Notice To Members 93-40

Request for Comments on Proposed Amendments to the Free-Riding and Withholding Interpretation Under Article III, Section 1 of the Rules of Fair Practice

Published Date:

June 01, 1993

SUGGESTED ROUTING

Senior Management
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Legal & Compliance
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Executive Summary

The NASD requests comment on proposed amendments to the Free-Riding and Withholding Interpretation under Article III, Section 1 of the Rules of Fair Practice. These amendments would change a number of the Interpretation's provisions. The complete text of the Interpretation follows this Notice.

Background

At its May 1992 meeting, the NASD Board of Governors (Board) appointed a special committee to examine the Free-Riding and Withholding Interpretation (Free-Riding Committee) to determine if the Interpretation's restrictions, definitions and obligations are relevant in today's securities markets. The Committee was comprised of representatives of the NASD's National Business Conduct, Corporate Financing, and Insurance Affiliated Members Committees as well as the members of the Board. The Board also asked the Committee to examine various interpretative issues that had been raised with the NASD. The Free-Riding Committee met numerous times from May 1992 until April 1993 and received input and suggestions, both in writing and in person, from members, issuers, law firms, the NASD Legal Advisory Board, and the staff of various NASD departments.

Overview of Free-Riding and Withholding Interpretation

The purpose of the Interpretation is to protect the integrity of the public offering system by ensuring that members make a bona fide public distribution of "hot issue" securities and neither withhold such securities for their own benefit nor use the securities to reward other persons in a position to direct future business to the member. As defined by the Interpretation, hot issues are securities of a public offering that trade at a premium in the secondary market when such trading commences. The Interpretation prohibits members from retaining such securities in their own accounts and prohibits members from using sales of such securities to directors, officers, employees, and associated persons of members and other broker/dealers. It also restricts member sales of hot-issue securities to the accounts of specified categories of persons, including among others, senior officers of banks, insurance companies, registered investment companies, registered investment advisory firms, and any other persons within such organizations whose activities influence or include the buying or selling of securities. These basic prohibitions and restrictions also apply to sales by members of hot-issue securities to accounts in which any such persons may have a beneficial interest and, with limited exceptions, to members of the immediate family of those persons restricted by the Interpretation.

NASD Compliance Department Procedures

As part of its deliberations, the Committee considered redefining the term "hot issue" to provide more guidance to the membership as to those offerings which are subject to the Interpretation. Rather than taking this approach, however, the Committee asked the staff of the NASD Compliance Department to provide guidance on the internal NASD procedures regarding hot issues. The following description is intended to provide that guidance.

The NASD's Compliance Department in Washington, D.C. has the responsibility of reviewing the after-market quotation and trading activity of all public offerings to determine whether the securities traded in the secondary market at a price which is higher than the public offering price. If the immediate bid quotations of market makers and trade reports by broker/dealers of purchases are at prices above the public offering price on the first day of trading, the offering is deemed to be a "hot issue." The determination of a hot issue is not necessarily based on the opening bid quotation or the first reported transaction; rather, the NASD's focus is on the overall market activity as the secondary market commences and continues, which includes consideration of a pattern of bid quotations and purchases at prices exceeding the public offering price.

This review by the Compliance Department is centralized to insure consistency and uniformity throughout the NASD's 14 district offices. For a security that is characterized by current quotations, real-time trade reporting and secondary market activity which develops on completion of the offering, the NASD takes a number of factors into consideration when determining whether the issue is hot. In active and competitive securities which are normally associated with issues that list on Nasdaq or an exchange, the NASD analyzes inside bid quotations in the immediate secondary market, actual initial transactions, the volume, and the amount of the premium.

While there is no formula or absolute rule that determines precisely at what point in time secondary market trading in securities that have the characteristics described above would result in an issue being deemed hot, the primary factors that are considered are fairly basic. Was there unsatisfied public demand for the issue at the time of the offering; was there immediate demand to buy the stock when it first opened for trading in the secondary market; could the shares purchased in the public offering be sold at a profit in the immediate secondary market?

As an example, a security with a public offering price of $10 that opens for trading on Nasdaq or on a national securities exchange at $10, and trades at that price for several hours, and then moves up to $11 by the close of trading would not be considered a hot issue. Nor would a similarly priced Nasdaq or exchange listed new issue that trades down initially at $9 3/4 from its public offering price of $10, only to move up after several hours to close at $10 1/2. Thus, the NASD focus is on immediate secondary market bids and transaction activity.

As referenced earlier, the regulatory process described above applies to issues where current price, volume and transactional information are accessible on a real-time basis, typically (i.e., Nasdaq or exchange-listed issues). For underwritings of issues that do not have those characteristics, or that may be subject to other conditions such as being dominated and controlled by a particular dealer or group of dealers, or are very inactive or infrequently traded, other criteria may be used by the NASD in determining whether the issue is deemed hot. The NASD also reviews such offerings and subsequent secondary market activity for indications of possible violations of other NASD rules or federal securities laws.

The NASD through its Compliance Department will authorize the issuance of a Free-Riding and Withholding Questionnaire (Free-Riding Questionnaire) for those hot issues that exceed certain preset and predetermined regulatory parameters determined by the NASD. While not all offerings that open at a premium are subject to a Free-Riding Questionnaire, any public offering that opens at a premium is considered a hot issue under the Free-Riding and Withholding Interpretation. District examiners routinely review for compliance with the Free-Riding Interpretation during field examinations for those hot issues that are not the subject of a Free-Riding Questionnaire.

Proposed Modifications for Member Comment

Securities to Be Covered

The Free-Riding Committee recommended that the Interpretation continue to apply to both equity and debt securities, but is seeking comment, including the views of the NASD Fixed Income Committee, on applying the Interpretation to "straight" debt securities. The Free-Riding Committee clearly believes that the Interpretation should continue to apply to convertible and high-yield debt securities. In addition, comments are solicited as to the Legal Advisory Board's suggestion that the NASD consider excluding, at least, "rated" debt from the Interpretation.

The Free-Riding Committee believes that closed-end mutual funds should remain covered by the Interpretation.

Stand-by Arrangements

The Free-Riding Committee concluded that securities purchased under a stand-by arrangement by a restricted account should not be subject to the Interpretation if:

The stand-by arrangement is disclosed in the prospectus.
The arrangement is the subject of a formal agreement.
There is a representation from the underwriter that it was unable to find any other purchaser for the securities.
An appropriate holding period for the securities be included. The Free-Riding Committee determined that for purposes of soliciting comment on the proposal it would apply the holding period of five months currently included in the Interpretation's provisions relating to conversion offerings. Comments are specifically solicited on the appropriate holding period for securities purchased under a standby agreement.

Cancellation of Trades as "Safeharbor"

The Free-Riding Committee believes that the Interpretation should make it clear that it is not a violation for a member to allocate a hot issue to a restricted person or account if the member cancels the trade and reallocates the security, at the public offering price, to a nonrestricted account prior to the settlement date. The Committee understands that there may be implications of such cancellations and reallocations under Securities Exchange Act Rule 10b-6 and seeks comment on this issue.

Definition of Immediate Family

The Interpretation now restricts immediate family members of persons enumerated in paragraph 2 which covers persons associated with broker/dealers, and paragraphs 3 and 4 of the Interpretation which relate to persons having a relationship with the offering and individuals related to banks, insurance companies, and other institutional type accounts (see page 262) from participating in hot issues. The rule defines immediate family members very broadly and includes such persons as father-, mother-, brother, and sister-in-law. Members have expressed concern over the compliance difficulties of monitoring whether such persons are restricted or become restricted. The Interpretation also contains a provision that allows for immediate family members of persons designated in paragraph 2 and for persons designated in paragraphs 3 and 4 of the rule to purchase hot issues if they have the requisite investment history with the member making the hot-issue allocation, and the allocation meets certain other requirements.

The Committee's recommendations are:

1. The investment history exemption should be retained in spite of the fact that it is infrequently used and should be expanded to include the use of investment history at firms other than the member making the allocation. The burden of obtaining such information would remain with the firm making the sale.

2. The immediate family restrictions on persons other than those associated with broker/dealers (categories 3 and 4 referenced above) would be eliminated and the restriction would only apply to the enumerated individuals in those categories and to persons who are supported directly or indirectly to a material extent by the restricted person.

3. For persons associated with broker/dealers, the immediate family restrictions would continue to apply to persons supported by the restricted individual and to allocations by the restricted individual's firm, but would no longer prohibit sales to non-supported family members by a broker/dealer other than that employing the restricted person where the restricted person has no ability to control the allocation of the hot issue. However, a violation would occur if it could be determined that the restricted person had a beneficial interest in the account to which an allocation was made.

Applicability to Persons With Limited Registration or Limited Purpose Broker/Dealers

The Free-Riding Committee believes that individuals with various limited purpose registrations should not be considered to be restricted persons. The categories would be persons registered as representatives or principals in registration categories limited to investment company securities, variable contracts, and Direct Participation Program securities. Comment is solicited on the propriety of exempting any securities industry professionals and, if appropriate, the proper scope of such an exclusion.

Investment Partnerships

The Interpretation, in dealing with the topic of "Investment Partnerships and Corporations," generally disallows sales to the partnership or corporation if restricted persons have a beneficial interest in the entity. In the August 1992 Notice to Members, the Board announced it was going to allow investment partnerships on an interim basis to use a "carve out" mechanism to prevent restricted persons in the partnerships from participating in hot-issue allocations. This carve-out mechanism involves the member making such allocation to set up a separate account for these transactions and obtaining from the partnership and its accountants documentation (the partnership agreement) that indicates the restricted persons are prevented from participating in hot-issue allocation.

The Free-Riding Committee believes the carve-out methodology is the most appropriate and should apply both to investment partnerships having restricted persons as investors (as allowed by the August 1992 Notice) and to partnerships that the restricted person or entity is engaged in the manages. The Free-Riding Committee recommends substituting an independent certified public accountant's opinion for the opinion of counsel currently called for in the Interpretation as well as those described below since such opinions are more certifications of fact than a true legal opinion and obtaining such an opinion from a law firm creates undue expense.

The required mechanisms are as follows:

1. The investment partnerships will establish a separate brokerage account, with a separate identification number, for its new-issue purchases. At the end of each fiscal year, the general partners will certify in writing to their independent certified public accountants that: (a) all hot issues purchased by the partnership were placed in this new-issue account; (b) the partners participating in the new-issue account are not restricted persons under the Interpretation; and (c) no management fees are based on the performance of securities in the new-issue account.

2. Before executing the initial hot-issue transaction, the partnership's accountants will provide a certification that complies with paragraph B of the section of the Interpretation entitled "Investment Partnerships and Corporations."

3. As part of its audit procedure for the partnership, the independent certified public accountant will confirm in writing to the partnership that all allocations for the new-issues account were made in accordance with the provisions of the applicable partnership agreement that restricts participation in hot-issue purchases.

4. The partnership will maintain in its files copies of the certifications, representations, and confirmations referred to in paragraphs (1) - (3) above for at least three years following the last purchase of a hot issue for the new-issue account.

5. The partnership will accept investment funds from other partnerships if such other partnerships provide the same documentation and assurances described in paragraphs (1) - (4) that restricted persons will not participate in the purchase of hot issues.

6. The certifications and documents required in paragraphs (1) - (3) shall be provided to the member holding such account at such time as these certifications and documents are filed with the partnership and its independent certified public accountant and the member shall make such documentation available to the NASD on request.

Foreign Mutual Funds

The Interpretation excludes from entities restricted as Investment Partnerships or Corporations, investment companies registered under the Investment Company Act of 1940. The Free-Riding Committee believes foreign mutual funds which are subject to a similar scheme of regulation as that governing domestic funds should be similarly exempted. Comments are solicited on the proper scope of such an exemption and the appropriate methodology for determining the similarity of regulation.

Venture Capital Investors

The Committee recommends allowing purchases by a venture capital investor (either a fund or an individual) if the following conditions are met:

1. One year of preexisting owner-ship of the company's securities.

2. No increase in the investor's percentage ownership above that of the securities held for the prior year as a result of the purchase of the new issue.

3. A lack of special terms connection with the purchase.

4. A six-month lock-up period for the newly purchased securities.

Comment is solicited on the appropriate lock-up period.

Requests for Comments

The NASD asks members and other interested persons to comment on the proposed amendments to the Free-Riding Interpretation. Comments should be directed to Mr. Stephen D. Hickman, Corporate Secretary, National Association of Securities Dealers, Inc., 1735 K Street, NW, Washington, DC 20006-1500.

Comments must be received no later than July 31, 1993. Comments received by this date will be considered by the National Business Conduct Committee and the Board. Before becoming effective, the proposed amendment must be approved by the Board, adopted by the membership, and filed with the SEC for final approval.

Questions concerning this Notice should be directed to T. Grant Callery, Vice President and General Counsel, at (202) 728-8285, or Craig L. Landauer, Associate General Counsel, at (202) 7288291. Questions concerning the Compliance Department procedures should be directed to P. William Hotchkiss, Director, at (202) 728-8235.

Text of Proposed Amendments to Free-Riding and Withholding Interpretation Under Article III, Section 1 of the Rules of Fair Practice

(Note: Proposed language is underlined; deleted language is in brackets.)

Interpretation of the Board of Governors

"Free-Riding and Withholding"

Introduction

The following Interpretation of Article III, Section 1 of the Association's Rules of Fair Practice is adopted by the Board of Governors of the Association pursuant to the provisions of Article VII, Section 3(a) of the Association's By-Laws and Article I, Section 3 of the Rules of Fair Practice.

This Interpretation is based upon the premise that members have an obligation to make a bona fide public distribution at the public offering price of securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins (a "hot issue") regardless of whether such securities are acquired by the member as an underwriter, as a selling group member, or from a member participating in the distribution as an underwriter or a selling group member, or otherwise. The failure to make a bona fide public distribution when there is a demand for an issue can be a factor in artificially raising the price. Thus, the failure to do so, especially when the member may have information relating to the demand for the securities or other factors not generally known to the public, is inconsistent with high standards of commercial honor and just and equitable principles of trade and leads to an impairment of public confidence in the fairness of the investment banking and securities business. Such conduct is, therefore, in violation of Article III, Section 1 of the Association's Rules of Fair Practice and this Interpretation thereof which establishes guidelines in respect to such activity.

As in the case of any other Interpretation issued by the Board of Governors of the Association, the implementation thereof is a function of the District Business Conduct Committees and the Board of Governors. Thus, the Interpretation will be applied to a given factual situation by individuals active in the investment banking and securities business who are serving on these committees or on the Board.

They will construe this Interpretation to effectuate its overall purpose to assure a public distribution of securities for which there is a public demand.

The Board of Governors has determined that it shall not be considered a violation of this Interpretation if a member which makes an allocation to a restricted person or account of an offering that trades at a premium in the secondary market, cancels the trade for such restricted person or account, prior to settlement date and reallocates such security at the public offering price to a non-restricted person or account.

Interpretation

Except as provided herein, it shall be inconsistent with high standards of commercial honor and just and equitable principles of trade and a violation of Article III, Section 1 of the Association's Rules of Fair Practice for a member, or a person associated with a member, to fail to make a bona fide public distribution at the public offering price of securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins regardless of whether such securities are acquired by the member as an underwriter, a selling group member or from a member participating in the distribution as an underwriter or selling group or otherwise. Therefore, it shall be a violation of Article III, Section 1 for a member, or a person associated with a member, to:

1. Continue to hold any of the securities so acquired in any of the member's accounts;

2. Sell any of the securities to any officer, director, general partner, employee or agent of the member or of any other broker/dealer, or to a person associated with the member or with any other broker/dealer, or to a member of the immediate family of any such person[;], provided however, that:

(a) This prohibition shall not apply to a person in a limited registration category as that term is defined below;

(b) The prohibition shall not apply to sales to a member of the immediate family of a person associated with a member who is not supported directly or indirectly to a material extent by such person if the sale is by a broker/dealer other than that employing the restricted person and the restricted person has no ability to control the allocation of the hot issue.

3. Sell any of the securities to a person who is a finder in respect to the public offering or to any person acting in a fiduciary capacity to the managing underwriter, including, among others, attorneys, accountants and financial consultants, or to [a member of the immediate family of any such person;] any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.

4. Sell any securities to any senior officer of a bank, savings and loan institution, insurance company, registered investment company, registered investment advisory firm or any other institutional type account, domestic or foreign, or to any person in the securities department of, or to any employee or any other person who may influence or whose activities directly or indirectly involve or are related to the function of buying or selling securities for any bank, savings and loan institution, insurance company, registered investment company, registered investment advisory firm, or other institutional type account, domestic or foreign, or to [a member of the immediate family of any such person;] any other person who is supported directly or indirectly, to a material extent, by any person specified in this paragraph.

5. Sell any securities to any account in which any person specified under paragraphs (1), (2), (3) or (4) hereof has a beneficial interest;

Provided, however, a member may sell part of its securities acquired as described above to:

(a) persons enumerated in paragraphs (3) or (4) hereof; and

(b) members of the immediate family of persons enumerated in paragraph (2) hereof provided that such person enumerated in paragraph (2) does not contribute directly or indirectly to the support of such member of the immediate family; and

(c) any account in which any person specified under paragraph (3) or (4) or subparagraph (b) of this paragraph has a beneficial interest;

if the member is prepared to demonstrate that the securities were sold to such persons in accordance with their normal investment practice with the member, that the aggregate of the securities so sold is insubstantial and not disproportionate in amount as compared to sales to members of the public and that the amount sold to any one of such persons is insubstantial in amount.

6. Sell any of the securities, at or above the public offering price, to any other broker/dealer; provided, however, a member may sell all or part of the securities acquired as described above to another member broker/dealer upon receipt from the latter in writing assurance that such purchase would be made to fill orders for bona fide public customers, other than those enumerated in paragraphs (1), (2), (3), (4) or (5) above, at the public offering price as an accommodation to them and without compensation for such.

7. Sell any of the securities to any domestic bank, domestic branch of a foreign bank, trust company or other conduit for an undisclosed principal unless:

(a) An affirmative inquiry is made of such bank, trust company or other conduit as to whether the ultimate purchasers would be persons enumerated in paragraphs (1) through (5) hereof and receives satisfactory assurance that the ultimate purchasers would not be such persons, and that the securities would not be sold in a manner inconsistent with the provisions of paragraph (6) hereof; otherwise, there shall be a rebuttable presumption that the ultimate purchasers were persons enumerated in paragraphs (1) through (5) hereof or that the securities were sold in a manner inconsistent with the provisions of paragraph (6) hereof;

(b) A recording is made on the order ticket, or its equivalent, or on some other supporting document, of the name of the person to whom the inquiry was made at the bank, trust company or other conduit as well as the substance of what was said by that person and what was done as a result thereof;

(d) Normal supervisory procedures of the member provide for a close follow-up and review of all transactions entered into with the referred to domestic bank, trust companies or other conduits for undisclosed principals to assure that the ultimate recipients of securities so sold are not persons enumerated in paragraphs (1) through (6) hereof.

8. Sell any of the securities to a foreign broker/dealer or bank unless:

(a) In the case of a foreign broker/dealer or bank which is participating in the distribution as an underwriter, the agreement among underwriters contains a provision which obligates the said foreign broker/dealer or bank not to sell any of the securities which it receives as a participant in the distribution to persons enumerated in paragraphs (1) through (5) above, or in a manner inconsistent with the provisions of paragraph (6) hereof; or

(b) In the case of sales to a foreign broker/dealer or bank which is not participating in the distribution as an underwriter, the selling member:

(i) makes an affirmative inquiry of such foreign broker/dealer or bank as to whether the ultimate purchasers would be persons enumerated in paragraphs (1) through (5) hereof and receives satisfactory assurance that the ultimate purchasers of the securities so purchased would not be such persons, and that the securities would not be sold in a manner inconsistent with the provisions of paragraph (6) hereof;

(ii) a recording is made on the order ticket, or its equivalent, or upon some other supporting document, of the name of the person to whom the inquiry was made at the foreign broker/dealer or bank as well as the substance of what was said by that person and what was done as a result thereof; and

(iii) the order ticket, or its equivalent, is initialed by a registered principal of the member.

The obligations imposed upon members in their dealings with foreign broker/dealers or banks by this paragraph 8(b) can be fulfilled by having this foreign broker/dealer or bank to which sales falling within the scope of this Interpretation are made execute Form FR-1, or a reasonable facsimile thereof. This form, which gives a blanket assurance from the foreign broker/dealer or bank that no sales will be made in contravention of the provisions of this Interpretation, can be obtained at any District Office of the Association or at the Executive Office. The acceptance of an executed Form FR-1, or other written assurance, by a member must in all instances be made in good faith. Thus, if a member knows or should have known of facts which are inconsistent with the representations received, such will not operate to satisfy the obligations imposed upon him by this paragraph.

Scope and Intent of Interpretation

In addition to the obvious scope and intent of the above provisions, the intent of the Board of Governors in the following specific situations is outlined for the guidance of members.

Limited Registration Category

The term limited representative shall include persons registered solely as either investment company and variable contracts products principal or representative, direct participation program principal or representative.

Issuer Directed Securities

This Interpretation shall apply to securities which are part of a public offering notwithstanding that some or all of those securities are specifically directed by the issuer to accounts which are included within the scope of paragraphs (3) through (8) above. Therefore, if a person within the scope of those paragraphs to whom securities were directed did not have an investment history with the member or registered representative from whom they were to be purchased, the member would not be permitted to sell him such securities. Also, the "disproportionate" and "insubstantial" tests would apply as in all other situations. Thus, the directing of a substantial number of securities to any one person would be prohibited as would the directing of securities to such accounts in amounts which would be disproportionate as compared to sales to members of the public. This Interpretation shall also apply to securities which are part of a public offering notwithstanding that some of those securities are specifically directed by the issuer on a non-underwritten basis. In such cases, the managing underwriter of the offering shall be responsible for insuring compliance with this Interpretation in respect to those securities.

Notwithstanding the above, sales of issuer directed securities may be made to restricted persons without the required investment history after receiving permission from the Board of Governors. Permission will be given only if there is a demonstration of valid business reasons for such sales (such as sales to distributors and suppliers or key employees, who are in each case incidentally restricted persons), and the member seeking permission is prepared to demonstrate that the aggregate amount of securities so sold is insubstantial and not disproportionate as compared to sales to members of the public, and that the amount sold to any one of such persons is insubstantial in amount.

Stand-By Purchasers

Securities purchased pursuant to a stand-by arrangement shall not be subject to the provisions of the Interpretation if the following conditions are met:

1. The stand-by agreement is disclosed in the prospectus.

2. The arrangement is the subject of a formal written agreement.

3. The managing underwriter represents in writing that it was unable to find any other purchasers for the securities.

4. The securities purchased shall be restricted from sale or transfer for a period of five months.

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 complies with either of the following alternatives:

(A) prior to the execution of the transaction, the member has received from the account a current list of 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,

or

(B) prior to the execution of the transaction, the member has obtained a copy of a current opinion from [counsel admitted to practice law before the highest court of any state] the partnership's independent certified public accountants stating that [counsel] the accountants reasonably believe[s] that no person with a beneficial interest in the account is a restricted person under this Interpretation and stating that, in providing such opinion, [counsel] the accountants:

(1) ha[s]ve reviewed and [is] are familiar with this Interpretation;

(2) ha[s]ve reviewed a current list of all persons with a beneficial interest in the account supplied by the account manager;

(3) ha[s]ve reviewed information supplied by the account manager with respect to each person with a beneficial interest in the account, including the identity, the nature of employment, and any other business connections of such persons; and

(4) ha[s]ve requested and reviewed other documents and other pertinent information and made inquiries of the account manager and received responses thereto, if [counsel] the accountants deter-mine[s] that such further review and inquiry are necessary and relevant to determine the correct status of such persons under the Interpretation.

The member shall maintain a copy of the names and business connections of all persons having any beneficial interest in the account or a copy of the current opinion of counsel in its files for at least three years following the member's last sale of a new issue to the account, depending upon which of the above requirements the member elects to follow. For purposes of this section, a list or opinion shall be deemed to be current if it is based upon the status of the account as of a date not more than 18 months prior to the date of the transaction.

Beneficial Interest

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.

Provided, however, that no restricted person shall be deemed to have a beneficial interest in an account receiving a hot issue as a result of ownership of an interest in or the receipt of management fees from an investment partnership or corporation if the following conditions are met.

1. The investment partnership or corporation establishes a separate brokerage account, with a separate identification number, for its new-issue purchases. At the end of each fiscal year, the general partners will certify in writing to its independent certified public accountants that: (a) all hot issues purchased by the partnership were placed in this new-issue account; (b) the partners participating in the new-issue account are not restricted persons under the Interpretation; and (c) that no management fees are based upon the performance of the securities in the new-issue account.

2. Prior to the execution of the initial hot-issue transaction, the partnership's accountants will provide a certification that complies with paragraph B of the section of the Interpretation entitled "Investment Partnerships and Corporations."

3. As part of its audit procedure for the partnership, the independent certified public accountant will confirm in writing to the partnership that all allocations for the new-issue account were made in accordance with the provisions of the applicable partnership agreement that restricts participation in hot-issue purchases.

Venture Capital Investors

This Interpretation shall not prohibit the sale of hot issues in an initital public offering to a person enumerated in paragraphs (1) through (4) hereof or to an entity in which such restricted person has a beneficial interest (a "Venture Capital Investor") if the following conditions are met:

1. The Venture Capital Investor has held securities in the company issuing the hot issue securities for a period of one year prior to the effective date of the public offering.

2. The acquisition of the hot-issue securities in the public offering does not increase the percentage equity ownership of the Venture Capital Investor in the company above that held one year prior to the offering.

3.The Venture Capital Investor received no special terms in connection with the purchase.

4.The securities purchased shall be restricted from sale or transfer for a period of six months following the conclusion of the offering.

Violations by Recipient

In those cases where a member or person associated with a member has been the recipient of securities of a public offering to the extent that such violated the Interpretation, the member or person associated with a member shall be deemed to be in violation of Article III, Section 1 of the Rules of Fair Practice and this Interpretation as well as the member who sold the securities since their responsibility in relation to the public distribution is equally as great as that of the member selling them. In those cases where a member or a person associated with a member has caused, directly or indirectly, the distribution of securities to a person falling within the restrictive provisions of this Interpretation the member or person associated with a member shall also be deemed to be in violation of Article III, Section 1 of the Rules of Fair Practice and this Interpretation. Receipt by a member or a person associated with a member of securities of a hot issue which are being distributed by an issuer itself without the assistance of an underwriter and/or selling group is also intended to be subject to the provisions of this Interpretation.

Violations by Registered Representative Executing Transaction

The obligation which members have to make a bona fide public distribution at the public offering price of securities of a hot issue is also an obligation of every person associated with a member who causes a transaction to be executed. Therefore, where sales are made by such persons in a manner inconsistent with the provisions of this Interpretation, such persons associated with a member will be considered equally culpable with the member for the violations found taking into consideration the facts and circumstances of the particular case under consideration.

Disclosure

The fact that a disclosure is made in the prospectus or offering circular that a sale of securities would be made in a manner inconsistent with this Interpretation does not take the matter out of its scope. In sum, therefore, disclosure does not affect the proscriptions of this Interpretation.

Explanation of Terms

The following explanation of terms is provided for the assistance of members. Other words which are defined in the By-Laws and Rules of Fair Practice shall, unless the context otherwise requires, have the meaning as defined therein.

Public Offering

The term public offering shall mean all distribution of securities whether underwritten or not; whether registered, unregistered or exempt from registration under the Securities Act of 1933, and whether they are primary or secondary distributions, including intrastate distributions and Regulation A issues, which sell at an immediate premium, in the secondary market. It shall not mean exempted securities as defined in Section 3(a)(12) of the Securities Exchange Act of 1934.

Immediate Family

The term immediate family shall include parents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children. In addition, the term shall include any other person who is supported, directly or indirectly, to a material extent by the member, person associated with the member or other person specified in paragraph[s] (2)[, (3), or (4)] above.

Normal Investment Practice

Normal investment practice shall mean the history of investment of a restricted person in an account or accounts maintained with the member making the allocation. In cases where an account was previously maintained with another member, but serviced by the same registered representative as the one currently servicing the account for the member making the allocation, such earlier investment activity may be included in the restricted person's investment history. Usually the previous one-year period of securities activity is the basis for determining the adequacy of a restricted person's investment history. Where warranted, however, a longer or shorter period may be reviewed. It is the responsibility of the registered representative effecting the allocation, as well as the member, to demonstrate that the restricted person's investment history justifies the allocation of hot issues. Copies of customer account statements or other records maintained by the registered representative or the member may be utilized to demonstrate prior investment activity. In analyzing a restricted person's investment history the Association believes the following factors should be considered:

(1) The frequency of transactions in the account or accounts during that period of time. Relevant in this respect are the nature and size of investments.

(2) A comparison of the dollar amount of previous transactions with the dollar amount of the hot issue purchase. If a restricted person purchases $1,000 of a hot issue and his account revealed a series of purchases and sales in $100 amounts, the $1,000 purchase would not appear to be consistent with the restricted person's normal investment practice.

(3) The practice of purchasing mainly hot issues would not constitute a normal investment practice. The Association does, however, consider as contributing to the establishment of a normal investment practice, the purchase of new issues which are not hot issues as well as secondary market transactions.

Disproportionate

In respect to the determination of what constitutes a disproportionate allocation, the Association uses a guideline 10% of the member's participation in the issue, however acquired. It should be noted, however, that 10% factor is merely a guideline and is one of a number of factors which are considered in reaching determinations of violations of the Interpretation on the basis of disproportionate allocations. These other factors include, among other things: the size of the participation;

the offering price of the issue;

the amount of securities sold to restricted accounts;

and,

the price of the securities in the aftermarket.

It should be noted that disciplinary action has been taken against members for violations of the Interpretation where the allocations made to restricted accounts were less than 10% of the member's participation. The 10% guideline is applied as to the aggregate of the allocations.

Notwithstanding the above, a normal unit of trading (100 shares or 10 bonds) will in most cases not be considered a disproportionate allocation regardless of the amount of the member's participation. This means that if the aggregate number of shares of a member's participation which is allocated to restricted accounts does not exceed a normal unit of trading, such allocation will in most cases not be considered disproportionate. For example, if a member receives 500 shares of a hot issue, he may allocate 100 shares to a restricted account even though such allocation represents 20% of the member's participation. Of course, all of the remaining shares would have to be allocated to unrestricted accounts and all other provisions of the Interpretation would have to be satisfied. Specifically, the allocation would have to be consistent with the normal investment practice of the account to which it was allocated and the member would not be permitted to sell to restricted persons who were totally prohibited from receiving hot issues.

Insubstantiality

This requirement is separate and distinct from the requirements relating to disproportionate allocations and normal investment practice. In addition, this term applies both to the aggregate of the securities sold to restricted accounts and to each individual allocation. In other words, there could be a substantial allocation to an individual account in violation of the Interpretation and yet be no violation on that ground as to the total number of shares allocated to all accounts. The determination of whether an allocation to a restricted account or accounts is substantial is based upon, among other things, the number of shares allocated and/or the dollar amount of the purchase.

[Interpretation adopted effective November 1, 1970; amended effective January 11, 1972, March 21, 1972, December 1, 1973, June 1, 1983, July 16, 1983 and August 29, 1988].

Sales By Issuers in Conversion Offerings

Definitions

(a) For purposes of this Subsection, the following terms shall have the meanings stated:

(1) "Conversion offering" shall mean any offering of securities made as part of a plan by which a savings and loan association or other organization converts from a mutual to a stock form of ownership.

(2) "Eligible purchaser" shall mean a person who is eligible to purchase securities pursuant to the rules of the Federal Home Loan Bank Board or other governmental agency or instrumentality having authority to regulate conversion offerings.

Conditions for Exemption

(b) This Interpretation shall not apply to a sale of securities by the issuer on a non-underwritten basis to any person who would otherwise be prohibited or restricted from purchasing a hot issue security if all of the conditions of this Subsection (b) are satisfied.

Sales to Members, Associated Persons of Members and Certain Related Persons

(1) If the purchaser is a member, person associated with a member, member of the immediate family of any such person to whose support such person contributes, directly or indirectly, or an account in which a member or person associated with a member has a beneficial interest:

(A) the purchaser shall be an eligible purchaser;

(B) the securities purchased shall be restricted from sale or transfer for a period of 150 days following the conclusion of the offering; and

(C) the fact of purchase shall be reported in writing to the member where the person is associated within one day of payment.

Sales to Other Restricted Persons

(2) If the purchaser is not a per-son specified in Subsection (b)(1) above, the purchaser shall be an eligible purchaser.

[Added effective September 25, 1986.]