Document ID: SEC-2010-0415-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: National Association of Securities Dealers, Inc. (n/k/a Financial IndustryRegulatory Authority, Inc.)
Posted Date: 2010-03-18T04:00Z

[Federal Register: March 18, 2010 (Volume 75, Number 52)]
[Notices]               
[Page 13176-13181]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18mr10-113]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61690; File No. SR-NASD-2003-140]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); 
Notice of Filing of Proposed Rule Change, as Modified by Amendment No. 
3, Relating to the Prohibition of Certain Abuses in the Allocation and 
Distribution of Shares in Initial Public Offerings (``IPOs'')

March 11, 2010.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 15, 2003, the National Association of Securities Dealers, 
Inc. (``NASD'') (n/k/a Financial Industry Regulatory Authority, Inc. 
(``FINRA'')) \3\ filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared 
substantially by FINRA. NASD amended the proposed rule change on 
December 9, 2003 and August 4, 2004. FINRA amended the proposed rule 
change on February 17, 2010.\4\ The Commission is publishing this 
notice to solicit comments on the proposed rule change, as modified by 
Amendment No. 3, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On July 26, 2007, the Commission approved a proposed rule 
change filed by the NASD to amend the NASD's Certificate of 
Incorporation to reflect its name change to Financial Industry 
Regulatory Authority, Inc., or FINRA, in connection with the 
consolidation of the member firm regulatory functions of NASD and 
NYSE Regulation, Inc. See Securities Exchange Act Release No. 56146 
(July 26, 2007), 72 FR 42190 (August 1, 2007) (SR-NASD-2007-053).
    \4\ The text of the proposed rule change in Amendment No. 3 
replaces and supersedes the text in the original rule filing and 
Amendment Nos. 1 and 2 thereto.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing Amendment No. 3 to SR-NASD-2003-140, a proposed 
rule change to further and more specifically prohibit certain abuses in 
the allocation and distribution of shares in initial public offerings 
(``IPOs''). The text of the proposed rule change in Amendment No. 3 
replaces and supersedes the text in the original rule filing and 
Amendment Nos. 1 and 2 thereto.
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA 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. FINRA 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
    On September 15, 2003, NASD (n/k/a FINRA) filed with the SEC SR-
NASD-2003-140, a proposed rule change to adopt new FINRA Rule 5131 
(originally proposed as NASD Rule 2712) to address disclosure and 
management of conflicts of interests that may adversely affect the 
allocation and distribution of IPOs. The proposed rule change also is 
intended to sustain public confidence in the IPO process, which is 
critical to the continued success of the capital markets. The SEC 
published the proposed rule change for notice and comment on December 
20, 2004 and received twelve comment letters.\5\
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    \5\ See Securities Exchange Act Release No. 50896 (December 20, 
2004), 69 FR 77804 (December 28, 2004) (``Proposing Release'').
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    FINRA is filing this Amendment No. 3 to address the substantive 
issues raised by commenters and to clarify and streamline the proposed 
rule. Among other things, the revisions simplify the spinning 
provision, clarify the scope of the lock-up disclosure and returned 
shares provisions and propose several new defined terms.

Proposed Rule 5131(b)--Spinning

    FINRA is eliminating the presumption that any allocation within the 
prior six months of the receipt of investment banking business would 
violate the spinning provision. Instead, FINRA is proposing an outright 
prohibition on allocations in certain specified situations where a 
client relationship exists, where compensation has been received or 
where a member intends to provide or expects to be retained for 
investment banking services. Specifically, FINRA is proposing 
amendments to clarify that the spinning prohibition would apply to 
allocations to the account of an executive officer or director of a 
current investment banking client of the member in addition to 
companies from which the member has received investment banking 
compensation during the past twelve months. Further, FINRA is proposing 
to narrow the forward-looking window to three months in order to 
capture circumstances during such period where the member intends to 
provide, or expects to be retained by the company for, investment 
banking services within the next three months.
    FINRA is adding Supplementary Material .01 to provide that the 
spinning prohibition would not apply to allocations of securities that 
are directed in writing by the issuer, its affiliates or selling 
shareholders, so long as the member has no involvement or influence, 
directly or indirectly, in the allocation decisions of the issuer, its 
affiliates or selling shareholders with respect to such issuer-directed 
securities. In addition, to clarify the scope of the types of accounts 
to which the spinning restrictions would apply, FINRA is proposing a 
new defined term ``account of an executive officer or director.'' The 
proposed definition would mean any account in which an executive 
officer or director of a company, or a person materially supported by 
such executive officer or director, has a financial interest or over 
which such executive officer, director,

[[Page 13177]]

or materially supported person has discretion or control, other than 
(A) an investment company registered under the Investment Company Act 
of 1940 and (B) any other investment fund over which neither an 
executive officer, director, or materially supported person has 
discretion or control, provided that executive officers, directors, and 
materially supported persons collectively own interests representing no 
more than 25% of the assets of such fund.

Proposed Rules 5131(d)(2)(B) and 5131(d)(3) and (4)--IPO Pricing and 
Trading Practices

    FINRA is proposing to exempt from the notice and disclosure 
requirements releases and waivers effected solely to permit transfers 
of securities that are not for consideration where the transferee has 
agreed in writing to be bound by the same lock-up agreement terms in 
place for the transferor. FINRA believes that, where the transfer is 
not for consideration and the transferee is bound by the same terms, 
the concerns that generally would prompt the need for disclosure under 
the proposal are mitigated.
    In addition, FINRA is proposing to amend the provision addressing 
the agreement among underwriters, which provides that the agreement 
between the book-running lead manager(s) and other syndicate members 
must require that any shares returned by a purchaser to a syndicate 
member after secondary market trading commences be used to: (a) Offset 
the existing syndicate short position, or (b) if no syndicate short 
position exists, the member must offer returned shares at the public 
offering price to unfilled customers' orders pursuant to a random 
allocation methodology. Because the allocation concerns underlying the 
proposed rule only exist where the market price of the returned shares 
is above the IPO price, FINRA is proposing to amend the proposed rule 
to provide that the returned shares provision would only be applicable 
where such shares are trading at a premium to their IPO price. In 
addition, because a reallocation of returned shares may extend the 
distribution of the securities for the purposes of SEC Regulation M, 
FINRA reminds members of their responsibility to undertake 
reallocations under the proposal in a manner that also is not 
inconsistent with SEC Regulation M.
    FINRA also is proposing to limit the prohibition on the acceptance 
of market orders to the period prior to the commencement of secondary 
market trading in the IPO. Therefore, once a trading price on the 
secondary market has been established, members may accept market orders 
from customers, even on the first day of trading. FINRA believes that 
this revised approach strikes an appropriate balance by helping to 
avoid inadvertent purchases at prices that do not reflect an investor's 
true investment decision nor reasonable expectations, while limiting 
the scope and duration of the prohibition to address the pre-open entry 
of market orders occurring prior to the availability of last trade 
price information.

Definitions

    FINRA is proposing to add a definition of ``investment banking 
services'' substantially similar to that found in the research rules. 
The proposed definition of ``investment banking services'' would 
include ``acting as an underwriter, participating in a selling group in 
an offering for the issuer or otherwise acting in furtherance of a 
public offering of the issuer; acting as a financial adviser in a 
merger, acquisition or other corporate reorganization; providing 
venture capital, equity lines of credit, private investment, public 
equity transactions (PIPEs) or similar investments or otherwise acting 
in furtherance of a private offering of the issuer; or serving as 
placement agent for the issuer.''
    FINRA also is proposing a definition of ``IPO'' to mean the 
``initial public offering of an issuer's equity securities, which 
offering is registered under the Securities Act of 1933 and as a result 
of which the issuer becomes a public company.'' The proposed definition 
of ``public company'' means ``any company that is registered under 
Section 12 of the Securities Exchange Act of 1934 or files periodic 
reports pursuant to Section 15(d) thereof.''
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no less than 90 and no 
more than 180 days following publication of the Regulatory Notice 
announcing Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\6\ which require, among 
other things, that FINRA rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the new, specifically targeted 
provisions in the proposed rule change will aid member compliance 
efforts and help to maintain investor confidence in the capital 
markets.
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    \6\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The SEC published the proposed rule change for notice and comment 
on December 20, 2004 and received twelve comment letters.\7\ Commenters 
generally supported rules to address abuses in the allocation and 
distribution of IPOs, but expressed concerns regarding the operation of 
specific proposed provisions and requested clarification, as further 
discussed below.
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    \7\ See Letter from Christopher J. Ailman, Chief Investment 
Officer, California State Teachers' Retirement System (CalSTRS), to 
Jonathan Katz, Secretary, SEC, dated March 27, 2006; Letter from 
Christianna Wood, Senior Investment Officer, CalPERS Global Equity, 
to Jonathan Katz, Secretary, SEC, dated March 13, 2006; Letter from 
Phil Angelides, California State Treasurer; Michael Fitzgerald, Iowa 
State Treasurer; Randall Edwards, Oregon State Treasurer; Richard 
Moore, North Carolina State Treasurer; Alan Hevesi, New York 
Comptroller; George Philip, New York State Teachers' Retirement 
System; and Orin S. Kramer, Chairman, New Jersey State Investment 
Council, to Jonathan Katz, Secretary, SEC, dated December 30, 2005; 
Letter from Eliot Spitzer, Attorney General, Office of the Attorney 
General, State of New York, to Jonathan Katz, Secretary, SEC, dated 
December 30, 2005; Letter from Michael Touff, Senior Vice President 
and General Counsel, M.D.C. Holdings (MDC), to Jonathan Katz, 
Secretary, SEC, dated November 1, 2005; Letter from Dixie L. 
Johnson, Committee Chair, Committee on Federal Regulation of 
Securities, Business Law Section, American Bar Association (ABA), to 
Jonathan Katz, Secretary, SEC, dated March 8, 2005; Letter from 
Edward M. Alterman, Fried, Frank, Harris, Shriver & Jacobson LLP 
(Fried Frank), to Jonathan Katz, Secretary, SEC, dated February 27, 
2005; Letter from John Faulkner, Chairman, SIA Capital Markets 
Committee, Securities Industry Association (SIA), to Jonathan Katz, 
Secretary, SEC, dated February 15, 2005; Letter from Ross Langill, 
to the SEC, dated January 20, 2005; Letter from Mark G. Heesen, 
President, National Venture Capital Association (NVCA), to Jonathan 
Katz, Secretary, SEC, dated January 19, 2005; Letter from 
Renaissance Capital, to the SEC, dated January 18, 2005; and Letter 
from Dixie L. Johnson, Committee Chair, Committee on Federal 
Regulation of Securities, and Peter W. LaVigne, Chair, NASD 
Corporate Financing Rules Subcommittee, Committee on Federal 
Regulation of Securities, Business Law Section, American Bar 
Association, to Jonathan Katz, Secretary, SEC, dated January 4, 2005 
(available at http://www.sec.gov/rules/sro/nyse/nyse200412.shtml).
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Prohibition on Abusive Allocation Arrangements
    Proposed Rule 5131(a) (originally proposed as NASD Rule 2712(a)) 
would

[[Page 13178]]

prohibit a member from offering or threatening to withhold shares it 
allocates in an IPO as consideration or inducement for the receipt of 
compensation that is excessive in relation to the services provided by 
the member (i.e., quid pro quo allocations). While commenters largely 
supported this proposal as an important safeguard against abusive 
activity, a few requested clarification with respect to its intended 
scope.
    For example, one commenter requested that the proposal be limited 
to compensation that is ``clearly excessive.'' \8\ FINRA does not 
support this change and believes that the modifier ``clearly'' 
ironically makes the standard less clear as it would introduce 
uncertainty around what is ``excessive'' versus ``clearly excessive.'' 
Moreover, FINRA believes that compensation that is ``excessive'' is the 
appropriate standard for establishing improper quid pro quo activities.
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    \8\ See SIA.
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    Commenters also requested that FINRA provide additional guidance to 
clarify that, in determining whether or not compensation is excessive, 
all the facts and circumstances surrounding the services provided will 
be considered including, among other things, the risk and effort 
involved in the transaction.\9\ A commenter further noted that while 
some fees can easily be benchmarked, other fees may be more highly 
negotiated due to the more customized nature of the services provided 
and this should be considered in determining whether or not a fee is 
excessive.\10\ Commenters also requested that FINRA clarify that 
trading fees earned from certain wash sale transactions would not be 
deemed excessive if entered into for a valid purpose.\11\
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    \9\ See ABA and SIA.
    \10\ See SIA.
    \11\ See ABA.
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    FINRA agrees that an assessment of whether compensation is 
excessive will be based upon all of the relevant facts and 
circumstances including, where applicable, the level of risk and effort 
involved in the transaction and the rates generally charged for such 
services. Likewise, given that a determination of what is ``excessive'' 
compensation will involve a consideration of all the relevant facts and 
circumstances, FINRA cannot clarify whether or not compensation for a 
particular wash sale transaction will be deemed excessive. While NASD 
(n/k/a FINRA) has stated in the Proposing Release that trading activity 
that serves no economic purpose other than to generate compensation for 
the member (such as certain wash sales) would be considered excessive, 
if a wash sale has an economic purpose, that factor will be considered 
in assessing whether the transaction has an economic purpose, and in 
turn whether the trading fees for such sales are excessive.\12\
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    \12\ We note this would not affect the determination as to 
whether the wash sale transaction violated the anti-fraud provisions 
of the securities laws.
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Prohibition on Spinning
    Proposed Rule 5131(b) (originally proposed as NASD Rule 2712(b)) 
would prohibit the allocation of IPO shares to an executive officer or 
director of a company, or to persons materially supported by such 
person, if the member received compensation from the company for 
investment banking services in the past 12 months or expects to receive 
or intends to seek investment banking business from the company in the 
next 6 months. The proposal included a rebuttable presumption that, 
where a firm allocates IPO shares to an executive officer or director 
of a company and then subsequently receives investment banking business 
from that company, the allocations would be deemed to have been made 
with the expectation or intent to receive such business. Finally, the 
proposed provision would prohibit allocations made on the express or 
implied condition that the executive officer or director, on behalf of 
the company, would direct future investment banking business to the 
member.
    Commenters generally supported the adoption of a rule that would 
address the practice of spinning, but expressed concern that the 
proposal is overbroad and would lead to compliance difficulties.\13\ 
Specifically, commenters opposed the six-month forward-looking 
presumption in that it would shift the burden of proof to member firms 
to demonstrate that a past allocation was not part of a quid pro quo 
arrangement for investment banking business.\14\ In addition, 
commenters were concerned that the length of the presumption had the 
potential to implicate too many past IPO allocations that were 
unrelated to a subsequent award of investment banking business.\15\ In 
addition, some commenters proposed that, if adopted, the six-month 
forward-looking period should be reduced to three months, which is the 
standard currently required for addressing conflicts of interest in the 
research analyst rules.\16\
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    \13\ See ABA and SIA.
    \14\ See ABA, MDC and SIA.
    \15\ See ABA.
    \16\ See SIA.
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    FINRA is proposing to narrow the forward-looking window to prohibit 
allocations in cases where the member intends to provide, or expects to 
be retained by the company for, investment banking services over the 
next three months. FINRA believes that a three-month window, combined 
with the prohibition on allocations based on the express or implied 
condition that the member will be retained for future investment 
banking business as set forth in paragraph 5131(b)(3), will 
sufficiently addresses this conflict of interest.
    In addition, FINRA has eliminated the presumption that all 
allocations within the prior specified period are violations of the 
rule. Where an executive officer or director receives an IPO allocation 
and the investment bank is subsequently retained for the performance of 
investment banking services within the three-month window by such 
executive officer or director's employing firm, FINRA will investigate 
what particular information about the business relationship was known 
by the firm, including a review of the communications between the 
broker-dealer and the investment banking client as well as the member's 
systems for logging and managing prospective and current client and 
transaction information.
    FINRA also is proposing revisions to clarify that the spinning 
prohibition would apply to allocations to an executive officer or 
director of a current investment banking client of the member (in 
addition to companies from which the member has received investment 
banking compensation during the past twelve months). FINRA believes 
that, in all cases, allocations to executive officers and directors of 
existing clients should be prohibited, and that allocations should not 
be permitted due to the compensation schedule between the client and 
the member where the business relationship falls within the specified 
windows.
    Commenters also raised concerns regarding the provision prohibiting 
the allocation of IPO shares to an executive officer or director on the 
``express or implied'' condition that such executive officer or 
director, on behalf of the company, will retain the member for the 
performance of future investment banking services.\17\ Commenters 
expressed concern that the prohibition on IPO allocations based on an 
``implied condition'' to retain the member for future investment 
banking business injects a level of uncertainty that may prevent 
members from selling IPO securities to executive officers and

[[Page 13179]]

directors as the result of a legitimate business relationship and, 
therefore, may interfere with the ability of members to allocate 
securities to customers.\18\ FINRA does not believe that the 
commenters' concerns warrant a change to the proposed rule. An 
effective prohibition on spinning must, in FINRA's view, address 
express as well as implied relationships and arrangements.
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    \17\ See ABA.
    \18\ See ABA.
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    Several commenters requested an exemption from the spinning 
provision for allocations to executive officers and directors that were 
directed by the issuer (``issuer-directed shares'').\19\ Commenters 
believed that, because underwriters do not control these allocations, 
they do not give rise to the regulatory concerns that the proposed rule 
change is intended to address.\20\ Commenters further noted that 
issuers have long included their own officers and directors in directed 
share programs, and that it would be a dramatic departure from that 
practice if the final rules did not include an exception for issuer-
directed shares.\21\ Commenters requested that an exception be provided 
for allocations directed by an issuer, its affiliates or selling 
shareholders.\22\
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    \19\ See ABA, Fried Frank and SIA.
    \20\ See ABA and SIA.
    \21\ See SIA.
    \22\ See ABA and SIA.
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    FINRA believes that so long as the member has no involvement or 
influence, directly or indirectly, in the allocation decisions of an 
issuer, its affiliates or selling shareholders, allocations directed by 
such parties should fall outside of the spinning prohibitions. 
Accordingly, FINRA is adding Supplementary Material .01 to provide that 
the spinning prohibition would not apply to allocations of securities 
that are directed in writing by the issuer, its affiliates or selling 
shareholders, so long as the member has no involvement or influence, 
directly or indirectly, in the allocation decisions of the issuer, its 
affiliates or selling shareholders with respect to such issuer-directed 
shares.
    Along with the carve-out for issuer-directed sharers, commenters 
also requested an exemption for allocations made by a separately 
organized investment adviser.\23\ While FINRA notes that the Voluntary 
Initiative, in addition to exempting issuer-directed allocations, also 
exempted allocations directed by a separately organized investment 
adviser, FINRA is not proposing a similar carve-out for investment 
advisers. FINRA believes that the purpose of providing an exception for 
issuer-directed shares is to clarify that, in cases where the member is 
effecting an allocation made by the issuer, its affiliates or selling 
shareholders without the direct or indirect involvement or influence of 
the member, the member would not be prohibited from carrying out such 
directives. In contrast, where an allocation is being directed by a 
party other than the issuer (e.g., a separately organized investment 
adviser), there is a higher risk that improper incentives would 
motivate such party's decision to allocate shares to the account of an 
executive officer or director of a company that falls within the 
purview of the proposed rule. Providing an exception for allocations by 
separately organized investment advisers would create a significant 
loophole through which the member and its affiliates may indirectly 
engage in the same abusive conduct the spinning rule is designed to 
address.
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    \23\ See ABA and SIA.
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    To comply with the proposed spinning provision, members would be 
required to determine whether an account is an ``account of an 
executive officer or director'' prior to making an allocation of IPO 
shares in order to avoid violating the rule. Commenters expressed 
concern regarding the compliance burden of tracking executive officers 
and directors and those materially supported by them, and requested 
that the rule be limited to apply only to the officers and directors 
themselves and immediate family members living in the same 
household.\24\ FINRA believes that limiting the scope of the rule only 
to relatives residing in the same household is too narrow and could 
open up means of circumventing the rule. In addition, the proposed 
definition of ``material support'' is substantively similar to that 
found in FINRA Rule 5130 (Restrictions on the Purchase and Sale of 
Initial Equity Public Offerings), with respect to the purchase and sale 
of ``new issue'' securities. FINRA believes that members can comply 
with the proposed provision by developing policies and procedures 
reasonably designed to identify those persons covered within the scope 
of the proposed rule. Therefore, FINRA believes that the appropriate 
scope of the rule is to reach executive officers and directors as well 
as those who they ``materially support.''
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    \24\ See ABA and SIA.
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    Commenters also stated that the rule should be limited to officers 
and directors of a U.S. public company or where the securities of the 
officer or director's company are principally traded in the U.S.\25\ 
FINRA believes that the proposed prohibitions should apply to member 
conduct in the area prescribed, irrespective of where the recipient's 
company is domiciled or in what jurisdiction the securities of the 
recipient's company principally trade. Furthermore, spinning abuses 
also are possible where the recipient's company is not yet a public 
company, e.g., companies seeking to conduct their first initial public 
offering are often actively solicited by member firms.\26\
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    \25\ See SIA.
    \26\ FINRA notes, however, that the proposed new definition of 
an ``IPO'' (discussed below) is limited to the securities of a U.S. 
registered company.
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    In addition, in order to clarify the scope of the types of accounts 
to which the spinning restrictions would apply, FINRA is proposing a 
new defined term ``account of an executive officer or director.'' The 
proposed definition would mean any account in which an executive 
officer or director of a company, or a person materially supported by 
such executive officer or director, has a financial interest or over 
which such executive officer, director, or materially supported person 
has discretion or control, other than (A) an investment company 
registered under the Investment Company Act of 1940 and (B) any other 
investment fund over which neither an executive officer, director, or 
materially supported person has discretion or control, provided that 
executive officers, directors, and materially supported persons 
collectively own interests representing no more than 25% of the assets 
of such fund. FINRA believes that the proposed exceptions for 
registered investment companies and any other fund in which covered 
persons' collective interests are limited to 25% of the fund's assets 
will prevent firms from indirectly allocating IPOs to executive 
officers and directors.
IPO Pricing and Trading Practices
    Commenters generally supported the proposals related to IPO Pricing 
and Trading Practices; however some commenters expressed concern 
regarding certain provisions. Commenters argued that the notice and 
public disclosure requirements relating to lock-up agreements would 
result in a flood of meaningless information and that, therefore, at a 
minimum, only the release of a significant amount of shares should be 
required to be disclosed.\27\ Commenters also requested that FINRA 
require notification two days prior to

[[Page 13180]]

the ``sale'' rather than the ``release'' or ``waiver'' of a lock-
up.\28\
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    \27\ See ABA and SIA.
    \28\ See generally ABA and SIA.
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    FINRA continues to believe that public disclosure should be 
required for releases and waivers permitting the transfer of securities 
subject to a lock-up agreement, and that such disclosure should be made 
two business days prior to the impending release. However, FINRA is 
proposing to exempt from the notice and disclosure requirements 
releases and waivers effected solely to permit a transfer of securities 
that are not for consideration and where the transferee has agreed in 
writing to be bound by the same lock-up agreement terms in place for 
the transferor. Where the transfer is not for consideration and the 
transferee is bound by the same terms, the concerns that generally 
would prompt the need for disclosure under the proposal are mitigated.
    Commenters requested that FINRA permit the disclosure of the 
required information through any method permitted under SEC Regulation 
FD.\29\ A commenter also requested that FINRA clarify that the natural 
expiration of a lock-up need not be preceded by a public announcement 
where such expiration is disclosed in the IPO prospectus.\30\
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    \29\ See ABA and SIA.
    \30\ See SIA.
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    FINRA believes that any news service used by issuers for providing 
public disclosure of material information pursuant to SEC Regulation FD 
would satisfy the proposed rule's requirement that public disclosure be 
made ``through a major news service.'' FINRA also agrees that notice 
and public disclosure is not necessary for the natural expiration of a 
lock-up already disclosed in the prospectus. However, FINRA does not 
believe that it is necessary to make these clarifications in the rule 
text.
    One commenter requested that FINRA clarify that the notice 
requirement would be fulfilled by providing an announcement to a major 
news organization irrespective of whether the news organization 
ultimately publishes the announcement.\31\ FINRA believes that, as 
required pursuant to Regulation FD, it is important that members 
utilize a method (or combination of methods) of disclosure reasonably 
designed to provide broad, non-exclusionary distribution of the 
required information to the public.\32\ Therefore, in announcing the 
required information, members are expected to select a method that is 
likely to result in the actual public dissemination of the specified 
information.
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    \31\ See SIA.
    \32\ See 17 CFR Sec.  234.101(e)(2).
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    Commenters also expressed concern regarding the proposed 
requirements applicable to returned shares.\33\ The proposal provides 
that the agreement between the book-running lead manager(s) and other 
syndicate members must require that any shares returned by a purchaser 
to a syndicate member after secondary market trading commences be used 
to (a) offset the existing syndicate short position, or (b) if no 
syndicate short position exists, the member must offer returned shares 
at the public offering price to unfilled customers' orders pursuant to 
a random allocation methodology. Commenters expressed concern that the 
proposal does not provide an alternative to address cases where the 
current market price is lower than the public offering price, making 
allocating shares to unfilled indications of interest 
inappropriate.\34\ FINRA believes that if the current market price of 
returned shares is below the IPO price, then the concerns underlying 
the proposed rule are non-existent, as the ability to purchase at the 
public offering price does not confer an economic benefit. Accordingly, 
FINRA proposes to amend the proposed rule change to apply the returned 
share provisions only to shares that are trading at a premium to their 
IPO price.
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    \33\ See ABA and SIA.
    \34\ See ABA and SIA.
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    Commenters further requested clarification regarding the 
requirements for returned shares. Commenters argued that certain 
scenarios should be exempted from the rule, including where the 
securities returned were the subject of a bona fide sale but the 
investor failed to pay for the securities.\35\ FINRA disagrees and does 
not believe that the circumstance under which IPO shares are returned 
to the firm should influence whether the firm can then award them to 
favored customers. The proposed rule change, as amended, addresses the 
potential conflicts of the member in awarding a customer shares at the 
IPO price when they are already trading at a premium on the secondary 
market; the manner and circumstances surrounding the return of the 
shares does not alter the analysis as to how the member should proceed 
with a reallocation.
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    \35\ See ABA and SIA.
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    Commenters also raised concern that the reallocation of shares 
subsequent to the commencement of aftermarket trading may be considered 
to be new sales of securities that continue the distribution of the IPO 
shares with the result that members' market-making purchases in the 
aftermarket may be deemed to be in violation of SEC Regulation M.\36\ 
FINRA has revised the proposed rule change to specifically address the 
need to comply with SEC Regulation M, and FINRA intends to work with 
SEC staff in applying the proposed rule change in a manner that does 
not conflict with Regulation M.
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    \36\ See ABA.
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    The proposed rule change also provides that no member may accept a 
market order for the purchase of IPO shares during the first day that 
the IPO shares commence trading on the secondary market. Commenters 
expressed concern that this provision would increase volatility in 
secondary market trading and also would be technologically cumbersome 
and costly for members to implement.\37\ As discussed in the Proposing 
Release, the IPO Report noted that IPOs are inherently more volatile 
than stocks with a public trading history. In addition, FINRA notes 
that institutional investors have generally relied on limit orders for 
IPOs in the aftermarket. FINRA also notes that market orders may result 
in an investor inadvertently purchasing a security at prices that 
neither reflect their true investment decisions nor their reasonable 
expectations. Such complaints were not uncommon during the market 
bubble that led the IPO Advisory Committee to make this recommendation.
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    \37\ See SIA.
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    FINRA notes that technological advancements since the time of the 
initial filing have resulted in improved access to real-time price 
information, making it less likely that a customer's market order would 
result in the purchase of a security at a price that is unrelated to 
the customer's expectations. Thus, FINRA proposes to modify the 
prohibition on the acceptance of market orders to apply only to orders 
entered prior to the commencement of secondary market trading in an 
IPO. FINRA believes that this revision more precisely focuses the rule 
to the time posing greatest potential for investor harm.
Definitions
    Commenters requested several amendments to the definitional section 
with respect to certain terms used in the proposal. Commenters 
requested that a definition of ``investment banking services'' be added 
and that such definition be based on the research analyst rules.\38\ In 
response to comments, FINRA is proposing to add a

[[Page 13181]]

definition of ``investment banking services'' that is substantially 
similar to that found in the research rules. The proposed definition of 
``investment banking services'' would include ``acting as an 
underwriter, participating in a selling group in an offering for the 
issuer or otherwise acting in furtherance of a public offering of the 
issuer; acting as a financial adviser in a merger, acquisition or other 
corporate reorganization; providing venture capital, equity lines of 
credit, private investment, public equity transactions (PIPEs) or 
similar investments or otherwise acting in furtherance of a private 
offering of the issuer; or serving as placement agent for the issuer.''
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    \38\ See ABA and SIA.
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    One commenter requested that, if a definition of ``investment 
banking services'' were adopted, it should be limited to U.S. 
registered offerings.\39\ FINRA disagrees that the proposed rule should 
permit abusive IPO allocation arrangements in exchange for compensation 
for investment banking services in an overseas transaction (which may 
involve an affiliate of the U.S. member). In such cases, the same or 
similar potential conflicts of interest and problematic incentives 
apply both for the member as well as for the executive officers and 
directors and should not be permitted.
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    \39\ See ABA.
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    Commenters supported the addition of definitions for the terms 
``initial public offering'' and ``public company.'' \40\ In response to 
comments, FINRA is proposing to add a definition of ``IPO'' to mean the 
``initial public offering of an issuer's equity securities, which 
offering is registered under the Securities Act of 1933 and as a result 
of which the issuer becomes a public company.'' The proposed definition 
of ``public company'' means ``any company that is registered under 
Section 12 of the Securities Exchange Act of 1934 or files periodic 
reports pursuant to Section 15(d) thereof.'' These proposed definitions 
are identical in scope to the corresponding definitions found in the 
Voluntary Initiative.
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    \40\ See generally ABA and SIA.
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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. Additional Comment

    We seek specific comment on whether there are any alternatives to 
the proposed rule change that FINRA should consider, such as whether 
proposed new Rule 5131(b)'s spinning provision should be modified to 
include a mandatory ban prohibiting members from seeking or providing 
investment banking services to a company for a period of 12 months 
following any allocation of IPO shares to an account of an executive 
officer or director of such company and whether such a ban would 
facilitate compliance.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-NASD-2003-140 on the subject line.

Paper Comments

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

    All submissions should refer to File Number SR-NASD-2003-140. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for Web site 
viewing and printing in the Commission's Public Reference Room, 100 F 
Street, NE., Washington, DC 20549, on official business days between 
the hours of 10 a.m. and 3 p.m. Copies of such filing also will be 
available for inspection and copying at the principal office of FINRA. 
All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-NASD-2003-140 
and should be submitted on or before April 8, 2010.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\41\
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    \41\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-5913 Filed 3-17-10; 8:45 am]
BILLING CODE 8011-01-P