Skip to main content
Notice To Members 92-58

SEC Approval of Amendment to Section 13, Schedule E to the NASD By-Laws Effective October 1, 1992

Published Date:


Senior Management
Corporate Finance
Legal & Compliance
*These are suggested departments only. Others may be appropriate for your firm.


The Securities and Exchange Commission (SEC) has approved an amendment to Section 13 of Schedule E to the NASD By-Laws (Schedule E). The amendment permits NASD members to sell securities issued by an entity that wholly owns the member to their employees and other associated persons. The text of the amendment follows this Notice.


Section 13 provides an exemption from the NASD Free-Riding and Withholding Interpretation (Interpretation) and permits NASD members to sell securities of the member or those of its parent to its employees. Section 13 was part of the original amendments to the NASD By-Laws governing the distribution of securities of an NASD member. The NASD Board of Governors (Board) recognized the fact that employees of members would naturally desire to have an ownership interest in their employer. The Board also believed such an investment was beneficial for both the employee and employer.

The Interpretation is based on 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 a secondary market. This obligation applies regardless of whether such securities are acquired by the member and an underwriter, as a selling group member, or from a member participating in the distribution as an underwriter or selling group member, or otherwise. The NASD believes that 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 at which the security trades in the secondary market. Thus, failure to make a bona-fide distribution, 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.

Prior to 1988, Section 13 permitted sales to employees of an affiliated member. Notice to Members 86-28 requested comments to modify major sections of Schedule E, including a proposal specifically to exclude sales to affiliates. Notice to Members 88-33 adopted those modifications and, as a result, Section 13 was narrowed to restrict the exemption from the Interpretation to sales to employees of the member or its parent. To permit sales to employees of affiliates of NASD members was believed to be too broad and permissive in scope. Sales to employees of the member or its parent was the original intent of the exemption from the Interpretation. The NASD and the SEC now believe that certain sales to special purpose affiliates may be appropriate. The view is now that the modifications may have been too restrictive and may have disenfranchised persons that should have been permitted to invest in the securities of their employer's holding company.


Section 2(h) of Schedule E defines the term "parent" for purposes of Section 13 as any entity affiliated with the member from which the member derives 50 percent or more of its gross revenues or in which it employs 50 percent or more of its assets. Large diversified holding companies cannot meet this definition of a parent of a member because the activities of the broker/dealer are only a small part of their business. Employees and other associated persons of NASD member firms owned by such large holding companies, therefore, could not rely on the Section 13 exemption to the Interpretation to purchase shares of their respective holding company in a public offering.

Section 13 now allows employees and other associated persons of NASD members wholly owned by large holding companies to purchase the securities offered by such entities even though the holding company does not come within the Schedule E definition of a parent. It is the NASD's belief that enabling such persons to purchase shares of their respective holding company in a public offering is consistent with the policy of permitting employees of members to have an ownership interest in their member-employers.


The amendment became effective on October 1, 1992. Therefore, NASD members may sell securities to their employees and associated persons when the securities are issued by an entity that wholly owns the NASD member.

Questions concerning this Notice can be directed to Carl R. Sperapani, Assistant Director, or the staff of the Corporate Financing Department, at (202) 728-8258.


(Note: New language is underlined.)

Section 13 — Sales to Employees — No Limitations

Notwithstanding the provisions of the Board of Governors' Interpretation With Respect To "Free-Riding and Withholding," a member may sell securities issued by a member, a parent of a member, an entity which wholly owns a member, or by an issuer treated as a member or parent of a member under Section 9 hereof to the member's employees; potential employees resulting from an intended merger, acquisitions, or other business combination of members resulting in one public successor corporation; persons associated with the member; and the immediate family of such employees or associated persons without limitation as to amount and regardless of whether such persons have an investment history with the member as required by that interpretation; provided, however, that in the case of an offering of equity securities for which a bona fide independent market does not exist, such securities shall not be sold, transferred, assigned, pledged, or hypothecated for a period of five months following the effective date of the offering.