[Federal Register Volume 71, Number 136 (Monday, July 17, 2006)]
[Notices]
[Pages 40569-40575]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-11208]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54118; File No. SR-NASD-2005-114]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change Relating to the 
Regulation of Compensation, Fees, and Expenses in Public Offerings of 
Real Estate Investments Trusts and Direct Participation Programs

July 10, 2006.
    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 28, 2005, 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 
June 12, 2006, NASD filed amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, which replaced the original filing, NASD 
clarified its discussion of certain of the proposed amendments, and 
made other technical changes.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to amend NASD Rule 2810, to address the 
regulation of compensation, fees, and expenses in public offerings of 
real estate investments trusts and direct participation programs. Below 
is the text of the proposed rule change. Proposed new language is in 
italics; proposed deletions are in brackets.
* * * * *
2810. Direct Participation Programs
    (a) No Change.
    (b) Requirements
    (1) Application
    No member or person associated with a member shall participate in a 
public offering of a direct participation program or a limited 
partnership rollup transaction or, where expressly provided below, a 
real estate investment trust as defined in Rule 2340(c)(4) (``REIT''), 
except in accordance with this paragraph (b), provided however, this 
paragraph (b) shall not apply to an initial or secondary public 
offering of or a secondary market transaction in a unit, depositary 
receipt or other interest in a direct participation program that 
complies with subparagraph (2)(D).
    (2) No Change.
    (3) Disclosure
    (A) Through (C) No Change.
    (D) Prior to executing a purchase transaction in a direct 
participation program or a REIT, a member or person associated with a 
member shall inform the prospective participant of all pertinent facts 
relating to the liquidity and marketability of the program or REIT 
during the term of the investment[;]. Included in the pertinent facts 
shall be information regarding whether the sponsor has offered prior 
programs or REITs in which disclosed in the offering materials was a 
date or time period at which the program or REIT might be liquidated, 
and whether the prior program(s) or REIT(s) in fact liquidated on or 
around that date or during the time period. [provided, however, that 
paragraph (b) shall not apply to an initial or secondary public 
offering of a secondary market transaction in a unit, depositary 
receipt or other interest in a direct participation program which 
complies with subparagraph (2)(D).]
    (4) Organization and Offering Expenses
    (A) No member or person associated with a member shall underwrite 
or participate in a public offering of a

[[Page 40570]]

direct participation program or REIT if the organization and offering 
expenses are not fair and reasonable, taking into consideration all 
relevant factors.
    (B) In determining the fairness and reasonableness of organization 
and offering expenses for purposes of subparagraph (A) hereof, the 
arrangements shall be presumed to be unfair and unreasonable if:
    (i) The total amount of all items of compensation from whatever 
source, including offering proceeds and ``trail commissions'' payable 
to underwriters, broker/dealers, or affiliates thereof, which are 
deemed to be in connection with or related to the distribution of the 
public offering, exceeds an amount that equals ten percent of the gross 
proceeds of the offering[currently effective compensation guidelines 
for direct participation programs published by the Association];[*]
---------------------------------------------------------------------------

    [*A guideline for underwriting compensation of ten percent of 
proceeds received, plus a maximum of 0.5% for reimbursement of bona 
fide diligence expenses, was published in Notice to Members 82-51 
(October 19, 1982).]
---------------------------------------------------------------------------

    (ii) Organization and offering expenses, which include all items of 
compensation, paid by a program or REIT in which a member or an 
affiliate of a member is a sponsor exceed an amount that equals fifteen 
percent of the gross proceeds of the offering[currently effective 
guidelines for such expenses published by the Association];[**]
---------------------------------------------------------------------------

    [**A guideline for organization and offering expenses of 15 
percent proceeds received was published in Notice to Members 82-51 
(October 19, 1982).]
---------------------------------------------------------------------------

    (iii) No Change.
    (iv) Commissions or other compensation are to be paid or awarded 
either directly or indirectly, to any person engaged by a potential 
investor for investment advice as an inducement to such advisor to 
advise the purchaser of interests in a particular program or REIT, 
unless such person is a registered broker/dealer or a person associated 
with such a broker/dealer; [or]
    (v) The program or REIT provides for compensation of an 
indeterminate nature to be paid to members or persons associated with 
members for sales of program units or REIT, or for services of any kind 
rendered in connection with or related to the distribution thereof, 
including, but not necessarily limited to, the following: A percentage 
of the management fee, a profit sharing arrangement, brokerage 
commissions, and over-riding royalty interest, a net profits interest, 
a percentage of revenues, a reversionary interest, a working interest, 
a security or right to acquire a security having an indeterminate 
value, or other similar incentive items; [provided however, that an 
arrangement which provides for continuing compensation to a member or 
person associated with a member in connection with a public offering 
shall not be presumed to be unfair and unreasonable if all of the 
following conditions are satisfied:]
    [a. the continuing compensation is to be received only after each 
investor in the program has received cash distributions from the 
program aggregating an amount equal to his cash investment plus a six 
percent cumulative annual return on his adjusted investment;]
    [b. the continuing compensation is to be calculated as a percentage 
of program cash distributions;]
    [c. the amount of continuing compensation does not exceed three 
percent for each one percentage point that the total of all 
compensation pursuant to subparagraph (B)(i) received at the time of 
the offering and at the time any installment payment is made fall below 
nine percent; provided, however, that in no event shall the amount of 
continuing compensation exceed 12 percent of program cash 
distributions; and]
    [d. if any portion of the continuing compensation is to be derived 
from the limited partners' interest in the program cash distributions, 
the percentage of the continuing compensation shall be no greater than 
the percentage of program cash distributions to which limited partners 
are entitled at the time of the payment.]
    (vi) the program or REIT charges a sales load or commission on 
securities that are purchased through the reinvestment of dividends, 
unless the registration statement registering the securities under the 
Securities Act of 1933 became effective prior to (the effective date of 
this rule amendment); or
    (vii) the member has received reimbursement for due diligence 
expenses that are not included in a detailed and itemized invoice.
    (C) The organization and offering expenses subject to the 
limitations in paragraph (b)(4)(B)(ii) above include the following:
    (i) issuer organization and offering expenses, which include, but 
are not limited to: expenses, including overhead expenses, for:
    a. assembling and mailing offering materials, processing 
subscription agreements, generating advertising and sales materials;
    b. legal services provided to the sponsor or issuer;
    c. salaries and non-transaction-based compensation paid to 
employees or agents of the sponsor or issuer for performing services 
for the sponsor or issuer;
    d. transfer agents, escrow holders depositories, engineers and 
other experts, and
    e. registration and qualification of securities under federal and 
state law, including taxes and fees and NASD fees;
    (ii) underwriting compensation, which includes but is not limited 
to items of compensation listed in Rule 2710(c)(3) including payments:
    a. to any wholesaler that is engaged in the solicitation, 
marketing, distribution or sales of the program or REIT securities and 
any employee of the wholesaler involved in the solicitation, 
development, maintenance and monitoring of selling agreements and 
relationships with broker/dealers and accounts and account holders at 
broker/dealers;
    b. to any employee of a member and any dual employee of a member 
and the sponsor, issuer or other affiliate who receives transaction-
based compensation unless information has been provided to NASD, with 
regard to a program or REIT with fewer than ten people engaged in 
wholesaling, from which the Corporate Financing Department can readily 
conclude that the payments are made as consideration for non-broker/
dealer services provided to the sponsor, issuer or other affiliate; and
    c. for training and education meetings, legal services provided to 
a member in connection with the offering and advertising and sales 
material generated by a member;
    (iii) due diligence expenses incurred when a member affirmatively 
discharges its responsibilities to ensure that all material facts 
pertaining to a program or REIT are adequately and accurately disclosed 
in the offering document.
    (C) through (E) Renumbered as (D) through (F)
    (5) through (6) No Change.
    (c) Non-Cash Compensation
    (1) No Change.
    (2) Restriction on Non-Cash Compensation
    In connection with the sale and distribution of direct 
participation program or REIT securities, no member or person 
associated with a member shall directly or indirectly accept or make 
payments or offers of payments of any non-cash compensation, except as 
provided in this provision. Non-cash compensation arrangements are 
limited to the following:
    (A) through (B) No Change.

[[Page 40571]]

    (C) Payment or reimbursement by offerors in connection with 
meetings held by an offeror or by a member for the purpose of training 
or education of associated persons of a member, provided that:
    (i) No Change.
    (ii) the location is appropriate to the purpose of the meeting, 
which shall mean a United States[an] office of the offeror or the 
member holding the meeting, or a facility located in the vicinity of 
such office, or a United States regional location with respect to 
meetings of associated persons who work within that region or, with 
respect to[regional] meetings with direct participation programs or 
REITs, a United States location at which a significant or 
representative asset of the program or REIT is located;
    (iii) through (iv) No Change.
    (D) through (E) No Change.
    (d) No Change.
* * * * *

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
    NASD is proposing to amend Rule 2810 (the ``Rule'') to address the 
regulation of compensation, fees, and expenses in public offerings of 
direct participation programs (``DPPs'') and real estate investment 
trusts as defined in Rule 2340(c)(4) (``REITs'') (collectively 
``Investment Programs''). Specifically, NASD's proposed rule change 
would address the following issues: (1) Compensation limitations and 
the use and allocation of offering proceeds; (2) disclosure regarding 
the liquidity of prior programs offered by the same sponsor; (3) sales 
loads on reinvested dividends; and (4) non-cash compensation provisions 
regarding the appropriate location for training and education meetings.
    Rule 2810 governs the underwriting terms and arrangements of DPP 
securities. Rule 2710 governs the underwriting terms and arrangements 
of REITs. However, because REITs and real estate limited partnerships 
are competing alternative forms of investing in real estate securities 
with equivalent costs of distribution, NASD's Corporate Financing 
Department (``Department'') has applied the same underwriting and due 
diligence guidelines to both DPPs and REITs since the early 1980s. As 
discussed in more detail below, NASD proposes to amend Rule 2810 so 
that the Rule's compensation, disclosure and non-cash compensation 
provisions expressly govern REITs.
    In February 2004, NASD published Notice to Members 04-07 (the 
``Notice'') requesting comment on a proposed rule change and 
interpretive policies regarding the allocation of fees and expenses 
between issuers, sponsors and broker-dealers for Investment Programs in 
which the sponsors and broker-dealers offering such securities are 
affiliated. The Notice also addressed due diligence practices and 
disclosure in connection with Investment Programs as well as the 
allocation of underwriter compensation and issuer organization and 
offering expenses. The Notice also proposed prohibiting sales loads on 
reinvested dividends in Investment Programs and closed-end funds. 
Finally, the Notice requested comment on two non-cash compensation 
provisions in Rules 2710(i) and 2810(c): (1) a proposal to amend what 
would constitute an ``appropriate location'' for training and education 
meetings; and (2) the new ``equal weighting'' and ``total production'' 
limitations for internal sales contests.
    NASD received 10 comment letters on Notice to Members 04-07 
addressing the proposed rule change, which are discussed below.\4\
---------------------------------------------------------------------------

    \4\ Comments were received from Bob Cornish (Feb. 25, 2004); 
Mewbourne Securities, Inc. (Roe Buckley) (March 8, 2004); Wells 
Investment Securities, Inc. (Philip M. Taylor) (March 11, 2004); 
Hines Real Estate Securities, Inc. (Leslie B. Jallans) (March 11, 
2004); Pacific West Financial Group (Philip A. Pizelo) (March 11, 
2004); NASAA (Ralph A. Lambiase) (March 12, 2004); CNL Securities 
Corp. (Robert A. Bourne) (March 12, 2004); Investment Program 
Association (Christopher L. Davis) (March 12, 2004); Massachusetts 
Securities Division (Matthew J. Nestor) (March 18, 2004); and Duane 
Morris (Laurence S. Lese) (April 2004).
    An additional 26 comment letters received in response to Notice 
to Members 04-07 pertain solely to NASD's proposal to rescind an 
NASD interpretive policy regarding trail commissions charged by 
commodity DPPs. This issue was resolved separately in Notice to 
Members 04-50, which announced rescission of this policy effective 
October 12, 2004. See Notice of Filing and Immediate Effectiveness 
of Proposed Rule Change by the National Association of Securities 
Dealer, Inc. Relating to the Treatment of Commodity Pool Trail 
Commissions, 69 FR 45870 (July 30, 2004); Notice of Filing and 
Immediate Effectiveness of Proposed Rule Change by the National 
Association of Securities Dealers, Inc. Relating to the 
Implementation Date of Notice of Members 04-50 (Treatment of 
Commodity Pool Trail Commissions Under Rule 2810), 69 FR 55855 
(September 16, 2004).
---------------------------------------------------------------------------

a. Organization and Offering Expenses
    Rule 2810 currently provides three limitations on organization and 
offering expenses (``O & O expenses'') in Investment Programs. In the 
current rule, as interpreted by NASD compensation guidelines, these 
expenses are broken down into three categories: ``Compensation,'' ``due 
diligence,'' and ``issuer organization and offering expenses.'' First, 
compensation payable to underwriters, broker-dealers, or affiliates may 
not exceed 10 percent of the gross proceeds of the offering, regardless 
of the source from which it is derived. Second, members or independent 
due diligence firms currently may be reimbursed for an additional .5 
percent for bona fide due diligence expenses. And third, total issuer O 
& O expenses for programs in which the member is affiliated with the 
program sponsor may not exceed 15 percent of the offering proceeds, 
including any compensation and due diligence expenses.\5\ For offerings 
of programs in which the member is affiliated with the sponsor, this 
allows an additional 4.5 percent for issuer O & O expenses above the 10 
percent underwriting compensation and .5 percent due diligence 
expenses.
---------------------------------------------------------------------------

    \5\ See current Rule 2810(b)(4)(B)(i) and Notice to members 82-
51. This 15 percent limitation on O & O expenses applies only to 
sponsors that are affiliated with NASD members, while the ten 
percent limitation applies to all DPPs and REITS.
---------------------------------------------------------------------------

    As discussed below, the proposed rule change would make the Rule 
more explicit and objective in its treatment of the allocation of 
certain fees and expenses between issuer O & O and compensation 
(eliminating the current 0.5 percent limit on due diligence expenses) 
and modify the limitations pertaining to due diligence expenses.
i. Issuer Offering and Organization Expenses
    Notice to Members 04-07 described the current methodology for 
allocating O & O expenses between compensation, due diligence and 
issuer O & O expenses and provided guidance on how the Department 
allocates certain expenses in the review process. Commenters generally 
supported the review procedures set out in the Notice, and the proposed 
rule change would codify the allocation methodologies described 
therein. Thus, issuer O & O expenses would include: (i) Expenses, 
including overhead expenses, for

[[Page 40572]]

assembling and mailing offering materials; processing subscription 
agreements and generating advertising and sales materials; (ii) legal 
services provided to the sponsor or issuer; and (iii) salaries and non-
transaction-based compensation paid to employees or agents of the 
sponsor or issuer for performing such services. Also included would be 
expenses for transfer agents, escrow holders depositories, engineers 
and other experts, and registration and qualification of securities 
under Federal and state law, including taxes and fees and NASD fees.\6\
---------------------------------------------------------------------------

    \6\ See proposed amendment to Rule 2810(b)(4)(c)(i).
---------------------------------------------------------------------------

ii. Limits on Compensation
    As noted above, O & O expenses include fees for underwriting 
compensation. The proposed rule change would clarify that amounts 
deducted from the offering proceeds or amounts paid to members, 
underwriters or affiliates as trail commissions over time are to be 
treated as underwriting compensation.\7\ In addition, paragraph 
(b)(4)(B)(i) of Rule 2810 would be amended to expressly state that all 
items of compensation deemed to be in connection with or related to the 
public offering shall not exceed ``ten percent of the gross proceeds of 
the offering.'' \8\ Accordingly, all items of compensation paid from 
any source, including offering proceeds, partnership assets or 
management fees, would be subject to a ``hard cap'' of an amount that 
equals ten percent of gross offering proceeds.\9\
---------------------------------------------------------------------------

    \7\ See proposed amendment to Rule 2810(b)(4)(B)(i).
    \8\ The ten percent figure currently is NASD policy and not in 
the text of the Rule.
    \9\ An alternative fifteen percent limitation on all items of 
compensation in which a member or an affiliate of a member is a 
sponsor is discussed in the text accompanying footnote 16.
---------------------------------------------------------------------------

    The proposed rule change also would delete paragraphs 
(b)(4)(B)(v)(a) through (d) of Rule 2810 relating to continuing 
compensation arrangements. Members have not relied on these provisions 
since their adoption, and the limitations on continuing compensation 
are included in paragraph (b)(4)(B)(i) of Rule 2810 as proposed to be 
amended.
iii. Dual Employees
    Prior to the publication of Notice to Members 04-07, members had 
urged the Department not to allocate automatically all payments (e.g., 
salaries, bonuses, and expense reimbursements) to registered persons as 
underwriting compensation because their primary or secondary job 
responsibilities may involve providing non-distribution related 
services to the sponsor. Notice to Members 04-07 proposed that any 
salary, bonus, or other form of compensation paid to a dual employee 
would be allocated to the ten percent underwriting limitation if any of 
the employee's compensation was contingent on or varied depending on 
how much money is raised or the number of securities that are sold in 
the public offering. Commenters generally were in favor of this 
standard, although several commenters suggested that with respect to 
smaller programs, prorating a dual employee's compensation would be 
preferable to the objective standard described in the Notice.
    Thus Rule 2810(b)(4)(C)(ii)(b) in general would provide that if the 
employee of a member and any dual employee of a member and the sponsor, 
issuer or other affiliate who receives transaction-based compensation, 
then payments to the employee would be treated as underwriting 
compensation. With regard to smaller programs with fewer than 10 people 
engaged in wholesaling, the proposed Rule provides that filers can 
provide detailed per-employee information to the Department for review. 
Based on its review, the Department may conclude that certain salary or 
other non-transaction-based payments made to a dual employee may be 
allocated to issuer O & O expenses notwithstanding that fact that the 
dual employee also received transaction-based compensation for other 
services.\10\ For example, after reviewing the relevant documents and 
information, the Department may conclude that not all of the payments 
to an employee who is engaged only part time in wholesaling shall be 
deemed compensation in connection with or related to the distribution 
of a public offering.
---------------------------------------------------------------------------

    \10\ See proposed amendment to Rule 2810(b)(4)(C)(ii)(b). These 
review provisions related to smaller programs apply only to dual 
employees of a broker-dealer and the sponsor, issuer or other 
affiliate. Conversation between Joseph Price, Vice President, NASD 
Corporate Financing Department, and Michael Hershaft, Special 
Counsel, SEC, June 30, 2006.
---------------------------------------------------------------------------

iv. Wholesaling
    As described in Notice to Members 04-07, the proposed rule change 
would require that underwriting compensation include payments to any 
wholesaler that is engaged in the solicitation, marketing, distribution 
or sales of the Investment Program securities and any employee of the 
wholesaler involved in the solicitation, development, maintenance and 
monitoring of selling agreements and relationships with broker-dealers 
and accounts and account holders at broker-dealers.\11\ NASD staff 
views wholesaling as a quintessential sales activity in connection with 
the distribution of Investment Programs and thus should be part of 
underwriting compensation.
---------------------------------------------------------------------------

    \11\ Proposed amendment to Rule 2810(b)(C)(ii)(a).
---------------------------------------------------------------------------

    Based on comments received, however, and as discussed above, the 
Rule would provide NASD with the flexibility to determine on a case-by-
case basis whether payments to dual employees of a broker-dealer, and a 
sponsor, issuer or other affiliate with fewer than ten people engaged 
in wholesaling pertain to wholesaling activities or other, non-related 
activities.\12\
---------------------------------------------------------------------------

    \12\ Proposed amendment to Rule 2810(b)(C)(ii)(b).
---------------------------------------------------------------------------

v. Training and Education Meetings, Legal Services, and Advertising and 
Sales Materials
    Notice to Members 04-07 described the Department's policy to 
allocate to underwriting compensation fees and payments for training 
and education meetings, legal services provided to a broker-dealer 
participating in the offering, and advertising and sales material 
generated by a broker-dealer participating in the offering. The 
commenters generally supported this policy, and the proposed rule 
change would codify this policy.\13\
---------------------------------------------------------------------------

    \13\ Proposed amendment to Rule 2810(b)(C)(ii)(c).
---------------------------------------------------------------------------

vi. Due Diligence
    In Notice to Members 04-07, NASD addressed due diligence practices 
and disclosure in connection with Investment Programs. Specifically 
NASD reminded members that for purposes of the current .5 percent 
allowance for bona fide due diligence expenses, ``due diligence 
expenses'' relate only to those expenses incurred when the member 
affirmatively discharges its responsibilities to ensure that all 
material facts pertaining to a program are adequately and accurately 
disclosed in the offering document.\14\ The following principles were 
outlined in the Notice:
---------------------------------------------------------------------------

    \14\ NASD proposes to codify this requirement at 
2810(b)(4)(c)(iii).
---------------------------------------------------------------------------

     Any due diligence payment or reimbursement that is 
mischaracterized in a filing with NASD or in an offering document would 
be deemed to be undisclosed underwriting compensation, and the 
mischaracterization would violate NASD rules and the federal securities 
laws. Accordingly, members may include only their actual costs incurred 
for bona fide due diligence expenses.
     Any reimbursement that includes a profit margin to the 
member will be

[[Page 40573]]

deemed to be underwriting compensation subject to the ten percent 
limitation, whether or not the member claims that the reimbursement was 
for ``due diligence expenses.''
     A sponsor may not reimburse a member for activities that 
are inconsistent with the due diligence objective, such as golf 
outings, cruises, tours, and other forms of entertainment.
     Members should expect the Department to request a copy of 
any due diligence meeting agenda to verify that the meeting served a 
bona fide due diligence purpose.
    Commenters strongly supported clarification of the treatment of due 
diligence expenses under Rule 2810. NASD recognizes that conducting 
appropriate due diligence in connection with Investment Program 
offerings is an important part of protecting investors and satisfying 
members' obligations to their customers. However, NASD also is 
concerned that some members may have merely ``piggybacked'' on the due 
diligence of others and accepted reimbursements that amounted to little 
more than an additional fifty basis points of underwriting 
compensation. Accordingly, the proposed rule change would require that 
a member not accept any payments or reimbursements for due diligence 
expenses unless they are included in a detailed and itemized invoice 
that is presented by the member to the program sponsor or other entity 
that pays or reimburses due diligence expenses.\15\ In addition, the 
proposal would eliminate the current .5 percent limit on due diligence 
expenses currently applicable to Rule 2810. NASD believes that the 
current cap may unnecessarily limit members' bona fide due diligence 
activities. Instead, the maximum amount of O & O expenses would remain 
fifteen percent of the gross offering proceeds (which amount would 
include: (1) Issuer O & O expenses; (2) compensation up to the maximum 
of ten percent of gross proceeds; and (3) due diligence expenses that 
are supported by a detailed and itemized invoice).\16\
---------------------------------------------------------------------------

    \15\ See proposed amendment to Rule 2810(b)(4)(B)(vii).
    \16\ See proposed amendment to Rule 2810(b)(4)(B)(ii).
---------------------------------------------------------------------------

b. Liquidity Disclosure
    The prospectuses of Investment Programs typically establish a date 
or time period when an investment will become liquid: either the assets 
of the Investment Program will be liquidated and the proceeds 
distributed to shareholders, or the Program may become listed on a 
national securities exchange or quoted on NASDAQ. Most prospectuses 
also provide that the liquidity event may be delayed due to market 
conditions or other factors.
    Rule 2810(b)(3)(D) currently provides that prior to executing a 
purchase transaction in a direct participation program, a member or 
person associated with a member shall inform the prospective 
participant of all pertinent facts relating to the liquidity and 
marketability of the program during the term of the investment. NASD is 
concerned that some investors do not fully appreciate that the 
liquidation of some sponsors' programs are frequently delayed. The 
proposal would amend Rule 2810(b)(3)(D) to include REITs as defined in 
Rule 2340(c)(4), and to require members and their associated persons to 
inform prospective investors whether the sponsor has offered prior 
programs for which the prospectus disclosed a date or time period when 
the program might be liquidated, and whether the prior programs in fact 
liquidated on or around that date or time period. Members selling 
Investment Programs would have to disclose whether prior programs 
offered by the program sponsor liquidated on or during the date or time 
period disclosed in the prospectuses for those programs. For example, 
if a sponsor has offered ten prior programs and only two of them 
liquidated by the date or time period set forth in the prospectus, the 
member would be required to disclose these facts.
    NASD recognizes that delays in liquidity may be due to market 
conditions and other factors beyond the sponsor's control, and that in 
some cases, investors may benefit from delays in liquidity. 
Importantly, the proposed rule change would not require liquidations in 
the time periods specified. However, NASD believes that investors 
should be provided with the sponsor's track record as an additional 
piece of data upon which to base an investment decision.
c. Sales Loads on Reinvested Dividends
    Notice to Members 04-07 requested comment on amending Rule 2810 to 
prohibit commissions (sales loads) on reinvested dividends in 
Investment Programs.\17\ NASD made similar amendments in April 2000 to 
the Investment Company Rule (Rule 2830), which prohibits members from 
offering or selling shares of an investment company if it has a front-
end or deferred sales charge imposed on shares purchased through the 
reinvestment of dividends. Three commenters supported NASD's proposal 
to prohibit loads on reinvested dividends in Investment Programs. One 
commenter suggested that the industry currently is moving in the 
direction of eliminating sales loads on shares purchased through 
dividend reinvestment programs, which reflects a desire among certain 
issuers and broker-dealers to allow stockholders to reinvest in 
companies at reduced prices. Another commenter suggested that, for most 
customers, the reinvestment of dividends typically does not involve a 
separate investment decision. This commenter also suggested that 
distributions in DPP investments often involve substantial returns of 
capital and that charging a commission for reinvesting those funds can 
result in double selling compensation. The third commenter suggested 
that a sales load on reinvested dividends is another means to increase 
overall sales commissions and that investors generally perceive 
dividend reinvestment plans as transactions without expenses.
---------------------------------------------------------------------------

    \17\ Notice to Members 04-07 also requested comment on 
prohibiting sales loads on reinvested dividends for closed-end 
funds. No commenters addressed this proposal. NASD does not propose 
amending rule 2710 to address closed-end funds in this filing, which 
is limited to regulatory proposals involving DPPs and REITs. NASD 
will further consider whether it is appropriate to adopt amendments 
prohibiting sales loads on reinvested dividends for closed-end 
funds.
---------------------------------------------------------------------------

    Three commenters opposed prohibiting sales loads on reinvested 
dividends because members provide more ongoing services in connection 
with DPP and REIT dividend reinvestment programs than with mutual fund 
dividend reinvestment programs. One commenter noted that registered 
representatives involved in dividend reinvestment plans of DPP and REIT 
programs usually continue to monitor their client's financial 
portfolios and perform valuable services for their clients on an 
ongoing basis. The commenter suggested that when a registered 
representative determines that a specific investor has reached an 
adequate level of real estate diversification in his/her portfolio, the 
financial planner would advise the investor to discontinue further 
investments in the applicable dividend reinvestment plan.
    One commenter also stated that due to limited liquidity 
opportunities, registered representatives who place their clients in 
DPP and REIT programs must also monitor the program portfolio (in 
addition to their clients' portfolios) more closely than their 
counterparts who place their clients in liquid investments such as 
mutual funds. This commenter noted that in order to properly advise a 
client on whether to make an additional investment in REITs

[[Page 40574]]

and DPPs, whether through a dividend reinvestment program or otherwise, 
or whether to apply for participation in a redemption program, the 
registered representative must continually review and analyze the 
properties in the investment portfolio, prevailing market conditions, 
and the management of the portfolio by the sponsor. The commenter 
stated that registered representatives should be compensated for this 
ongoing review and analysis because they are providing a valuable 
service to their clients. The commenter also noted that, without such 
compensation, the registered representatives might not be as motivated 
to do this work, which is in the interests of their clients.
    NASD has determined to move forward with its proposal to prohibit 
loads on reinvested dividends for Investment Programs after the 
effective date of this rule amendment.\18\ In response to commenters 
who believe loads on reinvested dividends are necessary in order to 
compensate registered representatives for providing ongoing services 
for Investment Programs, NASD notes that Rule 2810 allows for the 
receipt of trail commissions (up to the limits on underwriting 
compensation) to compensate them for such ongoing services.\19\
---------------------------------------------------------------------------

    \18\ See proposed amendments to Rule 2810(b)(4)(B)(vi).
    \19\ See proposed amendments to Rule 2810(b)(4)(B)(i).
---------------------------------------------------------------------------

    NASD does not believe that sales loads on reinvested dividends are 
necessary or should be used to finance monitoring of client positions 
and client communication. Since many dividends in Investment Programs 
include a return of principal invested, allowing a sales load on 
reinvested dividends would amount to a double charge to the investor in 
the NASD's view. In addition, NASD believes that many investors may be 
confused about what sales loads on reinvested dividends are and why 
they are paying them, since they may not view the reinvestment of 
dividends as a separate investment decision for which a sales charge 
would be levied.
d. Non-Cash Compensation Provisions
i. Location of Training and Education Meetings
    The non-cash compensation provisions of Rule 2810 currently permit 
payments and reimbursements by an offeror in connection with training 
and education meetings, if the meetings meet the conditions of the 
Rule. One of the current conditions is the requirement that:

    ``The location is appropriate to the purpose of the meeting, 
which shall mean an office of the issuer or affiliate thereof, the 
office of the member, or a facility located in the vicinity of such 
office, or a regional location with respect to regional meetings.'' 
\20\
---------------------------------------------------------------------------

    \20\ See proposed amendments to Rule 2810(b)(2)(c)(ii). NASD 
interprets the clause ``regional location with respect to regional 
meetings'' in the Rules to permit regional meetings held for the 
convenience of regional broker-dealers and their associated persons, 
not national meetings held in regional locations.

    The proposed rule change would amend the Rule to provide that an 
``appropriate location'' for a training and education meeting may 
include a location at which a significant or representative Investment 
Program asset is located. The proposed rule change would address the 
fact that an important part of bona fide training and education 
meetings for Investment Programs may be inspecting real estate, oil and 
gas production facilities, and other types of assets that will be held 
and managed by the program.\21\
---------------------------------------------------------------------------

    \21\ As discussed above, NASD proposes to amend Rule 2810 so 
that the Rule's compensation, disclosure and non-cash compensation 
provisions expressly govern illiquid REITs (i.e., REITs as defined 
in Rule 2340(c)(4)). The proposed rule change would not amend the 
non-cash compensation provisions in Rule 2710, which currently are 
identical to those in Rule 2810. Accordingly, the non-cash 
compensation provisions regarding the location of training and 
education meetings will be different for exchange-traded REITs under 
Rule 2710 and illiquid REITs under Rule 2810.
---------------------------------------------------------------------------

    This amendment was proposed in Notice to Members 04-07, and the 
commenters generally supported this proposed rule change. Commenters 
agreed that an important part of bona fide training and education 
meetings is inspecting real estate, oil and gas production facilities, 
and other types of assets held and managed by the program. Two 
commenters noted that it is especially important for associated persons 
to visit an issuer's assets to better understand the business of the 
issuer when selling non-liquid investments to customers whose money may 
be locked up for significant time periods. The commenters did not 
believe that it would be difficult to determine whether an asset is 
``significant'' to a program and did not think that this determination 
would complicate the ability of a member's legal or compliance staff to 
decide whether associated persons should attend a particular meeting.
    Two commenters to Notice to Members 04-07 suggested that NASD issue 
a comment indicating that significance might vary from program to 
program and may be determined based on various criteria in addition to 
the size of the asset. The commenters noted that an asset may be 
significant because it reflects a new segment or asset class in which 
an issuer has determined to invest or because it is representative of a 
geographic focus of the issuer. The commenters also suggested that the 
proposed rule language should be broadened to include ``a location at 
which a significant or representative asset of the program is 
located.'' This addition would allow associated persons to visit 
program assets in conjunction with training and education meetings even 
if a program's assets are of approximately the same size or type or are 
located in one geographic area. The commenters noted that associated 
persons still have a great interest in visiting assets of a program 
that consists of similar assets.
    Three commenters to Notice to Members 04-07 stated that they do not 
believe that the proposed amendments relating to the location of 
training and education meetings would create a significant risk that 
locations would be chosen to provide incentives and awards for selling 
products. Two commenters noted that the non-cash compensation 
provisions of Rule 2810 provide that training and education meetings 
may not be conditioned on meeting sales thresholds and may not include 
payments for expenses of guests. The commenters stated that the 
industry is aware that agendas must address training and education 
activities and should not include extracurricular activities such as 
golf outings.
    Based on the foregoing, NASD is proposing to amend Rule 2810 to 
provide that a training and education meeting may include a location at 
which a ``significant or representative'' asset is located.\22\
---------------------------------------------------------------------------

    \22\ See proposed amendment to Rule 2810(c)(2)(C)(ii).
---------------------------------------------------------------------------

ii. Total Production and Equal Weighting Requirements
    In Notice to Members 04-07, NASD proposed to amend Rule 2810 to 
incorporate the total production and equal weighting conditions for 
internal sales contests in the Investment Company Rule (Rule 2820) and 
the Variable Contracts Rule (Rule 2830) into Rule 2810. Subsequently, 
in June 2005, NASD published Notice to Members 05-40 proposing to 
expand the prohibitions on non-cash compensation to the sale and 
distribution of any security, not just the securities of DPPs, REITs, 
investment companies and variable insurance contracts. NASD staff will

[[Page 40575]]

consider whether any additional amendments are necessary to the non-
cash compensation provisions of Rule 2810 in the context of that 
rulemaking initiative.
e. Effective Date of the Proposed Rule Change
    NASD will 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 the 
provisions of Section 15A(b)(6) of the Act, which requires, among other 
things, that NASD's 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. Specifically, NASD believes that the proposed rule 
change amends Rule 2810 to provide greater clarity regarding 
limitations on compensation, fees, and expenses in public offerings of 
REITs and DPPs.

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

    The proposed rule change was published for comment in NASD Notice 
to Members 04-07 (February 2004). Ten comments were received in 
response to the Notice.\23\ All of the comment letters received were 
generally in favor of the proposed rule change, and are further 
discussed in Item II of this notice.
---------------------------------------------------------------------------

    \23\ See note 1, supra.
---------------------------------------------------------------------------

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-2005-114 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASD-2005-114. 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, 100 F Street, NE., 
Washington, DC 20549. Copies of such filing also will be available for 
inspection and copying at the principal office of 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 the File Number SR-NASD-2005-114 and should 
be submitted on or before August 7, 2006.
---------------------------------------------------------------------------

    \24\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\24\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-11208 Filed 7-14-06; 8:45 am]
BILLING CODE 8010-01-P