[Federal Register Volume 70, Number 104 (Wednesday, June 1, 2005)]
[Notices]
[Pages 31554-31558]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-2752]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-51735; File No. SR-NASD-2004-165]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
Nos. 1 and 2 Thereto Relating to NASD Rule 2790

May 24, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on October 29, 2004, 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. On February 1, 2005, NASD submitted Amendment No. 1 
to the proposed rule change.\3\ On April 18, 2005, NASD submitted 
Amendment No. 2 to the proposed rule change.\4\ 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\ Amendment No. 1 included minor changes to the rule text of 
the proposed rule change.
    \4\ Amendment No. 2 included minor changes to the proposed rule 
change including clarifying that most REITs have invested assets at 
the time of their initial public offering.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is filing with the Commission a proposed rule change to amend 
subparagraph (i)(9) of NASD Rule 2790

[[Page 31555]]

to exclude from the definition of ``new issue'' securities offerings of 
a business development company (``BDC''), a direct participation 
program (``DPP''), and a real estate investment trust (``REIT''). NASD 
also is proposing a technical change to the exemption for foreign 
investment companies in subparagraph (c)(6) of NASD Rule 2790 to 
clarify the scope of the exemption as reflected in a recent NASD staff 
memorandum dated August 6, 2004 (``Staff Memorandum'').\5\ In addition, 
NASD is proposing to amend NASD Rule 2790 to codify the filing 
requirement for distribution information. Below is the text of the 
proposed rule change. Proposed new language is italicized; proposed 
deletions are bracketed.
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    \5\ The Staff Memorandum is available on the NASD's Web site at 
http://www.nasdr.com.
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2700. Securities Distributions

* * * * *

2790. Restrictions on the Purchase and Sale of Initial Equity Public 
Offerings

    (a) through (b) No Change.
    (c) General Exemptions
    The general prohibitions in paragraph (a) of this rule shall not 
apply to sales to and purchases by the following accounts or persons, 
whether directly or through accounts in which such persons have a 
beneficial interest:
    (1) through (5) No Change.
    (6) An investment company organized under the laws of a foreign 
jurisdiction, provided that:
    (A) The investment company is listed on a foreign exchange for sale 
to the public or authorized for sale to the public by a foreign 
regulatory authority; and
    (B) No person owning more than 5% of the shares of the investment 
company is a restricted person;
    (7) through (10) No Change.
    (d) through (h) No Change.
    (i) Definitions
    (1) through (8) No Change.
    (9) ``New issue'' means any initial public offering of an equity 
security as defined in Section 3(a)(11) of the Act, made pursuant to a 
registration statement or offering circular. New issue shall not 
include:
    (A) Offerings made pursuant to an exemption under Section 4(1), 
4(2) or 4(6) of the Securities Act of 1933, or SEC Rule 504 if the 
securities are ``restricted securities'' under SEC Rule 144(a)(3), or 
Rule 144A or Rule 505 or Rule 506 adopted thereunder;
    (B) Offerings of exempted securities as defined in Section 3(a)(12) 
of the Act, and rules promulgated thereunder;
    (C) Offerings of securities of a commodity pool operated by a 
commodity pool operator as defined under Section 1a(5) of the Commodity 
Exchange Act;
    (D) Rights offerings, exchange offers, or offerings made pursuant 
to a merger or acquisition;
    (E) Offerings of investment grade asset-backed securities;
    (F) Offerings of convertible securities;
    (G) Offerings of preferred securities;
    (H) Offerings of an investment company registered under the 
Investment Company Act of 1940; [and]
    (I) Offerings of securities (in ordinary share form or ADRs 
registered on Form F-6) that have a pre-existing market outside of the 
United States[.]; and
    (J) Offerings of a business development company as defined in 
Section 2(a)(48) of the Investment Company Act of 1940, a direct 
participation program as defined in NASD Rule 2810(a)(4), or a real 
estate investment trust as defined in Section 856 of the Internal 
Revenue Code.
    (10) No Change.
    (j) Information Required To Be Filed
    (1) The book-running managing underwriter of a new issue shall be 
required to file the following information in the time and manner 
specified by NASD with respect to new issues:
    (A) The initial list of distribution participants and their 
underwriting commitment and retention amounts on or before the offering 
date; and
    (B) The final list of distribution participants and their 
underwriting commitment and retention amounts no later than three 
business days after the offering date.

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
    I. Securities Offerings of BDCs, DPPs, and REITs. Currently, the 
definition of ``new issue'' under subparagraph (i)(9) of NASD Rule 2790 
excludes, among other things, securities offerings of closed-end 
investment companies registered under the Investment Company Act of 
1940 (the ``Investment Company Act''). NASD staff has observed that 
securities of closed-end investment companies ``typically commence 
trading at the public offering price with little potential for trading 
at a premium because the fund's assets at the time of the offering are 
the capital it has previously raised.'' \6\ Moreover, if there is a 
premium, it is generally small. In light of these facts, NASD exempted 
securities of closed-end investment companies registered under the 
Investment Company Act from the definition of ``new issue,'' noting 
that including such offerings within the scope of NASD Rule 2790 would 
do little to further the purposes of the Rule and, moreover, may impair 
the ability of such companies to obtain capital.\7\ For similar 
reasons, as discussed below, NASD is proposing to exclude from the 
definition of ``new issue'' securities offerings of BDCs as defined in 
Section 2(a)(48) of the Investment Company Act,\8\ DPPs as defined in 
NASD Rule 2810(a)(4), and REITs as defined in Section 856 of the 
Internal Revenue Code (the ``Code'').\9\
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    \6\ Securities Exchange Act Release No. 48701 (October 24, 
2003), 68 FR 62126 (October 31, 2003) (order approving File No. SR-
NASD-99-60).
    \7\ Id.; Securities Exchange Act Release No. 43627 (November 28, 
2000), 65 FR 76316 (December 6, 2000) (notice of filing of Amendment 
No. 2 to File No. SR-NASD-99-60).
    \8\ 15 U.S.C. 80a-2(a)(48).
    \9\ 26 U.S.C. 856.
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    A. BDCs. According to NASD, through the passage of the Small 
Business Investment Incentive Act of 1980 and the corresponding 
amendments to the Investment Company Act, Congress enacted a regulatory 
structure for BDCs in an effort to encourage capital investment in 
small developing businesses and financially troubled businesses.\10\
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    \10\ See Investment Company Act Release No. 11493 (December 16, 
1980), 45 FR 83479 (December 19, 1980).
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    A BDC is defined as a domestic, closed-end investment company that: 
is operated for the purpose of making investments in small and 
developing businesses and financially troubled businesses; that must 
make available significant managerial assistance to certain of its 
portfolio companies; and that has notified the Commission of its 
election to be subject to the provisions of Sections 55 through 65 of 
the Investment Company Act.\11\ According to NASD, while a BDC 
technically is not registered under the Investment

[[Page 31556]]

Company Act, it is subject to many of the same requirements that are 
applicable to registered investment companies.\12\
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    \11\ See Section 2(a)(48) of the Investment Company Act; 15 
U.S.C. 80a-2(a)(48).
    \12\ For example, in December 2003, the Commission adopted a new 
rule under the Investment Company Act that requires each registered 
investment company as well as each BDC to adopt and implement 
written policies and procedures reasonably designed to prevent 
violation of the federal securities laws, review those policies and 
procedures annually for their adequacy and the effectiveness of 
their implementation, and designate a chief compliance officer to be 
responsible for administering the policies and procedures. See 
Investment Company Act Release No. 26299 (December 17, 2003), 68 FR 
74714 (December 24, 2003) (Final Rule Relating to Compliance 
Programs of Investment Companies and Investment Advisers).
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    Section 55 of the Investment Company Act,\13\ in part, describes 
the securities in which a BDC can invest. These securities generally 
must comprise at least 70% of the value of the BDC's investment assets 
and include securities of certain companies, cash, cash items, U.S. 
government securities, and high quality debt instruments. The companies 
in which a BDC can invest are primarily ``eligible portfolio 
companies'' as defined in Section 2(a)(46) of the Investment Company 
Act,\14\ which generally include small developing businesses and 
financially troubled businesses. Further, NASD staff understands that 
BDCs are similar to registered closed-end investment companies in that 
a BDC's primary asset at the time of its initial public offering is the 
capital it has raised through the offering process. Thus, NASD believes 
that like registered closed-end investment companies, BDCs generally 
commence trading at their public offering price and premiums, if any, 
tend to be very small.
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    \13\ 15 U.S.C. 80a-54.
    \14\ 15 U.S.C. 80a-2(a)(46).
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    B. DPPs and REITs. A DPP, as defined in NASD Rule 2810(a)(4), is a 
program that provides for flow-through tax consequences regardless of 
the structure of the legal entity or vehicle for distribution, 
including, but not limited to, oil and gas programs, cattle programs, 
condominium securities, Subchapter S corporate offerings and all other 
programs of a similar nature, regardless of the industry represented by 
the program, or any combination thereof. NASD Rule 2810 excludes REITs 
from the definition of a DPP.
    A REIT is a recognized investment vehicle for income-generating 
real estate, and it is allowed to benefit from the tax advantages of a 
trust as long as certain asset, income, and distribution criteria have 
been satisfied as set forth in the Code.\15\ For instance, pursuant to 
the Code, at least 75 percent of a REIT's gross income must be derived 
from real estate, and at least 75 percent of the value of its total 
assets must be represented by real estate assets, cash and cash items, 
and Government securities.\16\
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    \15\ See Section 856 of the Code; 26 U.S.C. 856.
    \16\ Id.
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    According to NASD, nearly all DPPs and a few REITs, at the time of 
their initial public offering, have no invested assets. The initial 
public offering raises capital, which is subsequently invested. As 
such, NASD believes that the initial public offerings of these DPPs and 
REITs, like registered closed-end investment companies, are not 
expected to open at a premium. Like registered closed-end funds, the 
primary asset of these DPPs and REITs immediately following the public 
offering is the capital raised in the offering.
    According to NASD, most REITs making an initial public offering 
have invested assets upon consummation of the offering. Although the 
common stock of these REITs has a greater potential for immediate 
premiums in the secondary market, NASD staff's review of such offerings 
has shown that even in these cases, premiums, if any, tend to be small. 
According to NASD, because the assets of REITs (e.g., rental properties 
or mortgage portfolio) generally have a reasonably determinable market 
value, it is rare that REITs will commence trading at a significant 
premium. Moreover, NASD believes that investors typically invest in 
REITs for income rather than capital appreciation, which may further 
limit premiums in the immediate aftermarket.
    For these reasons, NASD is proposing to exclude securities 
offerings of all BDCs, DPPs, and REITs from the definition of ``new 
issue'' under subparagraph (i)(9) of NASD Rule 2790. As noted above, 
NASD staff has found that historically most of these offerings have not 
traded at a substantial premium. If warranted by future developments in 
the trading pattern of such securities in the immediate secondary 
market, however, the staff would reconsider the appropriateness of a 
blanket exclusion for these types of offerings.
    II. Foreign Investment Company Exemption. NASD also is proposing a 
technical change to the exemption for foreign investment companies in 
subparagraph (c)(6) of NASD Rule 2790 to clarify the scope of the 
exemption as reflected in the Staff Memorandum. The Staff Memorandum 
was prepared in response to inquiries about whether the foreign 
investment company exemption would apply to various hedge funds and 
other funds exempt from registration under the Investment Company Act 
that were listed on a foreign exchange (such as the Irish Stock 
Exchange). In the Staff Memorandum, NASD staff explained that the 
foreign investment company exemption is intended to extend to foreign 
investment companies that are similar to U.S. registered investment 
companies.\17\ NASD staff further explained the exemption for foreign 
investment companies extends only to an investment company organized 
under the laws of a foreign jurisdiction that is either ``listed on a 
foreign exchange for sale to the public'' or ``authorized for sale to 
the public,'' and that does not have any restricted person that 
beneficially owns more than 5% of the company's shares.
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    \17\ In Notice to Members (``NtM'') 97-30, which proposed the 
foreign investment company exception in the Free-Riding and 
Withholding Interpretation, IM-2110-1 (the predecessor to Rule 
2790), NASD stated that:
    Purchases of shares of investment companies registered under the 
Investment Company Act of 1940 (1940 Act) are exempt from the 
restrictions of the Interpretation. The rationale for this existing 
provision is that the interest of any one restricted person in an 
investment company ordinarily is de minimis and that, because the 
ownership of investment company shares generally is subject to 
frequent turnover, determining compliance with the Interpretation 
would be extremely difficult in this context. NASD Regulation is 
proposing to extend this rationale to the purchase of shares of 
foreign entities that are similar to U.S. investment companies. 
(emphasis added).
    Likewise, in NtM 03-79, which announced the SEC's approval of 
NASD Rule 2790, NASD explained that ``the foreign investment company 
exception is intended to extend benefits to foreign investment 
entities that are similar to U.S. mutual funds.''
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    The Staff Memorandum also reiterated the position in NtM 03-79 that 
a foreign investment company that is limited to select investors would 
not be considered as ``for sale to the public.'' As NASD staff 
explained, foreign investment companies that are limited to high net 
worth individuals are not eligible for the foreign investment company 
exception. According to NASD, inasmuch as U.S. registered investment 
companies are not limited to sale to high net worth individuals, it 
would be inconsistent to permit foreign investment companies to impose 
such requirements and still avail themselves of the exemption provided 
for foreign investment companies under

[[Page 31557]]

NASD Rule 2790. NASD believes that none of the reasons underlying the 
exemption for U.S. registered investment companies, such as broad 
public ownership, the difficulty in identifying beneficial owners, the 
ability of any public investor to purchase an interest in the 
investment company, and the generally negligible interest of any single 
restricted person, are likely to be present with a foreign investment 
company offered only to high net worth individuals. Moreover, NASD 
staff believes that the purposes of NASD Rule 2790 could easily be 
frustrated by purchases of large quantities of a new issue by a foreign 
investment company listed on a foreign exchange that is owned entirely 
or principally by broker-dealer personnel (or other restricted 
persons). According to NASD, a foreign investment company that is 
limited to select investors would, however, be eligible to purchase new 
issues in accordance with the de minimis exemption set forth in 
subparagraph (c)(4) of NASD Rule 2790.
    While NASD staff believes the text of NASD Rule 2790, NtM 03-79, 
and the rulemaking history of the foreign investment company provision 
support the interpretation provided in the Staff Memorandum, NASD staff 
also believes that it is appropriate to amend the rule text. 
Specifically, NASD is proposing to revise the foreign investment 
company exemption to state as follows:
    (6) An investment company organized under the laws of a foreign 
jurisdiction, provided that:
    (A) The investment company is listed on a foreign exchange for sale 
to the public or authorized for sale to the public by a foreign 
regulatory authority; and
    (B) No person owning more than 5% of the shares of the investment 
company is a restricted person.
    III. Information Required to be Filed. In 1996, NASD initiated a 
regulatory service, ``NASDesk,'' for members to transmit underwriting 
commitment and retention information to NASD's Free-Riding Regulatory 
Database. NASD communicated with members regarding the ``hot issue'' 
status of initial public offerings (``IPOs'') using a companion system, 
``Compliance Desk.'' \18\ To coincide with the implementation of NASD 
Rule 2790, NASD replaced NASDesk/Compliance Desk with a new system for 
members to submit new issue distribution information named ``IPO 
Distribution Manager.'' \19\ IPO Distribution Manager is a Web-based 
application that permits the book-running managing underwriter to 
transmit distribution information to NASD through Web COBRA, the Web-
based filing system that members are required to use when filing 
information about IPOs under the Corporate Financing Rule (NASD Rule 
2710).
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    \18\ See NtM 96-18.
    \19\ See NtM 04-20 (March 2004).
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    NASD is proposing to amend NASD Rule 2790 to codify the requirement 
for the book-running managing underwriter to file distribution 
information as announced in NtM 04-20.
(2) Statutory Basis
    NASD believes that the proposed rule change, as amended, is 
consistent with the provisions of Section 15A(b)(6) of the Act,\20\ 
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 the proposed rule 
change to NASD Rule 2790, as described herein, protects investors and 
the public interest by ensuring that member firms make a bona fide 
public offering of securities at the public offering price.
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    \20\ 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, as amended, 
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 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-2004-165.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, 
Washington, DC 20549. All submissions should refer to File Number SR-
NASD-2004-165. 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 Section, 450 Fifth Street, NW, Washington, DC 20549. Copies 
of such filing also will be available for inspection and copying at the 
principal office of the NASD. All 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-2004-165 and should be submitted on or before June 
22, 2005.


[[Page 31558]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\
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    \21\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-2752 Filed 5-31-05; 8:45 am]
BILLING CODE 8010-01-P