Use of third parties to aid in compliance with NASD Rule 2790(b).


 

February 17, 2004

 

Mr. Tom Fleming
Dealogic
120 Broadway, 11th Floor
New York, NY 10217

 

Dear Mr. Fleming:

 

This is in response to your letter dated February 1, 2004, in which you request confirmation that members may rely on due diligence performed by your firm, Dealogic, in ascertaining whether an account is eligible to purchase new issues in accordance with Rule 2790. Dealogic provides a family of enterprise content and workflow applications and communications systems for use globally by financial institutions and regulators involved in the capital markets. Among other things, Dealogic operates CobraDesk for NASD’s Corporate Financing Department, and performs services for members in maintaining a “QIB List” as a method for permitting a seller, or any person acting on its behalf, to establish a reasonable belief that a prospective purchaser is a qualified institutional buyer as defined in Securities Act Rule 144A(a)(l).1

 

Background

 

Based on your letter and subsequent conversations with OGC staff, we understand the facts as follows. Dealogic intends to compile a list of accounts that meet the criteria to purchase new issues in accordance with Rule 2790 (“Rule 2790 List”). In order for an account to be included on the Rule 2790 List, Dealogic must receive a completed customer account questionnaire that demonstrates that the certifying account is eligible to purchase new issues.2 Initial verification of an account’s status will require a positive affirmation from the account holder(s), or person authorized to represent the beneficial owners, or in certain cases, a conduit. Annual verification of an account’s status will be conducted through the use of negative consent letters.

 

The completed questionnaire and negative consent letters (including any response thereto) will be scanned into Dealogic’s database allowing subscriber members instant access to electronic copies of the documents. Accounts will be deleted from the Rule 2790 List if information suggesting that the account is no longer eligible to purchase newissues is provided following a negative response letter. One of the benefits you cite of the Rule 2790 List is that, with respect to Rule 2790 List subscriber members, customers will not be required to respond to multiple requests by member firms concerning whether an account is eligible to purchase new issues. You have represented that the software and systems used for the Rule 2790 List are similar to those used in operating and maintaining the “QIB List.”3

 

Analysis

 

As you are aware, NASD Rule 2790 replaces the Free-Riding and Withholding Interpretation. Paragraph (b) contains the preconditions for sale – the representations that a member must have from the account holder(s), or person authorized to represent the beneficial owners, or in certain cases, a conduit. Specifically, the Rule provides:

 

     (b) Preconditions for Sale

     Before selling a new issue to any account, a member must in good faith have obtained within the twelve months prior to such sale, a representation from:

  (1) Beneficial Owners

     the account holder(s), or a person authorized to represent the beneficial owners of the account, that the account is eligible to purchase new issues in compliance with this rule; or

(2) Conduits

     a bank, foreign bank, broker/dealer, or investment adviser, or other conduit that all purchases of new issues are in compliance with this rule.

     A member may not rely upon any representation that it believes, or has reason to believe, is inaccurate. A member shall maintain a copy of all records and information relating to whether an account is eligible to purchase new issues in its files for at least three years following the member’s last sale of a new issue to that account.

 

The Office of General Counsel does not believe the provisions in paragraph (b) preclude members from using a third party, such as Dealogic, to aid in their compliance with these requirements. However, if a member uses Dealogic, or any other third party, the member retains full responsibility for complying with the Rule. In other words, although a member may enlist the assistance of a third party to ascertain the status of a particular account, the member remains directly and fully responsible for compliance with Rule 2790. As such, members must evaluate the level of due diligence performed by Dealogic to determine whether the Rule 2970 List satisfies the requirements of the Rule. In stating that members may enlist the assistance of a third party, such a Dealogic, NASD staff is in no way making any representations or determinations about the accuracy or effectiveness of the information provided by the third party. Moreover, notwithstanding an account’s inclusion on the Rule 2790 List, if a member believes or has reason to believe that the representations are inaccurate, a member shall not allocate new issues to the account.

 

In addition, members must make provisions to ensure that they comply with the recordkeeping requirements of the Rule. We note that a member must maintain a copy of all records and information relating to whether an account is eligible to purchase new issues in its files for at least three years following the member’s last sale of a new issue to that account. Accordingly, members must make provisions to ensure that they download and retain the documents for the necessary three-year period.

 

Please note that the opinions expressed herein are staff opinions and have not been reviewed or endorsed by the Board of NASD. This letter responds only to the issues you have raised based on the facts you have described and does not address any other rule or interpretation of NASD, or all the possible regulatory or legal issues involved.

 

Sincerely,

 

Gary L. Goldsholle

 

cc:

 

Robert B. Kaplan, Associate Vice President and Acting Director
NASD District Office (New York - District 10)

 



1 See CommScan LLC, SEC No-Action Letter, 1999 SEC No-Act. LEXIS 116 (Feb. 3, 1999).

 

2  We understand that the Securities Industry Association has worked with member firms to develop a “standard” questionnaire that many firms intend to use. NASD staff has not reviewed this questionnaire and makes no representations about its accuracy or completeness.

 

3 CommScan, supra note 1.