Notice To Members 83-67

Proposed Amendments to the Corporate Financing Rule Proposed Amendments to Section 26 of the Rules of Fair Practice

Published Date:

I M P O R T A N T

MAIL VOTE

Officers * Partners * Proprietors

TO: All NASD Members

Last Voting Date is January 9, 1984

Attached are amendments regarding two separate issues which are being submitted to the membership for a vote. The first issue is that of amendments to the proposed Corporate Financing Rule filing requirements which would exempt from those requirements all debt and equity securities registered with the Securities and Exchange Commission on Registration Statement Form S-3. The proposed exemption would replace the present NASD exemptions for debt rated "B" or better by a recognized rating service and for debt and equity offerings registered on a Form S-3 and distributed pursuant to Rule 415.

On May 27, 1983, the Association requested comments on the amendments to the proposed Corporate Financing Rule filing requirements. (Notice to Members 83-25). The proposed amendment was approved by the Association's Board of Governors on July 15, 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 background and details of the amendment are discussed below (Exhibit A). The text of the proposed amendments is attached to this notice (Exhibit B).

The second issue requiring a membership vote is that of proposed amendments to Article III, Section 26 of the Rules of Fair Practice. The proposed amendments to subsection (k) of Section 26 are purely technical in nature and have no material effect on the standards contained in the rule. They represent language clarifications requested by the staff of the Securities and Exchange Commission in connection with the Commission's approval of prior amendments. The text of the proposed amendments is also attached to this notice (Exhibit C).

Should the proposed amendments be approved by membership vote, they 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.

Sincerely,

Gordon S. Macklin
President

Enclosures

Exhibit A

CORPORATE FINANCING RULE

BACKGROUND

The Interpretation of the Board of Governors — Review of Corporate Financing ("Corporate Financing Interpretation") under Article III, Section 1 of the Rules of Fair Practice (NASD Manual (CCH) Para. 2151) requires that most public offerings of debt and equity securities which involve member participation be filed with the Association for a review of the underwriting terms and arrangements. Historically, the Association, through its filing requirements, has tried to identify offerings in which review of the underwriting terms and arrangements would be most meaningful. In the past, certain types of offerings have been exempted from the filing requirements where market forces or other constraints were present to assure the fairness and reasonableness of underwriting terms and arrangements, including specifically the amount of underwriting compensation.

In Notice-to-Members 83-24 (May 19, 1983), the Association submitted to the membership for vote a new Corporate Financing Rule which, when approved by the SEC, will replace the Corporate Financing Interpretation. Sections (c)(3)(D) and (F) of the Corporate Financing Rule exempt from the filing requirements debt rated "B" or better by a recognized rating service and securities registered as part of a "shelf" registration on Form S-3 issued by a registrant which meets the requirements of Form S-3 as those requirements were in effect on March 1, 1983.

The exemption for offerings of debt securities rated "B" or better by a recognized rating service reflects the nature of the debt market during the late 1960's when the filing requirements were developed. At that time, most outstanding debt was rated "B" or better. There was a small amount of debt rated below "B" which was of significantly lesser quality.

The exemption for securities registered on a Form S-3 and distributed pursuant to Rule 415*/ is an extension of prior policy which provided an exemption for "shelf" offerings registered on a Form S-16 which do not involve an underwriting agreement. The current exemption reflects a determination that, irrespective of whether the securities are sold in normal brokerage transactions or pursuant to an underwriting agreement, market pressures in connection with "shelf" offerings result in the amount of underwriting compensation being determined through a virtual competitive bidding process which helps to achieve its reasonableness. Even in "shelf" offerings which eventually include a traditional underwriting agreement, the Association believes that the competitive pressures which come into play in the negotiations preceding the execution of that agreement can usually be relied upon to achieve the overall fairness of the arrangement.

Recently, the Association reexamined its filing requirements in light of the adoption by the SEC of the Form S-3 eligibility criteria. Form S-3 is the most streamlined of SEC registration statement forms and permits issuers to incorporate by reference substantial amounts of information from annual reports and other periodic filings. The Commission devoted substantial resources to identifying those securities and issuers which were widely followed and subject to sufficiently meaningful market forces as to assure that adequate information was readily available in the marketplace.

To use Form S-3, both the registrant and the transaction must meet specified qualifications. Form S-3 may be used by a U.S. registrant which has been a reporting company for 36 months prior to the filing, and has made timely filings for 12 months preceding the filing date. In addition, neither the registrant nor its subsidiaries may have defaulted in the payment of required dividends or any material obligations since the end of its last audited year.

Form S-3 may be used for primary offerings of such registrants which have outstanding voting stock held by non-affiliates with an aggregate market value of $150 million, or alternatively, $100 million aggregate market value and annual trading volume of three million shares. Primary offerings by qualified registrants of "investment grade" non-convertible debt and preferred securities may also be registered on Form S-3. Investment grade debt is defined as those securities rated by a nationally recognized statistical organization in the four highest categories (e. g. "AAA" through "BBB" by Standard & Poor's and "Aaa" through "Baa" by Moody's). Secondary offerings of outstanding securities by any person other than the issuer may be registered on Form S-3 if the securities are quoted on NASDAQ or listed on a national securities exchange. Finally, rights offerings, dividend and interest reinvestment plans, and offerings of securities upon conversion and the exercise of warrants may be registered on Form S-3.

Having observed the operation of the integrated disclosure system for over a year, the Corporate Financing Committee and Board of Governors have concluded that it is appropriate to amend the NASD filing requirements to reflect the new structure of SEC registration requirements.

EXPLANATION OF PROPOSED AMENDMENTS

The proposed amendments significantly alter present NASD filing requirements for both debt and equity securities. With respect to equity offerings, i.e. offerings which have any attribute of equity ownership, the number of offerings which would be required to be filed would be substantially reduced. Currently, most equity offerings are required to be filed with the Association, except where the offering is being made pursuant to Rule 415. Under the proposed amendment, the current exemption for equity offerings registered on a Form S-3 and distributed pursuant to Rule 415 would be eliminated. In its place, the Association is proposing that an exemption for all equity offerings registered with the SEC on Form S-3 (or an equivalent successor form) be adopted. As explained above, primary offerings of equity securities can generally be registered on Form S-3 when the issuer has outstanding voting stock held by non-affiliates with an aggregate market value of $150 million or such stock has an aggregate market value of $100 million and a trading volume of three million shares. The market value and trading volume requirements are inapplicable to preferred offerings, rights offerings, dividend and interest reinvestment plans and offerings upon conversion and the exercise of warrants.

With respect to debt offerings, i.e. offerings with no equity characteristics, the proposed amendments would require a greater number of such offerings to be filed than at present. Pursuant to the proposed amendment, the present exemptions for debt rated "B" or better and "shelf" offerings of debt registered on a Form S-3 would be eliminated. In its place, an exemption for all debt registered on Form S-3 (or an equivalent successor form) would be adopted. Generally speaking, therefore, debt instruments rated "B", or "BB" by Standard and Poor's and "B" or "Ba" by Moody's would become subject to NASD filing requirements. In today's market, the nature of debt instruments is significantly different than that which existed when the filing requirements were developed in the late 1960's. There has been a proliferation of types and levels of quality debt. The Corporate Financing Committee concluded, therefore, that it is appropriate to subject these instruments to review by the Association to assure the fairness and reasonableness of their overall underwriting terms and arrangements.

In recommending the proposed amendments, the Corporate Financing Committee concluded that competitive market forces which ordinarily affect a public offering by an issuer qualified to use Form S-3 are effective in assuring that the underwriting terms and arrangements generally are fair and reasonable. In addition, the Committee noted that rapid access to the marketplace has become increasingly critical for certain issuers and that such access has been facilitated by SEC policies which permit offerings to become effective without detailed review. The Association has long been committed to expediting its review of offerings where rapid market access was critical. It is therefore appropriate that the Association take steps to assure ready access to the marketplace so long as investor protection is assured.

It is important to note that the proposed amendments relate only to filing requirements and do not constitute exemptions from the substantive requirements of the Corporate Financing Interpretation or the proposed Rule. Members will still be expected to assure compliance with those requirements in any offerings in which they participate. Additionally, the proposed exemptions relate only to filing requirements under the proposed Corporate Financing Rule; these exemptions do not extend to offerings which are subject to Schedule E to Article IV, Section 2 of the NASD By-Laws concerning offerings by members of their own securities or those of affiliates.

The text of the proposed amendments is attached.

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.

Exhibit B

Text of Proposed Amendment*/

Subsection (c): Filing Requirements

(1) General
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.

* * *

(3) Excepted Offerings
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:
(A) securities which are defined as "exempt securities" in Section 3(a)(12) of the Securities Exchange Act of 1934, as amended;
(B) securities of investment companies registered under the Investment Company Act of 1940, as amended, except securities of a management company defined as a "closed-end company" in Section 5(a)(2) of that Act;
(C) variable contracts as defined in Article III, Section 29(b)(l) of the Rules of Fair Practice;
(D) nonconvertible debt securities or preferred stock which is rated "B" or better by a national rating agency recognized by the Association;
(E)
(D) securities issued pursuant to a competitively bid underwriting arrangement meeting the requirements of the Public Utility Holding Company Act of 1935, as amended;
(F)
(E) securities registered as part of a "shelf" registration, Provided that said securities are registered with the Securities and Exchange Commission on registration statement Form S-3 or a similar form promulgated in lieu of Form S-3 and are issued by an issuer which presently meets the issuer requirements of Form S-3 as those requirements were in effect on March 1, 1983; and provided further, that said securities are reasonably expected to be offered pursuant to Rule 415 adopted under the Securities Act of 1933, as amended, as that rule was in effect on March 1, 1983;
(G)
(F) private offerings which are exempt from registration under Section 4(1), 4(2) or 4(6) of the Securities Act of 1933, as amended; and
(H)
(G) tender offers made pursuant to Regulation 14D adopted under the Securities Exchange Act of 1934, as amended, as that regulation was in effect on March 1, 1983.

Exhibit C

Below are technical amendments which will have no substantive effect on Article III, Section 26. The proposed changes are merely in conformance with the Commission's request for language changes.

Proposed Amendments to Article III, Section 26(k) of the Rules of Fair Practice

(additions underlined; deleted material in brackets)

Execution of Investment Company Portfolio Transactions

(k)
(1) No member shall, directly or indirectly, favor or disfavor the sale or distribution of shares of any particular investment company or group of investment companies on the basis of brokerage commissions received or expected by such member from any source, including such investment company, or any covered account.
(2) No member shall, directly or indirectly, demand or require brokerage commissions or solicit a promise of such commissions from any source as a condition to the sale or distribution of shares of an investment company.
(3) No member shall, directly or indirectly, offer or promise to another member, brokerage commissions from any source as a condition to the sale or distribution of shares of an investment company and no member shall request or arrange for the direction to any member of a specific amount or percentage of brokerage commissions conditioned upon that member's sales or promise of sales of shares of an investment company.
(4) No member shall circulate any information regarding the amount or level of brokerage commissions received by the member from any investment company or covered account to other than management personnel who are required, in the overall management of the member's business, to have access to such information.
(5) No member shall, with respect to such member's activities as an underwriter of investment company shares, suggest, encourage, or sponsor any incentive campaign or special sales effort of another member with respect to the shares of any investment company which incentive or sales effort is, to the knowledge or understanding of such underwriter-member, to be based upon, or financed by, brokerage commissions directed or arranged by the underwriter-member.
(6) No member shall, with respect to such member's retail sales or distribution of investment company shares:
(A) provide to salesmen, branch managers or other sales personnel any incentive or additional compensation for the sale of shares of specific investment companies based on the amount of brokerage commissions received or expected from any source, including such investment companies or any covered account. Included in this prohibition are bonuses, preferred compensation lists, sales incentive campaigns or contests, or any other method of compensation which provides an incentive to sales personnel to favor or disfavor any investment company or group of investment companies based on brokerage commissions;
(B) recommend specific investment companies to sales personnel, or establish "recommended," "selected," or "preferred" lists of investment companies, regardless of the existence of any special compensation or incentives to favor or disfavor the shares of such company or companies in sales efforts, if such companies are recommended or selected on the basis of brokerage commissions received or expected from any source;
(C) grant to salesmen, branch managers or other sales personnel any participation in brokerage commissions received by such member from portfolio transactions of an investment company whose shares are sold by such member, or from any covered account, if such commissions are directed by, or identified with, such investment company or any covered account; or
(D) use sales of shares of any investment company as a factor in negotiating the price of, or the amount of brokerage commissions to be paid on, a portfolio transaction of an investment company or of any covered account, whether such transaction is executed in the over-the-counter market or elsewhere.
(7) Provided that the member does not violate any of the specific provisions of this subsection (k), [N] nothing [in this subsection (k)] herein shall be deemed to prohibit:
(A) the execution of portfolio transactions of any investment company or covered account by members who also sell shares of the investment company;
(B) a member from selling shares of, or acting as underwriter for, an investment company which follows a policy, disclosed in its prospectus, of considering sales of shares of the investment company as a factor in the selection of broker-dealers to execute portfolio transactions, subject to the requirements of best execution;
(C) a member from compensating its salesmen and managers based on total sales of investment company shares attributable to such salesmen or managers, whether by use or overrides, accounting credits, or other compensation methods, provided that such compensation is not designed to favor or disfavor sales of shares of particular investment companies on a basis prohibited by this subsection (k).

*/ The Association recently clarified the filing requirements with respect to "shelf" offerings registered on a Form S-3 in Notice-to-Members 83-12 (March 8, 1983).