Restrictions on the Purchase and Sale of Initial Equity Public Offerings - Rule 2790

The staff granted an exemption from NASD Rule 2790 in connection with new issue offering where all decisions regarding the allocation of shares in the offering are determined at the sole discretion of the issuer, and the involvement of a member in the offering is mandated under state law and limited solely to ministerial functions.

 

October 18, 2005
 
Noel M. Gruber, Esq.
Kennedy & Baris, L.L.P.
Suite P-15
4701 Sangamore Road
Bethesda, MD 20816

 

Re:  Request for Exemption from Rule 2790

 

Dear Mr. Gruber:

 

This is in response to your letter dated August 15, 2005, in which you request an exemption from NASD Rule 2790 in connection with the proposed initial public offering ("IPO") of The Washington Bank's ("Bank") common stock.

 

Pursuant to paragraph (h) of Rule 2790, 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 Rule 2790 to the extent that such exemption is consistent with the purposes of the Rule, the protection of investors, and the public interest.  For the reasons set forth below, the staff grants your request for an exemption from Rule 2790.

 

Background

 

Based upon your letter and our subsequent telephone conversations, we understand the facts to be as follows.  The Bank is a new Virginia-chartered commercial bank that is in the process of organizing.  As part of this process, the Bank is planning a forthcoming IPO of its common stock on a non-underwritten basis, through the efforts of its directors and executive officers, primarily to residents of Virginia, Maryland, and the District of Columbia.  The Bank plans to offer 1.5 million shares of common stock at a price of $10 per share, for an aggregate offering of $15 million.  The offering would be effected pursuant to an exemption from registration under Section 3(a)(2) of the Securities Act of 1933.  Upon completion of the offering, the Bank's common stock will not be listed, or eligible for listing, on the Nasdaq Stock Market or any national securities exchange.  Further, the Bank does not expect that there will be significant trading, if any, in its stock for an extended period of time.  The Bank expects that it will have fewer than 500 shareholders of record following the offering and that it will not be a reporting company under the Securities Exchange Act of 1934.

 

Pursuant to Virginia law, the Bank is required to solicit subscriptions for its common stock before filing its charter application.  Maryland law provides that such activities require the Bank to retain a licensed broker-dealer to perform certain ministerial functions in connection with the offering.  This Maryland requirement would not apply if Virginia did not require the Bank to begin its capital raising efforts before filing its charter application.  In accordance with Maryland law, the Bank has retained Koonce Securities, Inc. ("Koonce"), an NASD member, to perform the required ministerial functions.  Koonce would receive and review subscription agreements, deliver subscription funds to the independent escrow agent, ensure compliance with NASD rules, and answer procedural questions from potential subscribers.  Neither Koonce, nor any other broker-dealer, nor any associated person of any broker-dealer, would solicit or sell any shares of the IPO, would have the right, power, or authority to designate the allocation of any shares in the offering, or would otherwise influence the allocation of the IPO shares.  All decisions regarding the allocation of shares in the offering would be determined at the sole discretion of the Bank.

 

You are concerned that based on the application of Rule 2790(d)(1) the Bank would not be able to allocate shares of its IPO to certain "restricted persons," including "members or other broker-dealers" and "broker-dealer personnel" as defined in Rule 2790.  You represent that purchases by such persons can be critical to the success of the Bank's offering.  Therefore, you are requesting an exemption in connection with the Bank's forthcoming IPO so that the Bank can direct shares of its common stock to investors who may be "restricted persons," including "members or other broker-dealers" and "broker-dealer personnel."

 

Analysis

 

Rule 2790 is designed to protect the integrity of the public offering process by ensuring that: (1) members make bona fide public offerings of securities at the offering price; (2) members do not withhold securities in a public offering for their own benefit or use such securities to reward persons who are in a position to direct future business to members; and (3) industry insiders, including members and their associated persons, do not take advantage of their insider position to purchase "new issues" for their own benefit at the expense of public customers.  The Rule plays an important part in maintaining investor confidence in the capital raising and public offering process.

 

Rule 2790(d)(1) provides that the prohibitions on the purchase and sale of "new issues" in Rule 2790 generally do not apply to "new issue" securities that are specifically directed by the issuer to "restricted persons" as defined in the Rule.  However, issuer-directed securities cannot be sold to or purchased by an account in which "broker-dealer personnel"1 or "finders and fiduciaries" have a beneficial interest, unless such persons, or members of their immediate family, are employees or directors of the issuer, the issuer's parent, or a subsidiary of the issuer or the issuer's parent.  The term "broker-dealer personnel" includes, among others, any officer, director, general partner, associated person, and employee of a broker-dealer, as well as certain immediate family members of such persons.  The term "finders and fiduciaries," with respect to the security being offered, includes a finder or any person acting in a fiduciary capacity to the managing underwriter, including, but not limited to, attorneys, accountants, and financial consultants, as well as certain immediate family members of such persons.

 

The inclusion of this additional condition in Rule 2790(d)(1) (i.e., that "broker-dealer personnel" and "finders and fiduciaries," or members of their immediate family, must be employees or directors of the issuer, the issuer's parent, or a subsidiary of the issuer or the issuer's parent before they can receive issuer-directed securities) is designed to ensure that such persons, who typically have the greatest potential to influence the IPO allocation process, have a demonstrated basis for being selected to purchase shares in the IPO.  With respect to the proposed IPO of the Bank, the staff believes that the additional protections afforded by paragraph (d)(1) are not necessary in view of the fact that no broker-dealer has any role in directing the allocation of the IPO shares.  As noted above, all decisions regarding the allocation of shares are determined at the sole discretion of the issuer; Koonce's involvement is mandated under state law and limited solely to ministerial functions.

 

Given that the entire offering will be directed by the Bank, that no member (or any other broker-dealer) will have any role in directing the allocation of the IPO shares, and that Koonce's role in the offering process will be limited as described above, the staff believes that the additional condition in Rule 2790(d)(1) should not apply to the Bank's proposed IPO; provided further, that neither Koonce, nor its associated persons, nor Koonce's affiliates, may purchase any of the IPO shares.

 

Based on the unique facts and circumstances of the Bank's proposed IPO, the staff finds that granting an exemption is consistent with the purposes of Rule 2790, the protection of investors, and the public interest.  For these reasons and subject to the terms and conditions discussed above, the staff grants an exemption from Rule 2790 for the limited purpose of the Bank directing shares of its common stock to investors who may be "restricted persons," including "members or other broker-dealers" and "broker-dealer personnel" as defined in Rule 2790.

 

If you have any questions on this matter, please do not hesitate to contact me at (202) 728-8902.

 

Very truly yours,

 

 

Afshin Atabaki
Counsel 
 
cc:  
 
Gary L. Goldsholle
Associate Vice President and 
Associate General Counsel
 
John P. Nocella, Senior Vice President and
District Director
Philadelphia District Office

 

 

1 In addition, while broker-dealers are not expressly subject to the limitations applicable to "broker-dealer personnel" in Rule 2790(d)(1), to the extent that "broker-dealer personnel" have a beneficial interest in a broker-dealer, the broker-dealer would be subject to the limitations in Rule 2790(d)(1).  Consequently, the broker-dealer could not purchase any issuer-directed "new issues" unless each "broker-dealer personnel" that has a beneficial interest in the broker-dealer, or a member of their immediate family, also is an employee or director of the issuer, the issuer's parent, or a subsidiary of the issuer or the issuer's parent.