Notice To Members 87-25

Request for Comments and Suggestions on Regulation of Market Making By Affiliates of Issuers

Published Date:

TO: All NASD Members and Other Interested Persons

LAST DATE FOR COMMENT: MAY 8, 1987.

EXECUTIVE SUMMARY

The NASD is requesting comments and suggestions on the concept of a rule that would restrict broker-dealers that are affiliated with issuers from making a market or trading in the securities of those issuers. The NASD invites comments on whether such practices should be restricted and, if so, the nature of affiliation that should trigger the restrictions and the types of restrictions that should apply.

This request for comments and suggestions on the need for regulation in this area is the result of concerns as to whether conflicts of interest may exist or rule violations are more likely when broker-dealers engage in making a market or trading in securities issued by affiliates.

BACKGROUND

Questions have arisen concerning conflicts of interest and rule violations that are possible when broker-dealers engage in market making or otherwise execute principal transactions in securities issued by affiliates. In today's changing market environment, broker-dealers frequently are components of larger corporate families, a growing number of broker-dealers' securities are publicly traded and there is a continued proliferation of proprietary products and other securities being issued by broker-dealer affiliates.

Numerous requirements under the Securities Acts of 1933, the Securities Exchange Act of 1934 and SEC rules must be satisfied before an affiliate of an issuer can engage in such transactions, especially on a continuous basis. 1/ Some self-regulatory organizations restrict member broker-dealers' activity in their own securities and those of affiliates. 2/ The NASD, however, currently does not have a rule that specifically prohibits or restricts trading by members in securities of their affiliates.

POSSIBLE APPROACHES TO REGULATION

The NASD has not formulated a specific approach to regulation of trading by issuer affiliates and is therefore soliciting comments or suggestions on approaches that should be considered. The Subcommittee on Market Making by Issuer Affiliates of the NASD National Business Conduct Committee has considered various possible approaches. For example, an NASD rule could parallel or complement similar rules for other markets.

It should be noted that any rule is likely to affect (1) broker-dealers whose own securities or whose holding company's securities are publicly traded, (2) broker-dealers that are part of a larger corporate structure that includes any company whose securities are publicly traded, and (3) broker-dealers whose subsidiaries or affiliates issue "proprietary" mutual funds, venture capital or other specialty investment funds, limited partnerships, asset-backed securitized vehicles or similar products.

There are a number of questions and issues members and their counsel should address before making comments and suggestions to the NASD. Some of these are:

  • Should the NASD restrict market making or other principal transactions by affiliates of issuers?
  • If so, what degree of affiliation is necessary between a broker- dealer and an issuer before restrictions should apply?
  • Should different restrictions apply to trading in a broker-dealer's own securities as opposed to trading in an affiliate's securities? Should different restrictions apply to a holding company whose only subsidiary is a broker-dealer?
  • Should different restrictions apply to different kinds of securities, i.e., debt versus equity, rated debt versus unrated, proprietary funds, securitized vehicles or limited partnerships issued by a broker-dealer's affiliate versus securities of that affiliate or of the broker-dealer.
  • Should trading activity be a factor in determining the extent of restrictions applied to a security? Should actively traded securities be subject to less restriction?
  • Should special price and volume restrictions, such as those listed in SEC Rule 10b-18, for example, apply to trading in securities of affiliates?
  • Should special disclosure requirements be imposed?
  • Should market-making transactions be treated differently than other principal transactions? Should agency trades be treated differently than principal trades? Should solicited and unsolicited transactions be treated differently?

SOLICITATION OF COMMENTS

The NASD urges members and their counsel to provide comments and suggestions concerning these issues.

Additional background information is available from the NASD Office of General Counsel at (202) 728-8294.

Comments regarding this notice should be directed to:

Mr. Lynn Nellius
Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006-1506

All comments and suggestions must be received no later than May 8, 1987. After a review of the information received, the NASD Board of Governors will determine whether to propose a rule on this subject. Any proposed rule would be published for comment prior to its adoption and submission to the Securities and Exchange Commission.

Questions concerning this notice may be directed to Dennis C. Hensley, NASD Vice President and Deputy General Counsel, at (202) 728-8245.

Sincerely,

Frank J. Wilson Executive Vice President and General Counsel

1/ Firms engaging, or proposing to engage, in these transactions may wish to consult counsel regarding these requirements. An NASD memorandum analyzing these requirements is available from the Office of General Counsel.

2/ For example, New York Stock Exchange Rule 312(g) prohibits NYSE members from soliciting transactions in their own securities or from recommending transactions in their own or their affiliates' securities.