Request for Vote on Proposed Corporate Financing Rule
I M P O R T A N T
OFFICERS, PARTNERS AND PROPRIETORS
TO: All NASD Members
LAST VOTING DATE IS JUNE 20, 1983
The National Association of Securities Dealers, Inc. (the "Association") is submitting for membership vote a proposed new section of the Rules of Fair Practice which, if adopted, would replace the current Interpretation of the Board of Governors — Review of Corporate Financing pursuant to Article III, Section 1 of the Rules of Fair Practice.
On April 15, 1981, the Association requested comments on the proposed corporate financing rule (Notice to Members 81-16). The new rule was approved by the Association's Board of Governors on March 19, 1982 (with subsequent changes approved on March 8, and March 18, 1983), and now requires approval by the membership. If approved, it must be filed with and approved by the Securities and Exchange Commission pursuant to Section 19(b) of the Securities Exchange Act of 1934, as amended.
The text of the proposed rule is attached to this notice. The authority for this proposal is contained in Section 15A of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78o-3) and Article VII of the Association's By-Laws. A discussion of the background and purpose of the new rule, a subsection-by-subsection analysis, a summary of the comments received and the procedures required for adoption of the rule appear below. References to section numbers are to the revised and renumbered sections as they appear in the attached text.
BACKGROUND AND PURPOSE
Article III, Section 1 of the Association's Rules of Fair Practice obligates members to observe high standards of commercial honor and just and equitable principles of trade in the conduct of their businesses. In the early 1960's the Association began reviewing underwriting terms and arrangements of securities offerings in which members were participating. The Association's review was intended to determine whether those terms and arrangements were in compliance with the broad standard of fairness in Article III, Section 1. By 1970, the criteria for determining fairness and reasonableness had become more defined and were incorporated into the Interpretation of the Board of Governors - Review of Corporate Financing (the "Interpretation").
The Interpretation requires that most public offerings of securities in which members participate be filed with the Association's Corporate Financing Department (the "Department") for review. The Interpretation makes it a rule violation for a member or associated person to participate in a public offering if any of the underwriting terms or arrangements are unfair or unreasonable. Guidelines utilized in determining fairness and reasonableness are provided, but the guidelines generally lack specificity.
The language of the Interpretation has not been amended since the early 1970's and no longer accurately reflects all current industry practices. The language is also presented in a manner which sometimes makes it difficult for members and their counsel to clearly understand the requirements to which they are subject. Over the past several years, various clarifications of the policies embodied in the Interpretation have been rendered but these have never been incorporated into the language of the Interpretation.
For these reasons, the Association now proposes to replace the Interpretation with a new rule of fair practice. The new rule is intended to codify and clarify existing Association policy and procedures and in some cases implement new standards of fairness. The new rule was developed by the Corporate Financing Committee (the "Committee") and a subcommittee thereof over a period of several months and was approved by the Association's Board of Governors. The publication of the new rule was the culmination of several years' efforts by the Association to revise, update and recodify policies relating to corporate financing issues.
OF PROPOSED CORPORATE FINANCING RULE
Subsection (a): Definitions - This subsection incorporates definitions of "affiliate," "public offering," and "underwriter" into the rule. These terms are not defined in the Interpretation, but the proposed definitions are based on generally accepted concepts. The definition of "person related to an underwriter" which is found in the Interpretation is clarified to reflect present Association reading of the definition as including persons performing a service for the issuer which is normally performed by an underwriter.
Subsection (b): Underwriting Compensation and Arrangements - Subsection (b)(l) of the proposed rule first states a prohibition against any member or associated person participating in a public offering if the terms or arrangements are unfair or unreasonable. This prohibition is analogous to that currently found in the Interpretation. Subsection (b)(2)(A) of the rule prohibits such persons from receiving an unfair or unreasonable amount of underwriting compensation.
Subsection (b)(2)(B) explains how the amount of underwriting compensation is determined by the Association. The explanation contained in subsection (b)(2)(B) codifies existing practices and references subsection (b)(3) which lists items of compensation. Subsection (b)(2)(C) requires that all items of underwriting compensation be disclosed in the prospectus or offering circular.
Subsection (b)(2)(D) is important in that it lists factors considered in determining whether a proposed amount of underwriting compensation is fair and reasonable. The factors listed generally restate those now found in the Interpretation. Subsection (b)(2)(E) expressly states the Association's policy that more compensation is permitted for offerings with greater risk but lower percentages of compensation are permitted for large gross dollar amount offerings.
Subsection (b)(2)(F) expands upon the concept of risk used in subsections (b)(2)(D) and (E) and lists factors to be considered in determining the amount of risk being assumed by an underwriter.
Proposed subsection (b)(3) of the rule deals generally with items of compensation. Subsection (A) sets forth a list of items which are typically included as underwriting compensation, although it is clearly stated that "all other items of value received or to be received by an underwriter or related person ... in connection with or related to an offering shall be included" as compensation. The list of items contained in this subsection include all of the items currently stated in the Interpretation as well as other items generally included as compensation but heretofore not specifically enumerated. Wholesaler's fees, special sales incentive items, rights of first refusal, and demand registration rights are among such items. In particular, it should be noted that compensation to be received by an underwriter or related person as a result of the exercise of warrants or similar securities distributed as part of the offering would be considered as underwriting compensation if the exercise occurs within 12 months following the effective date.
Subsection (b)(3)(B)(i) provides that all items of compensation received pursuant to an agreement entered into within 12 months prior to an offering will be presumed to be underwriting compensation but that such a presumption may be rebutted on the basis of evidence satisfactory to the Association to support a finding that the compensation was not in connection with the public offering. Subsection (b)(3)(B)(ii) provides that all items of compensation received pursuant to an agreement entered into more than 12 months prior to an offering will be presumed not to be underwriting compensation but items received prior to such 12-month period may be included as underwriting compensation on the basis of evidence satisfactory to the Association to support a finding that the compensation was in connection with the public offering.
Subsection (b)(3)(B)(iii) clarifies and recodifies the factors used to determine whether securities are received in connection with an offering and are therefore underwriting compensation. This subsection provides a basis for rebutting the presumptions in subsection (b)(3)(B)(i) and (b)(3)(B)(ii) that particular securities are to be included or excluded in computing underwriting compensation. Factors to be used in determining whether securities are includable as underwriting compensation are specifically set forth and explained. Those factors are generally analogous to the factors presently contained in the Interpretation.
Subsection (b)(3)(C) provides the basis for excluding financial consulting and advisory fees where an on-going relationship between the issuer and the underwriter is demonstrated. Subsection (b)(3)(D) clarifies that expenses customarily borne by an issuer, even when paid through an underwriter, will not be included as underwriting compensation.
Subsection (b)(4) clarifies and recodifies the method used for determining the value assigned to securities received as underwriting compensation. In this regard, subsection (b)(4)(A) provides that securities shall be valued on the basis of the difference between the cost of the securities and either the proposed public offering price or, in case of securities with a bona fide independent market, the market price on the date of acquisition. Furthermore, subsection (b)(4)(B) lists the factors to be considered in the valuation of options, warrants, or convertible securities. Subsection (b)(4)(C) states that a lower value shall generally be assigned if securities are, or will be, restricted from sale, transfer, assignment or other disposition for a period of up to two years beyond the one-year period of restriction set forth in subsection (b)(6)(A)(i).
Subsection (b)(5) lists terms and arrangements which are presumed to be unfair and unreasonable. The arrangements described generally reflect present Association policy, although in several instances the specified arrangements have never been codified as presumptively unfair and unreasonable.
Particular attention is directed to items (i) through (ix) under subsection (b)(5)(A) which contain specific arrangements that are presumed to be unfair and unreasonable. These provisions restrict the allocation of overhead as expense allowances, the payment of fees prior to commencement of an offering, the duration of certain rights of first refusal and warrants or options, the exercise or conversion terms of certain securities, the receipt of any indeterminate compensation, the receipt of any over-allotment option greater than 15 percent, the receipt of certain compensation for offerings which are not completed, and the receipt of certain securities which are convertible or exercisable on terms more favorable than those received by the public.
Subsection (b)(5)(A)(x) contains the present "ten percent rule" in modified form. The Interpretation provides that underwriters may not receive an amount of securities as underwriting compensation which is greater than ten percent of the number of shares being offered. The present language, however, is unclear as to offerings of warrants, options or convertible securities. The Association believes that members should be permitted to receive securities as underwriting compensation irrespective of the nature of the security offered to the public. The proposed language would therefore make no distinction among various types of securities but would limit the securities received as compensation to ten percent of the number or dollar amount of the securities offered.
The proposed provisions of subsection (b)(5)(A)(xi) represent a new clarification of Association standards of fairness in connection with the exercise or conversion of warrants, options, or convertible securities. The receipt by a member and certain other persons of any compensation or expenses as a result of the exercise or conversion of such securities would be presumed to be unfair and unreasonable in enumerated circumstances. The circumstances described in items (1) through (4) of subparagraph (xi) are intended to assure that compensation is not received unless exercise or conversion will profit the investor, the investor retains the discretion to accept or reject the transaction, the investor is informed of the arrangements for compensation, the investor has not initiated the exercise or conversion, and the investor has designated in writing the broker/dealer which is to receive the compensation.
The foregoing conditions are viewed by the Association as necessary to avoid abuses in this area. The Association has witnessed a number of proposed arrangements which provide compensation of varying amounts and under varying circumstances to broker/dealers upon public investors' exercise or conversion of securities. In most instances, these arrangements appear to be attempts to secure greater amounts of underwriting compensation than normally considered fair. The payment of such compensation also represents potential conflicts between the investor's best economic interests and the broker/dealer's possible gain. Subsection (b)(5)(A)(xi) should assure the fairness and reasonableness of compensation arrangements for the exercise or conversion of securities.
Subsection (b)(5)(B) of the proposed rule recodifies existing procedures for excluding certain securities when calculating the amount of securities which may be received as underwriting compensation for purposes of the ten percent rule found in subsection (A)(x). Subsection (b)(5)(C) also recodifies existing requirements and states that securities constituting unreasonable underwriting compensation received by an underwriter or related person shall be returned at cost and without recourse.
Under subsection (b)(5)(D), the presumption that underwriting terms or arrangements are not in compliance with the standards of the rule may be rebutted and therefore found fair and reasonable in exceptional or unusual cases upon written application to the Association. This is a codification of existing practice.
Subsections (b)(6)(A) and (B) set forth a recodification of the Association's longstanding "lock-up" policy. This policy requires securities received as underwriting compensation to be restricted from sale, transfer, assignment, or hypothecation for one year, except under certain limited circumstances. Certificates of such securities are required to bear a legend describing the restriction.
Subsection (b)(6)(C) addresses possible abuses which may occur when broker/dealers make venture capital investments. This paragraph prohibits a member or person associated with a member who has acquired securities in a privately held issuer from selling those securities during the initial public offering and for a period of 12 months following the effective date of the offering.
Subsection (c): Filing Requirements - Subsection (c) codifies existing requirements for the filing of offerings with the Association without substantial change. Subsection (c)(l) prohibits members and associated persons from participating in offerings unless required documents have been filed with the Association. The paragraph also clarifies that "participation in a public offering" is intended to be broadly construed to include assistance in the preparation of documents, performance of advisory functions and the distribution of securities on any basis.
Subsection (c)(2) states technical procedures for filing and (c)(3) lists offerings which need not be filed. The latter subsection codifies existing practice and clarifies the language of the Interpretation in some respects. The new language clarifies, for example, that Form S-3 "shelf" registrations need not be filed.
Subsection (c)(4) reaffirms Association policy to treat filings confidentially. Subsection (c)(5) sets forth the parties responsible for filing in various circumstances. Both of these paragraphs only restate present policy.
Subsection (c)(6)(A) lists those documents which must be filed. The subsection generally tracks present requirements except for the fact that fewer copies of documents are required.
Subsection (c)(6)(B) incorporates certain language providing guidance as to supplemental information which the Association expects to be filed with the offerings. Such an approach codifies existing procedures and in some respects continues the requirements of the Interpretation. A new requirement is set forth in item (ii) which requires a statement of the basis for, and the underwriter's intended application of, any non-accountable expense allowance greater than three percent of the offering proceeds.
Subsections (c)(6)(C) and (c)(6)(D) contain new requirements. Subsection (c)(6)(C) requires that amendments to filed documents be marked to show changes, i.e., "red-lined." The Association believes this change will benefit all members filing offerings by expediting the review of each. Subsection (c)(6)(D) codifies the present requirement to notify the Association when an offering becomes effective and adds a requirement for such notice whenever an offering is withdrawn or abandoned. The latter requirement would enable the Association to keep abreast of the status of all offerings, thereby assuring that resources are directed to those which are being actively pursued.
Subsection (c)(7) codifies within the substantive rule the means of computing filing fees.
Subsection (d): Code of Procedure - Proposed subsection (d) incorporates into the new rule those procedures presently used on an informal basis to provide a review by hearing subcommittees and standing committees of the Association's Board of Governors of determinations made by the Department with respect to underwriting arrangements. These procedures provide for a hearing on the record, a written determination, and a right of appeal to a standing Board committee. In a departure from present practices for hearings of this nature, costs could be assessed. Costs are now assessed in other types of Association hearings.
The Code does not provide for any review beyond standing Board committees. This is consistent with the Association's policy that determinations by the staff and Committees regarding underwriting arrangements constitute opinions as to fairness and reasonableness and probable compliance with Association rules. Such a determination does not, however, constitute a finding of a rule violation; such a finding is made only by a District Business Conduct Committee, the National Business Conduct Committee, and the Board of Governors following formal complaint procedures. To permit Board review of opinions as to fairness would arguably taint the disciplinary process and place members in double jeopardy. This policy is explained in the Code of Procedure.
Fourteen letters of comment were received on the new corporate financing rule. Approximately a third of the commentators offered general comments regarding regulatory philosophy and the need for a corporate financing rule. Of those offering such general comments, most supported the effort to clarify the Association's requirements and recodify the Interpretation. Others were concerned that such an effort would lead to confusion as the new rule would require new interpretation and might result in more onerous regulation of investment bankers.
Some commentators, primarily smaller broker/dealers and their counsel, indicated that additional reliance on competition and free market forces was in order. They felt that competitively negotiated underwriting arrangements in the context of the disclosure requirements of federal securities law and merit regulation by state authorities provide sufficient protection for issuing companies and public investors. Several felt that additional specific detail on how the rule will be applied would provide useful guidance for members and their counsel. Numerous commentators urged the Association to disclose those amounts of compensation considered fair and the value assigned to various non-cash items of compensation.
A number of commentators suggested that the Association refrain from regulating allocations of underwriting compensation among syndicate members. In fact, such regulation was never contemplated. Underwriting compensation arrangements are reviewed and evaluated in the aggregate and allocations among members are not reviewed.
With respect to the specific provisions of the rule, one commentator noted that the definition of "affiliate" in subsection (a)(1) varies from that in Schedule E in that no percent-of-ownership tests are included as the basis of presumed control. The definition was written in that manner on the assumption that there is not the same need for specificity in the corporate financing rule as in Schedule E.
Another commentator suggested that the definition of "affiliate" be revised to more closely parallel the definition used by the SEC which utilizes direct or indirect control to determine affiliation. Language to effectuate this change has been inserted.
Two commentators suggested redefinition of "person related to the underwriter" to limit application to persons offering professional services who are "affiliated with" or functioning "at the direction of" the underwriter. It was concluded that those changes would unduly restrict the scope of this definition.
The rationale for not making this distinction can be seen clearly in the manner in which the term "underwriter and related person" is used in the review of underwriting compensation. Any services of an investment banking or financial consulting nature rendered in connection with a public offering contribute toward bringing the offering to pass and the provision of such services by persons other than the underwriter should reduce the time, effort and the consequent cost expended by the underwriter in preparing the offering. The Association's underwriting compensation limits were established to permit reasonable compensation for all such services and the permissible compensation to the underwriter should be accordingly adjusted downward to reflect lower costs borne by him.
To state this position in another way, compensation to "related persons" for services rendered in connection with the offering should be carved from maximum permissible underwriting compensation. This reflects the belief that the total cost of distributing a public offering should be reasonable, irrespective of how the distribution-related fees are divided among various parties. The proposed language was an attempt to more explicitly reflect this policy by including within the definition persons who have "performed a service for the issuer in connection with the offering which service is normally performed by an underwriter".
This application of the definition of "underwriter and related persons" has been endorsed on numerous occasions by the Committee and by hearing subcommittees. Modification of this application would allow an underwriter to contract out investment banking services to independent contractors and to negotiate compensation to the maximum permissible level at a subsequent point. Such a practice would amount to an increase in compensation for services in the distribution. Such a practice would also make it most difficult to apply compensation standards equitably among members.
A commentator suggested clarifying that all references in the definition to services performed included only "professional" services. The definition was not intended to be so limited. In view of the apparent confusion, language has been added to clarify that finders and financial consultants and advisors are included in the new definition just as they are in the present definition.
Several commentators suggested that "public offering" be defined so as to exclude public offerings made outside the United States to non-U.S. citizens, e.g. Euro-offerings. Language has been inserted to limit the definition to offerings made "within the United States or its territories."
Some suggestions were made to explicitly exclude from this definition offerings made pursuant to Section 4(6) of the 1933 Act (relating to certain private offerings) and Sections 3(a)(7) and (10) of the Act (relating to securities issued in connection with certain bankruptcy proceedings). There appears to be a sound basis for excluding offerings pursuant to Section 4(6). Following enactment of that provision, the Association has been advising members that such offerings would be deemed private offerings for filing and review purposes. Language amending the definition of "public offering" to codify this interpretation has been inserted.
The Corporate Financing Department very seldom receives filings or requests for exemptions for public offerings involving bankruptcies. It is therefore questionable whether it is necessary to specifically exempt all offerings under Sections 3(a)(7) and (10) of the 1933 Act or whether it is not more prudent to consider each such offering on a case-by-case basis.
Finally, it was suggested that the expression "straight debt" in Section (a)(3) should be redesignated "nonconvertible debt" to conform with the usage of Section (c)(3)(D). That change has been made.
The new rule would incorporate the definition of "underwriter" contained in the 1933 Act. A commentator suggested that the proposed definition be changed to also incorporate SEC rules and regulations adopted under the Act. There appears to be no sound basis for doing so, particularly in light of the difficulty in dealing with future SEC rules or future SEC interpretations of present rules.
Subsection (b)(2) contains a general description of the means for determining the fairness of underwriting compensation. Several commentators urged that the Association publish the amounts of compensation considered fair and the values placed on non-cash items. Commentators indicated that the provisions of the rule were too vague to provide adequate guidance to members in assessing the fairness and reasonableness of underwriting arrangements which they negotiate. The Association carefully weighed these comments and concluded that it would be inappropriate to publish specific amounts of compensation considered to be per se "fair". To do so might lead to abuses whereby higher levels of compensation than otherwise justified might be negotiated on the basis of an NASD "approved" scale.
Nevertheless, the Board of Governors concluded that broker/dealers should be entitled to greater guidance as to the amounts of compensation deemed fair and reasonable. Accordingly, the Association has published the overall average levels of compensation which would be expected for various sizes and types of offerings, based on a study of offerings filed. (See Notice to Members 83-15 (April 8, 1983).)
The lack of specificity in the relationship between risk and compensation also drew several comments. The manner in which the Association determines risk was considered to be unclear as was the permissibility of various levels of compensation at various risk levels.
One commentator considered the Association's practices in determining risk to be in error. That commentator indicated that corporate financing transactions for large, seasoned issuers were more risky than small new issues in terms of the underwriter's capital exposure and declining market risk. The premises underlying the Association's view of permissible amounts of underwriting compensation run contrary to this position. Another commentator indicated that an additional factor should be considered in determining underwriting risk in subsection (b)(2)(F): the risk inherent in the issuer's business.
Subsection (b)(3) sets forth items of compensation normally included in computing total underwriting compensation. As with subsection (b)(2), commentators generally felt that subsection (b)(3) did not offer sufficient specific detail on compensation standards and valuation techniques. In particular, commentators requested detailed guidance regarding evaluation methods for first refusal rights, demand registration rights, securities "lock-ups", and compensation standards for managing or structuring an underwriting arrangement.
A number of comments concerned subsections (b)(3)(B)(i) and (ii) which establish a presumption that compensation received pursuant to agreements entered into within 12 months prior to the filing of the registration statement is in connection with a public offering. One commentator asked that this be made a rebuttable presumption, based on the factual details on any particular transaction. Language has been inserted to effectuate this change.
Several commentators indicated that after-the-fact review of securities acquisitions by the underwriter and related persons to determine a connection to the offering under the criteria of subsection (b)(3)(B)(iii) leads to an unjustified bias toward connection. They argued that the uncertainty of a future public offering and the critically necessary role of the member as venture capital investor are not appropriately weighed. These commentators appear to be overlooking the fact that the criteria for determining a connection to an offering in the new rule are simply codifications of existing practice.
Subsection (b)(3)(C) relating to financial consulting and advisory fees drew considerable comment. Several commentators indicated that financial consulting fees for bona fide financial consulting services should not be attributed to underwriting compensation in a public offering.
Several other commentators offered suggestions for modifying subsection (b)(3)(C). One suggested that the basis for rebutting the presumption of a connection with a public offering be generalized to apply to any underwriting arrangement. Thus the procedure of subsection (b)(3)(C) would be available to all underwriting compensation items rather than being limited to financial consulting and advisory fees.
Another commentator suggested that routine investment banking services such as those for mergers and acquisitions be explicitly excluded from attribution to underwriting compensation in a public offering.
Subsection (b)(5) contains a listing of those underwriting terms and arrangements which are viewed by the Association as presumptively unfair and unreasonable. Most of the arrangements listed have long been treated as unreasonable under Association policy and their inclusion in the new rule only represents a codification and clarification of existing policy.
One longstanding policy, that relating to overallotment options, has been changed as incorporated into the rule, however. The Association has consistently held overallotment options of greater than ten percent to be presumptively unreasonable. On March 18, 1983, the NASD Board of Governors approved a change to increase the size of presumptively fair overallotment options to fifteen percent of the offering amount. This change was seen as necessary in view of the increased volatility of securities markets. The new fifteen percent policy is included in the rule as now proposed.
Subsection (b)(6) contains the Association's "lock-up" on underwriter's warrants and other securities deemed to be underwriting compensation. The subsection retains the prohibition against transfer for one year following the offering.
All commentators on subsection (b)(6)(A)(i) felt that the present practice of allowing transfer of securities to officers and partners should be continued. Several commentators indicated that the category eligible for transfer should be broadened to include directors and employees of the underwriter, underwriter's counsel and other professionals retained by the underwriter to provide services in connection with the public offering.
One commentator queried why more onerous regulation should be placed on professionals employed by the underwriter than those employed by the issuer. This commentator apparently failed to focus upon the limits of the Association's jurisdiction and the Association's policy of limiting underwriting compensation paid to the "underwriter and related persons".
The Association has followed a practice of requiring that securities received as underwriting compensation be retained for a one year period in the hands of members or other responsible officials of members who are subject to the Association's jurisdiction. This prevents a "bail out" by members during volatile aftermarket periods and thus reduces incentives for aftermarket manipulation.
Apparent abuses in the transfer of underwriter's warrants have recently arisen. Some firms specializing in initial public offerings of low-priced securities reportedly have been quickly transferring warrants to salespersons in proportion to their sales and to groups of other employees, including clerical staff members. These transfers have been facilitated in some cases by making certain employees nominal officers of the firm. Language has been added to restrict the transfer of securities received as underwriting compensation to "bona fide officers or partners of an underwriter" so as to clarify that securities cannot be transferred to persons who are designated as officers solely for the purpose of receiving the securities.
Members may recall that a rule filing has been made with the Securities and Exchange Commission to delete in its entirety the Policy of the Board of Governors regarding "Venture Capital and Other Investments by Broker/Dealers Prior to Public Offerings". The Commission staff has expressed concern that members acting in a venture capital capacity might have a conflict of interest by acting as selling shareholders in the initial public offering of a company in which they had made an investment if the member participates in the offering. Language has been added in subsection (b)(6)(C) addressing this potential problem. The new language prohibits members and specified associated persons from selling their holdings in a company as part of the initial public offering or for 12 months thereafter if the member participates in the offering.
Subsection (c) sets forth documents to be submitted and procedures to be followed in filing offerings and, like the remainder of the proposed rule, essentially codifies existing policy. Many of the persons commenting on this subsection suggested that the exemptions from the Association's filing requirements be expanded.
The Association has considered on a number of occasions over the last decade the appropriateness of the filing requirements under the Interpretation and the requirements have been maintained for a number of reasons. First, the focus of the Association review on the fairness of underwriting terms and arrangements is one that is not duplicated by other regulatory authorities who are primarily interested in the adequacy of disclosure or the financial condition of the issuer. The focus on compliance with the NASD Rules of Fair Practice and By-Laws provides an oversight of member's compliance in their investment banking activity that could not be easily duplicated.
Second, the scope of the Association's filing requirements has been determined on the basis of market considerations and represents the minimum amount of regulatory oversight considered necessary. In numerous cases, it has been determined that filings were unnecessary because market forces would assure fair compensation and arrangements. This explains differences in filing requirements between negotiated and competitively bid offerings of the same issuer. In the past, decisions to exempt particular types of offerings were made after an analysis of the unique considerations for that type of offering. The new exemption for "shelf" offerings registered on Form S-3 was adopted after such a process. In that connection, the Association will be publishing a proposal in the near future to exempt all offerings on SEC Form S-3 from NASD filing requirements.
One commentator indicated that subsection (c)(5)(A) should be altered to allow a filing of required documents "within two business days" after filing with the SEC or other authority. It was suggested that this would particularly benefit west coast underwriters. Another commentator suggested requiring filing "as soon as possible" after SEC filing. Balancing the need for early processing against concerns for member convenience, it was deemed appropriate to require filing no later than one business day after filing with the SEC or other authority. Language to effectuate this change has been added.
A number of commentators indicated that subsection (c)(6) should further reduce the number of copies of documents required to be filed. The number of copies required in the new rule (generally two) is the minimum needed by the Association.
Several commentators suggested that subsection (c)(6)(A)(vi) which refers to other documents as requested should specify all supplemental information and documents which might be required as now set out in the "Supplemental Requirements" section of the Interpretation. While the new rule as proposed was drafted to minimize detail in setting out filing requirements, there may be merit in reinserting some details on frequently requested information. Language setting forth these supplemental requirements has been inserted in subsection (c)(6)(B).
Finally, a number of commentators requested that the requirements of subsection (c)(7)(B) for payment of filing fees in the form generally of cash or a certified cheek be eased since all funds will clear during the registration period. Language to make this change has been included in the rule.
Subsection (d) contains a code of procedure for hearings and other reviews of the Department's determination of offerings filed. One commentator suggested that the Corporate Financing Department's role in rendering an opinion regarding the fairness of the underwriting arrangement should be incorporated into the rule. Subsection (d) is intended to provide a right of review from a Department action. It was concluded that it would be cumbersome to describe the Department's internal administrative procedure in the rule.
PROCEDURES FOR ADOPTION OF RULE
The authority for this proposal is contained in Section 15A of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78o-3) and Article VII of the Association's By-Laws.
On April 15, 1981, the Association requested comments on the corporate financing rule (Notice to Members 81-16). The rule was approved by the Association's Board of Governors on March 19, 1982 and amended on March 8 and 18, 1983, and now requires approval by the membership. If approved, it must be filed with and approved by the Securities and Exchange Commission pursuant to Section 19(b) of the Securities Exchange Act of 1934, as amended.
* * * *
The proposed corporate financing rule hereto attached merits your immediate attention. Please mark the ballot according to your convictions and return it in the enclosed stamped envelope to "The Corporation Trust Company." Ballots must be postmarked no later than June 20, 1983.
The Board of Governors believes this proposal to be necessary and appropriate and recommends that members vote their approval.
Any questions regarding this Notice should be directed to Dennis C. Hensley, Vice President, Corporate Financing, at (202) 728-8258.
S. William Broka
Text of Proposed Corporate Financing Rule */
Article III, Section : Underwriting Terms and Arrangements
Subsection (a): Definitions
When used in this section, the following terms shall have the meanings stated below:
Subsection (b): Underwriting Compensation and Arrangements
No member or person associated with a member shall participate in any manner in any public offering of securities in which the terms or arrangements relating to the distribution of the securities are unfair or unreasonable as determined by application of this section.
For purposes of determining the value to be assigned to securities received as underwriting compensation, the following criteria and procedures shall be applied:
Subsection (c); Filing Requirements
No member or person associated with a member shall participate in any manner in any public offering of securities unless documents and information as specified herein relating to such offering have been filed with and reviewed by the Association for compliance with this section. For purposes of this section, participation in a public offering shall include participation in the preparation of offering or other documents, participation in the distribution of the offering on an underwritten, non-underwritten, or any other basis, or participation in any advisory capacity related to the offering.
Documents or information required by this rule to be filed with the Association shall be considered to be filed only upon receipt by the Association at its Executive Office.
The provisions of paragraph (1) notwithstanding, documents and information shall not be required to be filed with respect to offerings of the following types of securities:
The Association shall accord confidential treatment to all documents and information required by this section to be filed and shall utilize such documents and information solely for the purpose of review by the Corporate Financing Department to determine compliance with the provisions of this section or for other regulatory purposes deemed appropriate by the Association.
Subsection (d): Code of Procedure for Handling Corporate Financing and Direct Participation Program Matters
This Code of Procedure is adopted pursuant to the authority of the Board of Governors set forth in Article IV, Section 2(b), and Article VII, Sections 1 and 3(b), of the By-Laws and is prescribed to provide a procedure for review of determinations by the Association's staff regarding compliance with Association rules relating to corporate financing and direct participation program matters by which any person is aggrieved.
Any person aggrieved by a determination of the Corporate Financing Department rendered pursuant to any rule or regulation of the Association relating to underwriting terms or arrangements may make application for review of such determination. In exceptional or unusual circumstances, a member may request conditionally or unconditionally an exemption from such rules or regulations. The Director of the Corporate Financing Department may, of his own initiative, request review of the fairness or reasonableness of any terms and arrangements proposed in documents filed pursuant to this section. Applications for review will be accepted only with respect to offerings for which a registration statement or similar document has been filed with the appropriate federal or state regulatory agency; provided, however, that a hearing committee may waive the requirement for filing prior to review upon a finding that such review is appropriate under the circumstances.
Any person making application for review pursuant to paragraph (d)(2) (hereinafter referred to in this subsection as "applicant") shall request such review in writing and shall specify in reasonable detail the source and nature of the aggrievement and the relief requested. The applicant shall state whether a hearing is requested and shall sign the written application. All applications shall be directed to the Corporate Financing Department at the Association's Executive Office.
Any applicant shall have a right to a hearing before a hearing committee constituted as provided in paragraph (5). The hearing committee may request a hearing on its own motion. A hearing shall be scheduled within ten days following receipt by the Association of the written application for review, or as soon thereafter as practicable, at a location determined by the hearing committee. Written notice of the hearing shall be sent to the applicant at the earliest practicable date, stating the date, time, and location of the hearing.
The hearing committee shall render a determination as to all issues which the committee finds to be relevant as soon as practicable following conclusion of the hearing or, in cases in which a hearing is not requested, completion of the committee's review of the record. The hearing committee may determine whether proposed arrangements are fair and reasonable and in compliance with applicable rules and regulations. The determination of the hearing committee shall be issued in writing. A copy of the determination shall be sent to each applicant.
A hearing committee may, in its discretion, assess costs of a hearing against any person requesting the hearing.
Any determination by a hearing committee or standing committee rendered pursuant to this section shall constitute the opinion of that committee as to compliance with applicable Association rules, interpretations or policies and shall be advisory in nature only. No such determination shall constitute a finding of a violation of any rule, interpretation or policy. A finding of a violation shall be made only by a District Business Conduct Committee pursuant to the Code of Procedure for Handling Trade Practice Complaints.
*/ If approved by the Association's members and the Securities and Exchange Commission, this rule will be added as a new section under Article III of the NASD Rules of Fair Practice and will replace in its entirety the Interpretation of the Board of Governors — Review of Corporate Financing adopted under Article III, Section 1 of the Rules of Fair Practice.