Federal Register / Vol. 63, No. 100 /Tuesday, May 26, 1998 / Notices 28535

18Registered persons submit to the authority of

the organizations or states to which they apply for

registration on the Form U–4.

19See 1982 Letter, supra note 9.

20As noted above, persons in this category may

include, for example, for example, senior officers in

a division of a broker-dealer that does not

participate in the member’s securities business. See

March 13 Conversation, supra note 10.

21See NASD Rule 1060(a)(1) and (2).

22See Amendment No. 3, supra note 6.

23See NASD By-Law Article V, Section 2(c).

24 15 U.S.C. 78s(b)(2).

25 17 CFR 200.30–3(a)(12).

1On March 12, 1998, NASD Regulation filed

Amendment No. 1 to the proposal. Amendment No.

1 revised Paragraph (b)(9)(A)(ii) to include the

shares of a member’s parent that are publicly traded

on an exchange or Nasdaq in the exemption granted

for shares of members traded on an exchange or

Nasdaq. Section III of this approval order contains

a further discussion of this amendment. In brief, the

technical amendment was necessary to reflect the

fact that members are often part of a holding

company structure wherein the parent of the

member is the entity that actually trades on an

exchange or Nasdaq. Amendment No. 1 also

corrected a drafting error in the original proposal’s

Paragraph (d) of IM–2110–1 to clarify that both

employees and directors may take advantage of an

exemption for issuer directed securities programs.

Because this amendment is technical the statute

does not require that it be published for comment.

2 15 U.S.C. 78s(b)(1).

3 17 CFR 240–19b–4.

4Securities Exchange Act Release No. 39620

(February 4, 1998), 63 FR 7026 (February 11, 1998).

5See letter from Sullivan & Cromwell to Jonathan

G. Katz, Secretary, SEC, dated March 13, 1998.

CHX’s jurisdiction,18 the proposal also

will facilitate the CHX’s oversight of

such persons by ensuring that the CHX

has the authority to enforce its rules and

the federal securities laws against such

persons.

The CHX’s proposal also protests

investors and the public interest by

noting that a person characterized as an

independent contractor must register

with the CHX if he or she falls within

the definition of registered person. This

position is consistent with the 1982

Letter,19 which stated, among other

things, that an independent contractor

salesperson whose activities are subject

to control by a broker-dealer must be

registered with a SRO. By providing a

clear statement of the CHX’s policy

regarding the registration of

independent contractors, the CHX’s

proposal should help to ensure that

independent contractors who come

within the CHX’s definition of

registered person register with the CHX.

CHX Article VI, Rule 2(c), ‘‘Person

Exempt from Registration,’’ provides

exemptions from registration for

associated persons who functions are

solely and exclusively clerical or

ministerial or who are not actively

engaged in the securities business.20

The Commission notes that the rules of

the National Association of Securities

Dealers, Inc. (‘‘NASD’’) also provide

these exemptions from registration.21

Accordingly, the Commission believes

that these exemptions from registration

are reasonable and raise no new

regulatory issues.

New CHX Article VI, Rule 2(d),

‘‘Other Registration Requirements,’’

prohibits members from making

application for the registration of any

associated person when there is no

intent to employ such person in the

member’s securities business. NASD

Rule 1031(a) also contains this

prohibition. Accordingly, the

Commission believes that this provision

of the CHX’s proposal is reasonable and

raises no new regulatory issues.

The Commission believes that it is

reasonable for the CHX to amend

Interpretation and Policy .01 to indicate

that amendments to Forms U–4 and

BDA regarding any registered person

must be submitted to the CHX within 30

days after the registered person learns

the facts or circumstances requiring the

forms to be revised, or, if the

amendment involves a statutory

disqualification, as defined in the Act,

within 10 days after the disqualification

occurs.22 The Commission notes that the

rules of the NASD contain a similar

provision.23 Accordingly, the

Commission believes that the CHX’s

amendment to Interpretation and Policy

.01 is reasonable and raises no new

regulatory issues.

The Commission finds good cause for

approving Amendment Nos. 2 and 3 to

the proposal prior to the thirtieth day

after the date of publication of notice of

filing thereof in the Federal Register.

Amendment No. 2 clarifies new CHX

Article VI, Rule 2(b) by indicating that

members, as well as associated persons,

are registered persons under CHX

Article VI, Rule 2(b). This change

reflects the inclusion of sole proprietors

within CHX Article VI, Rule 1(b)’s

enumerated list of registered persons

and eliminates an inconsistency that

would arise if the CHX defined

registered persons to include only

persons associated with members and

member organizations. Amendment No.

3 strengthens the CHX’s proposal by

requiring the filing of amendments to

Forms U–4 and BD that involve a

statutory disqualification within 10 days

after the statutory disqualification

occurs. Accordingly, the Commission

believes that it is consistent with

Sections 6 and 19(b) of the Act to

approve Amendment Nos. 2 and 3 on an

accelerated basis.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning Amendment Nos.

2 and 3, including whether Amendment

Nos. 2 and 3 are consistent with the Act.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549. 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 persons, 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 CHX. All

submissions should refer to file number

SR–CHX–98–06 and should be

submitted by June 16, 1998.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,24 that the

proposed rule change (SR–CHX–98–06)

is approved.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.25

[FR Doc. 98–13816 Filed 5–22–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–40001; File No. SR–NASD–

97–95]

Self-Regulatory Organizations; Order

Granting Approval of Proposed Rule

Change By the National Association of

Securities Dealers, Inc. Relating to

Amendments to the Free-Riding and

Withholding Interpretation

May 18, 1998.

I. Introduction

On December 23, 1997,1 the National

Association of Securities Dealers

Regulation, Inc. (‘‘NASD Regulation’’)

filed with the Securities and Exchange

Commission (‘‘SEC’’ or ‘‘Commission’’)

a proposed rule change pursuant to

Section 19(b)(1) of the Securities

Exchange Act of 1934 (‘‘Act’’),2 and

Rule 194–b thereunder.3 Notice of the

proposal appeared in the Federal

Register on February 11, 1998.4 The

Commission received one comment

letter regarding the proposal.5 The
28536 Federal Register / Vol. 63, No. 100 /Tuesday, May 26, 1998 / Notices

6On April 9, 1998. NASD Regulation filed

Amendment No. 2 to the proposal. See letter to

Katherine A. England, Assistant Director, Division

of Market Regulation. Amendment No. 2 responds

to the comment letter submitted by Sullivan and

Cromwell regarding the proposed rule change.

NASD Regulation’s response to the comment letter

is discussed in detail in Section III of this approval

order. Because this amendment is technical the

statute does not require that it be published for

comment.

7The name of this committee has been changed

to National Adjudicatory Council. See Securities

Exchange Act Release No. 39470 (December 19,

1997), 62 FR 67927 (December 30, 1997).

8Securities Exchange Act Release No. 35059

(December 7, 1994), 59 FR 64455, 64457 (December

14, 1994).

commenter generally supported the

proposed rule change with some

modifications.6

The proposal amends Interpretative

Material IM–2110–1 and Rule 2720 to

revise certain aspects of the Free-Riding

and Withholding Interpretation

(‘‘Interpretation’’). The purpose of the

Interpretation is to protect the integrity

of the public offering system by

ensuring that members make a bona fide

public distribution of ‘‘hot issue’’

securities and do not withhold such

securities for their own benefit or use

the securities to reward other persons

who are in a position to direct future

business to the member. Hot issues are

defined by the Interpretation as

securities of a public offering that trade

at a premium in the secondary market

whenever such trading commences.

The Interpretation prohibits members

from retaining the securities of hot

issues in their own accounts and

prohibits members from allocating such

securities to directors, officers,

employees and associated persons of

such members and other broker-dealers.

It also restricts member sales of hot

issue securities to the accounts of

specified categories of persons,

including, among others, senior officers

of banks, insurance companies,

registered investment companies,

registered investment advisory firms

and any other person with such

organizations whose activities influence

or include the buying and selling of

securities. These basic prohibitions and

restrictions are also made applicable to

sales by members of hot issue securities

to accounts in which any such persons

may have a beneficial interest and, with

some exceptions, to members of the

immediate family of those persons

restricted by the Interpretation.

In March 1997, the NASD Regulation

Board of Directors (‘‘Board’’), acting

upon recommendation from the

National Business Conduct Committee

(‘‘NBCC’’) 7 considered various

amendments to the Interpretation. The

Board submitted a series of proposed

rule amendments to the membership for

comment in Notice to Members 97–30.

NASD Regulation received 22 comment

letters in response to Notice to Members

97–30. As described below, the proposal

has been amended in response to these

comments.

II. Summary Description of the

Proposed Rule Change

A. Exemptive Authority

Previously, there has not been a

provision in the Interpretation itself to

allow the NBCC, the Board, or NASD

Regulation staff to grant exemptive

relief. In the past, the NBCC, relying on

the NASD By-Law’s grant of authority to

the Board and its Committees, granted

exemptions in certain unique

circumstances. NASD Rule 9600

delegates exemptive authority in the

Interpretation to the Office of General

Counsel. The Interpretation previously

provided for exemption relief solely in

cases involving sales of issuer-directed

securities to non-employee-director

restricted persons pursuant to Paragraph

(d)(2) of the Interpretation.

As revised, the Interpretation

authorizes NASD Regulation staff, upon

written request and taking into

consideration all relevant factors, to

provide an exemption either

unconditionally or on specified terms

from any or all of the provisions of the

Interpretation, consistent with the

purposes of the Interpretation, the

protection of investors and the public

interest. The proposed rule revisions

also provide that persons may appeal

decisions of NASD Regulation staff to

the National Adjudicatory Council.

B. Treatment of Direct and Indirect

Owner of Broker-Dealers

In 1994, the Interpretation’s definition

of ‘‘associated person’’ was amended to

exempt certain passive investors in

broker-dealers.8 Among other things, the

rule amendments approved in the

instant filing address two limitations

from the previous amendments. First,

the definition of associated person as

previously provided in the

Interpretation did not include nonnatural persons that have an ownership

interest in or have contributed capital to

a broker-dealer. Secondly, the

Interpretation did not affirmatively

specify any ownership levels at which

a natural person becomes an associated

person by reason of his or her

ownership interest in a broker-dealer.

Rather, the Interpretation only specified

when a natural person is not an

associated person.

In Notice to Members 97–30, NASD

Regulation proposed creating a new

definition of ‘‘restricted person.’’

Among other things, commenters

advised the NASD that this approach

would result in confusion because the

term ‘‘restricted person’’ was already

used throughout the Interpretation.

Commenters also observed that when

the proposed restricted persons

provisions were read with other sections

of the Interpretation, the Interpretation

would appear to be so broad as to

preclude purchases by any entity that

owns 10 percent or more of a brokerdealer or any account in which such

entity has a beneficial interest.

Having considered the potential

problems with creating a new definition

of ‘‘restricted person,’’ to clarify the

application of the Interpretation to

natural and non-natural persons, the

Interpretation has been revised by

NASD Regulation to create a new

Paragraph (b)(9) of IM 2110–1.

Paragraph (b)(9)(A) would exempt from

the Interpretation’s prohibitions

purchases by any person who directly or

indirectly owns any class of equity

securities of, or who has made a

contribution of capital to, a member,

and whose ownership or capital interest

is passive and is less than 10 percent of

the equity or capital of a member, as

long as such person purchases hot

issues from a person other than the

member in which it has such passive

ownership and such person is not in a

position by virtue of its passive

ownership interest to direct the

allocation of hot issues.

Alternatively, a second exemption

embodied in Paragraph (b)(9)(A) would

exclude purchases by any person who

directly or indirectly owns any class of

equity securities of, or who has made a

contribution of capital to, a member,

and whose ownership or capital interest

is passive and is less than 10 percent of

the equity or capital of a member, as

long as such member’s shares, or shares

of a parent of such member, are traded

on an exchange or Nasdaq.

In response to commenters’ concerns

that the rule revisions proposed in

Notice to Members 97–30 would

prohibit sales of hot issues to all entities

within many insurance companies that

own a broker-dealer, Paragraph (b)(9)(B)

of the proposal exempts sales of hot

issues to any account established for the

benefit of bona fide public customers of

a person restricted pursuant to

Paragraph (b)(9). This exception

expressly notes that such accounts

would include, but are not limited to, an

insurance company’s general or separate

accounts.
Federal Register / Vol. 63, No. 100 /Tuesday, May 26, 1998 / Notices 28537

Finally, Paragraph (b)(9)(C) retains the

indirect ownership provisions originally

proposed in Notice to Members 97–30.

Specifically, it provides that any person

with an equity ownership or capital

interest in an entity that maintains an

investment in a member shall be

deemed to have a percentage interest of

the entity of the member multiplied by

the percentage interest of such person in

such entity.

C. Exception to the Public Offering

Definition

Heretofore, debt offerings have been

included in the Interpretation’s

definition of ‘‘public offering.’’ The

proposed rule change would provide an

exception from the Interpretation for

debt securities other than debt securities

convertible into common or preferred

stock. This exclusion is based upon the

rationale that such offerings do not raise

the same issues as equity offerings

inasmuch as the price for a particular

debt security generally fluctuates based

on interest rate movements rather than

demand factors. The definition of public

offering also would except financing

instrument-backed securities that are

rated by a nationally recognized

statistical rating organization in one of

the four highest generic rating

categories. Lastly, NASD Regulation has

reconsidered its earlier position and, in

response to comment letters received

regarding Notice to Members 97–30,

revised the term public offering so as to

exclude secondary offerings by an issuer

whose securities are actively traded

securities. The modified Interpretation

defines actively traded securities to

include securities that have a

worldwide average daily trading volume

value of at least $1 million and are

issued by an issuer whose common

equity securities have a public float

value of at least $150 million.

D. Foreign Mutual Funds

Purchases of shares of investment

companies registered under the

Investment Company Act of 1940 were

previously exempt from the

Interpretation based upon the rationale

that the interest of any one restricted

person in an investment company

ordinarily is de minimis and because

ownership of investment company

shares generally is subject to frequent

turnover. The proposed rule revisions

would extend this rationale to the

purchase of shares of foreign investment

companies and thus exempt such shares

from the Interpretation, subject to

verification procedures designed, among

other things, to ensure that the company

is listed on a foreign exchange or

authorized for sale to the policy by a

foreign regulatory authority.

E. Issuer-Directed Share Exemption

In Notice to Members 97–30, NASD

Regulation stated that persons have

requested that the language of Paragraph

(d) of the Interpretation be modified to

clarify that the exemption is available to

employees of the issuer who are

materially supported by a restricted

person and both employees and nonemployee directors. Based upon the

comments received and its own

initiative to clarify and streamline the

issuer-directed securities provisions

more generally, the proposed rule

change modifies Paragraph (d) of the

Interpretation to permit persons

associated with a member and their

immediate family members to purchase

hot issues. The amendments clarify that

the exemptions apply to employees and

directors of a parent or subsidiary of the

issuer, consistent with NASD

Regulation’s past practice.

F. Accounts for Qualified Plans Under

the Employment Retirement Income

Security Act (‘‘ERISA’’)

The Interpretation has not previously

expressly addressed the status of

qualified employee benefit plans under

ERISA. In direct response to the

requests of commenters, the proposed

rule change clarifies the status of such

accounts. To that end, the proposal

incorporates within the Interpretation

itself a prior NBCC interpretation

governing the matter. As a general rule,

NASD Regulation believes qualified

ERISA plans should not be deemed an

‘‘investment partnership or corporation’’

and should not be considered a

‘‘restricted account’’ for purposes of the

Interpretation. The proposed

amendments to the Interpretation

provide guidance, however, in

determining the factual circumstances

wherein a qualified ERISA plan could

be deemed restricted.

III. Comments Letters Received and

Amendment No. 2 to the Proposal

As noted above, the Commission

received one comment letter from

Sullivan and Cromwell. Amendment

No. 2 to the filing responds to the

comment letter and, as discussed below,

amends the proposal to address issues

raised by the Sullivan and Cromwell

letter.

A. Investment Grade Securities

The proposed rule change exempts

from the Interpretation debt securities

(other than debt securities convertible

into common or preferred stock) and

financing instrument backed-securities

that are rated by a nationally recognized

statistical rating organization in one of

its four highest generic rating categories.

Sullivan and Cromwell recommends

that NASD Regulation exempt

‘‘investment grade preferred securities,’’

(i.e., preferred equities) from the

Interpretation based upon its

understanding that prices for such

securities are principally based on

prevailing interest rates and that many

investors view investment grade

preferred securities of different issuers

as being largely fungible.

NASD Regulation does not agree with

Sullivan and Cromwell that ‘‘investment

grade preferred securities’’ should be

excluded from the Interpretation,

because NASD Regulation does not

believe that the prices of investment

grade preferred securities are based on

interest rate movements to the same

extent as investment grade debt. NASD

Regulation believes that demand-side

factors play an important role in the

price of many preferred securities. In

addition, preferred securities generally

differ from investment grade debt in that

they are rarely collateralized. Moreover,

purchasers of preferred securities often

look to the issuer’s business and

management in determining whether to

purchase the security. For these reasons,

NASD Regulation believes that

‘‘investment grade preferred securities’’

should not be excluded from the

Interpretation. Amendment No. 2 to the

filing states, however, that NASD

Regulation will 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 equities should also be

excluded.

B. Paragraph (b)(9) and Direct/Indirect

Owners of Broker-Dealers

In Paragraph (b)(9) of the proposed

rule change, NASD Regulation prohibits

members from selling hot issues to any

person or to a member of the immediate

family of such person who owns or has

contributed capital to a broker-dealer,

other than solely a limited business

broker-dealer as defined in Paragraph (c)

of the Interpretation, or the account in

which any such person has a beneficial

interest, with certain exceptions for

ownership interest of less than 10%.

Importantly, however, Paragraph (b)(9)

exempts sales to the account of a

restricted person that is established for

the benefit of bona fide public

customers.

The Sullivan & Cromwell letter makes

a number of particularized comments,

which are discussed in detail below.

The thrust of Sullivan & Cromwell
28538 Federal Register / Vol. 63, No. 100 /Tuesday, May 26, 1998 / Notices

comments is that Paragraph (b)(9)

should be revised to apply only to

institutions that are ‘‘principally

engaged in the broker-dealer business.’’

In responding to the suggestion, NASD

Regulation notes that it has rejected this

argument many times and continues to

believe that such a narrow approach is

inconsistent with the scope and intent

of the Interpretation. As reiterated in

Amendment No. 2 to the filing, NASD

Regulation is of the opinion that the

proposed revisions by Sullivan and

Cromwell would leave open a

substantial possibility of reciprocal selfdealing among broker-dealer and

owners of broker-dealers.

NASD Regulation notes that the

Interpretation protects the integrity of

the public offering process by ensuring

that members make a bona fide public

distribution at the public offering price

of hot issue securities and do not

withhold such securities for their own

benefit or use such securities to reward

other persons in the financial services

business who are in a position to direct

future business to the member. NASD

Regulation believes the Interpretation

also ensures that members of the

securities industry do not take

advantage of their inside position in the

industry to the detriment of public

investors. In light of the foregoing

rationales, NASD Regulation believes

that persons who own a significant

percentage of a broker-dealer, i.e., 10%

or more, should be restricted under the

Interpretation.

NASD Regulation notes that it has

provided an exemption from the

interpretation for persons that own 10%

or more of a broker-dealer by permitting

such persons to purchase hot issues for

the benefit of bona fide public

customers, or for an ERISA account

pursuant to Paragraph (f)(3). NASD

Regulation does not believe that

permitting such persons to purchase hot

issues for proprietary accounts, even if

such hot issues directly or indirectly

benefit some public shareholder, is

consistent with the purposes of the

Interpretation.

1. Banks and Industrial Companies with

Broker-Dealer Subsidiaries and

Affiliates

Sullivan and Cromwell states in its

letter that it is concerned that the

proposed rule change would affect the

public offering market by making hot

issues unavailable to many institutional

customers, and in particular, banks with

broker-dealer subsidiaries and affiliates.

Sullivan and Cromwell observes that

proposed Paragraph (b)(9) generally

would prohibit the sale of hot issues to

banks with broker-dealer subsidiaries

and affiliates. To the extent that these

banks purchase hot issues on a

proprietary basis, NASD Regulation

believes that the Interpretation should

apply. NASD Regulation notes,

however, that banks with broker-dealer

subsidiaries and affiliates may purchase

hot issues on behalf of bona fide public

customers, pursuant to the exemption

set forth in Paragraph (b)(9).

The proposed rule change also would

prohibit industrial companies that own

broker-dealers, such as General Electric

Company (‘‘GE’’) and Ford Motor

Company (‘‘Ford’’) from purchasing hot

issues for their own account. Here again,

NASD Regulation believes that this is

the correct result. However, companies

such as GE and Ford would be able to

purchase hot issues for an account in

which they have a beneficial interest,

provided that such account is

established for the benefit of bona fide

public customers.

2. Accounts Established for the Benefit

of Bona Fide Public Customers

As stated above, Paragraph (b)(a) of

the proposed rule change contains an

exemption for sales to the account of

any person restricted under this

subparagraph that is established for the

benefit of bona fide public customer.

Specifically, Paragraph (b)(9) states that

such accounts would include

‘‘insurance company general and

separate accounts.’’ NASD Regulation

included these examples because it

understood that investments from such

accounts are passed on directly to

policy holders, i.e., bona fide public

customers.

The Sullivan and Cromwell letter

suggests that the exemption for accounts

established for the benefit of bona fide

public customers applies solely to life

insurance companies. As explained by

NASD Regulation, it was not intended

that the exemption described in

Paragraph (b)(9) apply solely to life

insurance companies. NASD Regulation

intended that the exemption apply

across all industries. Accordingly,

Paragraph (b)(9)(B) of the proposed rule

change has been amended. The revised

language is set forth below. Additions to

the provision are italicized. Language to

be deleted appears in brackets.

This prohibition shall not apply to sales to

the account of any person restricted under

this paragraph established for the benefit of

bona fide public customers, including [an]

insurance company general [or] , separate

and investment accounts and bank trust

accounts.

3. Shares of a Member Traded as Part of

a Holding Company

As originally proposed, Paragraph

(b)(9) of the proposed rule change

would exempt any person who owns

any class of equity securities of, or who

has made a contribution of capital to, a

member, and whose ownership or

capital interest is passive and is less

than 10% of the equity or capital of a

member, so long as such member’s

shares are publicly traded on an

exchange or Nasdaq. Sullivan &

Cromwell states that this exemption

does not properly reflect the fact that

many of the largest broker-dealers are

subsidiaries of publicly traded holding

companies and are not themselves

publicly traded. NASD Regulation

previously addressed this issue in

Amendment No. 1 to the filing.

Amendment No. 1 revises paragraph

(b)(9)(A)(ii) to include within the

exemption shares of a parent of a

member firm that are publicly traded on

an exchange or Nasdaq.

4. Immediate Family Members

Paragraph (b)(9) applies to ‘‘any

person, or to a member of the immediate

family of such person.’’ Sullivan and

Cromwell states that Paragraph (b)(9)

would require a member, for example

Merrill Lynch, to confirm not only that

its customer does not own any Merrill

Lynch Parent stock, but also that none

of his or her immediate family members

owns any such stock. Sullivan and

Cromwell also states that Paragraph

(b)(9) does not exempt immediate family

members who are not materially

supported by the restricted person, as

does Paragraph (b)(2) of the

Interpretation. Sullivan and Cromwell

maintains that it would be almost

impossible for a broker-dealer owned by

a publicly traded holding company to

comply with Paragraph (b)(9) since, on

its face, it would require the brokerdealer to obtain complete information

regarding the securities portfolios of

each of its customers’ immediate family

members. Proposed Paragraph (b)(9),

however, is implicated only by persons

who own 10% or more of a member.

Nevertheless, NASD Regulation believes

that the provisions regarding the

immediate family members of restricted

persons under proposed Paragraph

(b)(9) should not be more restrictive

than the provisions in Paragraph (b)(2),

which pertain to associated persons of

a member. NASD Regulation has

therefore amended Paragraph (b)(9) so

as to exclude immediate family

members who are not materially

supported by restricted persons. Revised
Federal Register / Vol. 63, No. 100 /Tuesday, May 26, 1998 / Notices 28539

Paragraph (b)(9) is set forth below. New

language is italicized.

Sell any of the securities to any person, or

to a member of the immediate family of such

person who is supported directly or indirectly

to a material extent by such person, * * *.

5. Miscellaneous Changes to Paragraph

(b)(9)

Pursuant to Amendment No. 2, NASD

Regulation also corrected an inadvertent

clerical error in Paragraph (b)(9)(C) of

the proposed rule change that was

identified by the Sullivan and Cromwell

comment later. The missing language set

forth below was contained in the

proposed rule change as published in

NASD Notice to Members 97–30, but

was omitted from the rule filing. New

language is italicized. Revised

Paragraph (b)(9)(C) has been amended to

read as follows:

For purposes of this paragraph, any person

with an equity ownership or capital interest

in an entity that maintains an investment in

a member shall be deemed to have a

percentage interest in the member equal to

the percentage interest of the entity in the

member multiplied by the percentage interest

of such person in such entity.

C. Foreign Investment Companies

Paragraphs (f) and (1)(6) of the

proposed rule change would exempt

foreign investment companies i.e.,

foreign mutual funds, organized under

the laws of the foreign jurisdiction, that

have provided to the member a written

certification prepared by counsel or an

independent certified public

accountant, which states that: (1) The

fund has 100 or more investors; (2) the

fund is listed on a foreign exchange or

authorized for sale to the public by a

foreign regulatory authority, (3) no more

than 5% of the fund assets are to be

invested in the hot issue securities being

offered, and (4) any person owning more

than 5% of the shares of the fund is not

a restricted person.

Sullivan and Cromwell states that

while it agrees that an exemption

should be provided for foreign

investment companies, it opposes any

requirement that NASD members obtain

written certification from an attorney or

accountant. Sullivan and Cromwell

proposes instead that NASD Regulation

exempt foreign investment companies

based upon their ‘‘status’’ under foreign

regulatory regimes, for example, any

fund qualified for sale under the

European Union’s Directive on

Undertakings for Collective Investment

in Transferable Securities.

In response to comments received

regarding Notice to Members 97–30, and

to alleviate the burdens associated with

the written certification requirement,

NASD Regulation modified proposed

Paragraph (1)(6) to permit foreign, and

not just U.S., attorneys and accountants

to provide written certifications. NASD

Regulation continues to believe,

however, that written certifications are

an appropriate method of determining

whether a particular foreign investment

company meets the criteria for

exemption from the Interpretation and

does not agree that this requirement

should be eliminated.

Sullivan and Cromwell states in its

comment letter that if written

certifications are to be required, it

recommends two changes. First Sullivan

and Cromwell states that foreign

investment companies, like registered

investment companies, do not

investigate the status of their

shareholders and thus will be unable to

comply with the requirement to certify

that ‘‘any person owning more than 5%

of the shares of the fund is not a person

described in Paragraphs (b)(1), (2), (3),

or (4) of the Rule.’’

NASD Regulation considered this

issue in proposing the exemption for

foreign investment companies but

concluded that the concerns of the

Interpretation that restricted persons do

not indirectly purchase hot issues

through foreign investment companies

were paramount. Accordingly, if a

foreign investment company is owned

more than 5% by a person, an attorney

or accountant must certify that such

person is not a restricted person under

the Interpretation. The attorney or

accountant providing the written

certification required pursuant to

paragraph (1)(6) may rely upon

information supplied by the foreign

investment company and any

shareholder that owns more than 5% of

the foreign investment company. NASD

Regulation is of the opinion that the

shareholder is likely to cooperate with

any request by the foreign investment

company, or its counsel or accountant,

regarding the shareholder’s status under

the Interpretation since the

shareholder’s cooperation may enhance

the foreign investment company’s

investment opportunities by permitting

it to invest in hot issues. As a practical

matter, however, the requirement to

determine whether a more than 5%

shareholder is a restricted person is

unlikely to affect many foreign

investment companies because, as

Sullivan and Cromwell concedes in its

comment letter, each foreign investment

company must have at least 100

shareholders and, consequently, it is

unlikely that the interest of any one

person will exceed the 5% threshold.

Second, Sullivan and Cromwell states

that, as drafted, Paragraph (1)(6) of the

Interpretation would require a member

firm to obtain a written certification

prior to each hot issue sale to a foreign

investment company. Sullivan and

Cromwell views this as unduly

burdensome and recommends that

NASD Regulation revise Paragraph

(1)(6) to be consistent with Paragraph

(f)(2), which states that ‘‘a written

representation shall be deemed to be

current if it is based upon the status of

the account as of a date more than 18

months prior to the date of the

transaction.’’ NASD Regulation agrees

that members should not be required to

obtain a written certification before each

transaction and will adopt the same

standard in effect for certifications made

pursuant to Paragraph (f)(2).

Accordingly, the final sentence of

Paragraph (f)(2) of the Interpretation

shall be amended as set forth below.

New language is italicized.

For purposes of this paragraph (f) and the

certification required pursuant to paragraph

(1)(6). a list or written representation shall be

deemed to be current if it is based upon the

status of the account as of a date not more

than 18 months prior to the date of the

transaction.

In addition to responding to the

Sullivan and Cromwell observations,

Amendment No. 2 corrected proposed

Paragraph (1)(6)(D) to make the

paragraph clearer and more consistent

with other parts of the Interpretation.

The revised paragraph is set forth

below. New language is italicized.

Language to be deleted from the

paragraph appears in brackets.

Any person owning more than 5% of the

share of the fund is not a restricted person

as described in paragraph (b)(1), (2), (3), [or]

(4) or (9) of the [Rule] interpretation.

D. Secondary Distributions

The proposed rule change exempts

from the Interpretation secondary

distributions by an issuer whose

securities are actively-traded securities.

Sullivan and Cromwell supports the

decision to exempt secondary offerings

but objects to the provision in the

definition of ‘‘actively-traded securities’’

that excludes securities issued by the

distribution participant or an affiliate of

the distribution participant. NASD

Regulation’s proposed rule change to

exempt secondary offerings was drafted

to track the exemption for activelytraded securities set forth in the SEC’s

Regulation M. In adopting the

exemption for secondary distributions,

NASD Regulation was focusing on the

average daily trading value and public

float value provisions of Regulation M

exempt securities. NASD Regulation

agrees with Sullivan and Cromwell

concerning secondary offerings of
28540 Federal Register / Vol. 63, No. 100 /Tuesday, May 26, 1998 / Notices

9 15 U.S.C. 78o-3.

10 15 U.S.C. 78o-3.

11 15 U.S.C. 78c(f).

12 15 U.S.C. 78s(b)(2).

13 17 CFR 200.30–3(a)(12).

members or affiliates of members and

proposes revising the definition of

‘’actively-traded securities’’ to extend

the exemption to securities issued by a

distribution participant or an affiliate of

the distribution participant. Paragraph

(1)(7)(A), as amended, is set forth below.

Language to be deleted from the

paragraph appears in brackets.

Actively-traded securities means securities

that have an ADTV value of at least $1

million and are issued by an issuer whose

common equity securities have a public float

value of at least $150 million[; provided,

however, that such securities are not issued

by the distribution participant or an affiliate

of the distribution participant].

Finally, Sullivan Cromwell notes that

Paragraph (l)(1) refers to secondary

distributions ‘‘by an issuer.’’ Sullivan

and Cromwell asks whether secondary

distributions by an existing security

holder are subject to the Interpretation.

If not, Sullivan and Cromwell

recommends amending the text of

proposed Paragraph (l)(1) to extend the

exemption to such distributions. NASD

Regulation did not intend to exclude

from the exemption secondary offerings

by security holders. Accordingly, it has

revised Paragraph (l)(1) as set forth

below. New language is italicized.

Language to be deleted from the

paragraph appears in brackets.

The term public offering shall exclude

secondary distributions by an issuer or any

security holder of the issuer, of [whose

securities are] actively-traded securities.

IV. Conclusion

The Commission has carefully

considered the comments set forth in

the Sullivan and Cromwell letter. As

discussed in detail above, the NASD

Regulation has made a number of

technical amendments to the proposal

in response to the Sullivan and

Cromwell letter, which the Commission

believes are consistent with the spirit of

the Interpretation. Indeed, the

Commission believes the changes to the

proposal which were made pursuant to

Amendment No. 1 and No. 2 will

facilitate the ability of NASD member

firms to comply with the Interpretation,

because the amendments further clarify

the intent of the proposed rule change.

For example, in response to the Sullivan

and Cromwell letter, the Interpretation

was amended to clarify that the

exemption in paragraph (b)(9)(B) for

sales to the accounts of restricted

persons established for the benefit of

bona fide public customers was

intended to apply across all industries,

as opposed to life insurance companies

exclusively. Similarly, Amendment No.

1 to the proposal facilitates member firm

compliance by amending the paragraph

(b)(9)(A)(ii) exemption for shares of a

member traded on an exchange or

Nasdaq to include an exemption for

shares of a member traded as a part of

a holding company. This amendment

fosters member firm compliance with

the Interpretation by recognizing that

many of the largest broker-dealers are

subsidiaries of publicly traded holding

companies and are not themselves

publicly traded.

NASD Regulation has determined not

to revise the proposal in response to

Sullivan and Cromwell’s suggestion that

paragraph (b)(9) of the Interpretation,

which with certain exceptions, prohibits

sales of hit issue securities to any

person who owns or has contributed

capital to a broker-dealer, be revised

such that it only applies to institutions

engaged ‘‘principally in the brokerdealer business.’’ The Commission

agrees with NASD Regulation that such

an amendment is inconsistent with the

scope and intent of the proposal,

because the modification would leave

open a substantial possibility of selfdealing between broker-dealers and

owners of broker-dealers. Accordingly,

the Commission believes NASD

Regulation has a sound investor

protection basis for its decision not to

narrow the scope of paragraph (b)(9) of

the Interpretation as requested by

Sullivan and Cromwell.

The Commission believes the

proposed rule change, as amended, is

consistent with the provisions of section

15(A)(b)(6) of the Act,9 which provides

in pertinent part that the rules of a

national securities association be

designed to prevent fraudulent and

manipulative acts, promote just and

equitable principles of trade and protect

investors and the public interest.

Specifically, the proposal preserves

public confidence in the fairness of the

investment banking and securities

business by ensuring that members of

the investment banking community do

not unfairly benefit from public

offerings by virtue of their positions as

insiders, to the detriment of public

investors. Preservation of investor

confidence in the fairness of the markets

is critical to the continued participation

of all classes of securities marked

participants. The Commission believes,

moreover, that the proposed rule change

is consistent with section 15A(b)((9) 10

in that it will alleviate certain inequities

caused by the Interpretation, which

imposed burdens on competition not

necessary or appropriate in furtherance

of the purposes of the Act.

In approving this proposal, the

Commission notes that it is has

considered the proposal’s impact on

efficiency, competition, and capital

formation.11 The Commission believes

the proposal will facilitate the capital

raising process by removing restrictions

and compliance burdens imposed by the

Interpretation with respect to certain

transactions where application of the

Interpretation does not enhance investor

protection or the public interest. For

example, the proposal excludes from the

definition of public offering secondary

offerings by an issuer whose securities

are actively traded securities. At the

same time, the Interpretation continues

to apply to those securities allocations

that pose a risk of undercutting the

Interpretation’s objective of ensuring a

bona fide distribution of hot issue

securities to the public.

It is therefore ordered, pursuant to

Section 19(b)(2) 12 of the Act, that the

proposed rule change SR–NASD–97–95

be and hereby is approved.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.13

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–13850 Filed 5–22–98; 8:45 am]

BILLING CODE 8010–01–M

SMALL BUSINESS ADMINISTRATION

Notice of Action Subject to

Intergovernmental Review Under

Executive Order 12372

AGENCY: U.S. Small Business

Administration.

ACTION: Notice of Action Subject to

Intergovernmental Review Under

Executive Order 12372.

SUMMARY: The Small Business

Administration (SBA) is notifying the

public that it intends to grant the

pending applications of 22 existing

Small Business Development Centers

(SBDCs) for refunding on October 1,

1998, subject to the availability of funds.

Four states do not participate in the EO

12372 process, therefore, their addresses

are not included. A short description of

the SBDC program follows in the

supplementary information below.

The SBA is publishing this notice at

least 90 days before the expected

refunding date. The SBDCs and their

mailing addresses are listed below in

the addresses section. A copy of this

notice also is being furnished to the