Notice To Members 86-40

Request for Comments on Amendment to Free-Riding Interpretation Concerning Investment Partnerships

Published Date:

TO: All NASD Members and Other Interested Persons

LAST DATE FOR COMMENT: JUNE 23, 1986

The National Association of Securities Dealers, Inc. (NASD), is publishing for comments a proposed amendment to the Interpretation of the Board of Governors, Free-Riding and Withholding (Free-Riding Interpretation) 1/ that would provide members an alternative means of complying with the Interpretation for sales of new issues to investment partnerships. The text of the proposed amendment is attached.

The section of the Free-Riding Interpretation titled "Investment Partnerships and Corporations" 2/ currently prohibits members and their associated persons from selling securities of a new issue that trades at a premium ("hot issue" securities) to any investment partnership, corporation or similar account unless "the member receives from such account, prior to execution of the transaction, the names and business connections of all persons having any beneficial interest in the account." If the information discloses that any person restricted by the Interpretation has a beneficial interest in the account, the transaction can be effected only in compliance with the restrictions of the Interpretation.

The NASD National Business Conduct Committee (NBCC) is aware that members encounter difficulty in complying with this requirement because persons responsible for the management of investment partnerships and similar accounts are often hesitant to release the names of persons holding beneficial interests in such accounts. In fact, investment partnerships and similar accounts are often created to provide confidentiality for investors.

The Free-Riding Interpretation, however, has been interpreted strictly by the NASD and is intended to protect the integrity of the public offering system by assuring that underwriters make a bona fide public distribution of hot issue securities and do not retain those securities for their own profit or use those securities to favor persons who can direct future business to the firm. Without restricting purchases by investment partnerships, the restrictions of the Interpretation could be easily evaded.

The NBCC and the NASD Board of Governors concluded that it would be appropriate to propose an amendment to the Free-Riding Interpretation in consideration of these concerns.

EXPLANATION OF PROPOSED AMENDMENT

The proposed amendment is intended to provide an alternative means for members to comply with the Interpretation in selling "hot issue" securities to investment partnerships and similar accounts. The proposed amendment would provide a "safe harbor" presumption of compliance with the Interpretation in that a member or associated person would be presumed to be in compliance with the requirements of the Interpretation's subsection on investment partnerships if the member or associated person provides an officer or general partner of the investment adviser or the firm managing the account with a written copy of the Interpretation and receives a written representation from such account manager stating that he or she:

1. has reviewed the Interpretation and is knowledgeable as to its requirements, specifically including the Interpretation's restrictions on purchases by certain persons;
2. is aware of the name and occupation of each person holding a beneficial interest in the account;
3. has analyzed the applicability of the Interpretation's restric tions to each person holding a beneficial interest in the account;
4. has concluded that no person holding a beneficial interest in the account is restricted by the Interpretation from pur chasing hot issue securities; and,
5. prior to entering any orders with a member after any person holding a beneficial interest in the account becomes subject to the Interpretation's restrictions, will so notify the member or associated person in writing.

In addition, the member will be required to maintain in its files a copy of the written representation received from the account manager for at least three years following the member's last sale of a new issue to that account.

The NBCC believes that this proposed procedure will enable members to identify those investment partnerships to which hot issue securities may be sold without violating the Interpretation, while at the same time assuring that the regulatory purposes of the Interpretation are preserved.

* * * * *

The NASD encourages all members and other interested persons to comment on this proposed amendment. Comments should be directed to:

Mr. Lynn Nellius
Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006

Comments must be received no later than June 23, 1986. Comments received by this date will be considered by the NBCC and the NASD Board of Governors. If the proposed amendment is approved by the Board, the amendment must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions concerning this notice may be directed to either Dennis C. Hensley, NASD Vice President and Deputy General Counsel, or John F. Mylod, NASD Assistant General Counsel, at (202) 728-8294.

Sincerely,

Frank J. Wilson
Executive Vice President
Legal and Compliance

Attachment

PROPOSED AMENDMENT TO FREE-RIDING INTERPRETATION

Amend the section titled "Investment Partnerships and Corporations" of the Interpretation of the Board of Governors, Free-Riding and Withholding as follows:*

Investment Partnerships and Corporations

A member may not sell securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins ("hot issue"), to the account of any investment partnership or corporation, domestic or foreign (except companies registered under the Investment Company Act of 1940) including but not limited to, hedge funds, investment clubs, and other like accounts unless the member receives from such account, prior to the execution of the transaction, the names and business connections of all persons having any beneficial interest in the account, and if such information discloses that any person enumerated in paragraphs (1) through (4) hereof has a beneficial interest in such account, any sale of securities to such account must be consistent with the provisions of this Interpretation; provided, however, that [if the disclosure of such information by the account is prohibited by law, then in such case, the member must receive written assurance from the account that no person enumerated in paragraphs (1) through (4) hereof has a beneficial interest in such account] a member or person associated with a member shall be presumed to be in compliance with the requirements of this subsection if:

(a) the member or associated person provides an officer or general part ner of the investment adviser or other firm that manages the account ("account manager") with a written copy of this Interpretation;
(b) the member or associated person receives a written representation from the account manager that states that he or she:
(i) has reviewed this Interpretation and is knowledgeable as to its requirements, specifically including its restrictions on purchases by certain persons;
(ii) is aware of the name and occupation of each person holding a beneficial interest in the account;
(iii) has analyzed the applicability of the Interpretation's restrictions to each person holding a beneficial interest in the account;
(iv) has concluded that no person holding a beneficial interest in the account is restricted from purchasing securities by the terms of this Interpretation;
(v) prior to entering any further orders with the member after any person holding a beneficial interest in the account becomes subject to the restrictions of the Interpretation, will so notify the member or associated person in writing; and
(c) the member maintains a copy of the written representation in its files for at least three years following the member's last sale of a new issue to the account.

The term beneficial interest means not only ownership interests, but every type of direct financial interest of any persons enumerated in paragraphs (1) through (4) hereof in such account, including, without limitation, management fees based on the performance of the account.

1/ The complete text of the Free-Riding Interpretation may be found beginning on page 2039-3 of the NASD Manual.

2/ NASD Manual (CCH), p. 2043.

* Deleted language is bracketed; new language is underlined.