76316 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See Letter from Alden S. Adkins, Senior vice

President and General Counsel, NASD Regulation,

to Katherine A. England, Assistant Director,

Division of Market Regulation (‘‘Division’’),

Commission, dated November 14, 2000

(‘‘Amendment No. 2’’). In response to the comment

letters, Amendment No. 2 was filed to replace the

proposed rule change and Amendment No. 1 in

their entirety.

4See Letter from Gary L. Goldsholle, Assistant

General Counsel, NASD Regulation, to Katherine A.

England, Assistant Director, Division, Commission,

dated December 20, 1999 (‘‘Amendment No. 1’’). In

Amendment No. 1, NASD Regulation makes certain

technical amendments to the proposed rule change.

5Securities Exchange Act Release No. 42325

(January 10, 2000), 65 FR 2656.

6Letter from Willkie Farr & Gallagher to Jonathan

G. Katz, SEC, dated January 28, 2000 (‘‘Willkie’’);

Letter from Faith Colish to Jonathan G. Katz, SEC,

dated January 31, 2000 (‘‘Colish’’); Letter from

Katten Muchin Zavis to Jonathan G. Katz, SEC,

dated January 28, 2000 (‘‘Katten’’); Letter from

Driehaus Capital Management, Inc. to Jonathan G.

Katz, SEC, dated February 4, 2000 (‘‘Driehaus’’);

Letter from Fu Associates, Ltd. to Jonathan G. Katz,

SEC, dated February 7, 2000 (‘‘Fu’’); Letter from

Cadwalader, Wickersham & Taft to Jonathan G.

Katz, SEC, dated February 4, 2000 (‘‘Cadwalader’’);

Letter from Schulte Roth & Zabel LLP to Jonathan

G. Katz, SEC, dated February 7, 2000 (‘‘Schulte’’);

Letter from Rosenman & Colin LLP to Jonathan G.

Katz, SEC, dated February 7, 2000 (‘‘Rosenman’’);

Letter from Fried, Frank, Harris, Shriver & Jacobson

to Jonathan G. Katz, SEC, dated May 9, 2000

(‘‘Fried’’); Letter from Ropes & Gray to Jonathan G.

Katz, SEC, dated February 8, 2000 (‘‘Ropes’’); Letter

from The Washington Group to Jonathan G. Katz,

SEC, dated February 8, 2000 (‘‘Washington’’); Letter

from Testa, Hurwitz & Thibeault, LLP to Jonathan

G. Katz, SEC, dated February 8, 2000 (‘‘Testa’’);

Letter from Chicago Board Options Exchange to

Jonathan G. Katz, SEC, dated February 14, 2000

(‘‘CBOE’’); Letter from Sullivan & Cromwell to

Jonathan G. Katz, SEC, dated February 15, 2000

(‘‘Sullivan’’); Letter from Charles Schwab to

Jonathan G. Katz, SEC, dated February 15, 2000

(‘‘Schwab’’); Letter from Sidley & Austin to

Jonathan G. Katz, SEC, dated February 16, 2000

(‘‘Sidley’’); Letter from North American Securities

Administrators Association, Inc. to Jonathan G.

Katz, SEC, dated February 18, 2000 (‘‘NASAA’’);

Letter from Northern Trust Global Advisors, Inc. to

Jonathan G. Katz, SEC, dated February 13, 2000

(‘‘Northern’’); Letter from Securities Industry

Association to Jonathan G. Katz, dated February 18,

2000 (‘‘SIA’’); Letter from Morgan Stanley Dean

Witter to Jonathan G. Katz, SEC, dated March 17,

2000 (‘‘MSDW’’); Letter from Mayor, Day, Caldwell

& Keeton, LLP to Jonathan G. Katz, SEC, dated June

2, 2000 (‘‘Mayor’’); Letter from Covington & Burling

to Jonathan G. Katz, SEC, dated April 14, 2000

(‘‘Covington’’); Letter from Orrick, Herrington &

Sutcliffe LLP to Jonathan G. Katz, SEC, dated May

2, 2000 (‘‘Orrick’’); and Letter from Sandra K. Smith

to Jonathan G. Katz, SEC, dated February 1, 2000

(‘‘Smith’’).

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–43627; File No. SR–NASD–

99–60]

Self-Regulatory Organizations; Notice

of Filing of Amendment No. 2 to

Proposed Rule Change by the National

Association of Securities Dealers, Inc.

Relating to Trading in Hot Equity

Offerings

November 28, 2000.

Pursuant to section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’) 1 and Rule 19b–4 thereunder,2

notice is hereby given that on November

15, 2000, the National Association of

Securities Dealers, Inc. (‘‘NASD’’ or

‘‘Association’’), through its wholly

owned subsidiary NASD Regulation,

Inc. (‘‘NASD Regulation’’), filed with the

Securities and Exchange Commission

(‘‘Commission’’ or ‘‘SEC’’) Amendment

No. 2 to the proposed rule change 3 as

described in Items I, II, and III below,

which Items have been prepared by

NASD Regulation. The Commission is

publishing this notice of Amendment

No. 2 to solicit comments on the

amended proposed rule change from

interested persons.

On October 15, 1999, NASD

Regulation submitted the proposed rule

change to the Commission. On

December 21, 1999, NASD Regulation

submitted Amendment No. 1 to the

proposed rule change.4 The proposed

rule change and Amendment No. 1 were

published for comment in the Federal

Register on January 18, 2000.5 The

Commission received twenty-four

comment letters on the proposed rule

change.6 NASD Regulation is

responding to the comment letters with

Amendment No. 2.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

NASD Regulation proposes to

establish NASD Rule 2790, Restrictions

on the Purchase and Sale of Initial

Equity Public Offerings, to replace the

Free-Riding and Withholding

Interpretation, IM–2110–1. Below is the

amended text of the proposed rule

change as proposed in Amendment No.

2. Additions are italicized and deletions

are bracketed. (Note: Section (a)

‘‘Definitions’’ has been renumbered as

Section (i). The comparison of changes

to the defintions is located under

Section (i).

Rule 2790. [Trading in Hot Equity

Offerings]

[(b)] Restrictions on the Purchase and

Sale of Initial Equity Public Offerings

(a) General Prohibitions

(1) A member or a person associated

with a member may not sell, or cause to

[sell,] be sold, a [hot] new issue [in a

public offering] to any account in which

a restricted person [or a member of the

restricted person’s immediate family]

has a beneficial interest, except as

otherwise permitted herein [or through

an exemption pursuant to the Rule 9600

Series].

(2) A member or a person associated

with a member may not purchase a [hot

issue in a public offering, except as

permitted herein or through an

exemption pursuant to the Rule 9600

Series.] new issue in any account in

which such member or person associate

with a member has a beneficial interest,

except as otherwise permitted herein.

(3) A member may not continue to

hold [hot issues acquired in a public

offering except as permitted herein or

through an exemption pursuant to the

Rule 9600 Series.] new issues acquired

by the member as an underwriter,

selling group member, or otherwise,

except as otherwise permitted herein.

[(c) Canceling Trades

A member or a person associated with

a member does not violate this rule if it

cancels a sale of a hot issue made to the

account of a restricted person or a

member of the person’s immediate

family prior to the end of the first

business day following the date that

market trading commences (i.e., T+1)

and reallocates such hot issue at the

public offering price to a non-restricted

person.

(d)](b) Preconditions for Sale

Before selling a [hot] new issue to any

account, a member must in good faith

have obtained within the [previous]

twelve months [documentary evidence]

prior to such sale, a representation from

the account holder(s), or a person

authorized to represent the beneficial

owners of the account [or the ultimate

purchasers if the account is a conduit

account, demonstrating that no

restricted person or ultimate purchasere

in the case of a conduit account, has a

beneficial interest in the account, except

as permitted under the rule. Members],

that the account is eligible to purchase

new issues in compliance with this rule.

A member may not rely upon any

representation that it believes, or has

reason to believe, is inaccurate. A

member shall maintain a copy of all

records and information [used to

determine that] relating to whether an

account [does not contain a restricted

person] is eligible to purchase new

issues in its files for at least three years

following the member’s last sale of a

[hot] new issue to that account.

[(e) General Exemptions] (c) General

Exemptions

[A member or a person associated

with a member may sell hot issues to:]

The general prohibitions in paragraph

(a) of this rule shall not apply to sales

to and purchases by:

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76317

[(1) A registered investment company]

(1) An investment company registered

under the Investment Company Act of

1940[.];

[(2) A collective investment account

(including a joint back office broker/

dealer or a collective investment

account with a joint back office broker/

dealer subsidiary),] (2) A common trust

fund or similar fund as described in

Section 3(a)(12)(A)(iii) of the Act,

provided that:

(A) the fund has investments from

1,000 or more trust accounts; and

(B) the fund does not limit beneficial

interests in the fund principally to trust

accounts of restricted persons;

(3) An insurance company general,

separate or investment account,

provided that:

(A) the account has investments from

1,000 or more policyholders; and

(B) the insurance company does not

limit beneficial interests in the account

principally to restricted persons;

(4) An account that is beneifically

owned in part by restricted persons,

provided that such restricted persons in

the aggregate own less than 5% of such

account, and that:[.]

[(3) A publicly traded corporation

(other than an affiliate of a broker/

dealer) listed on an exchange or The

Nasdaq Stock Market, in which no

person with a 10% or more ownership

interest in a restricted person.] (A) each

such restricted person does not manage

or otherwise direct investments in the

account; and

[(4) A foreign] (B) on a pro rata basis,

each such restricted person who is a

natural person receives less than 100

shares of any new issue;

(5) A publicly traded entity (other

than a broker/dealer) that is listed on a

national securities exchange or is traded

on the Nasdaq National Market,

provided that the gains or losses from

new issues are passed on directly or

indirectly to public shareholders;

(6) An investment company organized

under the laws of a foreign jurisdiction,

[meeting the following criteria:]

provided that:

[(A) the company has 100 or more

investors;

(B) the](A) the investment company is

listed on a foreign exchange or

authorized for sale to the public by a

foreign regulatory authority; and

(B)[(C)] no person owning more than

5% of the shares of the investment

[company’s assets shall be invested in a

particular hot issue; and,

(D) no person owning more than 5%

interest in such] company is a restricted

person[.];

[(5) An employee benefits plan

qualified under the] (7) An Employee

Retirement Income Security Act

[provided that the plan sponsor is not a

member or an affiliate; or a state or

foreign government employee benefit]

benefits plan that is qualified under

Section 401(a) of the Internal Revenue

Code, provided that such plan is not

sponsored solely by a broker/dealer;

(8) A state or municipal government

benefits plan that is subject to [separate]

state [and] and/or municipal regulation;

or[.]

[6](9) A tax exempt charitable

organization under Section 501(c)(3) of

the Internal Revenue Code.

[(7) Employees and directors of the

issuer, an entity which controls, is

controlled by, or is under common

control of the issuer.]

(d) Issuer-Directed Securities

[(8) An immediate family member of

a restricted person in paragraph

(a)(11)(B) if:] The prohibitions on the

purchase and sale of new issues in this

rule shall not apply to securities that:

[(A) such restricted person does not

directly or indirectly provide material

support to, or receive material support

from, the immediate family member;]

(1) are specifically directed by the

issuer; provided, however, that this

exemption shall not apply to securities

directed by the issuer to an account in

which any restricted person specified in

subparagraphs (i)(10)(B) or (i)(10)(C) of

this rule has a beneficial interest, unless

such person, or a member of his or her

immediate family, is an employee or

director of the issuer, the issuer’s

parent, or a subsidiary of the issuer.

Also, for purposes of this subparagraph

(d)(1) only, a parent/subsidiary

relationship is established if the parent

has the right to vote 50% or more of a

class of voting security of the subsidiary,

or has the power to sell or direct 50%

or more of a class of voting securities of

the subsidiary;

[(B) such restricted person is not

employed by the member,]

(2) are part of a program sponsored by

the issuer or an affiliate of the issuer

that [member, selling the hot issue to

the immediate family member; and

(C) such restricted person has no

ability to control the allocation of the

hot issue.

(9) An immediate family member of a

restricted person in paragraphs

(a)(11)(C)–(D) if such restricted person

does not directly or indirectly provide

material support to the member of the

immediate family;

(10) A restricted person in paragraph

(a)(11)(E) provided that the sale is to an

account established for the benefit of

bona fide public customers, including

insurance company general, separate

and investment accounts, and bank trust

accounts.

(f) Anti-Dilution Provisions

The restrictions on the sale of hot

issued in this rule shall not apply to

sales to a restricted person in an initial

public offering who] meets the

following criteria:

(a) the opportunity to purchase a new

issue under the program is offered to at

least 10,000 participants;

(b) every participant is offered an

opportunity to purchase an equivalent

number of shares, or will receive a

specified number of shares under a

predetermined formula applied

uniformly across all participants;

(c) if not all participants receive

shares under the program, the selection

of the participants eligible to purchase

shares is based upon a random or other

non-discretionary allocation method;

(d) the class of participants does not

contain a disproportionate number of

restricted persons as compared to the

investing public generally; and

(e) sales are not made to participants

who are managing underwriter(s), the

broker/dealer administering the

program (‘‘Administering Broker/

Dealer’’), the officers or directors of the

managing underwriter(s) or

Administering Broker/Dealer, or any

employee of the managing

underwriter(s) or Administering Broker/

Dealer with access to non-publicly

available information about the new

issue; or

(3) are directed to eligible purchasers

as part of a conversion offering in

accordance with the standards of the

governmental agency or instrumentality

having authority to regulate such

conversion offering.

(e) Anti-Dilution Provisions

The prohibitions on the purchase and

sale of new issues in this rule shall not

apply to an account in which a

restricted person has a beneficial

interest that meets the following

conditions:

(1) the restricted person has held an

equity ownership interest in the issuer,

or a company that has been acquired by

the issuer in the past year, for a period

of one year prior to the effective date of

the [public] offering;

(2) the sale of the [hot issues] new

issue to the [restricted person] account

shall not increase the restricted person’s

percentage equity ownership in the

issuer above the ownership level as of

three months prior to the filing of the

registration statement [with the SEC] in

connection with the offering;

76318 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

(3) the sale of [hot issues to the

restricted person must not include any

special terms; and

(4) the hot issues purchased pursuant

to this subsection shall be restricted

from sale or transfer for a period of three

months following the effective date of

the offering.

(g) Conversion Offerings

The rule shall not apply to the sale of

securities directed by the issuer of a

conversion offering, either on an

underwritten or non-underwritten basis,

to any person eligible to purchase

securities in accordance with the

governmental agency or instrumentality

having authority to regulate such

conversion offering.] the new issue to

the account shall not include any

special terms; and

(4) the new issue purchased pursuant

to this subparagraph (e) shall not be

sold, transferred, assigned, pledged or

hypothecated for a period of three

months following the effective date of

the offering.

(f) Stand-by Purchasers

The prohibitions on the purchase and

sale of new issues in this rule shall not

apply to the purchase and sale of

securities pursuant to a stand-by

agreement that meets the following

conditions:

(1) the stand-by agreement is

disclosed in the prospectus;

(2) the stand-by agreement is the

subject of a formal written agreement;

(3) the managing underwriter(s)

represents in writing that is was unable

to find any other purchasers for the

securities; and

(4) the securities sold pursuant to the

stand-by agreement shall not be sold,

transferred, assigned, pledged or

hypothecated for a period of three

months following the effective date of

the offering.

(g) Under-Subscribed Offerings

Nothing in this rule shall prohibit an

underwriter, pursuant to an

underwriting agreement, from placing a

portion of a public offering in its

investment account when it is unable to

sell that portion to the public.

(h) Exemptive Relief

Pursuant to the Rule 9600 series, the

staff, for good cause shown after taking

into consideration all relevant factors,

may conditionally or unconditionally

exempt any person, security or

transaction (or any class or classes of

persons, securities or transactions) from

this rule to the extent that such

exemption is consistent with the

purposes of the rule, the protection of

investors, and the public interest.

(i) Definitions

(1) [‘‘Affiliate’’ shall have the same

meaning as in Rule 2720(b)(1). (2)

‘‘Beneficial interest’’ means any

[ownership or other direct financial

interest] economic interest, such as the

right to share in gains or losses. The

receipt of a management or performance

based fee for operating a collective

investment account shall not be

considered a beneficial interest in the

account.

[(3)](2) ‘‘Collective investment

account’’ means any hedge fund,

investment partnership, investment

corporation, or any other collective

investment vehicle [that manages assets

of other persons. Collective investment

account shall not include any entity in

which the decision to buy or sell

securities is made jointly by each of the

persons investing in the entity or by a

member of their immediate family.].

[(4)](3) ‘‘Conversion offering’’ means

any offering of securities made as part

of a plan by which a savings and loan

association, insurance company, or

other organization converts from a

mutual to a stock form of ownership.

[(5) ‘‘Hot issue’’ means any security

that is part of a public offering if the

volume weighted price during the first

five minutes of trading in the secondary

market is 5% or more above the public

offering price.]

(4) ‘‘Family partnership’’ means a

partnership comprised solely of

immediate family members.

[(6)](5) ‘‘Immediate family member’’

[shall include] means a person’s

parents, mother-in-law or father-in-law,

spouse, brother or sister, brother-in-law

or sister-in-law, son-in-law or daughterin-law, and children, and any other

individual to whom the person[, directly

or indirectly,] provides material

support.

[(7) ‘‘Joint back office broker/dealer’’

means any domestic or foreign private

investment fund that has voluntarily

registered as a broker/dealer solely to

take advantage of more favorable margin

treatment afforded under Section 220.7

of Regulation T of the Federal Reserve.

The activities of a joint back office

broker/dealer must not require that it

register as a broker/dealer under Section

15(a) of the Act.]

(6) ‘‘Investment club’’ means a group

of friends, neighbors, business

associates, or others that pool their

money to invest in stock or other

securities and are collectively

responsible for making investment

decisions.

[(8)](7) ‘‘Limited business broker/

dealer’’ means any broker/dealer whose

authorization to engage in the securities

business is limited solely to the

purchase [or] and sale of [either]

investment company/variable contracts

securities [or] and direct participation

program securities.

[(9)](8) ‘‘Material support’’ means

directly or indirectly providing more

than [10%] 25% of a person’s income

[or expenses. Material support shall be

presumed for members] in the current or

prior calendar year. Members of the

immediate family living in the same

household are deemed to be providing

each other with material support.

(9) ‘‘New issue’’ means any initial

[.(10) ‘‘Public offering’’ means any

initial or secondary] public offering of

an equity security as defined in [section]

Section 3(a)(11) of the Act, made

pursuant to a registration statement or

offering cicrcular, [including exchange

offers, rights offerings, offerings made

pursuant to a merger or acquisition,] or

other securities distributions of any

kind whatsoever, including securities

that are specifically directed by the

issuer on a non-underwritten basis.

[Public offering] New issue shall not

include:

(A) [Offerings] offerings made

pursuant to an exemption under Section

4(1), 4(2) or 4(6) of the Securities Act of

[1993 or SEC Rule 504, 505 or]1933, or

SEC Rule 504 if the securities are

‘‘restricted securities’’ under SEC Rule

144(a)(3), or Rule 505 or Rule 506

adopted thereunder; [and]

(B) [Offerings] offerings of exempted

securities as defined in Section 3(a)(12)

of the Act;

(C) rights offerings, exchange offers, or

offerings made pursuant to a merger or

acquisition;

(D) offerings of investment grade

asset-backed securities;

(E) offerings of convertible securities;

(F) offerings of preferred securities;

and

(G) offerings of securities of closedend companies as defined under

Section (5)(a)(2) of the Investment

Company Act of 1940. (10)[(11)]

‘‘Restricted person’’ [includes] means:

(A) Members or other broker/dealers[,

unless the ultimate purchaser is a nonrestricted person purchasing the

security at the public offering price;];

[(B) Officers, directors, general

partners, employees or agents] (B)

Broker/Dealer Personnel

(i) Any officer, director, general

partner, associated person, or employee

of a member or any other broker/dealer

(other than a limited business broker/

dealer), or any agent of a member or any

other broker/dealer (other than a limited

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76319

7See, e.g., Sullivan, SIA, and Schwab.

business broker/dealer) that is engaged

in the investment banking or securities

business;[;]

[(C)](ii) An immediate family member

of a person specified in subparagraph

(B)(i) if the person specified in

subparagraph (B)(i):

(a) materially supports, or receives

material support from, the immediate

family member;

(b) is employed by or associated with

the member, or an affiliate of the

member, selling the new issue to the

immediate family member; or

(c) has an ability to control the

allocation of the new issue.

(C) Finders and Fiduciaries

(i) With respect to the security being

offered, [finders] a finder or any person

acting in a fiduciary capacity to the

managing underwriter, including, but

not limited to, attorneys, accountants

and financial consultants; and

(ii) An immediate family member of a

person specified in subparagraph (C)(i)

if the person specified in subparagraph

(C)(i) materially supports, or receives

material support from, the immediate

family member.

(D) Portfolio Managers

(i) Any person who has authority to

buy or sell[(D) Any employee or other

person who supervises, or whose

activities directly or indirectly involve

or are related to, the buying or selling

of] securities for a bank, savings and

loan institution, insurance company,

investment company, investment

advisor, or collective investment

account, other than with respect to a

beneficial interest in the bank, savings

and loan institution, insurance

company, investment company,

investment advisor, or collective

investment account over which such

person has investment authority; [;]

[(E) Any affiliate of a broker/dealer

(other than a limited business broker/

dealer); and](ii) An immediate family

member of a person specified in

subparagraph (D)(i) that is materially

supported by such person, other than

with respect to a beneficial interest in

the bank, savings and loan institution,

insurance company, investment

company, investment advisor, or

collective investment account over

which such person has investment

authority.

[(F) Any natural person or member of

the person’s immediate family who

owns 10% or more or has contributed

10% or more of the capital of a broker/

dealer (other than a limited business

broker/dealer).] Provided, however, that

the term ‘‘restricted person’’ under this

subparagraph (D) shall not include a

person solely because he or she is a

participant in an investment club or a

family partnership.

(E) Persons Owning a Broker/Dealer

(i) Any person listed, or required to be

listed, in Schedule A of a Form BD,

except persons with ownership interests

of less than 10%;

(ii) any person listed, or required to be

listed, in Schedule B of a Form BD,

except persons whose listing on

Schedule B relates to an ownership

interest in a person listed on Schedule

A with an ownership interest of less

than 10%;

(iii) any person listed, or required to

be listed, in Schedule C of a Form BD

that meets the criteria of subparagraphs

(E)(i) and (E)(ii) above;

(iv) any person that directly or

indirectly owns 10% or more of a public

reporting company listed on Schedule A

of a Form BD (other than a reporting

company that is listed on a national

securities exchange or is traded on the

Nasdaq National Market, provided that

the gains or losses from new issues are

passed on directly or indirectly to public

shareholders);

(v) Any person that directly or

indirectly owns 25% or more of a public

reporting company listed on Schedule B

of a Form BD (other than a reporting

company that is listed on a national

securities exchange or is traded on the

Nasdaq National Market, provided that

the gains or losses from new issues are

passed on directly or indirectly to public

shareholders).

(vi) An immediate family member of

a person specified in subparagraphs

(E)(i)–(v) unless the person owning the

broker/dealer:

(a) does not materially support, or

receive material support from, the

immediate family member;

(b) is not an owner of the member, or

an affiliate of the member, selling the

new issue to the immediate family

member; and

(c) has no ability to control the

allocation of the new issue.

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with the Commission,

NASD Regulation included statements

concerning the purpose of and basis for

the proposed rule change and discussed

any comments it received on the

proposed rule change. The text of these

statements may be examined at the

places specified in Item IV below.

NASD Regulation has prepared

summaries, set forth in Sections A, B,

and C below, of the most significant

aspects of such statements.

A. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

1. Purpose

(i) Background. In general, NASD

Regulation believes that the commenters

supported its efforts to reform the FreeRiding and Withholding Interpretation.7

Several commenters believed that the

proposed rule change was a significant

improvement over the Interpretation.

Testa stated that ‘‘[i]n general, the

Proposal presents a much more easily

understood and more workable

regulatory scheme.’’ Kattan and Schwab

stated that the proposed rule change

was more carefully targeted towards the

purpose of the rule while at the same

time it was easier for firms, institutional

investors and the investing public in

general to understand and follow.

Katten also added that protecting the

integrity of the public offering process is

a noteworthy objective that benefits all

investors.

As NASD Regulation expected, the

commenters supported certain elements

of the proposed rule change, opposed

others, and made suggestions for further

changes. A summary and analysis of the

specific comments are provided below.

(ii) Scope of Securities Covered by the

Proposed Rule Change. The area that

generated the most comment was the

proposed definition of ‘‘hot issue.’’

Currently, under the Interpretation, a

hot issue is any security in a public

offering that trades at a ‘‘premium’’ in

the secondary market. In the October

1999 filing, NASD Regulation defined a

hot issue as a security that is part of a

public offering ‘‘if the volume weighted

price during the first five minutes of

trading in the secondary market was 5%

or more above the public offering

price.’’ Many commenters supported

NASD Regulation’s decision to adopt a

clear and measurable standard for

determining whether an offering is a hot

issue, but believed that the 5%

threshold was too low. Colish, Driehaus,

SIA, and MSDW questioned whether the

methodology proposed by NASD

Regulation would be effective in

identifying those offerings that should

be subject to the rule. Colish and

Dreihaus added that NASD Regulation

should supply data to support its

chosen methodology.

By contrast, Schwab and the SIA

suggested what they termed a more

‘‘straightforward’’ approach: prohibiting

76320 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

8Amendment No. 2, like the October 1999 filing,

limits the application of the proposed rule change

to equity offerings only.

9Although the proposed change applies only to

equity securities, the definition of equity security in

section 3(a)(11) of the Exchange Act, which is used

in the proposed rule change, includes any security,

including a debt security, that is convertible into

stock.

10See Letter to Peter C. Manbeck, Sullivan, from

Gary L. Goldsholle, NASD Regulation, dated

December 21, 1998.

allocations of all initial public offerings

(‘‘IPOs’’) to restricted persons. Schwab

stated that even though the

Interpretation and the proposed rule

change contain a safe harbor for

canceling a sale and reallocating the

security to a non-restricted account,

many firms do not and would not avail

themselves of the safe harbor. In

practice, Schwab said, under the

proposed hot issue definition, firms

would continue too treat all IPOs as hot

issues. The SIA, which argued in the

alternative for a higher threshold

premium, agreed and stated that if a 5%

threshold were adopted, firms would

continue to treat all IPOs as being

subject to the rule because they cannot

be in a position of having to anticipate

which offerings will trade through the

5% threshold.

Based on these comments, NASD

Regulation has amended the proposed

rule change to restrict the purchase and

sale of all initial equity public

offerings,8 not just those that open

above a certain premium. Like Schwab

and the SIA, NASD Regulation believes

that this approach is the most

straightforward way to achieve the

purposes of the rule. It is both easier to

understand and avoids many of the

complexities associated with canceling

and reallocating the sale of an IPO to a

non-restricted person in the event that

an offering unexpectedly becomes a hot

issue. NASD Regulation disagrees with

those commenters who recommended a

higher threshold premium, such as 10%

or more. In NASD Regulation’s view,

allocating IPOs with such notable gains

(approaching 10% or even more) to

restricted persons is precisely the type

of conduct that the rule is designed to

prevent.

As a corollary to the proposal to apply

the proposed rule change to all IPOs,

NASD Regulation is proposing to

exempt secondary offerings. Many of the

commenters opposed NASD

Regulation’s decision in the October

1999 filing to roll back the exemption

for secondary offerings of actively

traded securities. As NASD Regulation

stated in the October 1999 filing, the

decision to roll back the exemption for

secondary offerings was premised upon

the decision to adopt a 5% threshold

premium for hot issues. NASD

Regulation believed that with a 5%

premium, as a practical matter, all

secondary offerings would be exempt

from the rule. In proposing to eliminate

the requirement for a 5% threshold

premium, however, NASD Regulation

believes that reinstating the exemption

for secondary offerings is now

appropriate. NASD Regulation has

observed that secondary offerings rarely,

if at all, trade at a significant premium

to the public offering price. We also

agree with Schwab that the negative

consequences to both issuers and

customers in applying the rule to

secondary offerings would outweigh any

benefits associated with including such

offerings in the proposed rule change.

Schwab, Sullivan and others also

recommended that all secondary

offerings, not just those that are actively

traded, should be excluded from the

proposed rule change. NASD Regulation

has not observed any unique concerns

with respect to secondary offerings of

non-actively traded securities.

Accordingly, consistent with its

objective to develop a more streamlined

rule, NASD Regulation has proposed

expanding the exemption for secondary

offerings to include all secondary

offerings.

The decision to apply the proposed

rule change to all IPOs, not just those

that are hot issues, may lead to

problems in offerings for which there is

insufficient investor demand. Under the

current Interpretation, such offerings

would typically not open at a premium

and would not be hot issues. With a rule

that applies to all IPOs, however, NASD

Regulation is proposing to add

provisions to address circumstances

where purchases by restricted persons

are necessary for the successful

completion of an offering. Amendment

No. 2 contains provisions for stand-by

purchasers that are identical to the

stand-by provisions in the

Interpretation. With respect to the

stand-by provisions, MSDW suggested

imposing minimum capital contribution

requirements and extending the lock-up

requirements from three months to one

year. NASD Regulation does not believe

that these additional requirements are

necessary. Amendment No. 2 also

contains provisions addressing undersubscribed offerings. Specifically, the

proposed rule change states that nothing

in the rule shall prohibit an

underwriter, pursuant to an

underwriting agreement, from placing a

portion of a public offering in its

investment account when it is unable to

sell that portion to the public.

In the October 1999 filing, NASD

Regulation targeted the proposed rule

change to equity offerings only.

Historically, the Interpretation applied

to equity and debt offerings; in a series

of amendments in 1998, however,

NASD Regulation exempted most types

of debt. Several commenters, including

the SIA and Sullivan, expressed support

for the elimination of debt securities

entirely from the rule’s coverage. These

commenters generally believed that debt

offerings do not raise the same issues as

equity offerings and for that reason

should be excluded.

There are a number of other categories

of offerings that NASD Regulation does

not believe should be covered by the

proposed rule change. First, NASD

Regulation recommends exempting

public offerings of investment grade

asset-backed securities as defined in

SEC Form S–3, some of which may

otherwise fall within the definition of

new issue. The Interpretation currently

exempts investment grade, financing

instrument-backed securities and, in

view of the decision to eliminate the 5%

threshold, NASD Regulation believes

that it is appropriate to reinstate the

exemption.

Second, NASD Regulation

recommends exempting convertible

securities.9 NASD Regulation staff has

already exempted many convertible

securities from the Interpretation under

its exemptive authority.10 NASD

Regulation found that in light of the

Interpretation’s current exclusion for

debt securities and secondary offerings,

the failure to exclude convertible

securities led to an anomalous result. A

law firm noted that an issuer could

issue a non-convertible debt security

and make a secondary offering of an

actively traded security and neither

would be subject to the Interpretation.

Yet, if an issuer decided to, in effect,

combine these two securities and issue

a debt security that had the additional

feature of being convertible into an

actively traded security, then the

Interpretation would apply. To correct

this inconsistency, NASD Regulation

staff has used its exemptive authority to

exempt from the Interpretation debt

securities that are convertible into an

actively traded security. NASD

Regulation now proposes to codify this

exemption. However, in view of the

decision to exclude all secondary

offerings from the proposed rule change,

NASD Regulation has expanded the

exemption to include all convertible

securities, not just those that are

convertible into actively traded

securities.

Third, NASD Regulation recommends

exempting preferred securities. In

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76321

11Securities Exchange Act Release No. 40001

(May 18, 1998), 63 FR 28535 (May 26, 1998).

12 Id.

13Schwab also requested an exemption for

persons who, on a volunteer basis, make investment

decisions of behalf of a tax-exempt charitable

organization. NASD Regulation is not proposing

such an exemption. Depending on the particular

facts, NASD Regulation believes the purposes of the

rule may be implicated by a person who manages

the investments of a tax-exempt charitable

organization.

connection with amendments to the

Interpretation in 1998, NASD

Regulation considered, but deferred an

exemption for preferred securities.11

Specifically, NASD Regulation stated

that it would ‘‘evaluate the impact of

excluding investment grade debt and

investment grade financing backed

securities from the Interpretation and

will consider in the future whether

preferred [securities] should also be

excluded.’’12 Based upon its experience

with the 1998 amendments, and the

purposes of the proposed rule change,

NASD Regulation now recommends

excluding preferred securities. On

balance, NASD Regulation believes that

preferred securities exhibit pricing and

trading behavior that more closely

resemble debt than equity securities.

Fourth, NASD Regulation

recommends exempting offerings of

closed-end company securities as

defined under Section 5(a)(2) of the

Investment Company Act of 1940 from

the restriction of the rule. Generally,

when closed-end companies make a

public offering they are seeking as large

an infusion of capital as possible and

will expand the number of shares

offered to meet the demand. These

shares typically commence trading at

the public offering price; if there is a

premium, it is very small. Accordingly,

applying the proposed rule change to

closed-end companies does not further

the purposes of the rule and may impair

the ability of closed-end companies to

obtain capital. NASD Regulation

therefore recommends an exemption for

closed-end companies.

(iii) Portfolio Fund Managers. Another

area that generated a significant amount

of comment was the proposed definition

and treatment of portfolio managers. In

the October 1999 filing, NASD

Regulation proposed a ‘‘more functionoriented approach’’ towards personnel

with respect to the securities activities

of a bank, insurance company,

investment company, investment

adviser, or collective investment

account. NASD Regulation suggested

that only persons who supervise or

whose activities are directly or

indirectly related to the buying or

selling of securities for one of the listed

entities should be restricted. Ropes,

Testa, and Schwab supported this

function-oriented approach, but

believed that the proposed rule change

was still too broad and could reach

persons whose functions were purely

ministerial. These commenters

suggested that the restrictions in the

proposed rule change should apply only

to those persons who have ‘‘the

authority to make investment

decisions.’’ Ropes believed that this

would be a better and more precise

indicator of whether a person is in a

position to direct business to a member.

NASD Regulation believes that this is a

useful clarification and has amended

the proposed rule change accordingly.13

The proposed rule change also sought

to remove the restrictions on persons

who participate in an investment club

or manage a family partnership. Fu,

Sullivan, Smith and Schwab all strongly

supported these changes. Fu, the general

partner of a small investment club,

believed that he had been unfairly

restricted access to IPOs because the

Interpretation treated an investment

club as an ‘‘institutional account.’’

Similarly, Smith viewed her

participation in an investment club as a

‘‘learning and social activity’’ and did

not believe that her participation in an

investment club should affect her, or her

husband’s, ability to purchase an IPO.

Cadwalader noted, however, that, as

drafted, the exemption for investment

clubs and family partnerships would

inadvertently exempt sales to an

investment club or family partnership

consisting solely or predominantly of

restricted persons. NASD Regulation

agrees that this was not an intended

result. To correct this problem, the

proposed rule change no longer exempts

investment clubs or family partnerships

per se, but rather states that

participation in an investment club or

family partnership does not by itself

make a person restricted.

A number of commenters, including

Willkie, Katten, Washington, and

Northern, were strongly opposed to the

restrictions on portfolio managers, and

in particular hedge fund managers,

because they would prohibit a hedge

fund manager from investing in hot

issues through a fund he or she

manages. Although the proposed rule

change allowed portfolio managers and

other restricted persons in aggregate to

own up to 5% of a collective investment

account that invests in hot issues, these

commenters believed that the 5% figure

was too low. They added that investors

generally expect portfolio managers to

make significant investments in

accounts they manage as it helps to

align the managers’ interests with those

of investors. Several commenters,

including Rosenman, Willkie, and

Northern urged NASD Regulation to

exempt hedge fund managers with

respect to the accounts they manage,

while retaining the restriction with

respect to purchases of IPOs in their

personal accounts. Northern, for

example, stated ‘‘[w]e would not be in

favor of letting a hedge fund manager

receive benefits on the side that might

permit the manager to divert hot issues

to his or her own personal account.’’

Willkie added that the fiduciary duty of

a hedge fund manager would prevent

him or her from profiting from new

issues personally at the expense of

hedge fund investors.

Based upon these comments, NASD

Regulation has amended the restriction

on portfolio managers. NASD

Regulation agrees with the commenters

that the 5% exemption in the October

1999 filing did not achieve its intended

purpose and could, as discussed below,

undermine the purposes of the rule by

allowing broker/dealer personnel and

other restricted persons to purchase

substantial quantities of IPOs.

Amendment No. 2 treats a portfolio

manager and certain members of his or

her immediate family as restricted

persons other than with respect to a

beneficial interest in the bank, savings

and loan institution, insurance

company, investment company,

investment adviser, or collective

investment account, over which such

person has investment authority.

Amendment No. 2 thus permits a hedge

fund manager who in not otherwise

restricted to invest in IPOs through a

fund he or she manages. Under

Amendment No. 2, however, a portfolio

manager may not purchase IPOs in his

or her personal accounts. Several

commenters, including Willkie and

Rosenman, proposed language that is

substantively similar to that proposed

by NASD Regulation.

Amendment No. 2 does not define

what constitutes a personal account of

a portfolio manager. NASD Regulation

believes that a number of factors will

contribute to a determination of whether

an account is a personal account. These

factors include, but are not limited to,

the number of beneficial owners in the

account, the identity of the participants,

whether the account participants are

members of the portfolio manager’s

immediate family, the compensation

scheme, the manner in which profits

and losses are distributed, the

expectations of the account participants,

and the overall trading activity in the

account.

76322 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

Despite this change, NASD Regulation

does not believe that the treatment of

portfolio managers in Amendment No. 2

will lead to an environment that is

significantly different from that under

the current Interpretation. Under the

Interpretation, portfolio managers are

entitled to purchase hot issues if such

purchases are, among other things,

consistent with their normal investment

practices. They also are entitled to

receive benefits from new issues in

accounts they manage in the form of

performance fees.

Katten sought clarification on whether

an investment adviser organized as an

entity is a restricted person. Katten

stated that the proposed rule change

treats certain employees of an

investment adviser as restricted but

does not state whether an investment

adviser organized as an entity is a

restricted person. NASD Regulation

believes that the status of an entity

organized as an investment adviser

would depend on the status of its

beneficial owners. If the beneficial

owners are restricted persons because of

their investment advisory activities or

otherwise, then the entity would be a

restricted person.

(iv) Preconditions for Sale/

Documentation. The proposed rule

change streamlined the requirements for

members to demonstrate that sales of

IPOs were made in conformity with the

rule. NASD Regulation replaced the

myriad means for members to

demonstrate that they have not sold

IPOs to restricted persons, with a single

requirement applicable to all accounts—

a representation from the account

holder, or a person authorized to

represent the beneficial owners of the

account, that the account is eligible to

purchase new issues in compliance with

the rule. Colish supported these

changes. The SIA stated that the

requirement as to the type of evidence

that is needed ‘‘is a significant

improvement over current

requirements.’’ Commenters also had

concerns. Schwab and MSDW were

concerned that the proposed rule

change would require an annual mailing

to all customers that may be interested

in purchasing new issues and would

prohibit the use of electronic

communications. The SIA and MSDW

stated that firms should be permitted to

develop their own methods to verify the

status of a customer, including the use

of oral representations so long as such

representations are documented

internally. In response to these

comments, NASD Regulation intends to

state in a Notice to Members

announcing SEC approval of the

proposed rule change that an annual

mailing is not required, and that

electronic or oral communications are

permitted so long as such

communications and the response are

documented internally by the member

firm.

MSDW also stated that the

documentation requirements may

hinder a bona fide public distribution if

members withhold securities from

public customers because they have not

provided the necessary information.

NASD Regulation disagrees and believes

that MSDW’s comment may be based on

a misinterpretation of the nature of the

required documentation. In general,

NASD Regulation does not believe that

adhering to these requirements, even if

it means that certain public customers

cannot purchase IPOs, will cause a

member to fail to make a bona fide

public offering. In addition, NASD

Regulation expects that public

customers will provide the necessary

information or certifications to afford

them the opportunity to purchase IPOs.

NASD Regulation also is maintaining

the interval required for verification at

one year. The SIA, Sullivan, and MSDW

suggested lengthening the verification

period from one year to every two or

three years. By contrast, NASAA

suggested shortening the verification

period to something significantly

shorter than one year, to reflect possible

changes in ownership that could occur

within that period. NASD Regulation

believes that as a matter of policy,

allowing members to wait longer

between verifying that their customers

are eligible to purchase new issues

undermines the effectiveness of the rule.

Currently, under the Interpretation,

verification is required as frequently as

before every sale or as long as every 18

months. With the streamlined

documentation procedures and the

availability of electronic and oral

communications, NASD Regulation

believes that an annual verification

requirement strikes an appropriate

balance between benefit and burden. We

anticipate that in light of the

clarifications made above, the

commenters generally will agree with

NASD Regulation that the burdens of

ensuring that customers are eligible to

purchase IPOs on an annual basis are

not unreasonable. NASAA’s concerns

are addressed by the fact that a member

may not rely on a representation that it

has reason to believe is inaccurate.

Several commenters, including

Cadwalader and Ropers, were

concerned about how the

documentation requirement would

apply in light of the fact that a

customer’s status or percentage

ownership in a collective investment

account may change over the course of

a year. NASD Regulation recognizes that

the potential exists for a customer’s

status under the rule to change, but

believes that members may rely upon

information obtained as part of the

ordinary, annual verification process, so

long as the member does not believe or

have reason to believe that an account

is restricted. Currently, under the

Interpretation, NASD Regulation allows

members to rely upon certain

certifications dated not more than 18

months prior to the date of sale of the

hot issue. Under the proposed rule

change, members would be able to rely,

in good faith, on representations dated

not more than twelve months prior to

the date of sale of the new issue.

On the issue of intent, Schwab stated

that the rule should not impose a strict

liability standard. Specifically, Schwab

believed that a member should not be in

violation of the proposed rule change if

the member is unaware that an account

is beneficially owned by a restricted

person because the customer provided

false information. On this point, we

agree. As stated in the October 1999

filing, a member may rely upon the

information it has received from a

customer unless it believes, or has

reason to believe, that the information is

inaccurate. The proposed rule change

has been amended to expressly include

this standard.

Several commenters, particularly law

firms such as Katten, Schulte,

Rosenman, and Sullivan, sought

guidance on what type of information a

member would be required to review to

determine whether an account is

beneficially owned by restricted

persons, especially in a fund of funds

context. The proposed rule change

allows an account holder, or a person

authorized to represent the beneficial

owners of the account, to represent that

an account is eligible to purchase new

issues. So long as a member has no

reason to believe that the representation

is not accurate, it may rely upon the

representation. Alternatively, a

registered representative may ask

questions of a customer to allow him or

her to determine whether an account is

eligible to purchase new issues under

the rule. The application of the rule

would be the same for a fund of funds.

In that case, a member could secure a

representation from a person authorized

to represent the beneficial owners of the

fund that is purchasing the new issue

from the member (such as the fund’s

general partner) that the account is

eligible to purchase new issues.

Naturally, the ability of a general

partner to make such a representation

will be contingent on his or her

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76323

receiving similar representations from

general partners of the other funds

investing in the fund, or by reviewing

information about the investors in such

funds. However, unlike the current

Interpretation, there are no provisions

requiring certifications by attorneys or

certified public accountants. While

members may wish to rely upon counsel

or an accountant to investigate the

status of an account, such an approach

is no longer required by the rule.

NASD Regulation will announce in

the Notice to Members announcing

approval of Rule 2790 that members

may use negative consent letters in all

but the initial account verification.

Several commenters, including MSDW,

believed that the ability to use negative

consent letters would greatly ease the

burden of complying with the rule

without undermining its effectiveness.

NASD Regulation believes that once a

member firm verifies the status of an

account, it may use negative consent

procedures for each subsequent, annual

verification.

Finally, the SIA asked NASD

Regulation to explore an automated

means of updating certain account

information regarding restricted person

status. While NASD Regulation does not

currently intend to develop such a

system, NASD Regulation is not

opposed to third party vendors

compiling or aggregating information

about the status of persons under the

rule. If a private vendor developed a

reliable automated application to track

the status of purchasers under the rule,

NASD Regulation believes that members

generally could rely upon data from

such a vendor.

(v) De Minimis Exemption. As stated

above, one purpose behind the proposed

rule change is to streamline the rule.

One area in which NASD Regulation

believes that it can benefit investors

without sacrificing the integrity and

protections of the rule is with respect to

certain de minimis owners. The de

minimis ownership exemption avoids

imposing on investors the burden of

creating segregated accounts in those

instances where restricted persons have

only a nominal and passive interest in

an account that purchases new issues.

Commenters appreciated the efficiencies

that the de minimis exemption would

provide and generally urged that it be

expanded.

Several commenters asked NASD

Regulation to expand the de minimis

exemption to include a collective

investment account that is owned 10%

or more by restricted persons. NASD

Regulation, however, does not support

an expansion. One of the rationales for

the de minimis exemption was to

alleviate the impact of the October 1999

filing’s decision to treat portfolio

managers as restricted persons. As

discussed in the previous section, that

issue has been addressed separately.

Thus, a large class of persons for whom

the de minimis exemption was intended

have already been excluded from the

rule. In view of this change, NASD

Regulation is maintaining the de

minimis level at 5%. This comports

with recommendations by Katten,

Schulte, and Rosenman, which

supported a 5% de mimimis level so

long as portfolio managers were

excluded.

Northern noted that as originally

proposed, the de minimis exemption

may ‘‘tempt some brokers to favor hedge

funds that permit the brokers

themselves or their senior executives or

friends to invest in the hedge funds,

which would cut against the purposes of

the NASD proposal.’’ In response to this

comment and to ensure that the de

minimis exemption is consistent with

the purposes of the rule and the public

interest, NASD Regulation has revised

the de minimis exemption to impose a

strict numerical limit of 100 shares on

the number of shares that any one

person can purchase under the de

minimis exemption. In complying with

the 100 share limit, members may look

through an investing entity to a person’s

beneficial interest. The numerical limit

reduces the incentive for self-dealing

and the appearance that restricted

persons are receiving shares at the

expense of public investors. Under

Amendment No. 2, the de minimis

exemption also requires that a restricted

person does not manage or otherwise

direct investments in the account.

Members should be aware that the de

minimis exemption does not allow

restricted persons to purchase 100

shares directly. The de minimis

exemption was developed as an

accommodation to collective investment

accounts with only a small percentage

of restricted persons. Because the sale of

IPOs to such a collective investment

account principally benefits nonrestricted persons, NASD Regulation

believes, for administration purposes, it

should not be necessary to carve-out the

restricted persons or exclude the

account altogether. On the other hand,

direct purchasers of IPOs by restricted

persons do not in any way facilitate a

public distribution and will continue to

be prohibited under the proposed rule

change.

Several commenters, such as

Cadwalader, Ropes, Covington, and

Fried, suggested a variation on the de

minimis exemption in that the proposed

rule change should be amended to

exempt all passive investors in a

collective investment account,

regardless of the size of their interest.

While passive investors have no control

over the investment decisions made by

a collective investment account, their

participation in a particular account

may be known or inferred by the

member allocating new issues. A

passive investor exemption would allow

restricted persons to circumvent the

purposes of the rule by having such

purchases made on their behalf by a

portfolio manager. For these reasons,

NASD Regulation is not proposing to

exempt all passive investors.

NASD Regulation also disagrees with

MSDW’s recommendation that the de

minimis exemption be amended to

apply if a collective investment account

invests less than 10% of its assets in

new issues. For many collective

investment accounts, and certainly all

large accounts, such a limitation would

be tantamount to no limitation at all.

MSDW’s recommendation would allow

a fund comprised solely of broker/dealer

personnel to invest up to 10% of their

assets in new issues. NASD Regulation

believes that such an expansion of the

de minimis exemption is unwarranted

and would be inconsistent with the

purposes of the rule.

Sidley asked whether the proposed

rule change and the creation of the de

minimis exemption eliminated the

ability for collective investment

accounts to create carve-out accounts

that segregate the interests of restricted

persons. NASD Regulation did not

intend for the proposed rule change to

eliminate the ability of a collective

investment account that does not meet

the de minimis exemption to create a

separate account and carve out the

interests of restricted persons from the

account investing in new issues.

Accordingly, an account that wishes to

purchase a greater number of shares

such that a restricted person’s pro rata

allocation would exceed 100 shares, or

an account that wishes to allow

restricted persons to own collectively

more than 5% of the fund’s assets,

would be able to use carve-out

procedures and segregate the new issue

activity from restricted persons to keep

it below the threshold in the proposed

rule. However, unlike the current

Interpretation, the proposed rule change

does not contain detailed procedures

concerning how an account is required

to carve-out the interests of restricted

persons. A member’s obligation under

the proposed rule change is to receive

a representation from the account

holder, or a person authorized to

represent the beneficial owners of the

account, that the account is not

76324 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

14Pub. L. No. 106–102, 113 Stat. 1338 (1999).

15Schedule A of Form BD lists all direct owners

with ownership interests of 5% or more in a broker/

dealer. The ownership level is indicated by various

‘‘ownership codes’’: A for 5% but less than 10%,

B for 10% but less than 25%, and so on. For

purposes of Rule 2790, only persons with a 10% or

more interest, as indicated by ownership codes B

and higher will be restricted persons.

16The exemption does not apply to a broker/

dealer itself. NASD Regulation continues to believe

that broker/dealers, even publicly traded broker/

dealers, should not purchase or withhold IPOs. As

discussed below, NASD Regulation believes that an

exemption for publicly traded companies, even

affiliates of a broker/dealer, was appropriate in light

of protections against self-dealing under NASD Rule

2750, which applies to related persons of the

broker/dealer, but not the broker/dealer itself.

restricted from purchasing new issues

under the rule. At this time, NASD

Regulation does not intend to regulate

the manner in which an account carves

out restricted persons. If NASD

Regulation has reason to believe that

closer scrutiny of carve-out accounts is

necessary, it will consider additional

rulemaking in this area.

Sidley also asked NASD Regulation to

revise the proposal to permit funds to

transfer securities from a carve-out

account to a general account without

undertaking a secondary market

transaction, which it argued is

inefficient and unnecessarily costly.

Sidley correctly noted that current

NASD Regulation policy requires a

transfer from a carve-out account with

non-restricted persons to a fund’s

general account that is beneficially

owned by restricted person to be

effected in a market transaction. Under

the proposed rule change a fund

manager would be permitted to

determine how best to transfer new

issues that he or she intends to keep for

investment purposes from one account

to another, consistent with all other

applicable laws and regulations. NASD

Regulation cautions that where a carveout account purchases new issues with

a view towards distributing such shares

to another account, that such carve-out

account may be viewed as an

‘‘underwriter’’ under section 2(a)(11) of

the Securities Act of 1933.

(vi) Owners of Broker/Dealers. NASD

Regulation has substantially revised the

restrictions on owners of broker/dealers.

The October 1999 filing treated as

restricted persons affiliates of a broker/

dealer and natural persons, and certain

members of their immediate family,

who owned 10% or more, or

contributed 10% or more of the capital

of a broker/dealer. Many of the

commenters, including Willkie, Colish,

Sidley, and the SIA, stated that this

approach was too broad. Several

commenters stated that reaching all

companies that are under common

control with a broker/dealer, and in

particular sister companies, would

reach entities without any nexus to the

securities industry. The commenters

also were concerned about the impact

on affiliates in light of the repeal of the

restrictions on affiliation among banks,

insurance companies and securities

firms under the Gramm-Leach-Bliley

Act of 1999.14

Amendment No. 2 adopts a new

approach and treats as restricted

persons owners of broker/dealers as

defined in Schedule A of Form BD, with

at least a 10% ownership interest,15 and

as defined in Schedule B of Form BD.

NASD Regulation believes that this

approach is desirable from a compliance

perspective because the definitions are

understood by members and the

information is already required to be

maintained. NASD Regulation opted to

use existing ownership standards rather

than create a new concept for purposes

of this rule. From a technical

standpoint, this approach no longer

treats affiliates of broker/dealers as

restricted persons per se. The ownership

provisions look only at the direct and

indirect owners of a broker/dealer.

Moreover, the standard of control for

indirect owners in Schedule B of Form

BD is a 25% interest, not a 10% interest

as proposed in the October 1999 filing.

In this regard, Amendment No. 2 is

narrower in scope than the October

1999 filing.

The rationale for applying the rule to

owners of broker/dealers is

straightforward. A prohibition on a

broker/dealer could be easily

circumvented if IPOs could be

purchased by the broker/dealer’s parent.

Similarly, to avoid circumventing the

restriction on the owners and the

broker/dealer itself, it is necessary for

the rule to prohibit sales of new issues

to any account in which the owner or

broker/dealer has a beneficial interest. If

the rule did not restrict any account in

which a restricted person had a

beneficial interest, restricted persons

could purchase new issues in

downstream affiliates and flow the

profits back up to the restricted person.

The application of the rule to all

accounts in which a restricted person

has a beneficial interest is a

fundamental principle of the proposed

rule change and the Interpretation.

The net effect of these provisions is

that both upstream and downstream

affiliates, including sister companies,

are restricted persons. Although

commenters may view this approach as

unnecessarily broad, NASD Regulation

believes that it is necessary to effectuate

the purposes of the rule. However,

NASD Regulation has made a number of

reforms that we believe address many of

the commenters’ concerns.

The primary source of relief comes

from NASD Regulation’s decision to

exempt sales to and purchases by nearly

all publicly traded companies. The

commenters generally supported the

exemption in the October 1999 filing for

publicly traded companies. Sullivan, for

example, stated ‘‘that a blanket

exemption * * * for sales to publicly

traded corporations would substantially

lighten the administrative burden of

implementing the rule without

undermining the underlying objectives

of the rule in any meaningful way.’’

Amendment No. 2 expands the

exemption for publicly traded

companies to now include all publicly

traded companies listed on a national

securities exchange or traded on the

Nasdaq National Market, even those that

are affiliates of a broker/dealer.16 NASD

Regulation believes that purchases of

new issues by this class of publicly

traded companies, which in turn have

broad public ownership and whose

securities may be purchased by any

investor, is not the type of activity the

rule is designed to prevent. Purchases in

these instances benefit public investors

in much the same way that IPO

purchases by mutual funds benefit their

shareholders. To ensure that purchases

by publicly traded companies do in fact

benefit their shareholders, the

exemption requires that the gains or

losses from the IPOs must be passed on

to shareholders.

The decision to exempt publicly

traded companies in Amendment No. 2

greatly minimizes the rule’s impact on

many financial services conglomerates

and industrial companies that own a

broker/dealer. Where the owner is a

publicly traded company with a broker/

dealer subsidiary, the rule would no

longer apply, either at the parent level

or at the downstream affiliate level.

Thus, for example, a manufacturing unit

of an exchange listed financial services

holding company would not be a

restricted person. For publicly traded

companies, therefore, Amendment No. 2

would exempt sales to and purchases by

affiliates.

NASD Regulation is not, however,

expanding the exemption for owners of

broker/dealers that are private

companies. The purchase of IPOs in this

case does not reach public investors

because ownership of private companies

is not open to the public. NASD

Regulation also is not expanding the

exemption to include owners of broker/

dealers listed solely on a foreign

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76325

17The rationale for the joint back office broker/

dealer exemption was that a collective investment

account registered as a broker/dealer or with a

broker/dealer subsidiary would be precluded from

purchasing new issues even if none of its investors

were restricted persons. Under the revised

definition of beneficial interest, such a collective

investment account would no longer be restricted.

exchange. Sidley was concerned that

limiting the exemption to publicly

traded companies listed on a domestic

exchange would disadvantage publicly

owned foreign companies without a

U.S. listing. Despite these concerns,

NASD Regulation does not believe at

this time that foreign publicly traded

companies should be exempt from the

proposed rule change. Foreign

jurisdictions have various listing

standards and levels of regulatory

oversight. As such, there is greater

potential that a foreign publicly traded

company could be used to circumvent

the purposes of the rule. NASD

Regulation will, however, consider its

experience under the proposed rule

change and may in the future consider

whether it is appropriate to extend the

exemption to publicly traded companies

listed or traded solely on foreign

markets.

Amendment No. 2 also contains an

exemption for the purchase of new

issues by a bank common trust fund or

an insurance company general, separate

or investment account, provided that

the account has investments from 1,000

or more investors, and is not limited

principally to restricted persons. These

exemptions will allow, for example,

private banks and mutual and private

insurance companies with broker/dealer

subsidiaries to purchase new issues for

these accounts. NASD Regulation

believes that, collectively, these

restrictions on the owners of broker/

dealers will address many commenters’

concerns about the application of the

rule to broker/dealer affiliates.

The SIA was concerned that the

proposed rule change would adversely

affect ‘‘asset management affiliates that

manage discretionary accounts as well

as accounts for unaffiliated persons.’’

The SIA stated that to the extent that

affiliates of broker/dealers become

restricted persons under the rule, the

rule should more clearly exempt certain

classes of accounts maintained by

broker/dealers affiliates. The SIA’s

concerns appear unfounded. To the

extent that broker/dealers affiliates

manage accounts for non-restricted

persons, such accounts would not be

restricted under the proposed rule

change. On the other hand, if the SIA is

concerned about accounts at broker/

dealers affiliates that are owned by

restricted persons, NASD Regulation

believes that the rule should apply.

In proposing to allow purchases by

publicly traded companies that are

affiliates of broker/dealers, NASA

Regulation is relying in part on the

restrictions on a member engaged in a

fixed price offering under Rule 2750,

Transactions with Related Persons.

Specifically, Rule 2750 prohibits a

member from selling any securities in a

fixed price offering to any person or

account that is a related person of the

member. NASD Regulation believes that

Rule 2750 addresses the potential for

self-dealing in allocating new issues to

a publicly traded affiliate of a broker/

dealer.

Finally, Sullivan asked why

immediate family members of owners of

broker/dealers were treated differently

than immediate family members of

associated persons of a broker/dealer.

NASD Regulation did not intend for

different treatment of such family

members and has corrected the

proposed rule change.

(vii) Beneficial Interest Definition. At

its own initiative, NASD Regulation is

revising the definition of ‘‘beneficial

interest.’’ The term beneficial interest

was defined in the October 1999 filing

as ‘‘any ownership or other direct

financial interest.’’ NASD Regulation is

aware that members found the reference

to ownership as distinct from a financial

interest misleading. Because the rule is

intended to prohibit sales of new issues

to certain persons who stand to profit

from them, legal ownership, such as that

held by a trustee for beneficiaries, or a

hedge fund for its limited partners, is

not the type of interest that is the focus

of the rule.

NASD Regulation also is

recommending eliminating the term

‘‘direct’’ from the definition. In

determining whether an account is

beneficially owned by restricted

persons, members are often required to

look through a number of investment

vehicles. For instance, if Fund A invests

in Fund B, a member may not sell new

issues to Fund B unless it determines

the sale is consistent with the rule,

taking into account the status of each

beneficial owner of Fund A. To some,

the owners of Fund A may be viewed

as having an ‘‘indirect’’ ownership in

Fund B.

Rosenman stated that the definition of

beneficial interest should specifically

exclude management or performance

based fees that are deferred for bona fide

taxation reasons. Rosenman was

concerned of the effect that deferred

management or performances fees may

have on a hedge fund manager’s interest

in a collective investment account that

he or she manages. Because NASD

Regulation has eliminated the

restrictions on a hedge fund manager

with respect to a collective investment

account that he or she manages, we do

not believe it is necessary to amend the

definition of beneficial interest as

Rosenman suggests.

Finally, as a result of the amendments

to the definition of beneficial interest

and the definition of restricted person,

the conditions that gave rise to the need

for the exemption for joint back office

broker/dealers in the October 1999 filing

have been removed. By clarifying that

beneficial ownership means a financial

interest, such as the right to share in

gains or losses, we have clarified that a

hedge fund broker/dealer’s legal

ownership of securities does not

constitute a beneficial interest for

purposes of the rule. As a result, the

rule no longer needs a separate

exemption for joint back office broker/

dealers.17

(viii) Issuer-Directed Share Programs.

In the October 1999 filing, NASD

Regulation proposed amendments to the

exemption for securities distributed as

part of an issuer-directed share program

to all employees and directors of the

issuer, or an entity that controls, is

controlled by, or is under common

control with the issuer. NASD

Regulation proposed expanding the

scope of employees and directors of the

issuer that are covered by the exemption

to include employees and directors of

sister companies. NASD Regulation also

proposed eliminating the requirement

for a three-month lock up for those

issuer-directed shares that are sold to

restricted persons. Schwab supported

the elimination of the lock-up and

stated that it provides substantive relief

to members who will no longer be

required to investigate the status of

employee or director participants.

Issuer-directed share programs are a

valuable tool in employee development

and retention, and are often an integral

part of the employer/employee

relationship. In recent years, issuerdirected share programs have become

more popular, and issuers have sought

to expand the lists of persons invited to

participate in an IPO to include

business contacts, family and friends. In

general, NASD Regulation believes that

sales directed by an issuer are outside

the scope of activities that the proposed

rule change is designed to address.

Accordingly, Amendment No. 2

proposes to exempt IPO shares that

specifically are directed by the issuer to

such persons as employees, directors,

and friends and family of the issuer.

NASD Regulation believes, however,

that whether directed by the issuer or

76326 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

18NASD Regulation proposes allowing an

employee or director of an issuer to direct shares

in the issuer’s initial public offering to members of

his or her immediate family, even if such persons

are otherwise restricted persons. In recent years, the

staff has been presented with situations in which,

for example, an employee of a issuer wanted to

direct shares to his or her parent, but was unable

to do so because the parent was a restricted person

(and not an employee or director of the issuer). As

amended, the proposed rule change would allow

directed shares to be sold to, for example, a parent

of an issuer’s employee.

19The proposed rule change contains separate

provisions that permit venture capital investors to

participate in IPOs to avoid dilution in a public

offering. NASD Regulation believes that going

beyond these protections for venture capital

investors would be inconsistent with the purposes

of the proposed rule change.

20The CBOE also stated that members that lease

out their seats and who are not engaged in a

securities business should not be restricted persons.

NASD Regulation agrees. NASD Regulation does

not believe that a person who merely leases out a

seat to a broker/dealer should be treated as a

restricted person.

otherwise, broker/dealers, broker/dealer

personnel and their immediate family,

and certain persons acting as finders or

in a fiduciary capacity to the managing

underwriter, should not purchase IPOs,

unless such persons are employees or

directors of the issuer, the issuer’s

parent, or a subsidiary of the issuer or

members of the immediate family of an

employee or director of the issuer.18

Similarly, NASD Regulation disagrees

with MSDW that all non-underwritten

securities directed by the issuer should

be exempt from the proposed rule

change. NASD Regulation believes that

a general exclusion for all issuerdirected or all non-underwritten

securities would be readily susceptible

to abuse. Consequently, NASD

Regulation will continue its practice of

holding a managing underwriter

responsible for ensuring that all

securities that are part of the public

offering are distributed in accordance

with the rule.

As recommended by Testa, the

proposed rule change now expressly

states that for purposes of the issuerdirected exemption only, a parent/

subsidiary relationship is established if

the parent has the right to vote 50% or

more of a class of voting security or has

the power to sell or direct 50% or more

of a class of voting securities of the

subsidiary. NASD Regulation does not

agree with Sullivan that a 10%

ownership standard should apply for

this exemption. NASD Regulation

believes that it is not uncommon for a

member through its merchant banking

activities or otherwise to make venture

capital investments in issuers that

exceed 10% of the issuer’s securities. In

such cases, all employees of the member

would be able to purchase the new

issue. NASD Regulation does not

believe that exempting broker/dealer

personnel by virtue of venture capital

investments is consistent with the

purposes of the rule or the issuerdirected exemption.19

NASD Regulation believes that

Amendment No. 2 strikes the correct

balance between providing issuers with

flexibility to direct shares while

preserving the objectives of the rule.

NASD Regulation also believes that the

issuer-directed exemption should apply

only when shares are in fact directed by

the issuer; if a member firm asks or

otherwise suggests that an issuer direct

securities to a restricted person, NASD

Regulation does not believe that such

securities should be exempt from the

rule.

Sidley suggested that the scope of

permissible purchasers under the issuerdirected share provisions should be

amended to conform with the permitted

categories of offerees set forth in Rule

701 of the Securities Act of 1933. Rule

701 provides an exemption for private

companies to sell securities to their

employees without a need to file a

registration statement. Rule 701

provides an exemption from the

registration provisions of the Securities

Act of 1933 for offers and sales of

securities under certain compensatory

benefit plans or written agreements

relating to compensation. NASD

Regulation believes that this approach is

potentially less broad and is far more

difficult for members to implement.

The SIA, Sullivan, and MSDW all

believed that the proposed rule change

should exclude exchange offers, rights

offerings and offerings made pursuant to

a merger or acquisition. MSDW stated

that ‘‘[i]f rights or other securities are

offered to existing shareholders,

particularly shareholders of a publicly

traded company, it would seem the

purpose of the [proposed rule change]

(i.e., to assure a bona fide public

distribution of securities) is achieved.’’

Sullivan noted that the NASD has

previously stated that the Interpretation

does not apply to ‘‘exchange offers’’ and

‘‘offerings made pursuant to an merger

or acquisition.’’ SIA and MSDW noted

with approval the exemptive relief

NASD Regulation staff has granted in

connection with certain rights offerings.

NASD Regulation agrees with the

commenters and has amended the

proposed rule change to exclude from

the definition of public offering,

exchange offers, rights offerings and

offerings made pursuant to a merger or

acquisition. NASD Regulation also has

codified the staff’s existing exemptive

positions regarding certain directed

share programs. The conditions

imposed on such offerings in the

proposed rule change generally tract

those in the exemptive letters and

continue to ensure that these offerings

are conducted in a manner that is

consistent with the purposes of the

proposed rule.

(ix) Limited Business Broker/Dealers.

The proposed rule change, like the

Interpretation, does not apply to persons

associated with a limited business

broker/dealer. The proposed rule change

defined a limited business broker/dealer

as a broker/dealer whose authorization

to engage in the securities business is

limited solely to the purchase and sale

of investment company/variable

contracts securities and direct

participation program securities. Several

commenters believed that this definition

was too narrow. The CBOE believed that

its market-makers and floor brokers also

should be treated as limited business

broker/dealers.20 The CBOE stated that

‘‘[a]n options market-maker typically is

not a professional equities trader and is

generally removed from the equities

side of trading.’’ The CBOE also stated

that the ‘‘functions of a floor broker on

the CBOE * * * are limited to the

execution of orders for other market

professionals or public customers of

other broker/dealers. Floor brokers, with

the exception of a transaction effected

for their error accounts, do not effect

principal transactions.’’ Despite these

limited activities, NASD Regulation

does not believe that market-makers and

floor brokers should be treated as

limited business broker/dealers.

Notwithstanding the limited nature of

their activities, NASD Regulation

believes that market-makers and floor

brokers are in a position to direct

business to a member. The CBOE also

appeared to recognize the potential for

these individuals to direct business to a

member in seeking to exclude from the

exemption an ‘‘IPO [that] is

underwritten by the broker/dealer

which clears and carries the member’s

professional CBOE business.’’ NASD

Regulation also believes that the

relationships between market-makers

and member firms and floor brokers and

member firms, even in the absence of an

established clearing relationship, may

give rise to preferential allocations of

new issues. Moreover, the potential to

direct business to a member in exchange

for IPOs is just one of the reasons for

restricting broker/dealers. As noted in

the October 1999 filing, the proposed

rule change also is designed to ensure

that industry insiders do not take

advantage of their insider position in

the industry to purchase IPOs for their

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76327

21These requests are similar to requests

previously considered by NASD Regulation. As

noted in Notice to Members 97–30, NASD

Regulation continues to believe that persons

associated with firms engaged solely in proprietary

trading or investment or merchant banking

activities may enter into reciprocal arrangements

with other members that would violate the

purposes of the rule. In Notice to Members 97–30,

NASD Regulation stated that the limited business

broker/dealers definition should not be expanded to

include such firms ‘‘because of the difficulty in

defining those firms’’ and because ‘‘such broker/

dealers may influence or be involved in various

aspects of the underwriting process.’’ Further,

NASD Regulation was concerned that ‘‘such firms

may enter into reciprocal arrangements with other

members that would violate the intent of the

Interpretation.’’

22Under the Interpretation, conditionally

restricted persons can purchase hot issues ‘‘if the

member is prepared to demonstrate that the

securities were sold to such persons in accordance

with their normal investment practice, that the

aggregate of the securities so sold is insubstantial

and not disproportionate in amount as compared to

sales to members of the public and that the amount

sold to any one of such persons is insubstantial in

amount.’’

23This is similar to a request made during the

1994 rulemaking when the exemption for foreign

investment companies was first proposed.

own benefit at the expense of public

customers. NASD Regulation believes

that options market-makers and options

floor brokers are integral to the

functioning of an exchange and properly

characterized and perceived as industry

insiders.

Colish, Washington, and Fried also

believed the definition of limited

business broker/dealers should be

expanded. They suggested including

broker/dealers that do not have any

involvement in the capital formation or

underwriting business, such as marketmakers and electronic communications

networks. Colish suggested including

broker/dealers that engage in private

placements. Washington suggested that

the proposed rule change should apply

only to broker/dealers that engage in an

equity securities business.21 NASD

Regulation disagrees. NASD Regulation

believes that persons associated with

members engaged in these activities are,

like persons associated with other

broker/dealers, in a position to direct

business to, and to enter into reciprocal

arrangements with, other members.

They also are industry insiders. While it

is undoubtedly true that not every

person associated with a member

engaged in these activities is in a

position to enter into reciprocal

arrangements, many persons are. The

proposed rule change, like the current

Interpretation, is a prophylactic rule. It

achieves its goals by applying across a

class of persons to whom sales of IPOs

may violate the purposes of the rule.

In general, the SIA agreed with NASD

Regulation that reciprocal arrangements

between industry members in the

allocation of public offerings must be

prevented. The SIA, however, stated

that a rule targeted towards ‘‘conduct

which has the purpose or effect of

creating reciprocal arrangements, rather

than one [that is] * * * based on

complex definitions of status in the

industry, would better serve the capital

markets and would be more fair to

industry members, their relatives, and

other market participants.’’ The SIA did

not offer any suggestion on how such a

rule would operate in practice. NASD

Regulation believes that a rule that

requires members to determine whether

a particular individual is engaged in

reciprocal arrangements with a broker/

dealer would be difficult both from an

administration and examination

standpoint, and would eliminate the

certainty sought by the proposed rule

change.

(x) Elimination of Conditionally

Restricted Persons. Another significant

reform in the proposed rule change was

the elimination of the so-called

‘‘conditionally restricted’’ status 22 and

the decision to treat persons as either

restricted or non-restricted. Commenters

generally supported the decision to

eliminate the conditionally restricted

status. The proposed rule change

continues to treat persons as either

restricted or non-restricted as NASD

Regulation continues to believe that this

bright-line approach best serves

investors and members.

(xi) ERISA Plans. NASD Regulation

has further simplified the restrictions on

Employee Retirement Income Security

Act (‘‘ERISA’’) plans. The October 1999

filing proposed exempting tax-qualified

plans under ERISA, so long as such

plans were not sponsored by a broker/

dealer or an affiliate. A number of

commenters, including SIA, MSDW,

and Sullivan, believed that this

exemption was unnecessarily narrow

and would exclude a large number of

non-restricted plan participants in plans

sponsored by financial services

companies. The commenters added that

ERISA plans are already subject to a

separate regulatory scheme and that

they were unaware of any perceived or

actual abuses to cause NASD Regulation

to narrow the exemption for ERISA

plans from the current Interpretation.

NASD Regulation agrees with the

commenters that the treatment of ERISA

plans in the October 1999 filing could

reach many non-restricted persons

participating in a plan sponsored by an

affiliate of a broker/dealer. Amendment

No. 2 exempts an ERISA plan that is

qualified under section 401(a) of the

Internal Revenue Code, provided that

such plan is not sponsored solely by a

broker/dealer.

(xii) Foreign Investment Companies.

The October 1999 filing proposed an

exemption for foreign investment

companies that is substantially similar

to the Interpretation. Specifically, it

stated that a foreign investment

company is exempt from the proposed

rule change if: (1) It has 100 or more

investors; (2) it is listed on a foreign

exchange or authorized for sale to the

public by a foreign regulatory authority;

(3) no more than 5% of its assets are

invested in a particular hot issue; and

(4) no person owning more than a 5%

interest in such company is a restricted

person.

MSDW suggested exempting all

foreign investment companies that are

traded on a ‘‘designated offshore

securities market’’ as defined in Rule

902(b) under the Securities Act of

1933.23 NASD Regulation believes that

such an exemption would be too broad.

The standards for inclusion in Rule

902(b) do not appear related to the

concerns underlying the proposed rule

change. Although inclusion in Rule

902(9b) requires oversight by a

governmental or self-regulatory body,

NASD Regulation is not confident that

such regulation would prevent

restricted persons from suing foreign

investment companies to circumvent

the rule. The NASD continues to believe

that it is often difficult to assess the

comparability of a foreign country’s

investment company statutes and

regulation to those in the United States,

particularly as it relates to the purposes

of this rule, and believes, therefore, that

it is necessary to impose certain

conditions.

Colish and Sullivan suggested that

NASD Regulation eliminate the fourth

condition—a requirement that no

person owning more than 5% of the

foreign investment company is a

restricted person—because it is often

difficult to ascertain the ownership of a

foreign investment company. Despite

these concerns, NASD Regulation

believes that this requirement is

necessary to avoid purchases of new

issues by funds with concentrated

ownership interests of restricted

persons.

However, in response to concerns

generally about the exemption for

foreign investment companies, NASD

Regulation has simplified the exemption

by eliminating the 100 person

requirement and the limitation on the

size of the purchase in relation to the

size of the investment company. The

100 person condition basically

76328 Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices

24 15 U.S.C. 78o–3(b)(6).

addressed the same concerns about

concentration of ownership as condition

(4) and, therefore, was eliminated. The

limitation on the size of the purchase in

relation to the size of the investment

company appeared unnecessary and

was potentially burdensome for

members to calculate. Moreover, for

very large funds, the limitation was

meaningless inasmuch as 5% of their

total assets would often exceed the size

of the entire IPO. The other conditions

are maintained.

(xiii) Minor or Technical Revision. In

addition to the changes discussed

above, NASD Regulation made a

number of minor or technical

amendments in response to the

comment letters.

Testa stated that the anti-dilution

provisions, which were similar in scope

to the venture capital provisions of

paragraph (g) of the Interpretation,

applied to natural persons only. Testa

believed that entities as well as natural

persons that have a prior equity

ownership interest in an issuer, should

be able to avail themselves of the antidilution provisions. The omission of

entities in the anti-dilution provisions

was inadvertent and has been changed.

The anti-dilution provisions thus allow

an entity or a natural person investing

in such entity to retain the percentage

equity ownership in the issuer at a level

up to the ownership interest as of three

months prior to the filing of the

registration statement.

Testa also stated that, as a general

matter, family members of a restricted

person who receive ‘‘material support’’

from the restricted person should be

treated similarly to the restricted

person. Testa noted that the proposed

rule change in some cases made an

exemption for a restricted person to

purchase new issues, but did not extend

the exemption to the restricted person’s

immediate family members. NASD

Regulation believes that an exemption

for a restricted person also should be

available to an immediate family

member who is restricted under the

rule, and it has amended the proposed

rule change accordingly.

Several commenters, including Colish

and Washington, stated that the use of

the word ‘‘includes’’ in the definition of

restricted person creates uncertainty by

suggesting that the list is non-exclusive.

NASD Regulation agrees and has

removed the word ‘‘includes’’ from the

definition of restricted person.

Schwab stated that the definition of

restricted person should exlude

consultants or contractors of a broker/

dealer member who are not engaged in

securities-related activities. Schwab

stated that the policy concerns

underlying the rule do not require

restricting these individuals from

participating in new issues. NASD

Regulation agrees that consultants or

contractors of a broker/dealer should

not be restricted persons unless they are

engaged in the investment banking or

securities business. If, for example,

Schwab hires a contractor or consultant

to perform photocopying services or a

compensation survey, it should not

preclude such contractor or consultant

from purchasing new issues. The

definition of restricted person has been

revised to exclude agents of a broker/

dealer who are not engaged in the

investment banking or securities

business.

Schwab also supported the addition

of a bright line definition of ‘‘material

support’’ but believed that the 10%

threshold for support is too low and

recommended that a time frame be

established for measuring support.

NASD Regulation agrees and has revised

the definition of ‘‘material support’’ to

providing more than 25% of a person’s

income in the current or prior calendar

year. Separately, NASD Regulation

recommends clarifying that members of

the immediate family living in the same

household will be deemed to be

providing each other with material

support. Using this language makes

clear that the proposed rule change

establishes a bright line test, and NASD

Regulation will not evaluate material

support issues on a case-by-case basis.

2. Statutory Basis

NASD Regulation believes that

Amendment No. 2 is consistent with the

provisions of section 15A(b)(6) of the

Act,24 and, in general, to protect

investors and the public interest. NASD

Regulation believes that the provision of

Amendment No. 2 protect investors and

the public interest by ensuring that

members make a bona fide public

offering of securities at the public

offering price; ensuring that members do

not withhold securities in a public

offering for their own benefit or use

such securities to reward certain

persons who are in a position to direct

future business to the member; and

ensuring that industry ‘‘insiders,’’

including members and their associated

persons, do not take advantage of their

‘‘insider’’ position in the industry to

purchase new issues for their own

benefit at the expense of public

customers.

B. Self-Regulatory Organizations

Statement on Burden on Competition

NASD Regulation does not believe

that Amendment No. 2 will result in any

burden on competition that is not

necessary or appropriate in furtherance

of the purposes of the Act.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

The Commission received twenty-four

comment letter. NASD Regulation

responded to those comment letters

with Amendment No. 2.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of

publication of this notice in the Federal

Register or within such longer period (i)

as the Commission may designate up to

90 days of such date if it finds such

longer period to be appropriate and

publishes its reasons for so finding or

(ii) as to which the self-regulatory

organization consents, the Commission

will:

(A) By order approve such proposed

rule change, or

(B) Institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning Amendment No.

2, including whether the amendment is

consistent with the Act. Persons making

written submissions should file six

copies therof with the Secretary,

Securities and Exchange Commission,

450 Fifth Street, NW., Washington, DC

20549–0609. Copies of the submission,

all subsequent amendments, all written

statements with respect to the proposed

rule change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to File No.

SR–NASD–99–60 and should be

submitted by December 26, 2000.

Federal Register / Vol. 65, No. 235 / Wednesday, December 6, 2000 / Notices 76329

25 17 CFR 200.30–3(a)(12).

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.25

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–30976 Filed 12–5–00; 8:45 am]

BILLING CODE 8010–01–M

SMALL BUSINESS ADMINISTRATION

[Declaration of Disaster #3309]

State of Oklahoma

As a result of the President’s major

disaster declaration on November 27,

2000, I find that Caddo and Grady

Counties in the State of Oklahoma

constitute a disaster area due to

damages caused by severe storms and

flooding beginning on October 21, 2000

and continuing through October 29,

2000. Applications for loans for

physical damage as a result of this

disaster may be filed until the close of

business on January 26, 2001, and for

loans for economic injury until the close

of business on August 27, 2001 at the

address listed below or other locally

announced locations: U.S. Small

Business Administration, Disaster Area

3 Office, 4400 Amon Carter Blvd., Suite

102, Fort Worth, TX 76155.

In addition, applications for economic

injury loans from small businesses

located in the following contiguous

counties may be filed until the specified

date at the above location: Blaine,

Canadian, Cleveland, Comanche, Custer,

Garvin, Kiowa, McClain, Stephens, and

Washita in the State of Oklahoma.

The interest rates are:

Percent

For Physical Damage:

Homeowners with credit available elsewhere ...................... 7.375

Homeowners without credit

available elsewhere ............... 3.687

Businesses with credit available

elsewhere .............................. 8.000

Businesses and non-profit organizations without credit available elsewhere ...................... 4.000

Others (including non-profit organizations) with credit available elsewhere ...................... 6.750

For Economic Injury: Businesses

and small agricultural cooperatives without credit available

elsewhere .................................. 4.000

The number assigned to this disaster

for physical damage is 330911 and for

economic injury the number is 9J7900.

(Catalog of Federal Domestic Assistance

Program Nos. 59002 and 59008)

Dated: November 29, 2000.

Herbert L. Mitchell,

Acting Associate Administrator for Disaster

Assistance.

[FR Doc. 00–31062 Filed 12–5–00; 8:45 am]

BILLING CODE 8025–01–P

SMALL BUSINESS ADMINISTRATION

[License No.: 09/79–0416]

Notice of Surrender of License

Notice is hereby given that Sundance

Venture Partners II, L.P., located at 5030

E. Sunrise Drive, Suite 200, Phoenix,

Arizona 85044, has surrendered its

license to operate as a small business

investment company under the Small

Business Investment Act of 1958, as

amended (the Act). Sundance Venture

Partners II, L.P., was licensed by the

Small Business Administration on 05/

04/98. Under the authority vested by the

Act and pursuant to the Regulations

promulgated thereunder, the surrender

was acted on this date, and accordingly,

all rights, privileges and franchises

derived therefrom have been

terminated.

(Catalog of Federal Domestic Assistance

Program No. 59.11, Small Business

Investment Companies)

Dated: November 29, 2000.

Donald A. Christensen,

Associate Administrator for Investment.

[FR Doc. 00–31063 Filed 12–5–00; 8:45 am]

BILLING CODE 8025–01–P

SMALL BUSINESS ADMINISTRATION

Small Business Investment

Companies; Increase in Maximum

Leverage Ceiling

13 CFR 107.1150(a) sets forth the

maximum amount of Leverage (as

defined in 13 CFR 107.50) that a Small

Business Investment Company may

have outstanding at any time. The

maximum Leverage amounts are

adjusted annually based on the increase

in the Consumer Price Index published

by the Bureau of Labor Statistics. The

cited regulation states that SBA will

publish the indexed maximum Leverage

amounts each year in a Notice in the

Federal Register.

Accordingly, effective the date of

publication of this Notice, and until

further notice, the maximum Leverage

amounts under 13 CFR 107.1150(a) are

as stated in the following table:

If your Leverageable Capital is: Then your maximum Leverage is:

(1) Not over $18,100,000 ......................................................................... 300 percent of Leverageable Capital

(2) Over $18,100,000 but not over $36,300,000 ..................................... 54,300,000 + [2 × (Leverageable Capital—$18,100,000)]

(3) Over $36,300,000 but not over $54,400,000 ..................................... $90,700,000 + (Leverageable Capital—$36,300,000)

(4) Over $54,400,000 ............................................................................... $108,800,000

(Catalog of Federal Domestic Assistance

Program No. 59.011, small business

investment companies)

Dated: November 30, 2000.

Don A. Christensen,

Associate Administrator for Investment.

[FR Doc. 00–31064 Filed 12–5–00; 8:45 am]

BILLING CODE 8025–01–P

DEPARTMENT OF STATE

[Public Notice 3489]

Office of Defense Trade Controls;

Notifications to the Congress of

Proposed Commercial Export Licenses

AGENCY: Department of State.

ACTION: Notice.

SUMMARY: Notice is hereby given that

the Department of State has forwarded

the attached Notifications of Proposed

Export Licenses to the Congress on the

dates shown on the attachments

pursuant to sections 36(c) and 36(d) and

in compliance with section 36(e) of the

Arms Export Control Act (22 U.S.C.

2776).

EFFECTIVE DATE: As shown on each of

the forty-four letters.

FOR FURTHER INFORMATION CONTACT: Mr.

William J. Lowell, Director, Office of

Defense Trade Controls, Bureau of

Political-Military Affairs, Department of

State (202–663–2700).