Request For Comments On Proposed Amendments To The Exception To The Qualified Independent Underwriter Requirement In Schedule E To The NASD By-Laws;
Comment Period Expires August 1, 1995
The NASD® requests member comment on proposed amendments to Section 2 of Schedule E to the NASD By-Laws to amend the exception from the qualified independent underwriter requirement for offerings of securities with a bona fide independent market. The amendment would modify:
- the definition of "bona fide independent market" by providing for a national exchange or The Nasdaq Stock MarketSM listing requirement and per-share price test, and changing the trading volume, public float, and independent market-maker provisions; and
- the definition of "bona fide independent market maker" by requiring registration with The Nasdaq Stock Market, and requiring that it neither be affiliated with the issuer nor receive any portion of the net proceeds of the offering. Comments must be received by August 1, 1995.
The NASD adopted Schedule E to the NASD By-Laws (Schedule E) in 1972 to address concerns that public investors be protected adequately when investing in securities issued by an NASD member, its parent, or an affiliate of a member that is going public. To address conflicts of interest regarding the conduct of due diligence and the pricing of the securities, Schedule E requires that a qualified independent underwriter (that is, a member with a background in underwriting and a history of profitable operations) conduct due diligence; participate in the preparation of the prospectus, offering memorandum, or similar document; and provide an opinion that the public-offering price of an equity security is no higher or the yield of a debt security no lower than it recommends. Exceptions are provided to the qualified independent underwriter requirement where the offering is of rated investment grade debt or where the offering is of equity with a bona fide independent market.
The NASD Corporate Financing Committee (Committee) reviewed the bona fide independent market exception from the requirement for a qualified independent underwriter as in Section 3(c) of Schedule E, which was part of the original version of Schedule E adopted in 1972. The Committee reaffirmed its long-held view that the standards for determining a bona fide independent market should be stringent enough to properly regulate public distributions where a member issues its own securities or a conflict or control relationship with a parent or affiliate exists, and provide protection for investors that the conflicts as to pricing and due diligence are properly addressed. The criteria in the definition of bona fide independent market are to assure the public that a market of sufficient depth and duration exists to constitute an efficient pricing mechanism for the securities to be distributed.
The Committee is proposing to revise the definition of bona fide independent market and the related definition of bona fide independent market maker to incorporate more current standards for liquidity in a security. The Committee believes the proposed new requirements for listing, public float, trading volume, price, and number of bona fide independent market makers vastly improve the criteria used for determining the presence of a bona fide independent market. While still focusing on investor protection issues, the Committee believes that the proposed new definitions will permit a significant number of Nasdaq® and exchange-listed issuers to conduct a secondary offering without the unnecessary burden and expense of engaging a qualified independent underwriter, while providing the public with the added protection of a qualified independent underwriter in situations where the market cannot be relied on to price the securities appropriately.
Description Of Proposed Amendments
Bona Fide Independent Market Definition
The Committee believes that listing on a national securities exchange (as defined by the Securities Exchange Act of 1934) or The Nasdaq Stock Market indicates that the security trades in an efficient, regulated, and active market. Therefore, the Committee is proposing that such listing be made part of the definitional requirement of a bona fide independent market. The Committee also believes that a listing requirement brings to the definition the qualitative standards of a regulated trading environment, such as quote transparency, real-time transaction reporting, and corporate governance standards. Securities quoted on the NASD OTC Bulletin Board® service and those traded in the general over-the-counter market, such as the "pink sheets," will be excluded under this test.
Trading Volume Test
The Committee believes that the current aggregate 12-month trading volume of 100,000 shares requirement should be raised to a level that is more indicative of an active, efficient market, and the time period over which trading volume is measured should be adjusted to reflect the minimum period necessary to establish that a bona fide market exists for the security. The Committee is proposing to raise the trading volume requirement to at least 500,000 shares in the 90-calendar-day period before the filing of a registration statement (which is an average of 8,500 shares daily) to establish a better benchmark for justifying an exemption from the requirement that a qualified independent underwriter participate in the offering.
Public Float Test
The Committee is proposing to require a five-million-share public float, as the minimum necessary to assure that the market for an issuer's securities will not suffer undue volatility from the dilution that occurs when a large number of shares is offered to the public. The Committee noted that a typical follow-on offering of a company's stock places between one- and two-million additional shares in public float, which is equal to a 40 percent dilution, even at the five-million-share level.
The Committee expressed concern that a public float test without a corresponding standard for the market price of the securities may be detrimental to establishing a valid benchmark for a bona fide independent market. Therefore, the Committee is proposing to adopt a market-price requirement of at least $5 a share as of the close of trading on the day immediately preceding the filing of the registration statement, coupled with the requirement that the security trade at a price of $5 or more per share on at least 20 of the 30 trading days preceding the date on which the registration statement was filed. The Committee believes that these requirements are consistent with the purpose and intent of the SEC's Penny Stock Rules and Rule 10b-6.
The current definition of a bona fide independent market requires a security to have three bona fide independent market makers. Given that a security may be listed on The Nasdaq Stock Market with two market makers, the Committee is proposing to amend the definition to require only two bona fide independent market makers (as defined below), which it believes are sufficient to demonstrate the presence of a bona fide independent market away from any Schedule E affiliate that may also be making a market in the issuer's securities.
Bona Fide Independent Market Maker Definition
The current definition of "bona fide independent market maker" in Schedule E focuses on net capital requirements and the regular publication of two-sided quotations by the market maker. This definition was developed at the time Schedule E was drafted in 1971. The Committee is proposing to modify the definition to provide that a bona fide independent market maker must be unaffiliated with the issuer and beneficially own—together with its associated persons and their immediate family, parent, and affiliates—less than five percent of the outstanding voting securities, common equity, preferred equity, or subordinated debt of an issuer. The bona fide independent market maker will also be prohibited from receiving any of the net proceeds of an offering. The Committee believes these amendments provide investors with greater assurance that the market maker's activities are independent of any influences that may arise when the ownership of an issuer's securities or interest in the offering become material. These standards are largely drawn from the current definition of qualified independent underwriter in Schedule E and from the reporting requirements imposed on beneficial owners by Section 13 of the Securities Exchange Act of 1934.
Questions regarding this Notice may be directed to Richard J. Fortwengler, Associate Director, or Paul M. Mathews, Supervisor, NASD Corporate Financing Department, at (301) 208-2700.
Request For Comments
The NASD requests all members and interested persons to comment on these proposed amendments. Comments should be directed to:
Ms. Joan C. Conley
National Association of
Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1500.
Comments must be received no later than August 1, 1995. Comments will be reviewed by the NASD Corporate Financing Committee. Changes to proposed amendments must be approved by the NASD Board of Governors and filed with and approved by the Securities and Exchange Commission before becoming effective.
Text Of Proposed Amendments To Section 2 Of Schedule E To The NASD By-Laws
(Note: New text is underlined; deletions are bracketed.)
Distribution of Securities of Members and Affiliates—Conflicts of Interest
Section 1. General
Section 2. Definitions
For purposes of this Schedule, the following words shall have the stated meanings: