NASD Notice to Members 07-28 - June 2007

SEC Approves Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities; Effective Date: July 5, 2007

Executive Summary

On April 16, 2007, the Securities and Exchange Commission (SEC) approved IM-2440-2, "Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities" (Debt Mark-Up Interpretation or Interpretation), and renumbered IM-2440 as IM-2440-1.1 The Debt Mark-Up Interpretation supplements Rule 2440, "Fair Prices and Commissions," which requires broker-dealers to charge customers fair mark-ups and commissions, and IM-2440-1, "Mark-Ups."

In a debt security transaction with a customer, the broker-dealer’s mark-up (mark-down) must be calculated from the prevailing market price of that security. The new Debt Mark-Up Interpretation states that, presumptively, the prevailing market price of a debt security is the broker-dealer’s contemporaneous cost (or, in a sale, the broker-dealer’s contemporaneous proceeds).

The Interpretation also addresses the procedures for determining prevailing market price (as a price other than contemporaneous cost) when a broker-dealer has the discretion, under the Interpretation, not to use its contemporaneous cost as the measure. In addition, the Interpretation includes an exemption for transactions in non-investment grade debt securities between broker-dealers and qualified institutional buyers (QIBs), as defined in Rule 144A under the Securities Act of 1933 (Securities Act) (QIB Exemption).2 The Interpretation and the amendment to IM-2440 are set forth in Attachment A of this Notice.

The Interpretation and the amendment to IM-2440 become effective July 5, 2007.

Questions regarding this Notice may be directed to Sharon K. Zackula, Associate Vice President and Associate General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8985; Malcolm P. Northam, Director, Fixed Income Securities Regulation, Regulation Policy, Member Regulation, at (202) 728-8085; and the Legal Section, Market Regulation, at (240) 386-5126.

1 See Securities Exchange Act Release No. 55638 (April 16, 2007), 77 FR 20150 (April 23, 2007) (File No. SR-NASD-2003-141) (approval order). In this Notice, the term "mark-up" generally refers to both mark-ups and mark-downs, and the term "contemporaneous cost" refers to both contemporaneous cost and contemporaneous proceeds (or either of them). Single terms in parentheses within sentences, such as the term "(proceeds)," refer specifically to customer sale transactions where the member charges a mark-down.

2 Under Rule 144A of the Securities Act of 1933 (Securities Act), the definition of QIB includes, among others: (1) specified entities (including insurance companies, registered investment companies, employee benefit plans or similar plans maintained by a state, or a state agency or political subdivision, and investment advisors) that act for their own account or the accounts of other QIBs, that in the aggregate own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity; (2) any broker-dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934 (Act), acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $10 million of securities of issuers that are not affiliated with the broker-dealer; (3) any broker-dealer acting in a riskless principal transaction on behalf of a QIB; (4) any investment company registered under the Investment Company Act of 1940, acting for its own account or for the accounts of other QIBs, that is part of a family of investment companies that own in the aggregate at least $100 million in securities of issuers, other than issuers that are affiliated with the investment company or are part of such family of investment companies; and (5) any bank or certain other domestic and foreign financial institutions, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with it and that has an audited net worth of at least $25 million.