[Federal Register Volume 79, Number 201 (Friday, October 17, 2014)]
[Notices]
[Pages 62489-62492]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-24681]
[[Page 62489]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-73339; File No. SR-FINRA-2014-006]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving Proposed Rule Change, as Modified by
Amendment No. 1, Relating to Per Share Estimated Valuations for
Unlisted DPP and REIT Securities
October 10, 2014.
I. Introduction
On January 31, 2014, Financial Industry Regulatory Authority, Inc.
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc.
(``NASD'')) filed with the Securities and Exchange Commission (``SEC''
or ``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend provisions in the NASD
and FINRA rulebooks addressing per share estimated valuations for
unlisted direct participation program (``DPP'') and real estate
investment trust (``REIT'') securities. In particular, FINRA proposes
revising NASD Rule 2340 (Customer Account Statements) to modify the
requirements relating to the inclusion of a per share estimated value
for unlisted DPP and REIT securities on a customer account statement
and FINRA Rule 2310 (Direct Participation Programs) to modify the
requirements applicable to members' participation in a public offering
of DPP or REIT securities.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in the Federal
Register on February 19, 2014.\3\ The Commission received eighteen (18)
comment letters in response to the Notice of Filing.\4\ On March 14,
2014, FINRA extended the time period in which the Commission must
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to approve or disapprove
the proposed rule change to May 20, 2014. On May 20, 2014, the
Commission issued an order instituting proceedings pursuant to Section
19(b)(2)(B) of the Act \5\ to determine whether to approve or
disapprove the proposed rule change. The order was published for
comment in the Federal Register on May 27, 2014.\6\ The Commission
received six (6) comment letters in response to the Proceedings
Order.\7\
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\3\ Exchange Act Release No. 71545 (Feb. 12, 2014), 79 FR 9535
(Feb. 19, 2014) (Notice of Filing of Proposed Rule Change Relating
to Per Share Estimated Valuations for Unlisted DPP and REIT
Securities) (``Notice of Filing''). The comment period closed on
March 12, 2014.
\4\ Letters to Elizabeth Murphy, Secretary, SEC, from Mark
Goldberg, Chairman, Investment Program Association, dated February
5, 2014; David T. Bellaire, Esq., Executive Vice President and
General Counsel, Financial Services Institute, dated February 5,
2014; Mark Kosanke, President, Real Estate Investment Securities
Association, dated February 11, 2014; Steven A. Wechsler, President
and Chief Executive Officer, National Association of Real Estate
Investment Trusts, dated February 14, 2014; Jeff Johnson, Chief
Executive Officer, Dividend Capital Diversified Property Fund Inc.,
dated February 28, 2014; Michael Crimmins, Chief Executive Officer
and Managing Director, KBS Capital Markets Group, dated February 28,
2014; Scott Ilgerfritz, Immediate Past-President, Public Investors
Arbitration Bar Association, dated March 11, 2014; Thomas Price,
Managing Director, Securities Industry and Financial Markets
Association, dated March 12, 2014; Steve Morrison, Senior Vice
President and Associate Counsel, LPL Financial, dated March 12,
2014; Jacob Frydman, Chairman and Chief Executive Officer, United
Realty Trust Incorporated, dated March 12, 2014; Dechert LLP, dated
March 12, 2014; David Hirschmann, President and Chief Executive
Officer, Center for Capital Markets Competitiveness, U.S. Chamber of
Commerce, dated March 12, 2014; Steven A. Wechsler, President and
Chief Executive Officer, National Association of Real Estate
Investment Trusts, dated March 12, 2014; Kirk Montgomery, Head of
Regulatory Affairs, CNL Financial Group, LLC, dated March 12, 2014;
Mark Goldberg, Chairman, Investment Program Association, dated March
12, 2014; David T. Bellaire, Esq., Executive Vice President and
General Counsel, Financial Services Institute, dated March 12, 2014;
Martel Day, Principal, NLR Advisory Services, LLC, dated March 12,
2014; and Mark Kosanke, President, Real Estate Investment Securities
Association, dated March 12, 2014. Comment letters are available at
www.sec.gov.
The Commission discussed these comments in the Proceedings
Order. See infra note 6.
\5\ 15 U.S.C. 78s(b)(2)(B).
\6\ Exchange Act Release No. 72193 (May 20, 2014), 79 FR 30217
(May 27, 2014) (Order Instituting Proceedings to Determine Whether
to Approve or Disapprove a Proposed Rule Change Relating to Per
Share Estimated Valuations for Unlisted DPP and REIT Securities)
(``Proceedings Order''). The comment period closed on June 26, 2014.
\7\ Letters to Elizabeth Murphy, Secretary, SEC, from Kenneth
Mills, dated June 24, 2014; Jason Doss, President, Public Investors
Arbitration Bar Association, dated June 25, 2014; Mark Kosanke,
President, Real Estate Investment Securities Association, dated June
26, 2014; Thomas F. Price, Managing Director, Operations, Technology
and BCP, Securities Industry and Financial Markets Association,
dated June 26, 2014; David T. Bellaire, Executive Vice President and
General Counsel, Financial Services Institute, dated June 26, 2014;
and Peter Peters, dated July 15, 2014. Comment letters are available
at www.sec.gov.
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On July 11, 2014, FINRA filed a letter responding to comments and
Amendment No. 1 to the proposed rule change.\8\ A notice of the
amendment was published for comment in the Federal Register on July 22,
2014.\9\ The Commission received six (6) comment letters in response to
the Notice of Amendment.\10\ On September 16, 2014, FINRA filed a
letter responding to these comments.\11\
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\8\ Letter to Kevin O'Neill, Deputy Secretary, SEC, from Matthew
E. Vitek, Associate General Counsel, FINRA, dated July 11, 2014
(``FINRA's First Response Letter''). FINRA's First Response Letter
is available at www.sec.gov.
\9\ Exchange Act Release No. 72626 (July 16, 2014); 79 FR 42590
(July 22, 2014) (Notice of Filing of Amendment No. 1 to Proposed
Rule Change Relating to Per Share Estimated Valuations for Unlisted
DPP and REIT Securities) (``Notice of Amendment''). The comment
period closed on August 12, 2014.
\10\ Letters to Elizabeth Murphy, Secretary, SEC, from Mark
Goldberg, Chairman, Investment Program Association, dated July 28,
2014 (``IPA Letter''); Steven A. Wechsler, President and Chief
Executive Office, National Association of Real Estate Investment
Trusts, dated August 12, 2014 (``NAREIT Letter''); Frederick P.
Baerenz, President and Chief Executive Officer, AOG Wealth
Management, dated August 12, 2014 (``AOG Letter''); Daniel R.
Gilbert, Chief Investment and Operating Officer, NorthStar Asset
Management Group, Inc., dated August 12, 2014 (``NorthStar
Letter''); David T. Bellaire, Executive Vice President and General
Counsel, Financial Services Institute, dated August 12, 2014 (``FSI
Letter''); and Andrea Seidt, President, North American Securities
Administrators Association, Inc., and Commissioner, Ohio Division of
Securities, dated August 22, 2014 (``NASAA Letter''). Comment
letters are available at www.sec.gov.
\11\ Letter to Brent J. Fields, Secretary, SEC, from Matthew E.
Vitek, Associate General Counsel, FINRA, dated September 16, 2014
(``FINRA's Second Response Letter''). FINRA's Second Response Letter
is available at www.sec.gov.
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This order approves the proposed rule change, as modified by
Amendment No. 1.
II. Description of the Proposal, as Modified by Amendment No. 1
A. Proposed Revisions to NASD Rule 2340 (Customer Account Statements)
FINRA proposes to amend NASD Rule 2340 to require general
securities members to include in customer account statements a per
share estimated value for an unlisted DPP or REIT security, developed
in a manner reasonably designed to ensure that the per share estimated
value is reliable, as well as to make related disclosures.\12\ FINRA
also proposes two methodologies for calculating the per share estimated
value for a DPP or REIT security that would be deemed to have been
developed in a manner reasonably designed to ensure that it is
reliable: (1) The net investment methodology; and (2) the appraised
value methodology.\13\ Each methodology is described in greater detail
below, along with other proposed revisions.
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\12\ See Proposed NASD Rule 2340(c).
\13\ See Proposed NASD Rule 2340(c)(1).
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1. Net Investment Methodology
Under the proposal, the net investment methodology would reflect
the ``net investment'' disclosed in the issuer's most recent periodic
or current
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report. More specifically, the proposal would require ``net
investment'' to be based on the ``amount available for investment''
percentage in the ``Estimated Use of Proceeds'' section of the offering
prospectus; \14\ alternatively, where ``amount available for
investment'' is not provided, the proposal would require ``net
investment'' to be based on another equivalent disclosure that reflects
the estimated percentage deduction from the aggregate dollar amount of
securities registered for sale to the public of sales commissions,
dealer manager fees, and estimated issuer offering and organization
expenses.\15\
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\14\ ``This disclosure is typically included in the prospectus
for REIT offerings and is described in the SEC's Securities Act
Industry Guide 5 (Preparation of registration statements relating to
interests in real estate limited partnerships).'' Notice of Filing
at note 12.
\15\ See Proposed NASD Rule 2340(c)(1)(A).
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The proposal would not require the calculation of ``net
investment'' to involve the deduction from the per share estimated
value of ``over-distributions.'' \16\ The proposal would, however,
require members that use the net investment methodology to provide a
per share estimated value for a DPP or REIT security to disclose in the
customer account statement the following statement: ``IMPORTANT--Part
of your distribution includes a return of capital. Any distribution
that represents a return of capital reduces the estimated per share
value shown on your account statement.'' \17\ The proposal would
require the member to disclose this statement prominently and in
proximity to the disclosure of distributions and the per share
estimated value.\18\
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\16\ See Notice of Filing at note 20 (generally describing
``over-distributions'' as a return of investor capital as a
distribution rather than the use of that capital to generate return
on investment); see also Notice of Amendment (clarifying that
``over-distributions'' should be excluded from the calculation of
``net investment'').
\17\ See Proposed NASD Rule 2340(c)(2)(A).
\18\ Id.
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In addition, the proposal would clarify that when an issuer
provides a range of amounts available for investment, the proposal
would allow a general securities member to use the maximum offering
percentage unless the member has reason to believe that such percentage
is unreliable. If the member has reason to believe that it is
unreliable, the member must use the minimum offering percentage.\19\
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\19\ See Proposed NASD Rule 2340(c)(1)(A).
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Finally, the proposal would allow a member to use the net
investment methodology at any time before 150 days following the second
anniversary of the breaking of escrow.\20\
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\20\ See Id. See also Notice of Filing at note 11 (stating that
``[g]enerally, offering proceeds are placed in escrow until the
minimum conditions of the offering are met, at which time the issuer
is permitted to access the offering proceeds'').
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2. Appraised Value Methodology
Under the proposal, the appraised value methodology would consist
of the appraised valuation disclosed in the issuer's most recent
periodic or current report. More specifically, the proposal would
require: (1) That the valuation be based on valuations of the assets
and liabilities of the DPP or REIT; and (2) that those valuations: (a)
Be performed at least annually; (b) be conducted by, or with the
material assistance or confirmation of, a third-party valuation expert
or service; and (c) be derived from a methodology that conforms to
standard industry practice. The proposal would allow a member to use
the appraised value methodology at any time.\21\
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\21\ See Proposed NASD Rule 2340(c)(1)(B).
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The proposed rule change would, however, provide a different
requirement for DPPs subject to the Investment Company Act of 1940
(``1940 Act'') (e.g., business development companies). Specifically,
FINRA acknowledged that business development companies that fall under
the definitions of DPP are subject to the 1940 Act, which already
requires the issuer to determine and publish its net asset value on a
regular basis.\22\ Thus, for these DPPs, the proposed rule would
require the appraised value methodology to be consistent with the
valuation requirements of the 1940 Act and the rules thereunder.\23\
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\22\ See Notice of Amendment.
\23\ See Proposed NASD Rule 2340(c)(1)(B).
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3. General Disclosures
The proposal would also require members to include specific
disclosures on customer account statements that provide a per share
estimated value for a DPP or REIT security (calculated using either the
net investment methodology or the appraised value methodology). In
particular, the proposal would require a member to include disclosures
stating that the DPP or REIT security is not listed on a national
securities exchange, is generally illiquid, and that, even if a
customer is able to sell the security, the price received may be less
than the per share estimated value provided in the statement.\24\
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\24\ See Proposed NASD Rule 2340(c)(2)(B).
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B. Proposed Revisions to FINRA Rule 2310 (Direct Participation
Programs)
FINRA also proposes to amend FINRA Rule 2310(b)(5) to prohibit a
member from participating in a public offering of the securities of a
REIT or DPP unless the issuer of the DPP or REIT has agreed to
disclose:
(1) A per share estimated value of the DPP or REIT security that
is: (a) Developed in a manner reasonably designed to ensure it is
reliable, and (b) disclosed in the DPP's or REIT's periodic reports
filed pursuant to Sections 13(a) or 15(d) of the Act; an explanation of
the method by which the value was developed; and the date of the
valuation; and
(2) a per share estimated value of the DPP or REIT security that
is: (a) Based on valuations of the assets and liabilities of the DPP or
REIT performed at least annually by, or with the material assistance or
confirmation of, a third-party valuation expert or service; (b) derived
from a methodology that conforms to standard industry practice; and (c)
disclosed in the DPP's or REIT's periodic reports filed pursuant to
Sections 13(a) or 15(d) of the Act within 150 days following the second
anniversary of breaking escrow (and in each annual report thereafter);
and a concomitant written opinion or report by the issuer, delivered at
least annually to the member that explains the scope of the review, the
valuation methodology used, and the basis for the reported value.
The proposed rule change would, however, except DPPs subject to the
1940 Act from the requirements of proposed Rule 2310(b)(5). As stated
above, FINRA acknowledged that such DPPs are subject to an existing
regulatory framework (the 1940 Act) that already requires the issuer of
their securities to determine and publish their net asset value on a
regular basis.\25\
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\25\ See Notice of Amendment.
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C. Technical Change
FINRA also proposes making a change to its Rules Manual to conform
to the other revisions discussed above by deleting FINRA Rule
5110(f)(2)(L) (Corporate Financing Rule--Underwriting Terms and
Arrangements). That paragraph currently provides that it is unfair and
unreasonable for a member or person associated with a member to
participate in a public offering of a REIT unless the trustee will
disclose in each annual report distributed to investors a per share
estimated value of the trust securities, the methodology by which it
[[Page 62491]]
was developed, and the date of the data used to develop the value.
The text of the proposed rule change is available at the principal
office of FINRA, on FINRA's Web site at http://www.finra.org, and at
the Commission's Public Reference Room.
III. Description of Comments on the Proposal, as Amended, and FINRA's
Response
A. Comments
As stated above, the Commission received six (6) comment letters in
response to the Proceedings Order.\26\ Those commenters generally
reiterated concerns expressed in response to the Notice of Filing.
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\26\ See supra note 7.
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In addition, the Commission received six (6) comment letters in
response to the Notice of Amendment.\27\ Four (4) of these commenters
fully supported the proposal.\28\ Two (2) other commenters, however,
raised concerns (discussed below).\29\
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\27\ See supra note 10.
\28\ FSI Letter, IPA Letter, NAREIT Letter, and NorthStar
Letter.
\29\ AOG Letter and NASAA Letter.
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One of the concerned commenters supported aspects of the
proposal.\30\ This commenter, however, encouraged rejecting the
proposal's requirement for members to report initial share prices,
stating that substituting ``a flawed share pricing system with a
different flawed pricing system is apt to lead to confusion rather than
clarity.'' \31\ This commenter also suggested that market forces are
sufficiently driving improvements in the unlisted DPP and REIT
industry, noting changes in fee structures.\32\
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\30\ AOG Letter (stating that ``providing sponsor companies with
a formula and timeline . . . for appraising and reporting the values
[other than the initial value] of non-traded REITS is very
valuable'' and ``[providing] broker-dealers assurance that they can
rely on those values is also very helpful'').
\31\ Id.
\32\ Id.
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The second concerned commenter also supported aspects of the
proposal.\33\ This commenter, however, opposed the following other
aspects of the proposal:
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\33\ NASAA Letter (stating that ``[r]equiring securities to be
valued on the customer account statement enhances transparency to
the customer'').
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(1) The commenter opposed excluding over-distribution from the
valuation calculation under the net investment methodology, stating
that excluding it would decrease the accuracy and transparency of the
disclosed values of DPP and REIT securities.\34\
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\34\ See supra note 16 and surrounding text.
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(2) The commenter also expressed concern that members could use the
net investment methodology's requirements concerning offering and
organization expenses to manipulate valuation of DPP and REIT
securities.\35\
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\35\ See supra note 19 and surrounding text.
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(3) In addition, the commenter recommended that FINRA require
disclosure of the identity of the third-party valuation expert or
service used to obtain a valuation under the appraised value
methodology and clarify that such third-party must be independent.
(4) Finally, the commenter opposed the extension of the effective
date of the proposal, as amended, stating that ``industry should not
need an additional year-and-a-half to make the necessary changes'' and
``[investors] should not be forced to wait another year for more
transparent price reporting.'' \36\
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\36\ NASAA Letter.
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B. FINRA's Response
In its response letter, FINRA stated that it has considered the
concerns raised by the two concerned commenters.\37\ FINRA also stated,
however, that it believes that the proposal, as amended,
``significantly improves the transparency of the per share estimated
value of DPP and REIT securities on customer account statements.'' \38\
Accordingly, FINRA declined making any additional changes in response
to commenters' concerns but stated that it would ``continue to monitor
practices in this area to determine whether additional changes are
necessary.'' \39\
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\37\ FINRA's Second Response Letter. See, e.g., FINRA's First
Response Letter (summarizing and responding to commenters' concerns
about calculating over-distributions); FINRA's First Response Letter
(proposed NASD Rule 2340(c)(1)(A) (stating that if a member has
reason to believe that the maximum offering percentage is
unreliable, the member must use the minimum offering percentage);
FINRA's First Response Letter (extending the effective date to
provide industry participants sufficient time to make adjustments to
product structures and any necessary operational changes, as well as
to limit the impact of the amended proposal on current offerings);
and proposed NASD Rule 2340(c)(1)(B) (stating that the valuation
expert or service must be a third-party).
\38\ FINRA's Second Response Letter.
\39\ Id.
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IV. Discussion and Commission Findings
The Commission has carefully considered the proposal, as amended;
the comments received; and FINRA's responses to the comments. Based on
its review of the record, the Commission finds that the proposal is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
association.\40\ In particular, the Commission finds that the proposed
rule change is consistent with the provisions of Section 15A(b)(6) of
the Act, which requires, among other things, that FINRA's rules be
designed to prevent fraudulent and manipulative acts and practices;
promote just and equitable principles of trade; and, in general,
protect investors and the public interest.\41\
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\40\ In approving the proposal, as amended, the Commission has
considered the impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
See, e.g., Proceedings Order at 7 (noting commenters' concern
about the potential economic impact of the proposal, as originally
proposed; also FINRA's First Response Letter, which provided a
detailed economic impact statement in response to those commenters).
The Commission has received no additional public comment on the
potential economic impact of the proposed rule change, as amended.
\41\ 15 U.S.C. 78o-3(b)(6).
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The proposal, as amended, is designed to address longstanding
concerns with the current industry practice of displaying a DPP or REIT
security's immutable offering price as its per share estimated value on
customer account statements throughout the offering period (which can
last several years),\42\ despite the fact that the value of the DPP or
REIT security fluctuates. FINRA's proposed rule change would require
members to include in customer account statements per share estimated
values of unlisted DPP and REIT securities that are developed in a
manner reasonably designed to ensure they are reliable. The Commission
believes that the proposal would, therefore, greatly improve the
accuracy and transparency of the value of DPP and REIT securities and,
in turn, better protect the investing public.
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\42\ See Notice of Filing at note 8 and surrounding text
(stating that ``Rule 415(a)(5) under the Securities Act of 1933
(`Securities Act') provides that certain types of securities
offerings, including continuous offerings of DPPs and REITs, may
continue for no more than three years from the initial effective
date of the registration statement. Under Rule 415(a)(6), the SEC
may declare another registration statement for a DPP or REIT
effective such that an offering can continue for another three-year
offering period'').
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As discussed above, the Commission received eighteen (18) comment
letters in response to the Notice of Filing, six (6) comment letters in
response to the Proceedings Order, six (6) comment letters in response
to the Notice of Amendment, and two (2) response letters from FINRA.
The Commission appreciates the points raised by the commenters, and the
Commission believes that FINRA responded appropriately to their
concerns.\43\ The
[[Page 62492]]
Commission notes that, while one commenter on the amended proposal
suggested market forces should be sufficient to drive improvements in
the unlisted DPP and REIT industry,\44\ given current industry practice
with respect to disclosure of DPP and REIT values, the Commission
believes that FINRA's amended proposal is warranted.
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\43\ FINRA did not directly respond to the commenter's
recommendation to require disclosure of the name of the third-party
expert or service for purposes of proposed NASD Rule 2340(c)(1)(B).
The Commission notes, however, that this information may be
available in an issuer's prospectus.
\44\ AOG Letter.
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Also, given commenters' concern regarding the complexity of
calculating over-distributions, the Commission supports FINRA's amended
approach of requiring enhanced disclosure surrounding them. More
specifically, the Commission believes that, at this time, this approach
would improve investor awareness and understanding in a practical
manner.
In addition, one commenter on the amended proposal expressed
concern that members could use the net investment methodology's
requirements concerning offering and organization expenses to
manipulate DPP and REIT values.\45\ Under the amended proposal,
however, if a member has reason to believe a calculation of the
offering and organization expenses using the maximum offering
percentage is unreliable, the member must use the minimum offering
percentage.\46\
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\45\ NASAA Letter.
\46\ See FINRA's First Response Letter.
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The same commenter further recommended that FINRA require
disclosure of the identity of the service used to obtain a valuation
under the appraised value methodology and clarify that such service
must be independent.\47\ Regarding disclosure of the valuation
service's identity, the Commission notes that this information may be
available through an issuer's prospectus. Regarding the independence of
the service, the amended proposal requires the use of a ``third-party
valuation expert,'' which both the Commission and FINRA interpret as
being an independent entity.\48\
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\47\ Id.
\48\ See, e.g., FINRA's First Response Letter (discussing the
economic impact of requiring ``independent valuations'').
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Finally, the commenter opposed the extension of the effective date
under the amended proposal, stating that investors should not have to
wait for more transparent price reporting.\49\ FINRA extended the
effective date, however, to provide industry participants sufficient
time to make adjustments to product structures and any necessary
operational changes, as well as to limit the impact of the amended
proposal on current offerings.\50\
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\49\ NASAA Letter.
\50\ FINRA's First Response Letter.
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In sum, the Commission believes that the proposal, as amended,
represents a significant improvement to current industry practice
concerning the disclosure of the value of unlisted DPP and REIT
securities. As amended, the proposal would help ensure that investors
receive more accurate information regarding the nature and worth of
their holdings of DPP and REIT securities. While the Commission
believes that this outcome would improve accuracy and transparency and,
consequently, investor protection, it will continue to monitor the
activity in this market for potential abuses.
For the reasons stated above, the Commission finds that the
proposed rule change, as amended, is consistent with the Act and the
rules and regulations thereunder.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\51\ that the proposed rule change (SR-FINRA-2014-006), as modified
by Amendment No. 1, be, and hereby is, approved.
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\51\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\52\
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\52\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-24681 Filed 10-16-14; 8:45 am]
BILLING CODE 8011-01-P