duration, complexity or uniqueness of the 
structure, callability, the likelihood that the security will be 
called, tendered or exchanged, and other embedded options, as compared 
with the characteristics of the subject security; and
    (d) Technical factors such as the size of the issue, the float and 
recent turnover of the issue, and legal restrictions on transferability 
as compared with the subject security.
    When a debt security's value and pricing is based substantially on, 
and is highly dependent on, the particular circumstances of the issuer, 
including creditworthiness and the ability and willingness of the 
issuer to meet the specific obligations of the security, in most cases 
other securities will not be sufficiently similar, and therefore, other 
securities may not be used to establish the prevailing market price.
* * * * *

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

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD has prepared summaries, set forth in Sections A, B, 
and C below, of the most significant aspects of such statements.

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

1. Purpose
Introduction
    Under NASD Rule 2440, ``Fair Prices and Commissions,'' a member is 
required to sell securities to a customer at a fair price.\6\ When a 
member acts in

[[Page 12766]]

a principal capacity and sells a security to a customer, a dealer 
generally ``marks up'' the security, increasing the total price the 
customer pays. Conversely, when buying a security from a customer, a 
dealer that is a principal generally ``marks down'' the security, 
reducing the total proceeds the customer receives. IM-2440, ``Mark-Up 
Policy,'' provides additional guidance on mark-ups and fair pricing of 
securities transactions with customers.\7\ Both Rule 2440 and IM-2440 
apply to transactions in debt securities and IM-2440 provides that 
mark-ups for transactions in common stock are customarily higher than 
those for bond transactions of the same size.\8\
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    \6\ NASD Rule 2440 specifically provides that a member is 
required to sell a security at a fair price to customers, ``taking 
into consideration all relevant circumstances, including market 
conditions with respect to such security at the time of the 
transaction, the expense involved, and the fact that he is entitled 
to a profit * * *.'' Rule 2320, ``Best Execution and 
Interpositioning,'' also addresses a member's obligation in pricing 
customer transactions. In any transaction for or with a customer, 
NASD Rule 2320 requires a member to ``use reasonable diligence to 
ascertain the best inter-dealer market for the subject security and 
buy and sell in such market so that the resultant price to the 
customer is as favorable as possible under prevailing market 
conditions.'' Together, Rule 2440 and Rule 2320 impose broad 
responsibilities on broker-dealers to price customer transactions 
fairly. Cf. ``Review of Dealer Pricing Responsibilities,'' Municipal 
Securities Rulemaking Board (``MSRB'') Notice 2004-3 (January 26, 
2004) (discussing MSRB Rules requiring municipal securities dealers 
to ``exercise diligence in establishing the market value of [a] 
security and the reasonableness of the compensation received on [a] 
transaction'').
    \7\ The terms ``mark-up'' and ``mark-down'' are not found in 
Rule 2440, but are used in IM-2440. Statements regarding mark-ups 
also apply generally to mark-downs unless mark-downs are discussed 
specifically in a separate statement.
    \8\ IM-2440(b)(1).
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    Under Rule 2440 and IM-2440, when a customer buys a security from a 
dealer, the customer's total purchase price, and the mark-up included 
in the price, must be fair and reasonable. Similarly, when a customer 
sells a security to a dealer, the customer's total proceeds from the 
sale, which were reduced by the mark-down, and the mark-down, must be 
fair and reasonable. A key step in determining whether a mark-up (mark-
down) is fair and reasonable is correctly identifying the prevailing 
market price of the security, which is the basis from which the mark-up 
(mark-down) is calculated.\9\
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    \9\ The Commission notes that IM-2440 states: ``It shall be 
deemed a violation of Rule 2110 and Rule 2440 for a member to enter 
into any transaction with a customer in any security at any price 
not reasonably related to the current market price of the security 
or to charge a commission which is not reasonable.''
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    The proposed interpretation, ``IM-2440-2, Additional Mark-Up Policy 
For Transactions in Debt Securities, Except Municipal Securities'' 
(``Proposed Interpretation''), provides additional guidance on mark-ups 
(mark-downs) in debt securities transactions, except municipal 
securities transactions.\10\ The Proposed Interpretation addresses two 
fundamental issues in debt securities transactions: (1) How does a 
dealer correctly identify the prevailing market price of a debt 
security; and (2) what is a ``similar'' security and when may it be 
considered in determining the prevailing market price.
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    \10\ MSRB Rule G-30, ``Prices and Commissions,'' applies to 
transactions in municipal securities, and requires that a municipal 
securities dealer engaging in a transaction as a principal with a 
customer must buy or sell securities at an aggregate price that is 
``fair and reasonable.''
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Prevailing Market Price
    The Proposed Interpretation provides that when a dealer calculates 
a mark-up (or mark-down), the best measure of the prevailing market 
price of the security is presumptively the dealer's contemporaneous 
cost (proceeds).\11\ Further, the dealer may look to countervailing 
evidence of the prevailing market price only where the dealer, when 
selling a security, made no contemporaneous purchases in the security 
or can show that in the particular circumstances the dealer's 
contemporaneous cost is not indicative of the prevailing market price. 
When buying a security from a customer, the dealer may look to 
countervailing evidence of the prevailing market price only where the 
dealer made no contemporaneous sales in the security or can show that 
in the particular circumstances the dealer's contemporaneous proceeds 
are not indicative of the prevailing market price.
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    \11\ Of course, if a dealer violates NASD Rule 2320, the 
dealer's contemporaneous cost (proceeds) in such transactions would 
not be a reliable indicator of the prevailing market price for the 
purpose of determining a mark-up or mark-down. If a dealer violates 
Rule 2320 because the dealer fails to exercise diligence, fails to 
negotiate at arms length in the market, or engages in fraudulent 
transactions, including those entered into in collusion with other 
dealers or brokers, including inter-dealer brokers, the price that 
the dealer obtains is not a price reflecting market forces, and, 
therefore, is not a valid indicator of the prevailing market price 
and should not be used to calculate a mark-up (mark-down). In 
addition, if a dealer that is not a party to a transaction engages 
in conduct to improperly influence the pricing of such transaction, 
the dealer could not properly use the execution price as the basis 
from which to compute a mark-up (mark-down) because the execution 
price does not represent the prevailing market price of the 
security.
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    The presumption that contemporaneous cost is the best evidence of 
prevailing market price is found in many cases and NASD decisions, and 
its specific applicability to debt securities transactions was 
addressed by the SEC as early as 1992 in F.B. Horner & Associates, 
Inc., 50 S.E.C. 1063 (1992), aff'd, 994 F.2d 61 (2d Cir. 1993) (``F.B. 
Horner''), a debt mark-up case. In F.B. Horner, the SEC stated: ``We 
have consistently held that where, as in the present case, a dealer is 
not a market maker, the best evidence of the current market, absent 
countervailing evidence, is the dealer's contemporaneous cost.'' F.B. 
Horner, 50 S.E.C. at 1065-66.\12\ The basis for the standard was also 
restated. ``That standard, which has received judicial approval, 
reflects the fact that the prices paid for a security by a dealer in 
transactions closely related in time to his retail sales are normally a 
highly reliable indication of the prevailing market.'' F.B. Horner, 50 
S.E.C. at 1066 (citations omitted).
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    \12\ The term ``market maker'' is defined in Section 3(a)(38) of 
the Act [15 U.S.C. 78c(a)(38)] and a dealer in debt securities must 
meet the legal requirements of Section 3(a)(38) to be considered a 
market maker.
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    The Proposed Interpretation recognizes that in some circumstances a 
dealer may seek to overcome the presumption that the dealer's own 
contemporaneous cost (proceeds) are the prevailing market price of the 
subject security for determining a mark-up (mark-down), and sets forth 
a process for identifying a value other than the dealer's own 
contemporaneous cost (proceeds).
Cases Where the Presumption May Be Overcome
    A dealer may seek to overcome the presumption that its 
contemporaneous cost or proceeds are not indicative of the prevailing 
market price in either of two instances: (1) Where the dealer's 
contemporaneous trade was with an institutional account with which the 
dealer regularly effects transactions in the same or a similar security 
under certain conditions, or (2) where interest rates or the credit 
quality of the security changed significantly after the dealer's 
contemporaneous trades.
Specified Institutional Trades
    In instances when the dealer establishes that the dealer's 
contemporaneous trade was a ``Specified Institutional Trade,'' to 
overcome the presumption that the dealer's contemporaneous cost (or 
proceeds) is the best measure of the prevailing market price, the 
dealer must provide evidence of the then prevailing market price in the 
subject security by referring exclusively to inter-dealer trades in the 
same security executed

[[Page 12767]]

contemporaneously with the dealer's Specified Institutional Trade.\13\
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    \13\ A ``Specified Institutional Trade'' is defined as a 
dealer's contemporaneous trade with an institutional account with 
which the dealer regularly effects transactions in the same or a 
``similar'' security, as defined below, and in the case of a sale to 
such an account, the trade was executed at a price higher than the 
then prevailing market price, and in the case of a purchase from 
such an account, the trade was executed at a price lower than the 
then prevailing market price, and the execution price was away from 
the prevailing market price because of the size and risk of the 
transaction.
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Transactions Other Than Specified Institutional Trades.
    In instances other than those pertaining to a Specified 
Institutional Trade, where the dealer has presented evidence that is 
sufficient to overcome the presumption that the dealer's 
contemporaneous cost (proceeds) provide the best measure of the 
prevailing market price, or where interest rates or credit quality of 
the security changed significantly, the dealer must follow a process 
for determining prevailing market price, considering certain factors in 
the appropriate order, as set forth in the Proposed Interpretation. 
Initially, a dealer must look to three factors or measures in the order 
they are presented (the ``Hierarchy'') to determine prevailing market 
price. The most important and first factor in the Hierarchy is the 
pricing of any contemporaneous inter-dealer transactions in the same 
security. The second most important factor in the Hierarchy recognizes 
the role of certain large institutions in the fixed income securities 
markets. In the absence of inter-dealer transactions, the second factor 
a dealer must consider is the prices of contemporaneous dealer 
purchases in the security in question from institutional accounts with 
which any dealer regularly effects transactions in the same 
security.\14\ If contemporaneous inter-dealer trades or dealer-
institutional trades in the same security are not available, a dealer 
must look to the third factor in the Hierarchy, which may be applied 
only to actively traded securities. For actively traded securities, a 
dealer is required to look to contemporaneous bid (offer) quotations 
for the security in question for proof of the prevailing market price 
if such quotations are made through an inter-dealer mechanism through 
which transactions generally occur at the displayed quotations.\15\
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    \14\ Contemporaneous dealer sales with such institutional 
accounts would be used to calculate a mark-down. If a dealer has 
overcome the presumption by establishing that interest rates or the 
credit quality of the security changed significantly after the 
dealer's trade, any inter-dealer or dealer-institutional trades in 
the same security that occurred prior to the event would not be 
valid measures of the prevailing market price as such transactions 
would be subject to the same imperfection.
    \15\ A dealer also is subject to the process of establishing 
prevailing market price, including the analysis under the Hierarchy 
and the other factors discussed below, where the dealer has not 
engaged in trading in the subject security for an extended period 
and therefore can evidence that it has no contemporaneous cost 
(proceeds) to refer to as a basis for computing a mark-up (mark-
down).
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Additional Factors That May Be Considered in Cases Other Than Specified 
Institutional Trades
    If none of the three factors in the Hierarchy is available, the 
dealer then may take into consideration the non-exclusive list of four 
factors in the Proposed Interpretation in trying to establish 
prevailing market price using a measure other than the dealer's 
contemporaneous cost (proceeds). In contrast to the Hierarchy of three 
factors discussed above, a dealer is not required to consider the four 
factors below in a particular order. The four factors reflect the 
particular nature of the debt markets and the trading and valuation of 
debt securities. They are:
     Prices of contemporaneous inter-dealer transactions in a 
``similar'' security, as defined below, or prices of contemporaneous 
dealer purchase (sale) transactions in a ``similar'' security with 
institutional accounts with which any dealer regularly effects 
transactions in the ``similar'' security with respect to customer mark-
ups (mark-downs);
     Yields calculated from prices of contemporaneous inter-
dealer transactions in ``similar'' securities;
     Yields calculated from prices of contemporaneous purchase 
(sale) transactions with institutional accounts with which any dealer 
regularly effects transactions in ``similar'' securities with respect 
to customer mark-ups (mark-downs); and
     Yields calculated from validated contemporaneous inter-
dealer bid (offer) quotations in ``similar'' securities for customer 
mark-ups (mark-downs).
    When applying one or more of the four factors, a dealer must 
consider that the ultimate evidentiary issue is whether the prevailing 
market price of the security will be correctly identified. As stated in 
the Proposed Interpretation, the relative weight one may attribute to 
these other factors depends on the facts and circumstances surrounding 
the comparison transaction, such as its size, whether the dealer in the 
comparison transaction was on the same side of the market as the dealer 
is in the subject transaction, the timeliness of the information, and, 
with respect to the final factor, the relative spread of the quotations 
in the ``similar'' security to the quotations in the subject security.
    Finally, if information concerning the prevailing market price of 
the subject security cannot be obtained by applying any of the above 
factors, a member may consider as a factor in determining the 
prevailing market price the prices or yields derived from economic 
models that take into account measures such as credit quality, interest 
rates, industry sector, time to maturity, call provisions and any other 
embedded options, coupon rate, and face value; and consider all 
applicable pricing terms and conventions (e.g., coupon frequency and 
accrual methods). However, dealers may not use any economic model to 
establish the prevailing market price for mark-up (mark-down) purposes, 
except in limited instances where none of the three factors in the 
Hierarchy apply, the subject security is infrequently traded, and the 
security is of such low credit quality (e.g., a distressed debt 
security) that a dealer cannot identify a ``similar'' security.\16\
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    \16\ When a dealer seeks to identify prevailing market price 
using information other than the dealer's contemporaneous cost or 
contemporaneous proceeds, the dealer must be prepared to provide 
evidence that will establish the dealer's basis for not using 
contemporaneous cost (proceeds), and information about the other 
values reviewed (e.g., the specific prices and/or yields of 
securities that were identified as similar securities) in order to 
determine the prevailing market price of the subject security. If a 
firm relies upon pricing information from a model the firm uses or 
has developed, the firm must be able to provide information that was 
used on the day of the transaction to develop the pricing 
information (i.e., the data that was input, and the data that the 
model generated and the firm used to arrive at prevailing market 
price).
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    The final principle in the Proposed Interpretation regarding 
prevailing market price addresses the use of pricing information from 
isolated transactions or quotations. The Proposed Interpretation 
provides that ``isolated transactions or isolated quotations generally 
will have little or no weight or relevance in establishing prevailing 
market price. For example, in considering yields of `similar' 
securities, except in extraordinary circumstances, members may not rely 
exclusively on isolated transactions or a limited number of 
transactions that are not fairly representative of the yields of 
transactions in `similar' securities taken as a whole.''
``Similar'' Securities
    The definition of ``similar'' security, and the uses and 
limitations of ``similar'' securities are the second part of the 
Proposed Interpretation. Several of the factors referenced above to 
which

[[Page 12768]]

a dealer may refer when determining the prevailing market price as a 
value that is other than the dealer's contemporaneous cost (proceeds) 
require a dealer to identify one or more ``similar'' securities.
    The Proposed Interpretation provides that a ``similar'' security 
should be sufficiently similar to the subject security that it would 
serve as a reasonable alternative investment. In addition, at a 
minimum, a dealer must be able to fairly estimate the market yield for 
the subject security from the yields of ``similar'' securities. 
Finally, to aid members in identifying ``similar'' securities when 
appropriate, the Proposed Interpretation sets forth a list of non-
exclusive factors to determine the similarity between the subject 
security and one or more other securities. The non-exclusive list of 
factors that can be used to assess similarity includes the following:
    (a) Credit quality considerations, such as whether the security is 
issued by the same or similar entity, bears the same or similar credit 
rating, or is supported by a similarly strong guarantee or collateral 
as the subject security (to the extent that securities of other issuers 
are designated as ``similar'' securities, significant recent 
information of either issuer that is not yet incorporated in credit 
ratings should be considered (e.g., changes in ratings outlooks));
    (b) The extent to which the spread (i.e., the spread over U.S. 
Treasury securities of a similar duration) at which the ``similar'' 
security trades is comparable to the spread at which the subject 
security trades;
    (c) General structural characteristics of the issue, such as 
coupon, maturity, duration, complexity or uniqueness of the structure, 
callability, the likelihood that the security will be called, tendered 
or exchanged, and other embedded options, as compared with the 
characteristics of the subject security; and
    (d) Technical factors, such as the size of the issue, the float and 
recent turnover of the issue, and legal restrictions on transferability 
as compared with the subject security.
    The provisions regarding ``similar'' securities, if adopted, would 
affirm explicitly, for the first time, that it may be appropriate under 
specified circumstances to refer to ``similar'' securities to determine 
prevailing market price.\17\
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    \17\ The Proposed Interpretation also states that, for certain 
securities, there are no ``similar'' securities. Specifically, when 
a debt security's value and pricing is based substantially, and is 
highly dependent, on the particular circumstances of the issuer, 
including creditworthiness and the ability and willingness of the 
issuer to make interest payments and otherwise meet the specific 
obligations of the security, in most cases other securities will not 
be sufficiently ``similar,'' and therefore, may not be used to 
establish prevailing market price of the subject security. As noted 
above, NASD may consider a dealer's pricing information obtained 
from an economic model to establish prevailing market price, when 
``similar'' securities do not exist and facts and circumstances have 
combined to create a price information void in the subject security. 
In addition, as provided in the Proposed Interpretation, NASD also 
may look to economic models other than the dealer's to make 
determinations as to the prevailing market price of a security.
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    If the proposal were approved, NASD would announce the effective 
date of the proposed rule change in a Notice to Members to be published 
no later than 60 days following Commission approval. The effective date 
will be 30 days following publication of the Notice to Members 
announcing Commission approval.
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with 
Section 15A(b)(6) of the Act,\18\ which requires, among other things, 
that NASD rules must be designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
and, in general, to protect investors and the public interest. NASD 
believes that clarifying the standard for correctly identifying the 
prevailing market price of a debt security for purposes of calculating 
a mark-up (mark-down), clarifying the additional obligations of a 
member when it seeks to use a measure other than the member's own 
contemporaneous cost (proceeds) as the prevailing market price, and 
confirming that similar securities may be used in certain instances to 
determine the prevailing market price are measures designed to prevent 
fraudulent practices, promote just and equitable principles of trade, 
and protect investors and the public interest.
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    \18\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor received.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-NASD-2003-141 on the subject line.

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 SR-NASD-2003-141. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission 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/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room. Copies of such 
filing also will be available for inspection and copying at the 
principal office of NASD. All

[[Page 12769]]

comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASD-2003-141 and should be 
submitted on or before April 5, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-1104 Filed 3-14-05; 8:45 am]
BILLING CODE 8010-01-P