Interpretive Letter to Lee A. Pickard, Pickard and Djinis
December 9, 1997
Mr. Lee A. Pickard
Pickard And Djinis
1990 M Street, N. W.
Washington, D.C. 20036
Re: Interpretive Guidance Under NASD Rule 2740 and IM-2740
Dear Mr. Pickard:
We are in receipt of your letter to John Ramsay, Deputy General Counsel, NASD Regulation, Inc. in which you requested an interpretive opinion of whether certain securities custodial, clearance and settlement services may be deemed to be "bona fide research" and/or "services in distribution" for purposes of NASD Rule 2740 (Rule) and IM-2740. According to your letter, several NASD members have raised the question of whether, under the Rule and related interpretive material, members may use selling concessions or underwriting discounts derived from customer purchases of fixed-price offerings to furnish or pay for securities custodial, clearance and settlement services provided to such customers by either the member itself or certain third parties.
The facts as represented in your letter are as follows: An NASD member participates as an underwriter or selling group member in fixed price offerings and receives underwriting discounts or selling concessions for such participation as a result of the sale of securities to a customer. The customer of the member may keep funds or securities at the member or at a third party, such as a custodial bank. The customer who purchases securities in fixed price offerings from the member requests that the member furnish or pay for securities custodial, clearance and/or settlement services as part of such member’s securities in distribution. These services rendered to the customer may or may not involve the securities purchased by the customer in fixed price offerings.
Based on these facts, you ask whether the securities custodial, clearance and settlement services described above would be deemed to be "bona fide research" and/or "services in distribution" for the purposes of NASD Rule 2740 and IM-2740?
In support of your inquiry, you provided the following analysis: Rule 2740 and IM-2740 allow a member to provide "bona fide research" to a customer who also purchases securities from fixed price offerings from the member whether or not there is an express or implied agreement between the member providing the research and the customer that the member will be compensated for the research in cash, brokerage commissions, selling concessions or some other form of consideration. Thus, the member can use underwriting discounts or selling concessions to furnish or pay for "bona fide research" which is provided to the customer purchasing securities in the fixed price offering. IM-2740 and NASD Notice to Members 81-3 state that the definition of "bona fide research" is substantially the same as the definition of the term research in Section 28(e)(3) of the Act, and as interpreted by the Commission. Section 28(e)(3) of the Act does not use the term research by itself but rather combines it with the word brokerage as it appears in paragraphs (A), (B) and (C) of the Section.
Paragraph (b) of NASD Rule 2740 defines the term "bona fide research". IM-2740 defines the term "services in distribution," which term is used in paragraph (a) of the Rule, and uses the same term --"bona fide research"-- in its description. All references by their terms do not include "securities custodial, clearance or settlement services" provided by a member or other third parties as described by your letter.
The Securities and Exchange Commission’s adopting release for Rule 2740 specifically states: "The section also contains a definition of bona fide research that is substantially the same as that in Sections 28(e)(3)(A) and (B) of the Act, as interpreted by the Commission."1 Paragraphs (A) and (B) of Section 28(e)(3) parallel or tracks the language of paragraph (b) of NASD Rule 2740. Paragraph (C) of Section 28(e)(3), which was excluded from the definition, specifically references brokerage services (i.e., securities custodial, clearance and settlement). Thus, the brokerage services described were not intended to come within the definition of "bona fide research" or "services in distribution" in Rule 2740 and IM-2740.
I hope this letter is responsive to your inquiry. Please note that the opinion expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation, Inc. This letter responds to the issues that you have raised based on the facts as you have described them, and does not address any other rule or interpretation of the Association or all the possible regulatory and legal issues involved.
Very Truly Yours,
David A. Spotts
1 See Section IV.B.5, SEC Rel. No. 34-17371 (December 12, 1980). In addition, NASD Notice to Members 81-3, which announced the Commission’s approval on the rule, specifically references pages 24-25 of the release for background information regarding the definition of the term "bona fide research".