75774 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

1The primary focus of Regulation M, and its 

predecessor Rule 10b–6, is (1) offerings that raise 

manipulative concerns, defined as distributions; (2) 

persons who are likely to engage in manipulative 

activity; and (3) the activities that likely could raise 

or support the security’s price. Securities Exchange 

Act Release No. 33924 (April 19, 1994), 59 FR 

21681, 21684 (‘‘Regulation M Concept Release’’) 

(stating that a person contemplating or making a 

distribution has an obvious incentive to artificially 

influence the price of the securities in order to 

facilitate the distribution or increase its profitability 

and citing Bruns, Nordeman & Co., 40 SEC 652, 660 

n.11 (1961)); Securities Exchange Act Release No. 

38067 (December 20, 1996), 62 FR 520 (January 3, 

1997) (‘‘Regulation M Adopting Release’’).

2Securities Exchange Act Release No. 5194 (July 

5, 1955), 20 FR 5075.

3Regulation M replaced former Rules 10b–6, 10b–

6A, 10b–7, 10b–8, and 10b–21. See Regulation M 

Adopting Release, 62 FR at 520. Rules 101, 102, and 

103 of Regulation M apply to distributions of 

securities, defined as an offering of securities, 

whether or not subject to registration under the 

Securities Act that are distinguished from ordinary 

trading by the magnitude of the offering and the 

presence of special selling efforts and selling 

methods. Rule 104 of Regulation M applies to 

offerings of securities, which generally 

encompasses all methods of offering and selling 

securities to investors. Regulation M Adopting 

Release, 62 FR at 535, n. 116. Rule 105 applies to 

offerings registered under the Securities Act, except 

offerings that are not firm commitment 

underwritings. 17 CFR 242.100 through 105.

4Under Regulation M, ‘‘distribution participant’’ 

is defined as an underwriter, prospective 

underwriter, broker, dealer, or other person who 

has agreed to participate or is participating in a 

distribution. 17 CFR 242.100(b).

5See supra note 3 for the definition of 

distribution. 17 CFR 242.100(b).

6 15 U.S.C. 77q(a); 15 U.S.C. 78i(a), 78j(b), and 

78(o)(c).

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 228, 229, 230, 240 and 

242 

[Release Nos. 33–8511; 34–50831; IC–

26691; File No. S7–41–04] 

RIN 3235–AF54 

Amendments to Regulation M: AntiManipulation Rules Concerning 

Securities Offerings

AGENCY: Securities and Exchange 

Commission.

ACTION: Proposed rule.

SUMMARY: The Securities and Exchange 

Commission (Commission) is proposing 

amendments to Regulation M under the 

Securities Exchange Act of 1934 

(Exchange Act), which governs the 

activities of underwriters, issuers, 

selling security holders, and others in 

connection with offerings of securities. 

The proposed amendments are intended 

to prohibit certain activities by 

underwriters and other distribution 

participants that can undermine the 

integrity and fairness of the offering 

process, particularly with respect to 

allocations of offered securities. The 

proposal also seeks to enhance the 

transparency of syndicate covering bids, 

which may affect the aftermarket price 

and trading of an offered security, and 

prohibit the use of penalty bids. The 

amendments also are intended to update 

certain definitional and operational 

provisions in light of market 

developments since Regulation M’s 

adoption. As a consequence of these 

proposed amendments to Regulation M, 

we are also recommending 

corresponding changes to disclosure 

rules under the Securities Act of 1933 

(‘‘Securities Act’’) as well as changes to 

certain recordkeeping rules under the 

Exchange Act.

DATES: Comments should be received on 

or before February 15, 2005.

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–41–04 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Jonathan G. Katz, Secretary, 

Securities and Exchange Commission, 

450 Fifth Street, NW., Washington, DC 

20549–0609.

All submissions should refer to File 

Number S7–41–04. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/

proposed.shtml). Comments are also 

available for public inspection and 

copying in the Commission’s Public 

Reference Room, 450 Fifth Street, NW., 

Washington, DC 20549. All comments 

received will be posted without change; 

we do not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

James Brigagliano, Assistant Director, 

Joan Collopy, Special Counsel, Elizabeth 

Sandoe, Special Counsel, Liza Orr, 

Special Counsel, Elizabeth Marino, 

Attorney, or Denise Landers, Attorney 

Fellow, Office of Trading Practices and 

Processing, Division of Market 

Regulation, at (202) 942–0772, at the 

Securities Exchange Commission, 450 

Fifth Street, NW., Washington, DC 

20549.

SUPPLEMENTARY INFORMATION: The 

Commission is requesting public 

comment on proposed amendments to 

Regulation M [17 CFR 242.100, 242.101, 

242.102, and 242.104], proposed rule 

106 to the Regulation and Rule 17a–2 

[17 CFR 240.17a–2] under the Exchange 

Act. 

I. Introduction 

Manipulation interferes with the 

securities markets’ fundamental 

function as an independent pricing 

mechanism and undermines the 

markets’ integrity and fairness. Under 

the securities laws, Congress granted the 

Commission broad authority to combat 

manipulative conduct. The 

Commission, in turn, has recognized 

that special opportunities and 

incentives for manipulation arise in 

securities offerings and has determined 

that certain offerings require specific 

regulation.1 Consequently, the 

Commission has focused its regulation 

on market activities that could 

artificially facilitate an offering.

Because price integrity is essential 

during a securities offering, the 

Commission adopted rules to proscribe 

and regulate activities that offering 

participants could use to manipulate the 

price of the offered security. The antimanipulation rules were first codified in 

1955,2 and today, Regulation M 

incorporates these provisions.3

Regulation M, among other things, 

prohibits issuers, selling security 

holders, underwriters, broker-dealers, 

and other distribution participants 4

from directly or indirectly bidding for, 

purchasing, or attempting to induce any 

person to bid for or purchase any 

security that is the subject of the 

distribution during the applicable 

restricted period.5 Regulation M 

proscribes activities that may increase a 

security’s offering price, and so increase 

the offering proceeds; or may stabilize 

the market price of an offered security 

in order to avoid a price decline during 

the sales period or in the immediate 

aftermarket, or to induce or attempt to 

induce prospective investors to buy in 

the aftermarket.

Although the general antifraud and 

anti-manipulation provisions of the 

federal securities laws (e.g., Section 

17(a) of the Securities Act, and Sections 

9(a), 10(b), and 15(c) of the Exchange 

Act 6 and Rule 10b–5 under the 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75775

7 17 CFR 240.10b–5.

8See Regulation M Concept Release, 59 FR at 

21687 (noting purpose of the anti-manipulation 

rules is to limit the scope of market activity during 

securities offerings in order to prophylactically 

prevent manipulation).

9 17 CFR 242.101. An affiliated purchaser 

generally means a person acting, directly or 

indirectly, in concert with a distribution 

participant, issuer or selling security holder in 

connection with the acquisition or distribution of 

any covered security or an affiliate of a distribution 

participant, issuer or selling security holder, that 

directly or indirectly, controls the purchases of any 

covered security by a distribution participant, 

issuer, or selling security holder, whose purchases 

are controlled by or under common control with 

any such person. See 17 CFR 242.100(b).

10See, e.g., NYSE/NASD IPO Advisory 

Committee, Report and Recommendations (http://

www.nyse.com/pdfs/iporeport.pdf) (May 2003) (IPO 

Blue Ribbon Report); NASD Notice to Members 03–

79 (December 2003) (adopting NASD Rule 2790 to 

prohibit sales of new issues to any account in 

which a restricted member has a beneficial interest); 

NASD Notice to Members 03–72 (November 2003) 

(proposing additional amendments to NASD Rule 

2712 Governing Allocations and Distributions of 

Shares in IPOs (SR–NASD–2003–140)); NASD 

Notice to Members 97–34 (June 1997) (launching 

initial public offering tracking system by The 

Depository Trust Company to monitor flipping).

11See, e.g., SEC v. J.P. Morgan Securities, Inc., 

No. 03 Civ. 02028 (D.D.C. 2003), Complaint, 

(alleging violations of Regulation M); SEC v. 

Robertson Stephens, Inc., Final Judgment of 

Permanent Injunction and Other Relief Against 

Robertson Stephens, Inc., 03 Civ. 0027 (RL) (D.D.C. 

2003), Complaint ¶¶ 1, 5 (alleging violations of 

NASD Conduct Rules 2110 and 2330 and Section 

17(a) of the Exchange Act and Rule 17a–3(a)(6) 

thereunder for improperly sharing customer profits 

by allocating ‘‘hot’’ IPO shares to customers and 

receiving in return shares of customer profits via 

excessive commissions or markdowns); SEC v. 

Credit Suisse First Boston Corp., No. 1:02 CV 00090, 

2002 WL 479836 (D.D.C. 2002), Complaint, ¶¶ 1, 6 

(alleging violations of NASD Conduct Rules 2110 

and 2330 and Section 17(a) under the Exchange Act 

and Rule 17a–3(a)(6) thereunder, for encouraging 

customers to channel profits from hot IPOs via 

excessive brokerage commissions); In the Matter of 

Michael J. Markowski, Securities Exchange Act 

Release No. 44086 (March 20, 2001) (finding a Rule 

10b–6 violation when a broker-dealer firm 

instructed its brokers to solicit aftermarket orders 

during the distribution).

12See NASD Notice to Members 4–50 (July 2004) 

(announcing Bear Stearns & Co., Inc., Deutsche 

Bank Securities Inc., and Morgan Stanley & Co., Inc. 

were censured for engaging in improper IPO 

allocation practices and profit-sharing with 

customers by charging excessive commissions on 

listed agency trades within one day of allocating 

IPO shares to those customers). See also supra note 

10, and accompanying text (detailing recent NASD 

actions to address the IPO allocation process).

13See In re Initial Public Offering Securities 

Litigation, 241 F. Supp. 2d 281 (S.D.N.Y. 2003) 

(denying defendant underwriters’ motion to dismiss 

in case involving multiple allocating underwriters 

charged with market manipulation for requiring 

customers to engage in tie-in agreements and to pay 

undisclosed excessive compensation in order to 

receive allocations of IPO stock). See also In re 

Initial Public Offering Antitrust Litigation, 287 F. 

Supp. 2d 497 (S.D.N.Y. 2003) (finding that investors 

could not pursue antitrust claims against 

underwriters whom they alleged conspired to 

inflate aftermarket prices under doctrine of implied 

immunity); Friedman v. Salomon Smith Barney, 

Inc., 313 F.3d 796, 801 (2nd Cir. 2002) (finding that 

underwriters and brokers are immune from antitrust 

liability for price stabilization practices in the 

aftermarket since it is the exclusive jurisdiction of 

the Securities and Exchange Commission).

14The Commission staff previously addressed 

manipulative conduct related to tie-in arrangements 

and solicitations for aftermarket purchases of an 

offered security in violation of Regulation M. See

Division of Market Regulation: Staff Legal Bulletin 

No. 10 ‘‘Prohibited Solicitations and ‘Tie-in’

Agreements for Aftermarket Purchases’’ (August 25, 

2000) (Staff Legal Bulletin 10). Although the 

aforementioned conduct would violate Regulation 

M or other provisions of the federal securities laws, 

or both, proposed Rule 106 would expressly 

prohibit the full array of fraudulent and 

manipulative conduct related to allocations of 

offered shares.

15 17 CFR 242.100(b) states that restricted period 

means: (1) For any security with an ADTV value of 

$100,000 or more of an issuer whose common 

equity securities have a public float value of $25 

million or more, the period beginning on the later 

of one business day prior to the determination of 

the offering price or such time that a person 

becomes a distribution participant, and ending 

upon such person’s completion of participation in 

the distribution; and (2) For all other securities, the 

Continued

Exchange Act 7) apply to all securities 

transactions, Regulation M takes a 

prophylactic approach and is focused 

on particular activities in connection 

with securities offerings.8 Rather than 

addressing manipulation after the fact, 

Regulation M seeks to prevent it by 

generally precluding certain persons 

from engaging in specified market 

activities. Also, unlike the more general 

anti-manipulation provisions, 

Regulation M does not require the 

Commission to prove in an enforcement 

action that distribution participants 

have a manipulative intent or purpose. 

As a prophylactic, anti-manipulation 

measure, Regulation M is designed to 

prohibit activities that could artificially 

influence the market for the offered 

security, including, for example, 

supporting the offering price by creating 

the exaggerated perception of scarcity of 

the offered security or creating the 

misleading appearance of active trading 

in the market for the security.

Regulation M consists of six rules. 

Rule 100 contains definitions of terms 

under Regulation M. Rule 101 governs 

the activities of underwriters and other 

persons participating in a distribution of 

securities and their affiliated 

purchasers.9 Rule 102 governs the 

activities of the issuer, selling security 

holders and their affiliated purchasers. 

Rule 103 describes the conditions for 

permissible ‘‘passive’’ market making 

during the restricted period for a 

distribution of a Nasdaq security. Rule 

104 governs stabilization, syndicate 

short covering activity, and penalty 

bids. Rule 105 prohibits covering short 

sales with offered securities purchased 

from an underwriter, broker, or dealer 

participating in an offering. Since 

Regulation M’s adoption in 1996, the 

Commission has examined underwriting 

practices and aftermarket activities. In 

recent years, anti-manipulation 

regulation has been extensively and 

intensively scrutinized, with a 

particular focus on initial public 

offerings (‘‘IPOs’’).10 Recent 

Commission 11 and SRO 12 actions and 

private litigation 13 have addressed 

certain misconduct in connection with 

IPOs.

On the basis of these developments, 

today we are proposing revisions to 

Regulation M and the addition of a new 

rule.14 Our proposals would:

• Amend Rule 100’s definition of 

‘‘restricted period’’ with respect to IPOs 

and to expressly reflect the 

Commission’s long-standing application 

of the definition in the context of 

mergers, acquisitions, and exchange 

offers; 

• Amend Rule 101’s ‘‘de minimis

exception’’ to require recordkeeping;

• Amend Rules 100, 101, and 102 to 

update the average daily trading volume 

(ADTV) value and public float value 

qualifying thresholds for purposes of the 

‘‘restricted period’’ definition and the 

‘‘actively-traded’’ securities and 

‘‘actively-traded’’ reference securities 

exceptions; 

• Amend Rule 104 to require 

disclosure of syndicate covering bids 

and to prohibit penalty bids; 

• Amend Rule 104(j)(2) to include 

reference securities in the exception for 

transactions in securities eligible for 

resale under Rule 144A; and 

• Adopt new Rule 106 to expressly 

prohibit conditioning the award of 

allocations of offered securities on the 

receipt of consideration in addition to 

the stated offering consideration.

As a consequence of these proposals, we 

are also recommending amendments to 

Rule 481 and Item 508 of Regulations S–

K and S–B under the Securities Act 

concerning disclosure, and Rules 17a–2 

and 17a–4 with respect to 

recordkeeping. We solicit specific 

comment on our approach and the 

specific proposals. We encourage 

commenters to present data on our 

proposals and any suggested alternative 

approaches. 

II. Discussion of Proposed Amendments 

to Regulation M 

A. Rule 100(b) 

1. ‘‘Restricted Period’’ for IPOs 

The Commission is proposing to 

amend the definition of ‘‘restricted 

period’’ in Rule 100(b) with respect to 

IPOs.15 Specifically, the Commission is 

75776 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

period beginning on the later of five business days 

prior to the determination of the offering price or 

such time that a person becomes a distribution 

participant, and ending upon such person’s 

completion of participation in the distribution. (3) 

In the case of a distribution involving a merger, 

acquisition, or exchange offer, the period beginning 

on the day proxy solicitation or offering materials 

are first disseminated to security holders, and 

ending upon the completion of the distribution.

16A distribution is generally considered 

completed when the securities in the distribution 

have been distributed or acquired for investment, 

e.g., when an underwriter’s participation has been 

distributed and any stabilization arrangements and 

trading restrictions in connection with the 

distribution have been terminated. 17 CFR 

242.100(b). Provided, however, that an 

underwriter’s participation will not be deemed to 

have been completed if a syndicate overallotment 

option is exercised in an amount that exceeds the 

net syndicate short position at the time of such 

exercise. Id. For a selling group member that is not 

part of the underwriting syndicate, its participation 

is completed when the selling group member has 

sold its entire allotment.

17A covered security is defined as ‘‘any security 

that is the subject of the distribution, or any 

reference security.’’ A reference security is defined 

as a ‘‘security into which a security that is the 

subject of a distribution (‘subject security’) may be 

converted, exchanged, or exercised or which, under 

the terms of the subject security, may in whole or 

in significant part determine the value of the subject 

security. 17 CFR 242.100(b).

18ADTV is defined as the worldwide average 

daily trading volume during the two full calendar 

months immediately preceding, or any 60 

consecutive calendar days ending within the 10 

calendar days preceding, the filing of the 

registration statement; or, if there is no registration 

statement or if the distribution involves the sale of 

securities on a delayed basis pursuant to 230.415 

of this chapter, two full calendar months 

immediately preceding, or any consecutive 60 

calendar days ending within the 10 calendar days 

preceding, the determination of the offering price. 

17 CFR 242.100(b).

19Rule100(b) provides that ‘‘public float value 

shall be determined in the manner set forth on the 

front page of Form 10–K even if the issuer of such 

securities is not required to file Form 10–K * * *.’’

17 CFR 242.100(b).

20However, if the distribution involves a 

corporate action, current subparagraph (3) of the 

restricted period governs the commencement of the 

restricted period. This is the day that proxy 

solicitation or offering materials are mailed. 

Additionally, current paragraphs (1) and (2) of the 

restricted period definition would apply to any 

valuation or election period in connection with the 

corporate action.

21 17 CFR 242.100(b) definition of restricted 

period, subparagraph (1).

22 17 CFR 242.100(b) definition of restricted 

period, subparagraph (2).

23See supra note 15.

24 17 CFR 242.101(c)(1) (providing an exception 

for actively-traded covered securities if the 

distribution participant or its affiliated purchasers 

did not issue the security). We note, however, that 

there is no actively-traded securities exception for 

IPOs because they have no trading market.

25 17 CFR 242.102(d)(1) (providing an exception 

for actively-traded reference securities if the issuer 

or its affiliated purchasers did not issue the 

reference security). Rule 102 did not except all 

actively-traded reference securities, because the 

Commission determined that issuers and selling 

security holders have a high stake in the proceeds 

of an offering (and thus, an incentive to 

manipulate), and so, should not be able to trade in 

their securities, whether or not they are activelytraded. Regulation M Adopting Release, 62 FR at 

531.

26See SEC v. J.P. Morgan Securities, Inc., supra

note 11.

27Regulation M’s proscription of attempts to 

induce bids and purchases are not intended to 

interfere with legitimate book-building. The 

determination as to whether an activity or 

communication constitutes legitimate bookbuilding or an attempt to induce a bid or purchase 

in violation of Regulation M depends on the 

particular facts and circumstances surrounding 

such activity or communication.

proposing new paragraph (4) to the 

definition to provide that the restricted 

period for an IPO would extend from 

the earlier of: (1) The period beginning 

at the time an issuer reaches an 

understanding with a broker-dealer that 

is to act as an underwriter, or such time 

that a person becomes a distribution 

participant; or (2) if there is no 

underwriter, the period beginning at the 

time the registration statement is filed 

with the Commission or other offering 

document is first circulated to potential 

investors, or such time that a person 

becomes a distribution participant, and 

would conclude when the distribution 

is completed.16

As defined in Rule 100(b), ‘‘restricted 

period’’ is the time period during which 

covered persons must refrain from 

directly or indirectly bidding for, 

purchasing, or attempting to induce any 

person from bidding for, or purchasing 

a covered security.17 The length of the 

restricted period is based on the 

liquidity of a security’s trading market, 

specifically the value of the average 

daily trading volume (‘‘ADTV’’)18 of the 

security and the value of the public 

float 19 of the issuer.20 If a covered 

security has an ADTV value of $100,000 

or more and a public float value of $25 

million or more, then the restricted 

period begins on the later of one 

business day prior to the determination 

of the offering price, or such time that 

a person becomes a distribution 

participant (‘‘one-day security’’).21 If a 

covered security’s ADTV and public 

float values are less than $100,000 and 

$25 million respectively, then the 

restricted period commences on the 

later of five business days prior to the 

determination of the offering price or 

such time that a person becomes a 

distribution participant (‘‘five-day 

security’’).22 The restricted period 

generally ends, for all securities, upon 

such person’s completion of 

participation in the distribution.23

However, distribution participants and 

their affiliated purchasers are not 

subject to a restricted period for a 

covered security that has an ADTV 

value of at least $1 million and a public 

float value of at least $150 million 

(‘‘actively-traded securities’’).24 Issuers, 

selling security holders, and their 

affiliated purchasers are not subject to a 

restricted period with respect to 

reference securities that have an ADTV 

value of at least $1 million and a public 

float value of at least $150 million.25

The restricted period provides a 

defined period of time during which the 

effects of a distribution participant’s 

bids, purchases, or attempts to induce 

bids or purchases on the market price 

for a security may dissipate. It therefore 

allows other market participants to 

observe trading in the offered security 

unaffected by the activity of persons 

with an incentive to facilitate the 

distribution. With a one or five-day 

restricted period, investors and market 

participants should observe prices in 

the offered security that result from the 

natural forces of supply and demand. 

A recent enforcement case alleged 

that a broker-dealer, prior to the pricing 

of IPOs, induced and attempted to 

induce investors to make aftermarket 

bids or purchases.26 Inducements and 

attempts to induce aftermarket bids or 

purchases by distribution participants 

in order to facilitate a securities 

distribution interfere with the securities 

markets’ function as an independent 

pricing mechanism and undermine the 

integrity of the capital raising process.27

The activity often creates the 

exaggerated perception to investors of 

scarcity of IPO stock and can affect the 

pricing of the offering.

The restricted period definition 

references trading market information, 

i.e., ADTV and public float, and 

provides two restricted periods based on 

these thresholds. Paragraph (2) of the 

definition provides that ‘‘for all other 

securities’’ that do not satisfy the ADTV 

and public float levels in paragraph (1) 

of the definition, the restricted period is 

five days. Currently, the absence of a 

trading market for IPOs has meant that 

the five-day restricted period applies to 

IPOs. 

In the case of IPOs, however, the 

market influences underlying the one 

and five-day restricted periods do not 

apply. There is no trading market that 

would provide an independent pricing 

mechanism for prospective investors to 

evaluate the IPO price set by 

underwriters. Therefore, any 

inducement activity by underwriters 

and other distribution participants can 

have long-lasting effects.

Attempts to induce aftermarket bids 

or purchases that occur earlier than five 

days before IPO pricing can affect the 

pricing of an offering. Thus, the 

Commission believes that current Rule 

100’s application to IPOs that results in 

a restricted period that commences five 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75777

28An underwriter is defined as a person who has 

agreed with an issuer or selling security holder: (1) 

To purchase securities for distribution; or (2) to 

distribute securities for or on behalf of such issuer 

or selling security holder; or (3) to manage or 

supervise a distribution of securities for or on 

behalf of such issuer or selling security holder. 17 

CFR 242.100(b).

29Restricted period means in the case of a 

distribution involving a merger, acquisition, or 

exchange offer, the period beginning on the day 

proxy solicitation or offering materials are first 

disseminated to security holders, and ending upon 

the completion of the distribution. 17 CFR 

242.100(b).

30See Regulation M Adopting Release, 62 FR at 

527 (stating that consistent with interpretations 

under Rule 10b–6, a restricted period under 

Regulation M would commence one or five days 

before the commencement of a valuation period, 

i.e., a period where the market price of the offered 

security would be a factor for determining the 

consideration paid in a merger, acquisition or 

exchange offer, and continue for the duration of 

such period), citing Securities Exchange Act Release 

No. 19565 (March 14, 1983), 48 FR 10628, 10638 

(stating that ‘‘any period during which the market 

price of the offered security was a factor in 

determining the consideration to be paid pursuant 

to the merger (‘valuation period’) * * * the issuer 

was required to cease bidding for or purchasing the 

security five business days prior to and for the 

duration of the valuation period. A similar 

restriction was applied to any period during which 

the target company shareholders had the right to 

elect among various forms of consideration offered 

in connection with [a] merger (‘election period’).’’). 

See also Division of Market Regulation Staff Legal 

Bulletin No. 9: Frequently Asked Questions About 

Regulation M (revised April 12, 2002) available at 

http://www.sec.gov/interps/legal/mrslb9.htm

(stating ‘‘the restricted period includes the 

valuation period as well. For instance, if the 

valuation period occurs outside of the proxy 

solicitation period, an additional restricted period 

would commence one or five business days prior 

to the commencement of the valuation period and 

continue until the valuation period ends.’’).

31See supra note 30.

32See supra note 30.

33 17 CFR 242.100(b). 34See supra Section II.A. for a discussion of 

restricted periods and corresponding ADTV and 

public float value thresholds. 35 17 CFR 242.100(b). 36 17 CFR 242.101(c)(1). Cf., Rule 100(b) 

definition of restricted period. 17 CFR 242.100(b). 

See also supra note 24. 37 17 CFR 242.102(d)(1). A reference security is a 

security into which a security that is the subject of 

Continued

days prior to pricing an IPO is 

inadequate to address potentially 

manipulative conduct because attempts 

to induce aftermarket bids and 

purchases are inappropriate at any time 

prior to the pricing and distribution of 

an IPO. 

In order to combat manipulative 

abuses in connection with IPOs, the 

Commission is proposing new 

paragraph (4) to the definition of 

restricted period to specify that in the 

case of an IPO, the restricted period 

generally begins the earlier of: when the 

issuer reaches an understanding with 

the broker-dealer that is to act as its 

underwriter, or such time that a person 

becomes a distribution participant; or if 

there is no underwriter, when the 

registration statement is filed with the 

Commission or other offering document 

is first circulated to potential investors, 

or such time that a person becomes a 

distribution participant.28 Additionally, 

the Commission is proposing to define 

IPO in Rule 100(b) to mean an issuer’s 

first offering of a security to the public 

in the United States, and if prior to the 

offering the issuer’s equity securities do 

not have a public float value, and the 

IPO would be an issuer’s first offering of 

an equity security to the public in the 

United States. We propose to use this 

definition of IPO so that if an issuer’s 

first offering of a security in the United 

States is debt, then both that debt 

offering and the issuer’s first offering of 

an equity security in the United States 

would fall within this proposed 

definition of IPO. However, if an offered 

equity security already has a trading 

market either domestically or abroad for 

which ADTV and public float values 

may be calculated, then the equity 

offering would not be an IPO, and either 

a one or five-day restricted period 

would apply based on the ADTV and 

public float values. We also note that 

the actively-traded security or reference 

security exception would not apply to 

IPOs.

Q. Is there a different restricted period 

that should apply to IPOs that would 

more appropriately restrict potentially 

manipulative activity? Should the 

restricted period for IPOs begin earlier 

than proposed? Should the restricted 

period begin with the filing of the 

registration statement (or with the first 

circulation of an offering document to 

potential investors) for all IPOs, 

including IPOs that have an 

underwriter? Please provide specific 

reasons and information to support an 

alternative recommendation. Please 

provide empirical data, when possible, 

and cite to economic studies, if any, to 

support any alternative approaches. 

2. Amendments to Rule 100(b)—

‘‘Restricted Period’’ for Corporate 

Actions 29

The Commission has a long-standing 

interpretation under both Regulation M 

and its predecessor, Rule 10b–6, that the 

restricted period for mergers, 

acquisitions, and exchange offers 

includes valuation and election 

periods.30 Valuation periods refer to 

time periods when the offered security’s 

market price is a factor in determining 

the consideration paid in a corporate 

action.31 Election periods refer to time 

periods when shareholders have the 

right to elect among various forms of 

consideration.32 These periods have 

been considered by the Commission to 

be included in the restricted period 

because they are deemed part of the 

distribution, and valuation and election 

periods are price-sensitive times during 

which the incentive for interested 

persons to manipulate is high. 

Currently, the Rule 100(b) definition of 

restricted period for mergers, 

acquisitions, and exchange offers refers 

to ‘‘the period beginning on the day 

proxy solicitation or offering materials 

are first disseminated to security 

holders * * *’’ but the rule text itself 

does not explicitly refer to valuation 

and election periods.33

Notwithstanding the long-standing 

interpretation, the staff occasionally 

receives inquiries about restricted 

periods concerning valuation and 

election periods in corporate actions. 

Therefore, we believe that expressly 

stating this interpretation in the rule 

would be beneficial. Accordingly, we 

propose to amend the definition of the 

restricted period in Rule 100(b) to 

include valuation and election periods 

and to add definitions for these terms. 

Q. We seek specific comment 

concerning the proposal to incorporate 

the interpretation concerning election 

and valuation periods into the text of 

the restricted period definition. 

B. Rule 100 Restricted Period Definition 

and Rules 101 and 102 Actively-Traded 

Security Exception: ADTV and Public 

Float Value Thresholds

As discussed earlier, Rules 101 and 

102 of Regulation M prohibit certain 

persons from making bids or purchases 

during restricted periods, as defined in 

Rule 100(b). The applicable restricted 

period begins either one or five days 

before determining the offering price (or 

other applicable event) and is 

determined on the security’s ADTV 

value and the issuer’s public float 

value.34 Securities that have an ADTV 

value of at least $100,000 of an issuer 

whose common equity securities have a 

public float value of at least $25 million 

have a restricted period that commences 

one day prior to the day of the pricing 

of the offering and for securities falling 

below those thresholds a five-day 

restricted period applies.35 The 

Commission additionally determined to 

except actively-traded securities from 

the provisions of Rule 101, when such 

securities are not issued by the 

distribution participant or an affiliate 

thereof.36 Similarly, actively-traded 

reference securities are excepted from 

the provisions of Rule 102 when such 

securities are not issued by the issuer, 

or any affiliate of the issuer, of the 

security in distribution.37 ActivelyVerDate jul<14>2003 17:35 Dec 16, 2004 Jkt 205001 PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 E:\FR\FM\17DEP3.SGM 17DEP3
75778 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

a distribution (‘‘subject security’’) may be 

converted, exchanged, or exercised or which, under 

the terms of the subject security, may in whole or 

in significant part determine the value of the subject 

security. 17 CFR 242.100(b). See also supra note 25. 38 17 CFR 242.100(b). When Regulation M was 

adopted, the Commission believed the two-part 

ADTV and public float standard appropriately 

distinguished which securities were more difficult 

to manipulate. The Commission reasoned that the 

use of a trading volume standard alone would 

permit securities experiencing an unusual shortterm volume increase in trading to be excepted from 

the restrictions of Rules 101 and 102. To avoid this 

result, the Commission added a public float 

component to the test, so that securities with an 

unusual increase in trading volume, but with a 

relatively small public float value, would be subject 

to the restricted periods under Rules 101 and 102. 

Regulation M Adopting Release, 62 FR at 527.

39 It should be noted, however, that activelytraded securities and reference securities are not 

excepted from Rule 104 of Regulation M. 17 CFR 

242.104.

40Regulation M Adopting Release, 62 FR at 527.

41 Id.

42 Id.

43 Id.

44See discussion supra Section II.A. 45Regulation M Adopting Release, 62 FR at 527. 

The Commission observed that the exception would 

not compromise investor protection because the 

general antifraud and anti-manipulation provisions 

would continue to apply to offerings of activelytraded securities. Thus, distribution participants 

(and their affiliated purchasers) would continue to 

be prohibited from influencing the price of such 

securities to facilitate the distribution. Securities 

Exchange Act Release No. 37094 (April 11, 1996), 

61 FR 17108, 17112 (April 18, 1996) (‘‘Regulation 

M Proposing Release’’). 46When we adopted Regulation M, the 

Commission estimated (based on 1995 data) a total 

of 4,255 securities would either have a one- or fiveday restricted period, with 2,693 one-day securities 

and 1,562 five-day securities respectively. 

Additionally, 1,901 securities would qualify for the 

actively-traded security exception. Regulation M 

Adopting Release, 62 FR at 525, n. 37 (based on an 

analysis of NYSE, Amex and Nasdaq-listed 

securities). Today, based on 2003 data, 

approximately 4,667 securities would either have a 

one- or five-day restricted period, with 2,035 

securities one-day securities and 2,632 securities 

five-day securities and 2,352 securities would 

qualify for the actively-traded security exception. 

These estimates are based on computations 

performed by the Office of Economic Analysis 

(‘‘OEA’’), July 8, 2004, using the CRSP database.

47The change in CPI is the percentage change in 

Urban CPI measured from July 1996 to July 2004, 

based on calculations performed by OEA. 48Adjusting the ADTV and public float value 

thresholds upwards for actively-traded securities by 

20% would yield 2,353 issuers, or approximately 

31% of all issuers would qualify as actively-traded 

securities. Based on calculations performed by 

OEA, in 1996 approximately 2,338 issuers were 

deemed actively-traded securities, which 

represented 27% of all issuers.

traded securities and reference 

securities are those with an ADTV value 

of at least $1 million and are issued by 

an issuer whose common equity 

securities have a public float value of at 

least $150 million.38 In effect, these 

actively-traded securities and reference 

securities have no restricted period.39

As discussed below, we now propose to 

increase the thresholds for the 

applicable restricted periods for the 

actively-traded securities and activelytraded reference securities exceptions in 

order to adjust for inflation since the 

time of Regulation M’s adoption in 

1996.

In excepting actively-traded securities 

from Rule 101 and actively-traded 

reference securities from Rule 102, the 

Commission believed that it was 

reasonable to rely on market 

mechanisms to curb the manipulative 

activity addressed by Regulation M.40 In 

particular, the Commission reasoned 

that as the value of trading volume 

increased, it became less likely that a 

person could, cost-effectively, 

manipulate the price of the security.41

Also, the Commission considered that 

actively-traded securities are followed 

widely by the investment community, 

and any aberrations in the price of an 

actively-traded stock would be observed 

by the investment community and 

corrected.42 In addition, actively-traded 

securities are listed and traded on 

exchanges or other organized markets, 

and so are relatively transparent and 

subject to surveillance.43

The restricted period threshold levels 

were intended to apply only to those 

securities where the potential for 

manipulation was relatively limited and 

which would allow the effects of the 

market activities of distribution 

participants and issuers to dissipate.44

Similarly, the Commission believed that 

the threshold values for the activelytraded security exception from Rule 101 

and actively-traded reference security 

exception from Rule 102 would except 

securities as to which the potential for 

a successful manipulation is relatively 

limited.45 The Commission is proposing 

to increase these threshold levels for the 

restricted period and actively-traded 

security and reference security 

exceptions to adjust for the effect of 

inflation. Since Regulation M was 

adopted in 1996, the value of the dollar 

has decreased due to inflation and has 

resulted in the ADTV and public float 

value thresholds becoming less 

restrictive than when Regulation M was 

initially adopted. As a result, more 

issuers’ securities would now qualify for 

the restricted periods and for the 

actively-traded security exceptions and 

the lower thresholds may except from 

Regulation M’s prohibitions securities 

that may be more susceptible to 

manipulation than we contemplated at 

adoption.46 Part of this increase in the 

number of actively-traded securities and 

securities qualifying for a one- or fiveday restricted period, is due to 

inflation’s effect on the value of the 

dollar.

Because ADTV and public float value 

are measured in dollars, the general 

change in the value of the dollar since 

Regulation M’s adoption has eroded the 

restrictiveness of the Regulation’s 

threshold values. We believe that the 

level of restrictiveness we employed in 

1996 for actively-traded securities 

remains an appropriate threshold, and 

therefore, in order to make the 

thresholds for the restricted period and 

actively-traded securities and reference 

securities current, the Commission is 

proposing to increase the ADTV and 

public float value thresholds to account 

for the decline in the value of the dollar 

that has occurred since 1996 (i.e., adjust 

the values by the change in the 

Consumer Price Index (‘‘CPI’’)). Between 

1996 and 2004, the CPI, a general 

measure for the change in the value of 

the dollar, rose approximately 20 

percent.47 The adjustment of the 

thresholds to reflect the current dollar 

value should simply reset the thresholds 

to the level of restrictiveness intended 

when Regulation M was adopted. As 

such, the adjusted thresholds should 

capture approximately the same type of 

issuers, with similar market liquidity 

and investment community following, 

as originally contemplated to be 

excepted when Regulation M was 

adopted.48 Thus adjusting the 

thresholds would express in today’s 

dollar value terms the same type of 

issuer meant to be excepted in 1996.

We propose to amend the Rule 100(b) 

definition of restricted period, the Rule 

101(c)(1) exception for actively-traded 

securities, and the Rule 102(d)(1) 

exception for actively-traded reference 

securities to reflect an adjustment to the 

ADTV and public float values for the 

change in CPI. Specifically we propose 

to adjust the one-day restricted period to 

require at least $120,000 for ADTV 

value and $30 million for public float 

value, and to adjust the actively-traded 

security and reference security 

thresholds to require at least $1.2 

million for ADTV value and $180 

million for public float value, which 

reflects the change in the CPI Index 

from 1996 to 2004.

Q. Should the current thresholds for 

actively-traded securities, as well as the 

thresholds for one and five-day 

restricted periods, be adjusted by a 

factor other than CPI? If so, what factor 

should be used? Should the 

Commission consider adjusting these 

threshold values for this rise in the 

value of the market since Regulation M 

was adopted in 1996, for example, by 

the change in the S&P 500 or Dow Jones 

Industrial Average? Commenters should 

provide specific reasons and data in 

support of their statements and any 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75779

49 17 CFR 242.101(b)(7).

50Regulation M Adopting Release, 62 FR at 530.

51Regulation M Adopting Release, 62 FR at 530 

(stating that ‘‘[t]he Commission notes that repeated 

reliance on the exception would raise questions 

about the adequacy and effectiveness of a firm’s 

procedures’’).

52 17 CFR 242.104. Rule 104 permits underwriters 

and syndicate members, in order to facilitate an 

offering, to conduct stabilizing and other 

aftermarket activities in compliance with the Rule’s 

conditions. Unlike Rules 101 and 102, which apply 

only to distributions, Rule 104 is broader in that it 

applies to security offerings. See Regulation M 

Adopting Release, 62 FR at 535, n. 116 and supra 

note 3.

53See Regulation M Adopting Release, 62 FR at 

520.

54See Friedman v. Salomon Smith Barney, Inc.,

2000 U.S. Dist. LEXIS 17785 (S.D.N.Y. 2000), aff’d 

313 F.3d 796 (2d Cir. N.Y. 2002) (dismissing 

plaintiffs’ claims on the basis that the defendants’

use of penalty bids and other price stabilization 

practices used to combat flipping were subject to 

regulation by the Commission under Section 9(a)(6) 

of the Exchange Act and, therefore, immune from 

anti-trust attack).

55Regulation M Adopting Release, 62 FR at 520.

56A syndicate covering transaction is the placing 

of any bid or the effecting of any purchase on behalf 

of the sole distributor or the underwriting syndicate 

or group to reduce a short position created in 

connection with the offering. 17 CFR 242.100(b).

57A penalty bid is an arrangement that permits 

the managing underwriter to reclaim a selling 

concession from a syndicate member in connection 

with an offering when the securities originally sold 

by the syndicate member are purchased in 

syndicate covering transactions. 17 CFR 242.100(b).

58 ‘‘Stabilizing’’ means ‘‘the placing of any bid, or 

the effecting of any purchase, for the purpose of 

pegging, fixing, or maintaining the price of a 

security.’’ 17 CFR 242.100(b). When adopting 

Regulation M, the Commission noted that 

‘‘syndicate short covering transactions and the 

Continued

alternative measure for adjusting the 

ADTV and public float values suggested. 

Q. Do ADTV and public float values 

provide an appropriate measure on 

which to base the actively-traded 

exception? That is, do these trading 

volume and public float criteria 

adequately identify a security’s liquidity 

and depth? Are these criteria sufficient 

to identify securities that are more 

difficult to manipulate? Should other 

criteria in addition to, or in lieu of, 

ADTV and public float value be used? 

If so, please provide specific comment 

on other criteria and reasons to support 

your recommendation. 

Q. Are the current actively-traded 

securities exception and one and fiveday restricted periods under Regulation 

M set at appropriate threshold levels? 

That is, do the current ADTV value and 

public float value thresholds for 

actively-traded securities and for one 

and five-day restricted periods 

adequately balance the goal of 

maintaining market liquidity with the 

mandate to protect investors from 

manipulation? If not, what threshold 

levels would? Commenters should 

provide specific reasons and data in 

support of their statements and any 

alternative thresholds suggested. 

C. Rule 101(b)(7)—De Minimis 

Exception 

The de minimis exception in Rule 

101(b)(7) is intended to excuse from 

Rule 101’s trading prohibitions small, 

inadvertent transactions that would not 

impact the market.49 It excepts 

purchases and unaccepted bids during 

the restricted period that total less than 

2% of the distributed security’s ADTV 

only if the person making the bid or 

purchase maintains and enforces 

written policies and procedures 

reasonably designed to achieve 

compliance with Regulation M. 

Moreover, a firm is expected to ‘‘review 

its policies and procedures and modify 

them as appropriate’’ in order to qualify 

for the exception.50 Repeated reliance 

on this exception by distribution 

participants or their affiliated persons 

raises concerns about whether the 

transactions were ‘‘inadvertent’’ and the 

adequacy and effectiveness of a firm’s 

compliance policies and procedures.51

From time to time, firms relying on 

this exception have informed the 

Commission’s staff of an inadvertent bid 

or purchase that occurred during the 

restricted period. However, other firms 

similarly relying upon the exception 

may not inform the Commission’s staff 

of that activity. Consequently, the 

Commission cannot know with a high 

degree of certainty how often the 

exception is used, whether certain firms 

repeatedly rely on it, or whether firms 

have adequate and effective procedures 

qualifying them for the exception. 

Thus, the Commission is proposing to 

modify Rule 101(b)(7) to require firms to 

create a separate record of each bid or 

purchase that is made in reliance on the 

de minimis exception, including among 

other things, that brokers and dealers 

specify the subject security, the day the 

restricted period commenced, the 

ADTV, and the bids or purchases that 

otherwise would violate Regulation M, 

including time, price, quantity, and 

market. Brokers and dealers would be 

required to maintain these records 

pursuant to proposed Exchange Act 

Rule 17a-4(b)(13). We believe this 

requirement would more easily allow 

Commission and SRO examiners to 

uncover patterns of abuse or policies 

and procedures that are not reasonably 

designed to achieve compliance with 

the rule. 

Q. Is the proposed amendment an 

effective and efficient manner in which 

to guard against repeated reliance on the 

exception and promote effective 

compliance policies and procedures? 

Please provide any alternatives. 

Q. Are there other aspects of the de 

minimis exception that the Commission 

should consider changing? For example, 

is the 2% ADTV threshold appropriate 

or should it be raised or lowered? Please 

provide data supporting your comment. 

D. Rule 104—Syndicate Covering and 

Penalty Bids 

We propose to amend Rule 104 of 

Regulation M to require any person 

communicating a bid that is for the 

purpose of effecting a syndicate 

covering transaction (‘‘syndicate 

covering bids’’) to identify or designate 

the bid as such wherever it is 

communicated and to prohibit the use 

of penalty bids.52 ‘‘Congress granted the 

Commission broad rulemaking authority 

to combat manipulative abuses in 

whatever form they might take.’’53

Congress also delegated to the 

Commission exclusive regulatory 

authority over price stabilization 

practices (i.e., syndicate covering 

transactions and penalty bids) in 

Section 9(a)(6) of the Exchange Act.54

‘‘In exercising its authority, the 

Commission [through Regulation M and 

its predecessor Rule 10b-6] has focused 

on the market activities of persons 

participating in a securities offering, and 

determined that securities offerings 

present special opportunities and 

incentives for manipulation that require 

specific regulatory attention.’’55 The 

objective of Regulation M is to preclude 

manipulative conduct by persons with 

an interest in the outcome of an offering 

and activity that undermines the 

integrity of the markets by interfering 

with the market’s function as an 

independent pricing mechanism. 

Security offerings are particularly 

susceptible to manipulative abuse 

because persons, such as underwriters, 

who stand to profit from such offerings 

have special incentives to manipulate in 

order to facilitate the offerings.

Syndicate covering transactions occur 

when the managing underwriter places 

a bid or effects a purchase on behalf of 

the underwriting syndicate in order to 

reduce a syndicate short position 

created in connection with the 

offering.56 Penalty bids are a means by 

which the managing underwriter may 

impose a financial penalty on syndicate 

members whose customers sell offering 

shares in the immediate aftermarket.57

Syndicate covering transactions and 

penalty bids may have the effect of 

stabilizing the market price in 

connection with an offering, by 

preventing or retarding a decline in the 

market price of the offered security once 

aftermarket trading commences.58

75780 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

imposition of penalty bids by underwriters are 

activities that can facilitate an offering in a manner 

similar to stabilization.’’ Regulation M Adopting 

Release, 62 FR at 537. Before Rules 10b-6 and 10b7 were adopted, the Commission considered 

syndicate covering transactions to be a means of 

facilitating the distribution by supporting the 

market price of an offered security. Exchange Act 

Release No. 3506 (November 16, 1943), 11 FR 10965 

(describing the conditions under which syndicate 

covering transactions may facilitate an offering). 

Stabilization, and syndicate covering transactions, 

are permitted only to prevent or retard a decline in 

the market price, and may not be used to raise the 

market price, or create a false or misleading 

appearance of either active trading in a security or 

with respect to the trading market for the offered 

security. Id. See also Proposed Rules: Stabilizing to 

Facilitate a Distribution, Securities Exchange Act 

Release No. 28732 (January 3, 1991), 56 FR 814.

59 17 CFR 242.104(h)(1). Consistent with the 

current disclosure requirement for stabilizing bids, 

the NASD requires market makers intending to 

initiate stabilizing bids to provide it with prior 

notice. See NASD Rule 4614. Stabilizing bids are 

then identified by a symbol on the Nasdaq 

quotation display. Id. In this way, the person 

engaged in stabilization satisfies the requirement to 

inform the market and the person to whom the bid 

is made of the stabilizing purpose of the bid by 

notifying the NASD. See Regulation M Adopting 

Release, 62 FR at 537. On the exchanges, 

underwriters must notify the exchange and provide 

disclosure to the recipient of the bid, i.e., the 

specialist. See NYSE Rule 392; Regulation M 

Adopting Release, 62 FR at 537.

60Rule 104(h)(2) would continue to require prior 

notice to the self-regulatory organization with direct 

authority over the principal market in the United 

States for the security for which the syndicate 

covering transaction is effected. 17 CFR 

242.104(h)(2).

61See supra note 58.

62See supra note 56.

63See supra note 57.

64 17 CFR 242.104(h)(1)–(2). For a discussion of 

Regulation M’s notice requirement for stabilizing 

bids, see Regulation M Adopting Release, 62 FR at 

537.

65 ‘‘Underwriters frequently receive an 

overallotment option (‘‘Green Shoe’’), which is the 

right, but not the obligation, to purchase securities 

from the issuer in addition to those initially 

underwritten by the syndicate, which may 

constitute up to 15% of the initial underwritten 

amount. Because the overallotment option may be 

insufficient to cover the entire syndicate short 

position, that portion in excess of the overallotment 

option must be covered through purchases in the 

secondary market.’’ Regulation M Proposing 

Release, 61 FR at 17124, n. 86.

66The creation of an uncovered short position in 

connection with an offering is permissible activity 

that facilitates the offering, and is different from the 

delivery obligations related to ‘‘uncovered short 

selling’’ of securities in the secondary market that 

is discussed in the Regulation SHO Adopting 

Release. See Securities Exchange Act Release No. 

50103 (July 28, 2004), 69 FR 48008 (August 6, 

2004).

67 If an underwriter were to exercise the 

Overallotment Option in an amount exceeding the 

net syndicate short position, under Regulation M 

and former Rule 10b–6, an underwriter’s 

participation in the distribution would not be 

deemed completed and purchases made prior to the 

exercise of the option may violate Regulation M. 

See Regulation M Adopting Release, 62 FR at 522–

23; Securities Exchange Act Release No. 19565 

(March 4, 1983), 48 FR 10628, 10640. Underwriters 

and issuers also would have to consider any 

prospectus disclosure issues this may raise. See 

infra note 69.

68See generally, Loss, L and Seligman, J., 

Securities Regulation, 3d Section 2–A–2 (2004).

69 Items 508(l) and 508(j) of Regulations S–K and 

S–B [17 CFR 229.508(l) and 228.508(j)]. Securities 

Act Rule 481(d) [17 CFR 230.481(d)] requires this 

disclosure in registration statements prepared on a 

form available solely to investment companies 

registered under the Investment Company Act of 

1940 or in a Securities Act registration statement for 

a company that has elected to be regulated as a 

business development company under Sections 55 

through 65 of the Investment Company Act [15 

U.S.C. 80a–54—80a–64].

70The Division of Corporation Finance has issued 

interpretive guidance indicating that the Staff will 

issue comments if the disclosure regarding 

applicable short sale transaction does not address 

the following material points: (1) The potential for 

underwriter short sales in connection with the 

offering; (2) a description of short sales and 

uncovered short sales; (3) an explanation of when 

an uncovered short sale position will be created; (4) 

how underwriters close out covered short sales and 

uncovered short sale positions; (5) how 

underwriters determine the method for closing out 

covered short sale positions; and (6) the potential 

effects of underwriters’ short sales and transactions 

to cover those short sales. See ‘‘Current Issues and 

Rulemaking Projects,’’ Nov. 14, 2000, Section 

VIII.A.3.c, at http://www.sec.gov. The guidance 

includes examples of language that issuers may use 

to provide the required disclosure.

71See Regulation M Proposing Release, 61 FR at 

17124.

72 Id. at 17124–17125.

To enhance the transparency of 

syndicate covering transactions, we are 

proposing to amend paragraph (h)(2) of 

Rule 104 to require identification or 

designation of syndicate covering bids, 

analagous to the identification of 

stabilizing bids.59 Specifically, the 

proposal would require a managing 

underwriter or other person 

communicating a bid that is for the 

purpose of effecting a syndicate 

covering transaction to identify or 

designate the bid as such wherever it is 

communicated.60 The proposal also 

would prohibit the use of penalty bids, 

as discussed below.

1. Overview of the Current Rule 104

Rule 104 governs stabilization,61

syndicate covering transactions,62 and 

penalty bids.63 For stabilizing bids, the 

rule currently requires prior notification 

to the market on which such bids are 

effected and to the person with whom 

the bid is entered, but for syndicate 

covering transactions and penalty bids, 

only requires prior notification to the 

relevant SRO.64 In the typical offering, 

the syndicate agreement allows the 

managing underwriter to ‘‘oversell’’ the 

offering, i.e., establish a short position 

beyond the number of shares to which 

the underwriting commitment relates. 

The underwriting agreement with the 

issuer often provides for an 

‘‘overallotment option’’ whereby the 

syndicate can purchase additional 

shares from the issuer or selling 

shareholders in order to cover its short 

position.65 To the extent that the 

syndicate short position is in excess of 

the overallotment option, the syndicate 

is said to have taken an ‘‘uncovered’’

short position.66 The syndicate short 

position, up to the amount of the 

overallotment option, may be covered 

by exercising the option or by 

purchasing shares in the market once 

secondary trading begins. Shares 

purchased in the market by or on behalf 

of the syndicate must be used to reduce 

the size of the syndicate short position. 

Therefore, the overallotment option may 

be exercised only to the extent required 

to cover the ‘‘net’’ short position.67

Shares needed to cover the uncovered 

short position must be purchased in the 

market.68

Currently, issuers are required to 

inform investors that the syndicate may 

effect stabilizing and syndicate covering 

transactions, or impose penalty bids, in 

connection with the securities offering 

by providing a general description of 

possible stabilization, syndicate 

covering transactions and penalty bids 

in the Plan of Distribution or 

Underwriting section of the prospectus, 

if an underwriter intends to engage in 

any of these activities.69 Generally, this 

disclosure is included in prospectuses 

for firm commitment offerings, 

regardless of whether the underwriters 

intend to or, in fact, stabilize the 

offering.70

2. Current Syndicate Practices 

Underwriters assume a large measure 

of the risk that an offering may not be 

successful, and so have manipulative 

incentives to varying degrees 

throughout the offering process. The 

point in time when underwriters no 

longer have manipulative incentive or 

purpose to facilitate an offering cannot 

be identified with precision.71 But the 

Commission has recognized that these 

incentives can continue into the 

aftermarket when syndicate covering 

transactions and penalty bids occur.72

The creation of a syndicate short 

position and the subsequent purchasing 

activity to cover the position can impact 

the offering and the aftermarket price. 

The potential ‘‘buying power’’ of the 

short position can allow the syndicate to 

price the offering more aggressively 

because its syndicate short covering can 

support the aftermarket at prices around 

or above the offering price, thereby 

validating the offering price. Purchasers 

in the offering also may conclude that 

the trading activity in the aftermarket 

validates the offering price, and 

therefore may be more inclined to retain 

the shares purchased in the offering 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75781

73See Regulation M Adopting Release, 62 FR at 

537. 74Regulation M Adopting Release, 62 FR at 535. 

While Rules 101 and 102 primarily protect 

investors in the offering, the disclosure of the 

stabilizing bid’s purpose under Rule 104 and the 

proposal regarding syndicate covering bids will 

benefit investors in the aftermarket of an offered 

security, as well as investors in the offering itself.

75See Regulation M Adopting Release, 62 FR at 

537. Instead, the Commission required SRO 

notification and recordkeeping of syndicate 

covering transactions. In so doing, the Commission 

believed that SRO notification of syndicate covering 

transactions would serve to apprise regulators of 

their possible market effects, while the new 

recordkeeping requirements would assist the 

Commission in assessing whether further regulation 

was warranted. Id. at 537–538; Regulation M 

Proposing Release, 61 FR at 17125.

76Regulation M Proposing Release, 61 FR at 

17125.

77See, e.g., Ekkehart Boehmer and Raymond P.H. 

Fishe, ‘‘Underwriter Short Covering in the IPO 

Aftermarket: A Clinical Study,’’ 10 Journal of 

Corporate Finance, at 575–594 (September 2004) 

(finding that short covering trades are often used as 

a substitute for Rule 104 stabilization in that they 

serve the same purpose without the disclosure 

obligation associated with Rule 104 trades); Reena 

Aggarwal, ‘‘Stabilization Activities by Underwriters 

After Initial Public Offerings,’’ 55 Journal of 

Finance 1075, 1079 (June 2000) (finding that 

underwriters do not stabilize through stabilizing 

bids, but by overselling the issue and covering this 

short position by purchasing shares in the 

aftermarket).

78 Id.

79See, e.g., Reena Aggarwal, ‘‘Stabilization 

Activities by Underwriters After Initial Public 

Offerings,’’ 55 Journal of Finance 1075–1103 (June 

2000) (noting that price levels decrease immediately 

after the underwriters’ ‘‘stabilizing’’ activities 

cease); Kathleen Weiss Hanley, A. Arun Kumar, and 

Paul J. Seguin, ‘‘Price Stabilization in the Market for 

New Issues,’’ 34 Journal of Financial Economics,

177–197 (October 1993).

80See, e.g., Ekkehart Boehmer and Raymond P.H. 

Fishe, Who Ends up Short From Underwriter Short 

Covering? A Detailed Case Analysis of Underwriter 

Stabilization in a Large IPO, at 32–34 (March 28, 

2001) (finding that short covering trades can slow 

down price declines and that short covering 

reduces the price impact of a sell by more than 

70%).

81See, e.g., supra note 79. Underwriters have an 

incentive to artificially influence aftermarket 

activity because they have underwritten the risk of 

the offering, and a poor aftermarket performance 

could result in reputational harm and subsequent 

financial loss.

82Rule 104(h)(2) would continue to require prior 

notice to the self-regulatory organization with direct 

authority over the principal market in the United 

States for the security for which the syndicate 

covering transaction is effected. 17 CFR 

242.104(h)(2). Because Rule 104 already requires 

underwriters to make disclosures with respect to 

stabilizing bids, we believe it will not require 

significant effort or technical changes (to internal 

systems and procedures) on the part of underwriters 

or other syndicate members in order to comply with 

the proposed disclosure for syndicate covering bids. 

See text accompanying supra note 60. Moreover, 

while the burden would be on the underwriter or 

other person displaying or transmitting a syndicate 

covering bid to satisfy the proposed disclosure 

requirements, we anticipate that the SROs will 

make changes to their existing rules and procedures 

to assist their members in complying with these 

requirements. For example, a special symbol or 

identifier could be used to identify the bid as a 

syndicate covering bid. The Commission staff will 

coordinate with the SROs to develop procedures to 

provide wide notice of such bids to the markets. 

Moreover, we are soliciting comment from the 

industry as to whether the Commission should 

require broader dissemination of the fact that an 

underwriter is engaged in syndicate covering 

transactions (e.g., by requiring the underwriter to 

publish a press release or issue some notice to the 

market), especially in cases where syndicate 

covering bids are not currently displayed to the 

market.

rather than sell the shares to realize a 

gain or avoid a loss.

When we adopted Regulation M, we 

specifically recognized that 

underwriters frequently engage in 

syndicate covering transactions, and 

noted that these transactions can 

facilitate an offering in a manner similar 

to stabilization.73 Currently, Rule 104 

addresses the risk that stabilization will 

create a false or misleading appearance 

with respect to the trading market for 

the offered security by imposing pricing, 

disclosure, and other conditions on this 

activity.74 Among other things, the 

Commission considered the 

contemporaneous disclosure that 

stabilization is occurring to be beneficial 

to market participants, because this 

information is important to their 

decisions to buy or sell the security.

Syndicate covering transactions are 

regulated quite differently under Rule 

104, in large measure because the 

Commission had insufficient 

information about syndicate covering 

transactions when Regulation M was 

adopted.75 We stated, however, that we 

could reconsider whether additional 

regulation was warranted.76 Since that 

time, our staff has been reviewing 

syndicate covering transactions and 

other aftermarket practices. The staff has 

learned that in the U.S. syndicate 

covering transactions have replaced (in 

terms of frequency of use) stabilization 

as a means to support post-offering 

market prices.77 Syndicate covering 

transactions may be preferred by 

managing underwriters primarily 

because they are not subject to the price 

and other conditions that apply to 

stabilization under Rule 104, and in 

particular the contemporaneous market 

disclosure of the bidding and 

purchasing activity.78 However, the lack 

of transparency of syndicate covering 

transactions has the potential to create 

a false or misleading appearance with 

respect to the trading market for the 

offered security. Because syndicate 

covering transactions are not required to 

be disclosed to the market, investors 

(i.e., those who purchased in the 

offering, as well as those who purchased 

in the aftermarket) are not informed 

about when the syndicate is actually 

making syndicate covering purchases in 

the market. As a result, investors have 

no way of knowing whether, and to 

what extent, the market price of the 

offered security may be supported by 

syndicate covering activity. Of note, 

once the managing underwriter has 

covered the syndicate’s short position 

and ceases such purchasing in the 

aftermarket, there is often a significant 

decline in the security’s price.79 As a 

result, syndicate covering transactions 

can, and studies show that they do, 

enable underwriters to support the 

aftermarket price of the offered security 

at levels that they may not obtain in the 

absence of their activity, thereby 

interfering with free market forces.80

Finally, the investing public who buy 

the offered shares in the aftermarket at 

syndicate-influenced prices 

unknowingly bear the risk of a 

significant subsequent decline in the 

security’s price.81

3. Proposal for Syndicate Covering 

Transactions 

As discussed above, stabilization and 

syndicate covering transactions can both 

be used to facilitate an offering by 

supporting the market price of the 

offered security, Rule 104 currently 

regulates these activities differently. 

While both stabilization and syndicate 

covering transactions support the price 

in the aftermarket of an offered security, 

they do operate differently. Stabilizing 

bids and purchases are conducted only 

by the managing underwriter who 

places bids at prices prescribed by Rule 

104 to peg, fix, or stabilize the market 

price for the security. In contrast, the 

managing underwriter places syndicate 

short covering bids in the market, 

typically when the security is trading 

below the offering price, in order to 

deliver securities sold short in the 

offering, i.e., cover the syndicate short 

position. This bidding and purchasing 

activity can also support the market 

price for the securities. Therefore, to 

address the disparate treatment of 

activities that similarly impact the 

aftermarket trading of an offered 

security, the Commission is proposing 

that Rule 104 be amended to require 

disclosure of syndicate covering bids. In 

particular, we propose to amend Rule 

104(h)(2) to require any person 

communicating a bid for the purpose of 

effecting a syndicate covering 

transaction to identify or designate the 

bid as such wherever it is 

communicated.82

We believe that requiring syndicate 

covering bids to be identified or 

designated in this way would help 

protect investors by providing 

contemporaneous information about the 

potential market impact of syndicate 

75782 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

83Regulation M Adopting Release, 62 FR at 537.

84 17 CFR 242.100(b). The immediate sale by an 

IPO purchaser is often referred to as ‘‘flipping.’’ See, 

e.g., Raymond P.H. Fishe, ‘‘How Stock Flippers 

Affect IPO Pricing and Stabilization,’’ Journal of 

Financial and Quantitative Analysis, Vol. 37, No. 2 

(June 2002).

85See, e.g., Reena Aggarwal, ‘‘Allocation of IPOs 

and Flipping Activity,’’ 68 Journal of Financial 

Economics 111–135 (April 2003) (finding that 

penalty bids are assessed in only 13% of offerings 

and amount to a small percentage of the total 

spread).

86See, e.g., M. Siconolfi and P. McGeehan, ‘‘Flip 

Side: Wall Street Brokers Press Small Investors To 

Hold IPO Shares—Big Institutions Can Cash Out 

Quickly; the ‘Little Guy’ Can’t Without Penalties—

Rife With Double Standards?’’, The Wall Street 

Journal, at A.1 (June 26, 1998).

87 Id. See also W. Wilhelm, Jr., ‘‘Secondary 

Market Price Stabilization in Initial Public 

Offerings,’’ 12 Journal of Applied Corporate 

Finance, 78–85 (January 1999) (finding that the 

suppression of small-quantity orders by penalty 

bids, particularly during the first few days of 

trading, bears most heavily on retail investors 

receiving IPO allocations).

88We also are aware that, even where penalty 

bids are not imposed, some firms pressure their 

sales representatives to discourage customers from 

selling when a stock’s price declines, unrelated to 

the recovery of any selling concessions. We 

understand that the NASD and the NYSE are 

currently in the process of rulemaking designed to 

address this specific concern. See File Nos. SR–

NASD–2003–140 and SR–NYSE–2004–12 

(publication pending).

bidding and purchasing activity.83 The 

proposal also would regulate 

consistently activities that are similar in 

terms of their market impact. While the 

Commission recognizes that 

stabilization and syndicate covering 

transactions both have the effect of 

supporting the market price of a 

security, these activities do operate 

differently, and so we are not, at this 

time, proposing to apply to syndicate 

covering bids the type of specific price, 

counter-party disclosure, or other 

limitations that now apply to 

stabilizing. Instead, the Commission 

will continue to monitor such 

transactions, and consider whether any 

additional regulation of syndicate 

covering transactions in the future is 

appropriate.

Q. Does the manner in which a 

managing underwriter effects syndicate 

short covering bids and purchases 

present issues for complying with the 

above notification and disclosure 

proposals? That is, would compliance 

with the proposal be complicated by the 

fact that managing underwriters may be 

purchasing for accounts other than the 

syndicate concurrently with making 

syndicate short covering bids and 

purchases? Please provide specific 

details of underwriter practices in this 

regard and suggest what modifications, 

if any, should be made to the proposal 

to address these concerns. 

Q. What, if any, burdens would be 

imposed by the proposed disclosure? 

For example, would there be any 

difficulty in identifying or designating a 

bid as a syndicate covering bid (i.e., by 

attaching a symbol or modifier to the 

bid) wherever it is communicated? 

Q. Should the Commission consider, 

in addition to the proposed disclosure, 

revising Rule 104 to require a general 

notification to the market (e.g., through 

a press release, a website posting, or an 

administrative message sent over the 

Tape) that syndicate covering activity 

has commenced (and another 

notification when syndicate covering 

activity has ceased)? 

Q. Should the Commission consider 

revising Rule 104 to require disclosure, 

such as disclosure in a press release, of 

either or both of the following 

information: (1) That the underwriting 

syndicate has an uncovered short 

position in the offered security; and (2) 

the size of the syndicate uncovered 

short position. We seek specific 

comment concerning this alternative, or 

any other alternatives, the Commission 

should consider in regulating syndicate 

covering transactions. We also seek 

specific comment and empirical data 

regarding the current use of syndicate 

covering transactions and other 

aftermarket activities by underwriters in 

connection with securities offerings.

Q. Should the Commission require 

SROs to develop a mechanism for their 

members to comply with the Rule 104 

proposal? Should the Commission 

consider using a different mechanism 

other than identifying or designating the 

bid itself, such as a press release or 

other notification mechanism? Should 

the SROs develop a mechanism on their 

own? 

Q. Should the Commission impose 

specific price or other conditions on 

syndicate short covering bids or 

purchases in the aftermarket? If so, 

please provide specific comment on 

what conditions would be appropriate 

to apply and provide reasons for your 

recommendations. 

Q. Should the Commission consider 

making the disclosure requirements for 

stabilization bids the same as the 

proposed requirements for syndicate 

covering bids? That is, should we also 

amend Rule 104(h)(1) to require that any 

person communicating a bid that is for 

the purpose of stabilizing identify or 

designate the bid as a stabilizing bid 

wherever it is communicated? 

Q. Are there differences between 

stabilization and syndicate covering that 

would require different kinds of 

disclosure or other regulation for 

syndicate short covering? If so, please 

identify these differences and make 

recommendations about the way in 

which the proposed disclosure 

requirement should be modified? 

4. Penalty Bids 

Penalty bids are a contractual term in 

underwriting agreements that allow the 

lead underwriter to reclaim a selling 

concession paid to a syndicate member 

if that member’s customers sell their 

allocated shares in the immediate 

aftermarket.84 Penalty bid provisions are 

assessed at the election of the managing 

underwriter, and are not assessed in all 

offerings. We understand that penalty 

bids are rarely assessed, and are 

assessed most often in connection with 

offerings for which there is relatively 

low demand to help prevent triggering 

or exacerbating a market price decline 

through investor sales of IPO shares.85

Based on discussions between the staff 

and securities industry representatives, 

we also understand that syndicate 

managers justify the use of penalty bids 

by claiming that if the securities are sold 

within a short period of time, i.e., 

flipped, the syndicate member has not 

earned its commission (i.e., for selling 

shares to long-term investors) and the 

syndicate is entitled to reclaim the 

associated selling concessions via the 

penalty bid provision.

Penalty bids raise three troublesome 

issues. First, because Rule 104 does not 

require the assessment of a penalty bid 

to be disclosed to the market, penalty 

bids can function as an undisclosed 

form of stabilization by discouraging 

immediate sales of IPO securities that 

would otherwise lower a stock’s market 

price. Second, we understand that some 

sales representatives may fear losing a 

sales commission if their customers sell 

their IPO shares.86 The salesperson’s 

concern may result in improper 

interference with a customer’s right to 

sell securities when the customer 

chooses to do so. Third, there is 

evidence that the assessment of penalty 

bids at the syndicate level results in 

discriminatory effects on the syndicate 

member’s customers. In particular, we 

understand that institutional 

salespersons are not penalized when 

their institutional customers flip their 

shares, but retail salespersons often are 

penalized.87 While internal 

compensation matters are not the focus 

of our proposed rule amendment, we are 

mindful that the pressure of a penalty 

bid assessment by a managing 

underwriter can result in discriminatory 

and improper conduct by a firm and its 

salespeople towards its customers.88

Because we believe the likelihood of 

harm through the use of penalty bids is 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75783

89For example, a firm may have a policy or 

practice of excluding clients from future IPOs if 

they flip shares, irrespective of whether a penalty 

bid is assessed.

90 17 CFR 242.104(j)(2). See also Regulation M 

Adopting Release, 62 FR at 536. 91Regulation M Adopting Release, 62 FR at 536, 

n. 119. 92This proposal would apply to any distribution 

of securities, i.e., a public offering or private 

placement, and would apply equally to initial and 

secondary offerings. 93An IPO is considered to be a ‘‘cold’’ offering 

when there is weak investor interest in the IPO 

shares. An IPO is considered to be a ‘‘hot’’ offering 

when investor demand significantly exceeds the 

supply of securities in the offering. Shares in hot 

offerings often trade at substantial premiums to the 

offering price.

94The Commission has stated that such activity 

involves possible violations of the antifraud and 

anti-manipulation provisions of the federal 

securities laws. See Securities Exchange Act 

Release No. 9824 (October 16, 1972), 37 FR 22796 

(October 25, 1972) (1972 Interpretive Release). SEC

v. Credit Suisse First Boston Corp., No. 1:02 CV 

00090, 2002 WL 479836 (D.D.C. 2002), Complaint 

¶¶ 1, 6 (alleging violations of NASD Conduct Rules 

2110 and 2330 and Section 17(a) under the 

Exchange Act and Rule 17a–3(a)(6) thereunder, for 

encouraging customers to channel profits from hot 

IPOs via excessive brokerage commissions in order 

to receive such hot shares).

95See supra notes 6–7 and accompanying text. 

See also C. James Padgett, 52 SEC 1257 (1997), aff’d 

sub. nom, Sullivan v. SEC, 159 F.3d 637 (D.C. Cir. 

1998) (finding underwriters violated Section 17(a) 

of the Securities Act and Section 10(b) of the 

Exchange Act and Rule 10b–5 thereunder by 

requiring that IPO purchasers sell their shares back 

to the firm at the beginning of aftermarket trading). 

See also 15 U.S.C. 77q (making unlawful fraudulent 

conduct in the offer or sale of any security or 

security-based swap agreement by means of 

interstate commerce); 15 U.S.C. 78(j)(b) and 17 

CFR.240.10b–5 (making it unlawful for any person 

to ‘‘employ any device, scheme, or artifice to 

defraud’’ or to ‘‘engage in any act, practice, or 

course of business which operates or would operate 

as a fraud or deceit upon any person’’). A ‘‘tie-in 

agreement’’ in the securities offering context 

generally refers to requiring either implicitly or 

explicitly that customers give consideration in 

addition to the stated offering price of any security 

in order to obtain an allocation of the offered 

shares. Securities Exchange Act Release No. 10636 

(February 11, 1974), 39 FR 7806 (February 28, 1974) 

(‘‘1974 Rule 10b–20 Proposing Release’’); Securities 

Exchange Act Release No. 11328 (April 2, 1975), 40 

FR 16090 (April 9, 1975) (‘‘1975 Rule 10b–20 

Proposing Release’’). These arrangements can also 

violate other provisions of the securities laws and 

SRO rules. SEC v. Credit Suisse First Boston Corp.,

No. 1:02 CV 00090, 2002 WL 479836 (D.D.C. 2002).

96Securities Exchange Act Release No. 6536 

(April 24, 1961) (reminding dealers that requiring 

customers to make purchases in the aftermarket for 

the offered security in exchange for allocations of 

that security violates the anti-manipulation rules 

including Rule 10b–6, the predecessor to Regulation 

M); Staff Legal Bulletin No. 10 (August 25, 2000), 

available at http://www.sec.gov/interps/legal/

slbmr10.htm.

97See NASD Conduct Rule 2710 (2004) (requiring 

disclosure to the NASD of all relevant aspects of the 

offering including accurate disclosure of 

underwriting compensation); NASD Conduct Rule 

2330 (2003) (prohibiting member firms from sharing 

Continued

significant, we propose that Rule 104 be 

amended to prohibit the use of such 

bids. In particular, we propose to add a 

new subparagraph under the Rule, 

which would state, ‘‘it shall be unlawful 

to impose or assess any penalty bid in 

connection with an offering,’’ and to 

eliminate the existing references to 

penalty bids in subparagraph (2) of the 

Rule. We also propose that Rule 17a–

2(c) of the Exchange Act (which 

imposes certain record keeping and 

notification requirements) and Rule 

481(d) (which requires certain 

information be included in a 

prospectus) and Item 508(l) of 

Regulations S–K and S–B (which 

imposes certain disclosure requirements 

for the ‘‘plan of distribution’’ section of 

a prospectus) be amended to eliminate 

all references pertaining to penalty bids. 

While we considered requiring 

disclosure of penalty bids by sales 

representatives to customers, we do not 

believe that such disclosure would 

address the conflicts that arise with 

respect to their use. We also believe that 

such direct disclosure could be 

confusing or intimidating, and 

ultimately have an even greater chilling 

effect on those investors who wish to 

sell their shares in the aftermarket. We 

also understand that penalty bids are 

rarely assessed, so our proposal to 

eliminate their use should not have a 

great effect on the practices of most 

broker-dealers. 

Q. Should the Commission consider, 

as an alternative, requiring syndicate 

members to disclose to their customers 

who seek to sell their IPO shares that 

the firm or sales representatives could 

have its selling concession reclaimed if 

the customer sells its IPO shares and 

that this raises a conflict of interest for 

the firm and its salespersons? Should 

we require disclosure of any other antiflipping policies that the firm has in 

place that may affect an investor’s 

decision to purchase or sell IPO 

shares? 89

Q. Are there other aftermarket 

practices or policies that create conflicts 

of interest that should be prohibited or 

subject to increased disclosure? There 

may be other practices that investors 

should be made aware of, or other 

conduct that raises the same type of 

concerns as discussed above. For 

example, should the Commission 

prohibit firms from imposing antiflipping policies that discriminate 

against retail investors, such as 

rescinding sales commissions for retail 

sales, or excluding retail customers (but 

not institutional customers) from future 

IPO allocations for quickly selling their 

IPO shares, or require disclosure of their 

policies? If so, please provide specific 

details regarding such practices or 

policies and suggest approaches to 

regulate such practices. 

5. Rule 104—Exception for Transactions 

in Rule 144A Securities 

Rule 104(j)(2) generally excepts from 

Rule 104 transactions in Rule 144A 

securities offered and sold in the U.S., 

provided they are sold either to 

qualified institutional buyers in a 

transaction exempt from registration 

under the Securities Act or to non U.S. 

persons in Regulation S offerings that 

are made concurrently with a Rule 144A 

offering.90 When we adopted Regulation 

M, the exception under Rule 104 was 

intended to be identical to the exception 

for Rule 144A securities under Rules 

101 and 102.91 We therefore propose to 

add the words ‘‘or any reference 

security’’ to Rule 104(j)(2) in order to 

make this subparagraph consistent with 

the same exception under Rules 101 

(b)(10) and 102(b)(7) for transactions in 

Rule 144A securities.

Q. The Commission seeks specific 

comment concerning the proposal to 

add the omitted language ‘‘or any 

reference security’’ to Rule 104(j)(2). 

E. New Rule 106 

The Commission is proposing new 

Rule 106 of Regulation M to expressly 

prohibit distribution participants, 

issuers, and their affiliated purchasers, 

directly or indirectly, from demanding, 

soliciting, attempting to induce, or 

accepting from their customers any 

consideration in addition to the stated 

offering price of the security.92 This new 

rule would expressly prohibit certain 

abuses that occurred in connection with 

IPOs, particularly those in the late 

1990’s and in other ‘‘hot issue’’ periods, 

such as conditioning or ‘‘tying’’ an 

allocation of shares in a ‘‘hot issue’’ on 

an understanding that the customer 

would buy shares in another, usually 

‘‘cold,’’ offering,93 or on paying 

excessive commissions to the 

underwriter.94 This proposal would also 

prohibit issuers, underwriters, brokerdealers, and other distribution 

participants from accepting an offer 

from a prospective purchaser to pay 

additional consideration in order to 

obtain an allocation of offered shares.

1. Background 

The Commission has long considered 

tying the award of allocations of offered 

shares to additional consideration to be 

fraudulent and manipulative, and such 

practices have always been actionable 

under Section 17(a) of the Securities Act 

and Section 10(b) and Rule 10b–5 of the 

Exchange Act.95 In addition, some forms 

of tie-ins are already prohibited by 

Regulation M 96 and SRO rules.97

75784 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

profits with customer accounts); NASD Conduct 

Rule 2120 (2003) (prohibiting members from using 

manipulation, deception or fraud to induce or effect 

transactions in offered securities); NASD Conduct 

Rule 2310–2 (2002) (requiring fair dealing in all 

relationships with customers); 15 U.S.C. 78q(a) 

(requiring broker dealers to make and keep records 

of terms and conditions of all purchases and sales 

of securities); NASD Conduct Rule 2210 (2001) 

(establishing professional standard of conduct 

required of NASD members); NASD Conduct Rule 

2110 (1996) (requiring that members observe ‘‘high 

standards of commercial honor and just and 

equitable principles of trade’’); 17 CFR 240.10b–5. 98See 1974 Rule 10b–20 Proposing Release, 39 FR 

at 7806 (describing how broker inducements for 

allocating offered shares: (1) encourages 

participation in cold offerings by investors with a 

view toward immediate resale of the security; (2) 

obscures actual demand for the offering making an 

assessment by investors of true demand difficult 

thus artificially affecting the offering price; and (3) 

stimulates demand for the offering and forces 

investors who could not participate to buy in the 

aftermarket). 99As proposed in 1975, Rule 10b–20 would have 

applied to offerings registered under the Securities 

Act or on Form 1–A. 1975 Rule 10b–20 Proposing 

Release, 40 FR 16090. As originally proposed in 

1974, Rule 10b–20 would have applied to any 

securities offering utilizing jurisdictional means. 

1974 Rule 10b–20 Proposing Release, 39 FR at 7806. 100See 1974 Rule 10b–20 Proposing Release 

(citing Securities Exchange Act Release No. 9824 

(October 16, 1972), 37 FR 22796 (October 25, 1972) 

(‘‘1972 Interpretive Release’’) (noting that allocating 

customers shares of hot IPOs in exchange for 

customer purchases of cold IPOs violates the 

antifraud and anti-manipulation provisions of the 

Exchange Act).

101See 1974 Rule 10b–20 Proposing Release, 39 

FR at 7806.

102 1975 Rule 10b–20 Proposing Release, 40 FR at 

16091–16092.

103See Securities Exchange Act Release No. 

26182 (October 14, 1988), 53 FR 41206. See also C. 

James Padgett, 52 SEC 1257 (1997), aff’d sub. nom, 

Sullivan v. SEC, 159 F.3d 637 (DC Cir. 1998) 

(finding underwriters violated Section 17(a) of the 

Securities Act and Section 10(b) of the Exchange 

Act and Rule 10b–5 thereunder by requiring that 

IPO purchasers sell their shares back to the firm at 

the beginning of aftermarket trading). Of note, the 

Commission determined that these tie-in 

agreements created a materially false impression of 

the extent of aftermarket activity. As such, the 

arrangement operated as a fraud upon the market 

and defrauded aftermarket purchasers. Id. at n. 53.

104See SEC v. Credit Suisse First Boston Corp.,

No. 1:02 CV 00090, 2002 WL 479836 (D.D.C. 2002), 

Complaint ¶¶ 1, 6 (alleging violations of NASD 

Conduct Rules 2110 and 2330 and Section 17(a) 

under the Exchange Act and Rule 17a–3(a)(6) 

thereunder, for encouraging customers to channel 

profits from hot IPOs via excessive brokerage 

commissions). CSFB encouraged its retail customers 

to pay excessive commissions in correlation to the 

profit (sometimes up to 65%) they made in flipping 

their IPO shares through the purchases of off-setting 

trades in order to receive IPO allocations. Id. at 

¶¶ 17–25, 42–43. See also SEC v. Robertson 

Stephens, Inc., Final Judgment of Permanent 

Injunction and Other Relief Against Robertson 

Stephens, Inc., 03 Civ. 0027 (RL) (D.D.C. 2003), 

Complaint ¶¶ 1, 5 (alleging violations of NASD 

Conduct Rules 2110 and 2330 and Section 17(a) of 

the Exchange Act and Rule 17a–3(a)(6) thereunder 

for improperly sharing customer profits by 

allocating ‘‘hot’’ IPO shares to customers and 

receiving in return shares of customer profits via 

excessive commissions or markdowns). Robertson 

Stephens is alleged to have ranked customers 

according to customers’ total commission dollars 

and used that ranking system to encourage 

customers to increase their commissions in order to 

receive IPO allocations. Id. at ¶¶ 14–26 . It was 

expected that a portion of the profits a customer 

made on an allocation would be filtered back to the 

firm by way of excessive commission business. Id.

at ¶¶ 29–33. The NASD has also taken related 

actions involving payments of excessive 

commissions in exchange for IPO allocations. See

NASD Notice to Members 4–50 (July 2004) 

(announcing that Bear Stearns & Co., Inc., Deutsche 

Bank Securities, Inc., and Morgan Stanley & Co., 

Inc. were censured for engaging in improper profit 

sharing with customers through the use of excessive 

commissions).

105See SEC v. J.P. Morgan Securities, Inc. at supra

note 26 and accompanying text.

106 Id.

107See Report of the Special Study of the 

Securities Markets of the Securities and Exchange 

Commission, H.R. Doc. No. 88–95, pt. 1 at 555–56 

(1 Sess. 1963) (noting that underwriters used 

manipulative tactics in order to increase issues to 

the level of ‘‘hot’’ offerings and create a ‘‘pop’’ in 

the offering price); Report of the Securities and 

Exchange Commission Concerning the Hot Issues 

Markets (August 1984) at 37–38 (noting existence of 

manipulative tie-in agreements during the hot 

issues market between 1980 and 1983); SEC v. 

Credit Suisse First Boston Corp., No. 1:02 CV 00090, 

2002 WL 479836 (D.D.C. 2002), Complaint ¶¶ 29–

45 (noting that violative conduct was not isolated 

but rather business as usual and pervasive). Brokers 

expected customers to pay CSFB for having granted 

them ‘‘hot’’ IPO allocations, considering such 

allocations quick profits on which they (the 

underwriters) deserved something in return. Id. at 

¶ 36. See also SEC v. Robertson Stephens, Inc.,

Final Judgment of Permanent Injunction and Other 

Relief Against Robertson Stephens, Inc., 03 Civ. 

0027 (RL) (D.D.C. 2003), Complaint ¶¶ 23–28 

(pressuring customers to increase their 

commissions in order to receive allocations by use 

of their ‘‘ranking system’’).

Underwriters’ or issuer’s demands for 

consideration in addition to the stated 

offering price have several pernicious 

effects. These activities can contribute 

to a false impression of scarcity in the 

offered shares. This, in turn, can 

stimulate and distort the offering and 

aftermarket prices by creating the 

impression that any unfulfilled demand 

for the offered shares may only be 

satisfied in the aftermarket.98 Moreover, 

such activities create the impression 

that the underwriters have ‘‘rigged the 

game’’ and only the market participants 

who know they are expected, and are 

willing, to pay the additional 

consideration are able to participate in 

IPOs.

In 1974 and 1975, in order to broadly 

and explicitly address such 

manipulative conduct, the Commission 

proposed Rule 10b–20 to prohibit 

broker-dealers and others from 

(explicitly or implicitly) demanding 

from their customers any payment or 

consideration, including a requirement 

to purchase other securities, in addition 

to the security’s disclosed offering 

price.99 This proposal would have 

prohibited, for example, conditioning or 

‘‘tying’’ an allocation of shares in a hot 

issue on an agreement to buy shares in 

another offering or in the aftermarket of 

another offering, for which there may be 

a lack of investor demand (i.e., cold 

offerings).100 When underwriters 

allocate shares in ‘‘hot offerings’’ to 

customers who agree to make 

aftermarket purchases in ‘‘cold 

offerings,’’ the purchasers in the cold 

offerings are deceived as to the true 

demand for that offering.101 Proposed 

Rule 10b–20 also would have prohibited 

underwriters from requiring customers 

to pay excessive commissions or 

agreeing to profit sharing arrangements 

with distribution participants in order 

to receive allocations of IPO shares. The 

proposal also broadly prohibited any 

kind of arrangement where the customer 

would be required to perform any act, 

or refrain from any conduct, effect 

another transaction or refrain therefrom, 

other than what was disclosed in the 

registration statement or offering 

circular in order to receive an 

allocation.102 The Commission 

withdrew the proposal in 1988, in part 

due to the passage of time since its 

proposal, and because the Commission 

believed that such agreements already 

could be reached under the existing 

antifraud and anti-manipulation 

provisions of the federal securities 

laws.103

During periods of high demand for 

new IPOs, such as occurred in the late 

1990s, some underwriters induced or 

required customers who wished to 

receive ‘‘hot’’ IPO allocations to provide 

additional consideration to obtain an 

allocation of IPO shares. For example, 

the Commission has alleged that 

underwriters required or induced 

customers to pay excessive 

commissions 104 on transactions in other 

securities, to purchase ‘‘cold’’ IPO 

shares,105 and to make purchases in the 

aftermarket 106 of the offered security.

Given the widespread nature of these 

abuses concerning underwriters 

inducing or accepting additional 

compensation from customers for 

allocations,107 as demonstrated by 

enforcement actions and studies, we 

believe that an express Commission rule 

that complements the current provisions 

of Regulation M would be beneficial. 

Although this conduct may be 

actionable, for example, under current 

Regulation M, the general antifraud and 

anti-manipulation provisions of the 

federal securities laws, as well as SRO 

rules, we believe that a prophylactic 

rule specifically addressing the full 

range of misconduct that we observed in 

this context is necessary to preserve the 

integrity of the securities offering 

process and to protect investors.

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75785

108See supra note 3 for the definition of 

distribution. 17 CFR 242.100(b).

109See IPO Blue Ribbon Report, Recommendation 

9.

110 17 CFR 242.103.

111See Regulation M Adopting Release, 62 FR at 

534.

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

113We have also proposed conforming changes to 

Rule 17a–4(b)(13) but the paperwork burden derives 

from the substance of the proposed amendments to 

Rule 101(b)(7) discussed herein.

2. Proposal 

Proposed new Rule 106 of Regulation 

M would explicitly prohibit distribution 

participants, including underwriters, 

and issuers and their affiliates, directly 

or indirectly, from demanding, 

soliciting, or attempting to induce, or 

accepting an offer from their customers 

of any payment or other consideration 

in addition to the security’s stated 

consideration. For example, this rule 

would prohibit distribution 

participants, issuers and their affiliated 

persons, in connection with allocating 

an offered security, from inducing, 

soliciting, requiring or otherwise 

accepting an offer from a potential 

purchaser to purchase any other 

security to be sold or proposed to be 

offered or sold by such person. 

Similarly, Rule 106 would also prohibit 

distribution participants, issuers and 

their affiliated persons, in connection 

with allocating an offered security, from 

inducing, soliciting, requiring (or 

accepting an offer from) prospective 

customers to effect any other transaction 

or refrain from any of the foregoing, 

other than as stated in the registration 

statement or applicable offering 

document for the offer and sale of such 

offered security. Rule 106 would apply 

to any distribution of securities, 

whether a public offering or private 

placement of securities, and would 

apply to initial as well as secondary 

offerings.108

Rule 106 would complement the 

current provisions of Regulation M. Like 

Regulation M, the proposed rule is 

intended to protect the integrity of the 

offering process. Presently, the focus of 

Regulation M is on the protection of the 

integrity of the pricing of an offering by 

prohibiting distribution participants and 

issuers from bidding for, or purchasing, 

the offered securities in the market, or 

attempting to induce others to do so. 

Rule 106 would address a broad range 

of conduct by distribution participants 

and issuers that can stimulate the 

market for the offered shares (thereby 

distorting the offering price and the 

aftermarket). It also would address 

conduct that can operate as a fraud on 

prospective purchasers of IPOs, who are 

unaware of the underwriters’ additional 

requirement for receiving an allocation.

We note, however, that the proposed 

rule is not intended to interfere with 

legitimate customer relationships. For 

example, this provision is not intended 

to prohibit a firm from allocating IPO 

shares to a customer because the 

customer has separately retained the 

firm for other services, when the 

customer has not paid excessive 

compensation in relation to those 

services. On balance, we believe a 

comprehensive rule specifically 

directed at the types of impermissible 

conduct discussed herein is warranted. 

Such conduct, which often recurs 

during ‘‘hot issues’’ periods, 

undermines the fundamental function of 

the securities markets as an 

independent pricing mechanism and 

erodes investor confidence in the 

securities offering process generally. 

Having a prophylactic rule that 

expressly addresses the conduct 

discussed above would therefore 

prevent potential misconduct in the 

future as well as enhance the 

Commission’s enforcement capabilities. 

Q. Is the language of the rule 

sufficient to address the full scope of 

manipulative conduct involved in the 

offering process, including the conduct 

discussed above? If it does not, how 

should the language be changed? What 

types of conduct should or should not 

be included within the rule? Please 

provide specific examples and any 

suggested alternative language. 

Q. Commenters are asked to discuss 

whether the proposed language 

adequately protects legitimate customer 

relationships or might potentially 

interfere with these relationships. If the 

language does interfere with such 

relationships, please explain how and 

provide specific examples and 

recommendations.

Q. Although firms are required to 

create and maintain records of customer 

orders, should firms also be required to 

create and maintain records of 

indications of interest and the basis for 

IPO allocations? To what extent do 

firms already create and maintain 

records indicating that information? 

How burdensome would such a 

recordkeeping requirement be? 

Q. Should the Commission consider 

prohibiting allocations of initial public 

offering shares to persons based solely 

on their status? For example, should a 

person be prohibited from receiving 

initial public offering shares because of 

his or her status as CEO of a public or 

nonpublic company?109

III. General Request for Comment 

Any interested person wishing to 

submit written comments on any aspect 

of the proposed rules discussed in this 

release, as well as on other matters that 

may have an impact on the proposals 

contained herein, is requested to do so. 

Commenters should provide empirical 

data to support their views. The 

Commission also requests general 

comment on the following: 

Rule 103 of Regulation M describes 

the conditions for permissible passive 

market making during the restricted 

period for a distribution of a Nasdaq 

security.110 Passive market making was 

included in Regulation M to alleviate 

special liquidity problems that could 

exist for a Nasdaq security in 

distribution, if distribution participants 

or their affiliates who are Nasdaq market 

makers were required to withdraw from 

making a market during the restricted 

period.111 The Commission is not 

proposing to amend Rule 103 at this 

time. However, as part our effort to 

comprehensively monitor the operation 

of Regulation M, we seek comment 

about Rule 103.

Q. Have the structural changes to the 

Nasdaq market since Regulation M’s 

adoption affected the operation of Rule 

103? Does Rule 103 continue to be 

necessary? If so, why? If not, why not? 

Q. Does the existence of multiple 

sources of liquidity for Nasdaq 

securities, such as electronic 

communications networks (ECNs), 

alleviate the liquidity concerns Rule 103 

was meant to address? If so, how? If not, 

why not? 

IV. Paperwork Reduction Act 

Certain provisions of the proposed 

amendments to Regulation M contain 

‘‘collection of information’’

requirements within the meaning of the 

Paperwork Reduction Act of 1995 

(PRA);112 the Commission has 

submitted information to the Office of 

Management and Budget (OMB) for 

review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. The 

Commission is revising the currently 

approved collection of information 

titled ‘‘Regulation M’’ under OMB 

control number 3235–0465. An agency 

may not conduct or sponsor, and a 

person is not required to respond to, a 

collection of information unless it 

displays a currently valid control 

number.

A. Summary of Collections of 

Information 

1. Proposed Amendments to Rule 

101(b)(7)113

The proposed amendments to Rule 

101(b)(7) of Regulation M would require 

75786 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

114Securities Exchange Act Release No. 38067 

(December 20, 1996), 62 FR 520, 530.

115This number is based on OEA’s review of 2003 

FOCUS Report filings reflecting registered brokerdealers. This number does not include brokerdealers that are delinquent on FOCUS Report 

filings.

116This number is based on information provided 

by the SEC’s Office of Economic Analysis.

117This number is based on information provided 

to the Commission staff by OEA.

distribution participants and their 

affiliated purchasers to maintain records 

of their reliance on the de minimis

transactions exception from Rule 101 of 

Regulation M. Currently, Rule 101(b)(7) 

excepts from the rule’s prohibitions 

purchases and unaccepted bids made by 

distribution participants and their 

affiliates during the restricted period 

that total less than 2% of the distributed 

security’s ADTV only if the person 

making the bid or purchase maintains 

and enforces written policies and 

procedures reasonably designed to 

achieve compliance with Regulation M. 

When Regulation M was adopted, the 

Commission stated a firm is expected to 

‘‘review its policies and procedures and 

modify them as appropriate’’ in order to 

qualify for the exception.114 While 

broker-dealers are currently required 

under Rule 17a–3 under the Exchange 

Act to make and keep records of the 

terms of each brokerage order and each 

purchase and sale of a security for a 

period of three years, the proposed 

amendments to Rule 101(b)(7) would be 

a new collection of information because 

it would require firms to maintain a 

separate written record of information 

about each bid or purchase that is made 

in reliance on the de minimis exception. 

Like Rule 17a–3, the proposed 

amendment to Rule 101(b)(7) would 

require these records be maintained for 

a period of three years.

2. Proposed Amendments to Rule 104 

The proposed amendments to Rule 

104 of Regulation M would require any 

person communicating a bid for the 

purpose of effecting a syndicate 

covering transaction to identify or 

designate the syndicate covering bid as 

such wherever it is communicated. Rule 

104 currently requires that any person 

effecting a syndicate covering 

transaction shall provide prior notice to 

the self-regulatory organization with 

direct authority over the principal 

market in the United States for the 

security for which the syndicate 

covering transaction is effected. We 

believe the identifying or designating 

the bid as a syndicate covering bid, 

would be an additional collection of 

information because the proposal would 

require entities to disclose syndicate 

covering bids. 

B. Need for and Proposed Use of the 

Collection of Information 

The information that would be 

required to be collected under the 

proposed amendments to Rules 

101(b)(7) and 104 of Regulation M is 

necessary to prevent fraudulent, 

manipulative and deceptive acts by 

issuers, broker-dealers and others. The 

purpose of the proposed amendment to 

Rule 101(b)(7) is to have a record that 

would allow Commission and SRO 

examiners to review distribution 

participants’ compliance with Rule 101 

and to provide a basis for potentially 

uncovering patterns of abuse or policies 

and procedures that are not reasonably 

designed to achieve compliance with 

the regulation. The purpose of the 

proposed amendments to Rule 104 is to 

improve the transparency of syndicate 

covering bids through contemporaneous 

identification of the bid to the market 

where it is communicated in order to: 

(1) Protect the integrity of the trading 

market by providing investors, both in 

the offering and in the aftermarket, with 

contemporaneous information about 

actual syndicate purchasing activity, (2) 

preclude the manipulative effects of 

such bids, and (3) prevent the investing 

public from unknowingly bearing the 

cost of undisclosed syndicate covering 

activities. 

C. Respondents 

1. Proposed Amendments to Rule 

101(b)(7) 

The proposed amendments to Rules 

101(b)(7) would require those 

distribution participants, and their 

affiliated purchasers who rely on the 

Rule 101 exception for de minimis

transactions to make and keep records 

of the bids or purchases made in 

reliance on the de minimis exception. 

Therefore, the proposed amendments 

would apply to all distribution 

participants and their affiliated 

purchasers who rely on the exception in 

connection with follow-on, i.e., 

secondary, distributions of securities 

other than those qualifying for the 

actively-traded securities exception 

under Rule 101 (i.e., securities that have 

at least $1 million ADTV value and 

$150 million public float value). The 

Commission’s Office of Economic 

Analysis (‘‘OEA’’) estimates that there 

are approximately 6,562 active brokerdealers registered with the Commission, 

of which 614 engage in underwriting.115

Based on OEA’s review of offerings in 

2003, we estimate there are 

approximately 64 offerings annually of 

securities other than actively-traded 

securities.116 Based on the staff’s 

discussions with broker-dealers 

concerning their practices and 

experience with the de minimis

transaction exception, we estimate that 

of the 614 brokers who engage in 

underwriting would utilize the de 

minimis transaction exception once 

every two years.

2. Proposed Amendments to Rule 104 

Proposed amendments to Rule 104 

will require distribution participants, 

such as managing underwriters, who are 

communicating a syndicate covering 

bid, to identify or designate the bid as 

a syndicate covering bid wherever it is 

communicated. Syndicate covering 

transactions typically are effected by a 

managing underwriter on behalf of the 

syndicate. Managing underwriters do 

not utilize syndicate covering 

transactions in all offerings. Rather, 

syndicate covering transactions 

generally occur in connection with 

IPOs. Further, only a fraction of all 

IPOs, typically those IPOs where supply 

exceeds investor demand for the offered 

security, are facilitated by the managing 

underwriter by means of syndicate 

covering transactions. The number of 

IPOs conducted per year is also 

dependent on general economic 

conditions, e.g., the business cycle. As 

noted above, OEA estimates that 

approximately 614 active broker-dealers 

registered with the Commission engage 

in underwriting. The staff estimates that 

there were 88 equity IPOs in 2003, and 

that all such IPOs involved a managing 

underwriter.117 Based on the staff’s 

review of syndicate covering practices 

in a sample of offerings in one year, the 

staff believes that approximately 53% 

(or 47 offerings) of such IPOs were 

facilitated by syndicate covering 

transactions.

D. Total Annual Reporting and 

Recordkeeping Burden 

1. Proposed Amendments to Rule 

101(b)(7) 

The proposed amendments to Rule 

101(b)(7) of Regulation M would require 

all distribution participants and 

affiliated purchasers who rely on the de 

minimis exception to maintain a record 

of each bid or purchase made in reliance 

of the exception. We believe that 

distribution participants already make 

records of the type of information 

required in the proposed amendment to 

Rule 101(b)(7) since broker-dealers must 

record the terms of bids and 

transactions they effect under Rule 17a–

3 and keep such records for 3 years. 

However, the proposal would require 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75787

118 62 FR at 542.

that a record of the de minimis bids and 

purchases be kept separately. Thus, we 

believe the proposed amendments 

would impose an additional collection 

of information by requiring distribution 

participants to maintain the records 

separately. 

Based on the staff’s review of broker 

practices with respect to record keeping 

and their reliance on the de minimis

transaction exception, we understand 

that the de minimis exception is rarely 

utilized by distribution participants and 

that it would take each broker 

approximately 20 minutes to create and 

maintain files for all de minimis bids 

and purchases made per offering. Based 

on the staff’s review of broker-dealer 

experiences, we assume that one 

syndicate member per offering would 

rely on the de minimis exception once 

every 2 years (or 0.5 times per year). We 

estimate that the total estimated annual 

hour burden per year is 10.7 burden 

hours (the product of one syndicate 

member per offering, 64 offerings 

involving non-actively traded securities, 

0.5 reliances per year, and 20 minutes 

recordkeeping per offering). We also 

estimate the paperwork compliance for 

the proposed amendments for each 

distribution participant per offering is 

approximately 10 minutes per year (the 

product of one syndicate member per 

offering, 0.5 reliances per year, and 20 

minutes recordkeeping per offering). 

With respect to the proposed 

amendments to Rule 101(b)(7), we 

estimate that the broker-dealers bear 

100% of the burden of preparation 

internally since the broker-dealers 

relayed to the staff that they would 

create and maintain such files 

internally. 

2. Proposed Amendments to Rule 104 

The proposed amendments to Rule 

104 of Regulation M would require 

managing underwriters to identify or 

designate syndicate covering bids as 

such wherever communicated and to 

provide notice of its intention to engage 

in short covering to the SRO with direct 

authority over the principal market in 

the United States for the security for 

which the syndicate covering bid was 

made. 

Managing underwriters do not utilize 

syndicate covering transactions in all 

offerings. Rather, syndicate covering 

transactions generally occur in 

connection with IPOs. Further, only a 

fraction of all IPOs, typically those IPOs 

where supply exceeds demand for the 

security, are facilitated by the managing 

underwriter by means of syndicate 

covering transactions. The number of 

IPOs conducted per year is also 

dependent on general economic 

conditions, e.g., the business cycle. We 

estimate that approximately 614 active 

broker-dealers registered with the 

Commission engage in underwriting. In 

2003, we estimate that there were 88 

equity IPOs of which approximately 

53% (or 47 offerings) involved a 

managing underwriting effecting 

syndicate covering transactions. We 

assume for purposes of this analysis that 

each offering had one managing 

underwriter. The staff reviewed the 

number of syndicate covering 

transactions made in a sample of 

offerings in a particular year and based 

upon that data, the staff believes that on 

average approximately 22 syndicate 

covering bids occur for each IPO that 

involves syndicate short covering. 

It was determined at the time of 

Regulation M’s adoption that in 

instances where such disclosure was 

required for stabilizing bids that it 

would require 15 minutes per bid.118

We are requiring only identification of 

the syndicate covering bids in addition 

to that which is already required under 

Rule 104 and we believe this will 

impose only nominal costs and time 

upon the syndicate manager or other 

person communicating the syndicate 

covering bid.

Based on the number of IPOs in 2003 

that involved syndicate short covering 

and the average number of short 

covering bids per offering, the annual 

number of syndicate short covering bids 

was 1034 (the product of 47 offerings, 

and 22 syndicate covering bids per 

offering). We estimate that identifying or 

designating each syndicate bid would 

take approximately 15 minutes. Thus, 

the total estimated annual hour burden 

per year is 258.5 burden hours (the 

product of 1034 syndicate covering bids 

and 15 minutes per bid). As stated 

above, typically the managing 

underwriter communicates the 

syndicate covering bid. Therefore, we 

also estimate that the paperwork 

compliance for the proposed rules for 

each managing underwriter is 

approximately 5.5 annual burden hours 

per offering (258.5 burden hours/47 

offerings). With respect to the proposed 

Rule 104 amendments, we estimate that 

the syndicate member bears 100% of the 

burden of preparation internally 

because the managing underwriter 

communicates the syndicate covering 

bids on behalf of the syndicate. 

E. Collection of Information Is 

Mandatory 

1. Proposed Amendments to Rule 

101(b)(7)

The collection of information is 

mandatory if a distribution participant 

or its affiliated purchasers wish to rely 

on the de minimis transactions 

exception from Rule 101 of Regulation 

M. 

2. Proposed Amendments to Rule 104 

The collection of information is 

mandatory for all persons 

communicating a bid that is for the 

purpose of effecting a syndicate 

covering transaction. 

F. Confidentiality 

1. Proposed Amendments to Rule 

101(b)(7) 

The collection of information under 

the proposed amendments to Rule 

101(b)(7) would be provided to 

Commission and SRO examiners, but 

not subject to public availability. 

2. Proposed Amendments to Rule 104 

The collection of information under 

the proposed amendments to Rule 104 

would be communicated and displayed 

publicly. 

G. Record Retention Period 

1. Proposed Amendments to Rule 

101(b)(7) 

The proposed amendments to Rule 

101(b)(7) would require a broker or 

dealer to preserve the records required 

under the rule in accordance with 

proposed Rule 17a–4(b)(13). Rule 17a–

4(b)(13) would require distribution 

participants and their affiliated 

purchasers to create and maintain 

separate written records of each bid or 

purchase made in reliance on the de 

minimis exception for a period of three 

years, the first two years in an accessible 

place. 

2. Proposed Amendments to Rule 104 

The proposed amendments to Rule 

104 do not contain any recordkeeping 

requirements. 

H. Request for Comment 

Pursuant to 44 U.S.C. 3506(c)(2)(B), 

the Commission solicits comments to: 

(1) Evaluate whether the proposed 

collection of information is necessary 

for the proper performance of the 

functions of the agency, including 

whether the information shall have 

practical utility; (2) evaluate the 

accuracy of the Commission’s estimate 

of the burden of the proposed collection 

of information; (3) determine whether 

75788 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

119The Commission is also proposing certain 

conforming changes to Rules 17a–2, 17a–4, 104(j)(2) 

under the Exchange Act, and Rule 481 and Item 508 

under the Securities Act. The costs and benefits, 

however, arise from the substance of the proposed 

amendments in the rule changes discussed herein.

there are ways to enhance the quality, 

utility, and clarity of the information to 

be collected; and (4) evaluate whether 

there are ways to minimize the burden 

of the collection of information on those 

who are to respond, including through 

the use of automated collection 

techniques or other forms of information 

technology. 

Persons submitting comments on the 

collection of information requirements 

should direct them to the Office of 

Management and Budget, Attention: 

Desk Officer for the Securities and 

Exchange Commission, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503, and should also 

send a copy of their comments to 

Jonathan G. Katz, Secretary, Securities 

and Exchange Commission, 450 Fifth 

Street, NW., Washington, DC 20549–

0609, with reference to File No. S7–41–

04. Requests for materials submitted to 

OMB by the Commission with regard to 

this collection of information should be 

in writing, refer to File No. S7–41–04, 

and be submitted to the Securities and 

Exchange Commission, Records 

Management, Office of Filings and 

Information Services, 450 5th Street, 

NW., Washington, DC 20549. OMB is 

required to make a decision concerning 

the collections of information between 

30 and 60 days after publication. 

Consequently, a comment to OMB is 

best assured of having its full effect if 

OMB receives it within 30 days of 

publication.

V. Consideration of Proposed 

Amendments to Regulation M’s Costs 

and Benefits 119

The Commission is considering the 

costs and benefits of the proposed 

amendments to Regulation M and new 

Rule 106 thereunder. The Commission 

is sensitive to these costs and benefits, 

and requests data to quantify the costs 

and the value of the benefits provided, 

and encourages commenters to discuss 

any additional costs or benefits beyond 

those discussed here. In particular, the 

Commission requests comment on the 

potential costs for any modification to 

both computer systems and surveillance 

mechanisms and for information 

gathering, management, and 

recordkeeping systems or procedures, as 

well as any potential costs or benefits 

resulting from the proposals for 

registrants, issuers, investors, brokerdealers, other securities industry 

professionals, regulators and others. 

Commenters should provide analysis 

and data to support their views on the 

costs and benefits associated with the 

proposed amendments. 

A. Proposed Amendments to Rule 100: 

Definition of Restricted Period and IPO 

1. Benefits 

We believe that the proposed 

amendments to Rule 100 of Regulation 

M would clarify what is considered to 

be an IPO under the regulation and 

when a restricted period under Rule 101 

and 102 begins for IPOs, thereby 

facilitating compliance by distribution 

participants, issuers, their affiliates and 

others. By explicitly defining IPO we are 

helping to ensure that the extended 

restricted period will apply to an 

issuer’s initial offerings of debt and 

equity, as well as clarifying when the 

extended restricted period would be 

applicable to issuers whose securities 

already trade on foreign markets. 

Similarly, we propose to amend the 

definition of restricted period to 

incorporate a long-standing 

interpretation under Regulation M, that 

is, to expressly describe the applicable 

restricted period for corporate actions 

such as valuation and election periods. 

We also propose to define these terms 

in Rule 100. By amending the definition 

of the restricted period to explicitly 

define the applicable restricted period 

for IPOs and for election and valuation 

periods, we would provide certainty to 

the issuers, distribution participants, 

their affiliates and others, as to when 

exactly the restricted period begins and 

ends. In addition, a defined restricted 

period for IPOs and explicitly defining 

the restricted period for valuation and 

election periods would help to combat 

manipulative abuses that may occur 

prior to an IPO and during price 

sensitive valuation and election periods 

and that have been the subject of recent 

enforcement actions. By prohibiting 

inducements, bids or purchases well in 

advance of IPO pricing the proposed 

amendment would allow the securities 

markets to function as independent 

pricing mechanisms by reflecting true 

demand for the security and improve 

the integrity of the capital raising 

process. Prohibiting such activity would 

also reduce the investors’ perception of 

scarcity of IPO stock, which affects the 

pricing of and aftermarket trading in the 

IPO security. 

2. Costs 

The proposed amendment would 

expand the restricted period for an IPO 

so that such period would generally 

commence from earlier of (i) the time 

that an issuer reaches an understanding 

with the broker-dealer that the brokerdealer is to act as its underwriter or (ii) 

the time a registration statement is filed 

with the Commission or other offering 

document is first circulated to potential 

investors. This proposed expansion of 

the IPO restricted period, were it 

adopted, would capture in a 

prophylactic rule, conduct that is 

already actionable under the antifraud 

and anti-manipulation provisions of the 

federal securities laws. We note that the 

amendment applies only to IPOs which 

are a small portion of all offerings. 

Similarly, we propose to expressly 

describe the applicable restricted period 

for valuation and election periods. This 

proposal is an application of a longstanding, broadly published, 

interpretation regarding the application 

of Regulation M in the context of 

valuation and election periods. 

We understand that distribution 

participants already have policies and 

procedures in place to monitor for 

compliance with the restricted periods 

under current Regulation M. The only 

incremental costs of the proposed 

restricted period for IPOs would be 

associated with monitoring for 

Regulation M compliance during that 

portion of the restricted period which is 

new—the period beginning when an 

issuer and broker dealer reach an 

understanding that the broker-dealer is 

to act an underwriter or when a 

registration statement is filed or offering 

document is circulated to potential 

investors until 5 days prior to pricing. 

Because there is no trading market for 

an IPO offered security prior to the 

pricing of offering, distribution 

participants should not incur any costs 

associated with monitoring for open 

market purchases during the new 

portion of the restricted period. 

However, there may be costs associated 

with training employees of distribution 

participants to understand the 

application of the proposed restricted 

period. However, as stated above, we 

believe such activity prior to an IPO is 

already prohibited by the general 

antifraud and anti-manipulation 

provisions of the securities laws and 

distribution participants and their 

employees should not engage in such 

conduct at any time prior to the 

distribution of the IPO. Similarly, 

distribution participants, issuers, their 

affiliates and others are already 

prohibited under Regulation M during 

election and valuation periods. As such, 

they should already have undertaken 

training, compliance procedures and 

monitoring to comply with the 

Regulation. Nonetheless, the proposals 

may require one-time changes by certain 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75789

120The change in CPI is the percentage change in 

Urban CPI measured from July 1996 to July 2004, 

based on calculations performed by OEA.

distribution participants, issuers, 

affiliated purchasers and others. Thus, 

costs, if any, associated with training, 

modifying, revising policies and 

behavior and monitoring for compliance 

should be minimal.

Of note, we believe that costs, if any, 

associated with the proposed 

amendment concerning IPOs would 

only be borne by distribution 

participants. Our experience indicates 

that distribution participants, rather 

than issuers, have engaged in inducing 

or attempting to induce persons to bid 

for or purchase a covered security prior 

to the 5-day IPO restricted period. The 

Commission believes that even if there 

are some costs generated by this 

proposal, such costs are minimal and 

are justified by the facilitation of 

investment and enhancement of 

investor confidence in the IPO capital 

raising process that we believe will 

result from this proposal. We are 

however sensitive to potential costs 

borne by industry participants and 

generally solicit comment on any costs 

this proposed amendment could 

generate and whether the proposed 

amendments impose greater costs than 

presently exist under the federal 

securities laws. 

B. Proposed Amendments to Rules 100, 

101 and 102: ADTV and Public Float 

Value Thresholds 

1. Benefits 

The Commission believes the 

proposed adjustments to ADTV and 

public float values will reset the 

thresholds to their original 

restrictiveness and thereby 

appropriately apply the one- and fiveday restricted period or actively-traded 

exception to the appropriate securities, 

thus minimizing the potential for 

manipulation during offerings. In order 

to make the thresholds for the restricted 

period and actively-traded securities 

and reference securities current, the 

Commission is proposing to increase the 

ADTV and public float value thresholds 

to account for the decline in the value 

of the dollar that has occurred since 

1996 (i.e., adjust the values by the 

Consumer Price Index (‘‘CPI’’). Between 

1996 and 2004, the CPI, a general 

measure for the change in the value of 

the dollar rose approximately 20 

percent.120 The adjustment of the 

thresholds to reflect the current dollar 

value should simply reset the thresholds 

to the level of restrictiveness intended 

when Regulation M was adopted. By 

resetting the ADTV and public float 

thresholds, the proposal would apply 

the actively-traded security exception 

and one- or five-day restricted period to 

the type of issuers and securities the 

Commission had considered appropriate 

at Regulation M’s adoption, i.e., those 

with a relatively limited potential for 

manipulation.

2. Costs 

The Commission believes that the 

adjustment to ADTV and public float 

value would not impose costs in 

addition to those considered when 

Regulation M was adopted since the 

amendments will reinstate the level of 

restrictiveness in effect at the time of 

Regulation M’s adoption. As a practical 

matter, should the ADTV and public 

float values be adjusted as proposed, 

certain issuers or securities will no 

longer be exempt from Rules 101 and 

102 or will be subject to a longer 

restricted period, and so issuers, 

distribution participants, their affiliates 

and others must modify their activities 

to comply with the applicable restricted 

period. This adjustment to a different 

restricted period (either one- or five-day, 

or none) may impose some initial costs 

upon issuers, distribution participants, 

their affiliates and others. The one- and 

five-day restricted periods, however, 

have been in place since 1997 so 

issuers, distribution participants, their 

affiliates and others should already have 

the capabilities and policies and 

procedures in place in order to be able 

to impose such restrictions on issuers 

and their securities. At this time, the 

Commission believes this one-time 

modification by issuers, distribution 

participants and their affiliates, should 

be minimal. The Commission has no 

data on these costs and solicits 

comments as to whether the proposed 

amendments impose greater costs on 

issuers than the current rule.

C. Proposed Amendments to Rule 

101(b)(7): De Minimis Exception 

1. Benefits 

We believe the proposed amendments 

to Rule 101(b)(7) of Regulation M would 

enhance compliance with Regulation M 

and assist the Commission and SRO 

examiners in identifying patterns of 

abuse or policies and procedures that 

are not reasonably designed to achieve 

compliance with the rule. 

2. Costs 

As discussed in the PRA, the 

proposed amendments to Rules 

101(b)(7) would involve a collection of 

information since those distribution 

participants, and their affiliated 

purchasers who rely on the Rule 101 

exception for de minimis transacations 

would be required to make and keep 

records of the bids or purchases made 

in reliance on the de minimis exception. 

As discussed below, the staff estimates 

this annual burden to be 10.7 burden 

hours. 

Currently under Regulation M, 

distribution participants, their affiliates 

and others are expected to ‘‘review 

[their] policies and procedures and 

modify them as appropriate’’ in order to 

qualify for the de minimis exception 

and no additional requirement 

concerning policies and procedures is 

proposed at this time. Additionally, 

broker-dealers are already required 

under Rule 17a–3 of the Exchange Act 

to make and keep records of the terms 

of each brokerage order and each 

purchase and sale of a security for a 

period of three years. The proposed 

amendments would only require firms 

to maintain a separate written record of 

the terms of the bids and purchases 

made in reliance upon the exception 

from Rule 101 for a period of 3 years. 

Based on discussions with distribution 

participants about their experience with 

the de minimis exception, the 

Commission believes these would be 

infrequent violations requiring 

infrequent recordkeeping. Further, the 

review of the policies and procedures is 

already required under Regulation M. 

For purposes of the PRA, the staff 

estimates an annual burden of 10 

minutes per distribution participant to 

keep separate records of their reliance 

on the exception. Therefore, the staff 

believes the proposed amendments 

regarding recordkeeping of de minimis

violations of Regulation M would 

impose minimal costs. 

D. Proposed Amendments to Rule 104: 

Syndicate Covering and Penalty Bids 

1. Benefits 

Identification or designation of 

syndicate covering transactions would 

help to protect investors by providing 

contemporaneous information about the 

actual occurrences of syndicate 

purchasing activity. The proposal 

obligates managing underwriters and 

others communicating a syndicate 

covering bid to identify it as such 

wherever the bid is communicated. The 

staff believes such identification is an 

essential first step to market-wide 

identification of syndicate covering 

bids. Contemporaneous disclosure of 

the fact that stabilization-like activity is 

occurring is beneficial to the market and 

its participants, because it would allow 

market participants, i.e., both holders of 

offered shares and potential investors in 

the secondary market, to base their 

75790 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

121See 1974 Rule 10b–20 Proposing Release 

(describing how broker inducements for allocating 

offered shares: (1) Encourages participation in cold 

offerings by investors with a view toward 

immediate resale of the security; (2) obscures actual 

demand for the offering making an assessment by 

investors of true demand difficult thus artificially 

affecting the offering price; and (3) stimulates 

demand for the offering and forces investors who 

could not participate to buy in the aftermarket). 

1974 Rule 10b–20 Proposing Release, 39 FR at 7806.

122 15 U.S.C. 78c(f).

123 15 U.S.C 78w(a)(2).

investment decisions and the resulting 

transactions on all available 

information. This proposed amendment 

also would inhibit underwriters from 

pricing offerings at higher levels than 

otherwise may be obtainable in the 

absence of their syndicate covering 

activity in the subsequent trading 

market. 

The proposal to prohibit penalty bids 

would greatly reduce the pressure of a 

penalty bid assessment by a managing 

underwriter on a syndicate that, in turn 

may result in discriminatory and 

improper conduct by the syndicate 

member and its salespeople toward its 

customers who may wish to sell a 

security purchased in an offering. 

2. Costs

Proposed amendments to Rule 104 

would require managing underwriters to 

identify or designate syndicate covering 

bids as such wherever communicated. 

For purposes of the PRA we estimated 

an annual burden of 5.5 hours per year 

for managing underwriters to comply. 

The Commission recognizes that SROs 

and markets receiving designation of a 

syndicate bid from managing 

underwriters could incur some costs to 

communicate this information to the 

market. The required disclosure and 

designation of a syndicate bid, however, 

is similar to what is already required for 

stabilizing transactions, so the 

Commission anticipates that the means 

of communicating such information is 

already in place and operational. Issuers 

may also incur one-time costs related to 

modifying the disclosure language in 

the Plan of Distribution. 

Although penalty bids are 

infrequently used, due to their 

elimination managing underwriters and 

issuers will no longer have the option of 

using them and may impose minimal 

costs upon them. Overall, the staff 

believes the costs of complying with the 

Rule 104 proposals would be minimal 

and the benefits from improved 

transparency and removal of penalty 

bids would outweigh these costs. 

E. Rule 104—Exception for Transactions 

in Rule 144A Securities 

1. Benefits 

We believe that the proposed 

amendment to Rule 104(j)(2) to include 

‘‘reference securities’’ will make the 

subparagraph consistent with the same 

exception under Rules 101(b)(10) and 

102(b)(7) for transactions in Rule 144A 

securities, as was intended when 

Regulation M was adopted and will 

clarify the application of the exception. 

2. Costs 

The Commission preliminarily 

believes that including reference 

securities in the 144A exception of Rule 

104 would impose minimal costs since 

it clarifies what securities are excepted 

and may require a one-time adjustment 

by training and modifying procedures 

by distribution participants and others. 

F. Proposed Rule 106: Unlawful 

Practices in Connection With 

Allocations of Offered Securities 

1. Benefits 

We believe that proposed Rule 106 

would help prevent abuses in awarding 

allocations of offered securities, 

particularly IPOs, that were common in 

the late 1990’s and other ‘‘hot issue’’

periods. Underwriters’’ or issuer’s 

solicitations, inducements, demands for, 

or acceptance of, consideration in 

addition to the stated offering price have 

several pernicious effects. These 

activities by distribution participants 

can contribute to a false impression of 

scarcity in the offered shares. This, in 

turn, can stimulate and distort the 

offering and aftermarket price of the 

offered security by creating the 

impression among investors that any 

unfulfilled demand for the offered 

shares may only be satisfied in the 

aftermarket.121 Moreover, such activities 

create the impression that the 

underwriters have ‘‘rigged the game’’

and only the market participants who 

know they are expected, and are willing, 

to pay the additional consideration are 

able to participate in IPOs. Additionally, 

when underwriters allocate shares in 

‘‘hot offerings’’ to customers who agree 

to make aftermarket purchases in ‘‘cold 

offerings,’’ the purchasers in the cold 

offerings are deceived as to the true 

demand for that offering. The proposed 

rule would expressly preclude conduct 

that can operate as a fraud on 

prospective and actual purchasers of an 

offered security, particularly in IPOs. 

Such conduct can undermine the 

fundamental function of the securities 

markets as an independent pricing 

mechanism and erode investor 

confidence in the securities offering 

process generally. Having an express 

prophylactic rule that prohibits the 

conduct would emphasize to 

distribution participants that engaging 

in such activity is prohibited and would 

assist the Commission in its 

enforcement of the federal securities 

laws.

2. Costs 

The Commission notes that the 

conduct the proposed rule prohibits is 

already prohibited by Regulation M or is 

illegal under the antifraud and antimanipulation provisions of the federal 

securities laws, as well as under SRO 

rules, and so the new Rule 106 does not 

add any additional requirements. 

Rather, it expressly prohibits such 

conduct. A few distribution 

participants, their affiliates and others 

who did not already have adequate 

policies and procedures may need to 

make a one-time revision and undertake 

corresponding training of employees. 

The Commission therefore believes that 

the proposed rule would impose 

minimal costs, if any, on distribution 

participants, issuers and their affiliated 

purchasers and would support investor 

protection. 

VI. Consideration on Burden and 

Promotion of Efficiency, Competition, 

and Capital Formation 

Section 3(f) of the Exchange Act 

requires the Commission, whenever it 

engages in rulemaking and must 

consider or determine if an action is 

necessary or appropriate in the public 

interest, to consider whether the action 

would promote efficiency, competition, 

and capital formation.122 In addition, 

Section 23(a)(2) of the Exchange Act 

requires the Commission, when making 

rules under the Exchange Act, to 

consider the impact such rules would 

have on competition.123 Exchange Act 

Section 23(a)(2) prohibits the 

Commission from adopting any rule that 

would impose a burden on competition 

not necessary or appropriate in 

furtherance of the purposes of the 

Exchange Act.

The Commission preliminarily 

believes that the proposed amendments 

to Regulation M are intended to improve 

market efficiency by providing greater 

clarity to all issuers, distribution 

participants and their affiliated 

purchasers as to the scope of 

permissible activity for offerings; 

helping to ensure that those securities 

excepted from the rules have no 

potential for manipulation; requiring 

companies to maintain records of 

inadvertent violations of Regulation M 

and to revise policies and procedures in 

order to prevent violating rules; and 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75791

124Pub. L. 104–121, Title II, 110 Stat. 857 (1996) 

(codified in various sections of 5 U.S.C. and as a 

note to 5 U.S.C. 601). 125 5 U.S.C. 603.

providing greater transparency to the 

market of actual syndicate covering 

transactions. The proposed amendments 

are intended to promote transparency 

and prevent manipulative activity in the 

offering process and aftermarket. 

The Commission preliminarily 

believes that the proposed amendments 

would promote capital formation since 

they seek to eliminate the abuses in the 

offering process and would promote a 

more even playing field for potential 

investors and issuers alike. These 

proposed amendments would promote 

investor confidence in the offering 

process as well as in the market as a 

whole, which would foster capital 

formation. 

The Commission has considered the 

proposed amendments in light of the 

standards cited in Section 23(a)(2) and 

believes preliminarily that, if adopted, 

they would not likely impose any 

significant burden on competition not 

necessary or appropriate in furtherance 

of the Exchange Act. Specifically, the 

proposed amendments if adopted, 

would require maintenance of separate 

records under Rule 101(b)(7) and 

identification or designation of 

syndicate covering bids under Rule 104. 

As discussed above, distribution 

participants under Rule 17a–3 already 

make and keep records of all orders and 

purchases and sales, including de 

minimis bids and purchases, so the 

Commission believes the additional 

burden of keeping records separately 

and for three years would be minimal. 

With regard to Rule 104, the 

Commission recognizes that SROs and 

markets receiving the identification or 

designation of a syndicate bid from 

managing underwriters may incur some 

costs to communicate this information. 

The required designation of a syndicate 

bid, would be analogous to what is 

already required for stabilizing 

transactions, so the Commission 

anticipates that the means of 

communicating such information is 

already in place and operational and 

would require minimal costs to extend 

such designation to include syndicate 

covering bids. Additionally, in regard to 

the proposed definition of IPO and 

expansion of the restricted period for 

IPOs we would be expressly prohibiting 

conduct which can create an 

exaggerated perception to investors of 

scarcity of IPO stock and affect the 

pricing of the offering, both of which 

undermine the market’s function as an 

independent pricing mechanism. The 

proposed amendments to Rules 100, 

101, and 102 concerning ADTV and 

public float values will restore the 

restricted period and actively-traded 

thresholds to the level originally 

contemplated at Regulation M’s 

adoption. By expressly providing for 

valuation and election periods within 

the definition of the restricted period 

the Commission would codify a longstanding interpretation and eliminate 

any confusion in these contexts. The 

new Rule 106 would expressly prohibit 

in a prophylactic rule conduct related to 

offerings that has been the subject of 

recent enforcement actions. Since the 

conduct covered by proposed Rule 106 

is already prohibited under either 

Regulation M or antifraud and antimanipulation provisions of the federal 

securities laws, the staff codifying the 

illegality of such conduct within a 

prophylactic rule imposes minimal 

additional costs and would not impose 

a burden on competition. 

We preliminarily believe that the 

proposed amendments would promote 

competition among distribution 

participants as the amendments would 

level the playing field by applying clear 

and uniform regulation concerning 

conduct during an offering, and by 

improving the transparency of syndicate 

covering bids in the aftermarket. 

The Commission requests comment 

on whether the proposed amendments 

are expected to promote efficiency, 

competition, and capital formation. 

VII. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or (SBREFA),124 we must advise 

the Office of Management and Budget as 

to whether the proposed amendments 

constitute a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’

where, if adopted, it results or is likely 

to result in:

• An annual effect on the economy of 

$100 million or more (either in the form 

of an increase or a decrease); 

• A major increase in costs or prices 

for consumers or individual industries; 

or 

• Significant adverse effect on 

competition, investment, or innovation. 

If a rule is ‘‘major,’’ its effectiveness 

will generally be delayed for 60 days 

pending Congressional review. We 

request comment on the potential 

impact of the proposed amendments on 

the economy on an annual basis. 

Commenters are requested to provide 

empirical data and other factual support 

for their view to the extent possible. 

VIII. Initial Regulatory Flexibility 

Analysis 

The Commission has prepared an 

Initial Regulatory Flexibility Analysis 

(IRFA), in accordance with the 

provisions of the Regulatory Flexibility 

Act (RFA)125 regarding the proposed 

amendments to Regulation M.

A. Reasons for the Proposed Action 

Based on our experience with the 

operation of Regulation M, and to reflect 

market developments since the 

Regulation’s adoption, we propose to 

revise Regulation M’s provisions. The 

proposed amendments, including 

amending the definition of ‘‘restricted 

period,’’ requiring recordkeeping for 

reliance on the de minimis transaction 

exception, updating the restricted 

period and ‘‘actively-traded’’ qualifying 

thresholds, requiring identification of 

syndicate covering bids, prohibiting 

penalty bids, and adopting a new rule 

to prevent conditioning the award of 

allocations of offered securities on the 

receipt of consideration in addition to 

the stated offering consideration, are 

designed to modernize Regulation M in 

light of recent developments while 

providing clear guidelines to prevent 

manipulation of the markets. 

If the proposed amendments were not 

adopted, the Regulation may not 

appropriately address the manipulative 

abuses that may occur prior to an IPO 

and that interfere with the securities 

markets’ function as an independent 

pricing mechanism. Without adjusting 

the qualifying thresholds for the 

restricted periods and actively-traded 

exceptions we could be exempting from 

the regulations restrictions securities 

that may be subject to manipulation. 

Additionally, if the proposed 

amendments to Rule 101(b)(7) were not 

adopted, Commission and SRO 

examiners would be unable to identify 

possible patterns of abuse or improper 

policies and procedures that may be in 

place. As a result of not adopting the 

proposals contained in rules 104 and 

106, investors may be precluded from 

receiving allocations, paying too high a 

price for a security or otherwise invest 

in an offered security (or trade in the 

aftermarket) with incomplete 

information as to the true demand for 

the security and the level or amount of 

actual syndicate covering activity. 

Similarly, if distribution participants 

were not required to disclose to the 

market and identify or designate when 

a syndicate short covering bid is made, 

prospective investors in, and holders of, 

offered shares will not know the extent 

75792 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

126 17 CFR 240.0–10(a).

127This number is based on the total number of 

issuers’ 10–KSB filings for the fiscal year ending 9/

30/04.

128 17 CFR 240.0–10(c)(1).

129These numbers are based on OEA’s review of 

2003 FOCUS Report filings reflecting registered 

broker dealers. This number does not include 

broker-dealers that are delinquent on FOCUS 

Report filings. 130 5 U.S.C. 603(c).

of syndicate covering activity at the time 

it occurs and may make investment 

decisions without all the necessary 

information about the offered security. 

Additionally, if distribution participants 

were not prohibited from demanding 

additional consideration from investors 

in order to obtain IPO allocations, we 

would be unable to prophylactically 

prevent such fraudulent activity from 

occurring and only reach such activities 

through the antifraud and antimanipulation provisions of the federal 

securities laws. Moreover, if we did not 

explicitly define IPOs and the restricted 

period for valuation and election 

periods, we would not be able to 

provide certainty to the issuers, 

distribution participants and others as 

to the exact application of the rules. 

B. Objectives 

The proposed amendments to 

Regulation M are designed to fulfill 

several objectives. First, the proposed 

amendments seek to prevent 

manipulation from occurring by 

precluding certain activities by 

underwriters and other distribution 

participants that can undermine the 

integrity and fairness of the offering 

process, particularly with respect to 

allocations of offered securities. Second, 

the proposal seeks to enhance the notice 

and disclosure of certain practices by 

distribution participants, such as 

syndicate covering that may affect the 

market price and trading of an offered 

security and to prohibit penalty bids. 

Third, the proposed amendments are 

designed to prohibit activities that could 

artificially influence the market for the 

offered security, including, supporting 

the offering price by creating the 

exaggerated perception of scarcity of the 

offered security or creating the 

misleading appearance of active trading 

in the market for the security. The 

amendments are also intended to update 

certain definitional and operational 

provisions in light of market 

developments since the Regulation’s 

adoption in 1996.

C. Legal Basis 

The amendments to Regulation M are 

proposed pursuant to the authority set 

forth under the Securities Act, 15 U.S.C. 

77a et seq., particularly Section 7, 17(a), 

19(a), 15 U.S.C. 77g, 77q(a), and 77s(a); 

the Exchange Act, 15 U.S.C. 78a et seq., 

particularly Sections 2, 3, 9(a), 10, 

11A(c), 12, 13, 14, 15(c), 15(g), 17(a), 

23(a), and 30, 15 U.S.C. 78b, 78c, 78i(a), 

78j, 78k–1(c), 78l, 78m, 78n, 78o(c), 

78o(g), 78q(a), 78w(a), and 78dd–1; and 

the Investment Company Act, 15 U.S.C. 

80a–1 et seq., particularly Sections 23, 

30, and 38, 15 U.S.C. 80a–23, 80a–29, 

and 80a–37. 

D. Small Entities Subject to the Rule 

Paragraph (a) of Rule 0–10 126 states 

that the term ‘‘small business’’ or ‘‘small 

organization,’’ when referring to issuers 

or affiliated purchasers, are those who 

on the last day of its most recent fiscal 

year had total assets of $5,000,000 or 

less. As of 2003, the Commission 

estimates that there were approximately 

3489 issuers that qualified as small 

entities as defined above, and were 

subject to Regulation M.127 Paragraph 

(c)(1) of Rule 0–10 128 states that the 

term ‘‘small business’’ or ‘‘small 

organization,’’ when referring to a 

broker-dealer, means a broker or dealer 

that had total capital (net worth plus 

subordinated liabilities) of less than 

$500,000 on the date in the prior fiscal 

year as of which its audited financial 

statements were prepared pursuant to 

§ 240.17a–5(d); and is not affiliated with 

any person (other than a natural person) 

that is not a small business or small 

organization. As of 2003, the 

Commission estimates that there were 

approximately 905 broker dealers, 33 of 

which engaged in underwriting, that 

qualified as small entities as defined 

above, and were subject to Regulation 

M.129 The Commission seeks comment 

on the number of issuers and brokerdealers that were subject to Regulation 

M and the number of such issuers, 

broker-dealers and syndicate members 

that are small entities.

E. Reporting, Recordkeeping and Other 

Compliance Requirements 

The proposed amendments to 

Regulation M would impose certain 

reporting, recordkeeping and other 

compliance requirements on brokerdealers and issuers who are small 

entities and engage in securities 

offerings. Those distribution 

participants that are small entities who 

rely on the de minimis transactions 

exception of Regulation M will now be 

subject to recordkeeping requirements. 

Also, if any broker-dealers that are small 

entities undertake syndicate covering 

transactions they will be subject to the 

new identification and designation 

requirements. We do not believe, at this 

time, that any additional or specialized 

professional skills will be necessary to 

achieve these new requirements. 

F. Duplicative, Overlapping or 

Conflicting Federal Rules 

The Commission believes that there 

are no federal rules that duplicate, 

overlap or conflict with, the proposed 

amendments. 

G. Significant Alternatives 

The RFA directs the Commission to 

consider significant alternatives that 

would accomplish the stated objective, 

while minimizing any significant 

adverse impact on small issuers and 

broker-dealers. Pursuant to Section 3(a) 

of the RFA,130 the Commission 

considered the following alternatives: 

(1) The establishment of differing 

compliance or reporting requirements or 

timetables that take into account the 

resources available to small entities; (2) 

the clarification, consolidation, or 

simplification of compliance and 

reporting requirements under the Rule 

for small entities; (3) the use of 

performance rather than design 

standards; and (4) an exemption from 

coverage of the Rule, or any part thereof, 

for small entities.

With respect to the proposed 

amendments to Regulation M, the 

Commission believes that in order to 

prevent manipulation and fraud in the 

offering process and trading markets, 

uniform rules applicable to all market 

participants (regardless of size) is 

necessary. The Commission believes 

that the majority of entities to whom 

Regulation M applies and the majority 

of syndicate members who would be 

affected by the proposed amendments 

are not small entities. Therefore, the 

establishment of different requirements 

for small entities is not practicable, nor 

in the public interest and for the 

protection of investors to do so. In 

addition, the proposed amendments 

impose minimal additional costs or 

burdens so establishing different 

compliance requirements or clarifying, 

consolidating, or simplifying 

compliance or reporting requirements 

for small entities would not be justified 

in this context. With regard to the 

proposed amendments to Regulation M, 

and clarification of the application of 

the regulation, small entities would not 

be specifically exempted, since all 

securities may be the subject of 

manipulation or other abuse the 

amendments seek to prevent. Regulation 

M imposes performance standards 

rather than design standards and would 

require all entities to comply with the 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75793

rule in order to ensure a proper 

application of the rule. 

H. Solicitation of Comments 

The Commission encourages written 

comments on matters discussed in the 

IRFA. In particular, the Commission 

requests comments on (1) the number of 

issuers and broker-dealers that were 

subject to Regulation M and the number 

of such issuers, broker-dealers and 

syndicate members that are small 

entities; (2) the nature of any impact the 

proposed amendments would have on 

small entities and empirical data 

supporting the extent of the impact 

(commenters are asked to describe the 

nature of any impact and provide 

empirical data supporting the extent of 

the impact); and (3) how to quantify the 

number of small entities that would be 

affected by and/or how to quantify the 

impact of the proposed amendments. 

Such comments will be considered in 

the preparation of the Final Regulatory 

Flexibility Analysis, if the proposed 

amendments are adopted, and will be 

placed in the same public file as 

comments on the proposed amendments 

themselves. As discussed above, for 

purposes of SBREFA, the Commission is 

also requesting information regarding 

the potential impact of the proposed 

amendments on the economy on an 

annual basis. Commenters should 

provide empirical data to support their 

views.

IX. Statutory Basis 

The proposed amendments to Rule 

17a–2 would be adopted under the 

Exchange Act, 15 U.S.C. 78a et seq., and 

particularly Sections 2, 3, 9(a)(6), 10(a), 

10(b), 13(e), 15(c), 17(a), and 23(a), 15 

U.S.C. 78b, 78c, 78i(a)(6), 78j(a), 78j(b), 

78m(e), 78o(c), 78q(a), and 78w(a). The 

proposed amendments to Item 508(l)(1) 

of Regulation S–K and Item 508(j)(1) of 

Regulation S–B and Rule 481 would be 

adopted under the Securities Act, 15 

U.S.C. 77a et seq., particularly Sections 

6, 7, 8, 10, and 19(a), 15 U.S.C. 77f, 77g, 

77h, 77j. and 77s(a); the Exchange Act, 

15 U.S.C. 78a et seq., particularly 

Sections 3, 4, 10, 12, 13, 14, 15, 16 and 

23; 15 U.S.C. 78c, 78d, 78j, 78l, 78m, 

78n, 78o, 78p, and 78w; and the 

Investment Company Act of 1940, 15 

U.S.C. 80a–1 et seq., particularly 

Sections 8 and 38(a), 15 U.S.C. 80a–8 

and 80a–37(a). Rules 100, 101, 102, 104, 

and 106 of Regulation M would be 

adopted under the Securities Act, 15 

U.S.C. 77a et seq., particularly Sections 

7, 17(a), 19(a), 15 U.S.C. 77g, 77q(a), and 

77s(a); the Exchange Act, 15 U.S.C. 78a 

et seq., particularly Sections 2, 3, 9(a), 

10, 11A(c), 12, 13, 14, 15(c), 15(g), 17(a), 

23(a), and 30, 15 U.S.C. 78b, 78c, 78i(a), 

78j, 78k–1(c), 78l, 78m, 78n, 78o(c), 

78o(g), 78q(a), 78w(a), and 78dd–1; and 

the Investment Company Act of 1940, 

15 U.S.C. 80a–1 et seq., particularly 

Sections 23, 30, and 38, 15 U.S.C. 80a–

23, 80a–29, and 80a–37. 

Text of Proposed Rule

List of Subjects 

17 CFR Part 228 

Reporting and recordkeeping 

requirements, Securities, Small 

businesses. 

17 CFR Parts 229, and 230 

Reporting and recordkeeping 

requirements, Securities. 

17 CFR Part 240 

Brokers, Reporting and recordkeeping 

requirements, Securities. 

17 CFR Part 242 

Brokers, Fraud, Reporting and 

recordkeeping requirements, Securities.

For the reasons set forth in the 

preamble, the Commission proposes to 

amend Title 17, chapter II of the Code 

of Federal Regulations as follows:

PART 228—INTEGRATED 

DISCLOSURE SYSTEM FOR SMALL 

BUSINESS ISSUERS 

1. The authority citation for Part 228 

continues to read in part as follows:

Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 

77k, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 

77ddd, 77eee, 77ggg, 77hhh, 77jjj, 77nnn, 

77sss, 78l, 78m, 78n, 78o, 78u–5, 78w, 78ll, 

78mm, 80a–8, 80a–29, 80a–30, 80a–37, 80b–

11, and 7201 et seq.; and 18 U.S.C. 1350.

* * * * *

§ 228.508 [Amended] 

2. Section 228.508, paragraph (j)(1), 

second sentence, is amended by 

removing the phrase ‘‘penalty bids,’’.

PART 229—STANDARD 

INSTRUCTIONS FOR FILING FORMS 

UNDER SECURITIES ACT OF 1933, 

SECURITIES EXCHANGE ACT OF 1934 

AND ENERGY POLICY AND 

CONSERVATION ACT OF 1975—

REGULATION S–K 

3. The authority citation for Part 229 

continues to read in part as follows:

Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 

77k, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 

77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 

77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 

78o, 78u–5, 78w, 78ll, 78mm, 79e, 79j, 79n, 

79t, 80a–8, 80a–9, 80a–20, 80a–29, 80a–30, 

80a–31(c), 80a–37, 80a–38(a), 80a–39, 80b–

11, and 7201 et seq.; and 18 U.S.C. 1350, 

unless otherwise noted.

* * * * *

§ 229.508 [Amended] 

4. Section 229.508, paragraph (l)(1), 

second sentence, is amended by 

removing the phrase ‘‘penalty bids,’’.

PART 230—GENERAL RULES AND 

REGULATIONS, SECURITIES ACT OF 

1933 

5. The authority citation for Part 230 

continues to read in part as follows:

Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 

77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 78c, 78d, 

78j, 78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), 

78mm, 79t, 80a–8, 80a–24, 80a–28, 80a–29, 

80a–30, and 80a–37, unless otherwise noted.

* * * * *

§ 230.481 [Amended] 

6. Section 230.481, paragraph (d)(1), 

third sentence, is amended by removing 

the phrase ‘‘penalty bids,’’.

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

7. The authority citation for Part 240 

continues to read in part as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 

77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 

77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 

78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p, 

78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 79q, 

79t, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 

80b–4, 80b–11, and 7201 et seq.; and 18 

U.S.C. 1350, unless otherwise noted.

* * * * *

8. Amend § 240.17a–2 by: 

a. Removing the authority citation 

following the section; 

b. Removing the phrase ‘‘or imposes 

a ‘penalty bid,’ as defined in § 240.100 

of this chapter’’ in the introductory text 

of paragraph (a); 

c. Revising the introductory text of 

paragraph (c); 

d. Removing the phrase ‘‘or a penalty 

bid has been imposed’’ in paragraph 

(c)(1)(i); 

e. Removing the phrase ‘‘, and 

whether any penalties were assessed’’ in 

paragraph (c)(1)(ii); 

f. Adding the word ‘‘and’’ at the end 

of paragraph (c)(i)(iii); 

g. Removing the ‘‘; and’’ and in its 

place adding a period at the end of 

paragraph (c)(1)(iv); and 

h. Removing paragraph (c)(i)(v). 

The revision reads as follows:

§ 240.17a–2 Recordkeeping requirements 

relating to stabilizing activities.

* * * * *

(c) Records relating to stabilizing and 

syndicate covering transactions required 

to be maintained by manager. Any 

person subject to this section who acts 

as a manager and stabilizes or effects 

syndicate covering transactions shall:

* * * * *

75794 Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 

9. Section 240.17a–4 is amended by 

adding paragraph (b)(13) to read as 

follows:

§ 240.17a–4 Records to be preserved by 

certain exchange members, broker and 

dealers.

* * * * *

(b) * * * 

(13) The record(s) required to be made 

pursuant to § 242.101(b)(7) of this 

chapter.

* * * * *

PART 242—REGULATIONS M, SHO, 

ATS, AND AC AND CUSTOMER 

MARGIN REQUIREMENTS FOR 

SECURITY FUTURES 

10. The authority citation for Part 242 

is revised to read as follows:

Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 

78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l,

78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 

78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a–

23, 80a–29, and 80a–37.

11. Section 242.100 is amended by: 

a. Revising the phrase ‘‘(§§ 242.100—

242.105 of this chapter)’’ to read 

‘‘(§§ 242.100 through 242.106)’’ in 

paragraph (a); 

b. Revising the phrase ‘‘(§§ 242.100 

through 242.105 of this chapter)’’ to 

read ‘‘(§§ 242.100 through 242.106)’’ in 

paragraph (b); 

c. Adding the following definitions in 

alphabetical order: Election period; 

Initial public offering; and Valuation 

period; and 

d. Revising the definition of 

Restricted period.

The revision and additions read as 

follows.

§ 242.100 Preliminary note; definitions.

* * * * *

Election period means any period 

during which shareholders have the 

right to elect among various forms of 

consideration offered in a distribution.

* * * * *

Initial public offering (IPO) means: 

(1) An issuer’s first offering of a 

security to the public in the United 

States, and 

(2) If prior thereto the issuer’s equity 

securities do not have a public float 

value, an issuer’s first offering of an 

equity security to the public in the 

United States.

* * * * *

Restricted period means the period 

beginning: 

(1) For any security with an ADTV 

value of $120,000 or more of an issuer 

whose common equity securities have a 

public float value of $30 million or 

more, the period beginning on the later 

of one business day prior to the 

determination of the offering price or 

such time that a person becomes a 

distribution participant, and ending 

upon such person’s completion of 

participation in the distribution. 

(2) For any security with an ADTV 

value of less than $120,000 of an issuer 

whose common equity securities have a 

public float value of less than $30 

million, the period beginning on the 

later of five business days prior to the 

determination of the offering price or 

such time that a person becomes a 

distribution participant, and ending 

upon such person’s completion of 

participation in the distribution. 

(3) In the case of a distribution 

involving a merger, acquisition, or 

exchange offer: 

(i) The day proxy solicitation or 

offering materials are first disseminated 

to security holders and ending upon the 

completion of the distribution;

(ii) The period one or five business 

days prior to the commencement of any 

valuation period and for the duration of 

such period (refer to paragraphs (1) and 

(2) of this definition to determine if one 

or five business days is applicable); and 

(iii) The period one or five business 

days prior to the commencement of any 

election period and for the duration of 

such period (refer to paragraphs (1) and 

(2) of this definition to determine if one 

or five business days is applicable). 

(4) In the case of a distribution 

involving an IPO, the earlier of: 

(i) The period beginning at the time 

when the issuer reaches an 

understanding with the broker-dealer 

that is to act as an underwriter, or such 

time that a person becomes a 

distribution participant, and ending 

upon the issuer’s or distribution 

participant’s completion of participation 

in the distribution; or 

(ii) The period beginning at the time 

the registration statement is filed with 

the Commission or other offering 

document is first circulated to potential 

investors, or such time that a person 

becomes a distribution participant, and 

ending upon the issuer’s or distribution 

participant’s completion of participation 

in the distribution.

* * * * *

Valuation period means any period 

during which the market price of the 

offered security is a factor in 

determining the consideration to be 

paid in the distribution. 

12. Amend § 242.101 by revising 

paragraph (b)(7) and in paragraph (c)(1) 

by revising the phrases ‘‘$1 million’’

and ‘‘$150 million’’ to read ‘‘$1.2 

million’’ and ‘‘$180 million’’

respectively.

§ 242.101 Activities by distribution 

participants.

* * * * *

(b)(7) De minimis transactions.

Purchases during the restricted period, 

other than by a passive market maker, 

that total less than 2% of the ADTV of 

the security being purchased, or 

unaccepted bids: Provided, however,

that the person making such bid or 

purchase has maintained and enforces 

written policies and procedures 

designed to achieve compliance with 

other provisions of this section. Any 

person relying on this exception shall 

create a separate record specifying: 

(i) The security that is the subject of 

the relevant distribution; 

(ii) The day the restricted period 

commenced; 

(iii) The ADTV; 

(iv) The bid or purchase that occurred 

during the restricted period, including 

time, price, quantity, and market; 

(v) The individual who made such bid 

or purchase and the system used to 

make such bid or purchase; 

(vi) How and when such bid or 

purchase was discovered; 

(vii) The policies and procedures 

designed to achieve compliance with 

this section in effect at the time of such 

bid or purchase; 

(viii) The review of the policies and 

procedures performed following the 

discovery of such bid or purchase; and 

(ix) Any modifications made to those 

policies and procedures. A broker or 

dealer shall preserve the record 

specified in this paragraph in 

accordance with § 240.17a–4(b)(13) of 

this chapter; or

* * * * *

13. Amend § 242.102, paragraph 

(d)(1), by revising the phrases ‘‘$1 

million’’ and ‘‘$150 million’’ to read 

‘‘$1.2 million’’ and ‘‘$180 million’’

respectively. 

14. Amend § 242.103, paragraph 

(b)(7), by revising the phrase 

‘‘§§ 228.502, 228.508, 229.502, and 

229.508’’ to read ‘‘§§ 228.508 and 

229.508’’. 

15. Amend § 242.104 by: 

a. Revising paragraphs (a), (h)(2), and 

the introductory text of paragraph (j)(2); 

and 

b. In paragraph (h)(3) revise the 

phrase ‘‘Item 502(d) of Regulation S–B 

(§ 228.502(d) of this chapter) or Item 

502(d) of Regulation S–K (§ 229.502(d) 

of this chapter)’’ to read ‘‘§ 230.481(d) of 

this chapter’’. 

The revisions read as follows.

§ 242.104 Stabilizing and other activities in 

connection with an offering. 

(a) Unlawful activity. It shall be 

unlawful for any person, directly or 

Federal Register / Vol. 69, No. 242 / Friday, December 17, 2004 / Proposed Rules 75795

indirectly, to stabilize or to effect any 

syndicate covering transaction in 

connection with an offering of any 

security, in contravention of the 

provisions of this section. No stabilizing 

shall be effected at a price that the 

person stabilizing knows or has reason 

to know is in contravention of this 

section, or is the result of activity that 

is fraudulent, manipulative, or 

deceptive under the securities laws, or 

any rule or regulation thereunder. It 

shall be unlawful for any person to 

impose or assess a penalty bid in 

connection with an offering.

* * * * *

(h) * * * 

(2) Any person communicating a bid 

that is for the purpose of effecting a 

syndicate covering transaction shall: 

(i) Identify or designate the bid as 

such wherever it is communicated; and 

(ii) Provide prior notice to the selfregulatory organization with direct 

authority over the principal market in 

the United Sates for the security for 

which the syndicate covering 

transaction is effected.

* * * * *

(j) * * * 

(2) Transactions of Rule 144A 

securities. Transactions in securities 

eligible for resale under 

§ 230.144A(d)(3) of this chapter, or any 

reference security, if such securities are 

offered or sold in the United States 

solely to:

* * * * *

16. Add § 242.106 to read as follows:

§ 242.106 Allocating offered securities. 

(a) Unlawful activity. It shall be 

unlawful for a distribution participant, 

issuer or their affiliated purchasers, 

directly or indirectly, acting either alone 

or in concert with another person, to 

attempt to induce, induce, solicit, 

require, or accept from a potential 

purchaser of an offered security in 

connection with an allocation of the 

offered security, any consideration for 

such offered security in addition to that 

stated in the registration statement filed 

under the Securities Act of 1933 (15 

U.S.C. 77a et seq.) or applicable offering 

document for the offer and sale of such 

offered security. 

(b) Exemptive authority. Upon written 

application or upon its own motion, the 

Commission may grant an exemption 

from the provisions of this section, 

either unconditionally or on specified 

terms and conditions, to any person or 

class of persons, to any transaction or 

class of transactions, or to any security 

or class of securities to the extent that 

such exemption is necessary or 

appropriate, in the public interest, and 

is consistent with the protection of 

investors.

Dated: December 9, 2004.

By the Commission. 

J. Lynn Taylor, 

Assistant Secretary.

[FR Doc. 04–27434 Filed 12–16–04; 8:45 am] 

BILLING CODE 8010–01–P