[Federal Register Volume 62, Number 104 (Friday, May 30, 1997)]
[Notices]
[Pages 29382-29385]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-14120]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38670 File No. SR-NASD-97-29]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change and Amendments No. 1 and No. 2 Thereto by the National
Association of Securities Dealers, Inc. Relating to Prohibition on
Members Receiving any Payment to Publish a Quotation, Make a Market in
an Issuer's Securities or Submit an Application to Make a Market in an
Issuer's Securities
May 22, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and rule 19b-4 thereunder, \2\ notice is hereby given
that on April 18, 1997, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association'') filed with the Securities and
Exchange Commission (``SEC'' or ``Commission'') the proposed rule
change as described in Items I, II and III below, which Items have been
prepared by the self-regulatory organization. On May 19, 1997 and May
21, 1997, NASD submitted two amendments (``Amendment No. 1'') and
``Amendment No. 2''), respectively, to the proposed rule change. \3\
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Letter from Alden Adkins, Vice President and General
Counsel, NASD Regulation, to Elaine Darroch, Attorney, Division of
Market Regulation, SEC (May 16, 1997)(``Amendment No. 1''). In
Amendment No. 1, NASD Regulation made technical corrections to the
text of the rule, provided an explanation for not expressly
prohibiting member-to-member payments of making a market, and added
an explanatory footnote concerning the rule's coverage. Letter from
Alden Adkins, Vice President and General Counsel, NASD Regulation,
to Elaine Darroch, Division of Market Regulation, SEC (May 21,
1997)(``Amendment No. 2''). Amendment No. 2 corrected a minor
omission in Amendment No. 1.
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1. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD is proposing Rule 2460 to prohibit members from receiving
any payment to publish a quotation, make a market in an issuer's
securities, or submit an application to make a market. \4\ Below is the
text of the proposed rule change. Proposed new language is in italics.
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\4\ The proposed rule change was approved by the Board of
Directors of the NASD Regulation at its meeting on March 12, 1997,
which authorized the filing of the rule change with the SEC. The
NASD, Inc., Board of Governors declined to review the proposed rule
change at its meeting on April 10, 1997. No other action is
necessary to approve the proposed rule change. See Amendment No. 1,
supra note 3.
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2460. Payments for Market Making
(a) No member or person associated with a member shall accept any
payment or other consideration, directly or indirectly, from an issuer
of a security, or any affiliate or promoter thereof, for publishing a
quotation, acting as market marker in a security, or submitting an
application in connection therewith.
(b) The provisions of paragraph (a) shall not preclude a member
from accepting:
(1) payment for bona fide services, including, but not limited to,
investment banking services (including underwriting compensation and
fees); and
(2) reimbursement of any payment for registration imposed by the
Securities and Exchange Commission or state regulatory authorities and
for listing of an issue of securities imposed by a self-regulatory
organization.
(c) For Purposes of this rule, the following terms shall have the
stated meanings:
(1) ``affiliate'' shall have the same definition as used in Rule
2720 of the business Conduct Rules of the Association:
(2) ``promoter'' means any person who founded or organized the
business of enterprise of an issuer, is a director or employee of an
issuer, acts or has acted as a consultant, advisor, accountant, or
attorney to an issuer, is the beneficial owner of any of an issuer's
securities that are considered ``restricted securities'' under Rule
144, or is the beneficial owner of five percent (5%) or more of the
public float of any class of an issuer's securities, and any other
person with a similar interest in promoting the entry of quotations or
market marking in an issuer's securities; and
(3) ``quotation'' shall mean any bid or offer at a specified price
with respect to a security, or any indication of interest by a member
in receiving bids or offers from others for a security, or an
indication by a member that he wishes to advertise his general interest
in buying or selling a particular security.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of, and basis for, the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements
[[Page 29383]]
may be examined at the places specified in Item IV below. The NASD has
prepared summaries, set forth in Section A, B, and C below, of the most
significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
It has been a longstanding policy and position of the NASD that a
broker-dealer is prohibited from receiving compensation or other
payments from an issuer for quoting, making a market in an issuer's
securities, or for covering the member's out-of-pocket expenses for
making a market, or for submitting an application to make a market in
an issuer's securities.\5\ As stated in Notice to Members 75-16
(February 20, 1975), such payments may be viewed as a conflict of
interest since they may influence the member's decision as to whether
to quote or make a market in a security and, thereafter, the prices
that the member would quote.
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\5\ See NASD Notice to Members 75-16 (February 20, 1975) and 92-
50 (October 1992).
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In the past, certain broker-dealers have entered into arrangements
with issuers to accept payments from an issuer, affiliate, or promoter
of the issuer to make a market in the issuer's securities, or for
covering out-of-pocket expenses of the member incurred in the course of
market making, or for submitting an application to act as a market
maker. As stated above, the NASD believes that such conduct may be
viewed as a conflict of interest. The NASD believes that a market maker
should have considerable latitude and freedom to make or terminate
market making activities in an issuer's securities. The decision by a
firm to make a market in a given security and the question of price
generally are dependent on a number of factors, including, among
others, supply and demand, the firm's expectations toward the market,
its current inventory position, and exposure to risk and competition.
This decision should not be influenced by payments to the member from
issuers or promoters.
On October 27, 1994, the United States Court of Appeals, Tenth
Circuit, reversed, in part, an SEC decision in the matter of General
Bond & Share Co. (``General Bond'').\6\ The NASD had held that General
Bond had, among other things, violated Article III, Section 1 of the
Association's Rules of Fair Practice (currently NASD Rule 2110) by
accepting payments from issuer's in return for listing itself as a
market maker for the securities in the National Quotation Bureau, Inc.
(``NQB'') Pink Sheets (``Pink Sheets''). The NASD position was based on
NASD policy as articulated to the members in Notice to Members 75-16
(February 20, 1975). The SEC, in affirming the NASD decision, agreed
with the NASD that this conduct was inappropriate and in violation of
NASD rules.\7\
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\6\ General Bond & Share Co. v. Securities and Exchange
Commission, 39 F. 3d 1451 (10th Cir. 1994).
\7\ In the Matter of General Bond & Share Co., Securities
Exchange Act Release No. 32291 (May 11, 1993), 54 SEC Docket 129.
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The Tenth Circuit decision held that the NASD rules at the time did
not prohibit a member firm from accepting issuer-paid compensation for
making a market in a security.\8\ Although the NASD had previously
stated that such specific conduct was prohibited, the Court held that
the NASD was required by statute to submit a filing with the SEC
amending NASD rules in this respect. The NASD is proposing this rule to
clarify the application of NASD rules to situations involving the
acceptance of compensation for market making activities.
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\8\ The Court reversed the SEC's finding of violation that
related to the firm's acceptance of issuer-paid compensation, but
sustained all of the SEC's other findings of violation by General
Bond. General Bond, 39 F.3d 1458, 1461.
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The proposed rule is intended to apply a fair practice standard to
a particular course of conduct of a member as described below. In
addition, however, the action of a member in charging an issuer a fee
for making a market, or accepting an unsolicited payment from an issuer
where the member makes a market in the issuer's securities, could also
subject the member to violations of the antifraud provisions of federal
securities laws and NASD Rule 2120. Further, the payment by an issuer
to a market maker to facilitate market making activities also may cause
the member to contribute to violations of Section 5 of the Securities
Act of 1933.\9\
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\9\ The insertion of quotations for a security in an interdealer
quotation system in exchange for a payment by an issuer may result
in a violation of Section 5 of the Securities Act of 1933 based on
the issuer's interest in facilitating the subsequent sale. This
``second sale'' theory was articulated by the SEC and upheld by the
court in SEC v. Harwyn Industries, Inc., 326 F. Supp. 943 (S.D.N.Y.
1971) See, Letter from Kenneth S. Spirer, Attorney, Division of
Market Regulation, SEC, to Jack Rubens, Monroe Securities, Inc. (May
4, 1973).
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Description of Proposed Rule
The proposed rule would prohibit receipt by a broker-dealer of
``any payment or other consideration'' from a prohibited party and is
intended to cover any form of payment in cash, non-cash items, or
securities. The term ``consideration'' would include, for example,
granting or offering of securities products on terms more favorable
than those granted or offered to the public. This term would include
the granting of options in any security, where the options are
exercisable at a price that is discounted from the prevailing market
price. The rule also would cover the purchase of securities by a member
from a prohibited party at a discount from the prevailing market. Such
payments are intended to be prohibited because they may, as discussed
in Notice to Members 75-16, create a conflict of interest that would
influence the member to enter a quotation or make a market in a
security.
The proposed rule prohibits payments that are made ``for publishing
a quotation, acting as a market maker in a security, or submitting an
application in connection therewith.'' This language would apply the
prohibitions of the rule to the entry of a quotation in a security,
making a market in a security, and the entry of a quotation or the
quotation of a security at a particular price.\10\ The definition of
``quotation'' is drawn from Rule 15c2-11 of the Act \11\ and includes
indications of interest.\12\ The proposed rule also specifies that a
member may not impose a fee or accept a payment for submitting an
application to enter quotations or make a market in an issuer's
securities, e.g., a NASD Form 211 application to enter a quotation in
the OTC Bulletin Board or NQB Pink Sheets.
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\10\ NASD Notice to Members 75-16 states that questionable
payments to market marker have the potential to influence the
member's ``* * * decision to make a market and thereafter, perhaps,
the prices it would quote.'' NASD Notice to Members, supra note 5.
\11\ 17 CFR 240.15c2-11(e)(3).
\12\ The proposed rule would apply to any situation in which
member broker-dealer quotations are published in any interdealer
quotation system, or any publication or electronic communication
network or device which is used by brokers or dealers to make known
to others their interest in transactions in any security, including
offers to buy and sell at a stated price or otherwise, or
invitations of offers to buy or sell. See Amendments No. 1 and No.
2, supra note 3.
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The proposed rule would apply to payments by an issuer, an
affiliate of the issuer, or a promoter, whether received directly or
indirectly through another party. Whether a person is considered an
affiliate would be determined under the provisions of NASD Rule 2720
that relate to the existence of a control relationship between an
issuer and a member. For purposes of NASD Rule 2720, the term
``affiliate'' shall mean ``a company which controls, is controlled by
or is under common control with a member.'' In addition, the term
[[Page 29384]]
``affiliate'' is also presumed under certain circumstances in which a
member or company is presumed to control, or presumed to be under
common control, when the respective entities beneficially own ten
percent or more of the outstanding voting securities of the other
entity.\13\
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\13\ See NASD Rule 2720(b)(1)(B) (i), (ii), and (iii).
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The concept of ``promoter'' is broadly defined to encompass all
persons other than the issuer and its affiliates who would have an
interest in influencing a member to make a market in a security. Thus,
the definition includes not only the organizer of the issuer's
business, but also any director, employee, consultant, accountant, or
attorney of the issuer. In addition, certain categories of
securityholders are also within the definition, since these persons are
considered to have an interest greater than that of the average
securityholder in ensuring the existence of an active market. The
categories in the definition, however, are intended to be illustrative
only, and the proposed rule would prohibit payments by any similar
person with an interest in promoting the entry of quotations or market
making in the issuer's securities.
The proposed rule change does not specifically cover member-to-
member payments in the express language of the proposed rule.\14\ The
reasons for the exclusion of member-to-member conduct in the express
language of the rule are as follows. This member-to-member conduct
arguably is already covered by other provisions of the proposed rule,
provisions of another proposed Conduct Rule, and an existing Conduct
Rule.\15\ First, the definition of a promoter could apply to payments
by one member to another member to publish a quote, make a market, or
file an application therewith for a particular security for the purpose
of promoting interest in a particular security.\16\ In addition, such
payments may also fall within the scope of proposed conduct rule
interpretation IM-2110-5 (SR-NASD-97-37),\17\ which would prohibit
certain anticompetitive conduct of member broker-dealers. In
particular, the proposed rule interpretation would prohibit certain
``coordinated'' activity among member broker-dealers regarding prices
(including quotations), trades, or trade reports. Thus, certain
coordinated efforts in publishing quotations or setting prices may be
subject to the provisions of the proposed rule.\18\ Furthermore,
member-to-member payments in some cases may also be covered by NASD
Conduct Rule 2110 as conduct that is inconsistent with high standards
of commercial honor and just and equitable principles of trade.\19\ In
addition, member-to-member payments not specifically prohibited under
the provisions above may involve legitimate broker-dealer activity for
which exemptions from the proposed rule would have to be crafted.
Crafting appropriate exemptions would complicate the proposed rule
unnecessarily in light of the absence of a history of abusive conduct
in member-to-member payments that would not otherwise be prohibited
under the provisions above.\20\
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\14\ See Amendment No. 1, supra note 3.
\15\ Id.
\16\ Id.
\17\ The NASD filed this proposed rule change with the
Commission on May 7, 1997. The notice of the proposed rule change
will be published in the near future.
\18\ Id.
\19\ Id.
\20\ Id.
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The proposed rule also is intended to prohibit indirect payments by
the issuers, affiliates, or promoters through other members. Thus,
members may not accept payments from other members that originate from
an issuer, affiliate, or promoter of the issuer.
In addition, the proposed rule contains a general exception that
permits payments to a member by prohibited persons for ``bona fide
services''. Such bona fide services are intended to include, but not be
limited to, investment banking services, including traditional
underwriting compensation and fees. The proposed rule contains a
further exemption for reimbursement of fees imposed by the SEC and
states and listing fees imposed by self-regulatory organizations. Such
fees have been generally considered costs of the issuer, even when paid
by a broker-dealer.
The proposed rule as originally proposed for public comment \21\
included a third exception,\22\ which was intended to encourage members
to conduct an initial Rule 15c2-11 review \23\ of the issuer and the
security by permitting reimbursement of the member's reasonable out-of-
pocket expenses related to this review. The third exception was
eliminated from the proposed rule due to concerns that such payments
could violate Section 17(b) of the Securities Act of 1933 \24\ and
could be used inappropriately to avoid the limitations of the proposed
rule.
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\21\ NASD Notice to Members 96-83 (December 1996).
\22\ The third exception to the original proposed rule stated:
(b) The provisions of paragraph (a) shall not preclude a member from
accepting: . . . (3) reimbursement of reasonable out-of-pocket
expenses on an accountable basis, not including the member's
overhead, in connection with the member's initial review process in
determining whether to agree to publish a quotation or to act as a
market maker in a particular security.
\23\ Rule 15c2-11 imposes an ``affirmative review'' obligation
on a broker-dealer to form a reasonable belief that the information
submitted in connection with an application to enter a quotation is
accurate in all material respects and that the sources of the
information are reliable. See Securities Exchange Act Release No.
29094 (April 17, 1991), 56 FR 19148 (April 25, 1991).
\24\ Section 17(b) of the Securities Act of 1933 explicitly
makes it unlawful for any person receiving consideration, directly
or indirectly from an issuer, to publish or circulate any material
which describes such issuer's securities without fully disclosing
the receipt of such consideration, whether past or prospective, and
the amount thereof.
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The NASD will announce the effective date of the proposed rule
change in a Notice to Members to be published no later than 45 days
following Commission approval. The effective date will be no more than
30 days following the publication of the Notice to Members announcing
Commission approval.
(b) The NASD believes that the proposed rule change is consistent
with the provisions of Section 15A(b)(6) of the Act \25\ in that
regulating the conduct of member broker-dealers by prohibiting the
receipt of compensation or other payments from an issuer or others for
quoting, or make a market in an issuer's securities is in furtherance
of the requirements that the Association's rules promotes just and
equitable principles of trade, prevent fraudulent and manipulative acts
and practices, and to protect investors and the public interest.
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\25\ 15 U.S.C. Sec. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed rule change will result
in any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act, as amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
The proposed rule change was published for comment in Notice to
Members 96-83 dated December, 1996. In addition, the proposed rule was
posted on the NASD website (www.nasdr.com), which also solicited
comments via E-mail. In total, four (4) comments were received in
response thereto. A copy of the Notice to Members is attached as
Exhibit 2 to the rule filing. A copy of the comment letters received in
response thereto are attached as Exhibit 3 to the rule filing. Of the
four (4) comment letters received, two (2) were in favor of the
proposed
[[Page 29385]]
rule change, one (1) was opposed, and one (1) was neither in favor nor
opposed.
Of the two commentators that were in favor of the proposal, one was
in favor on the assumption that the proposed rule would continue not to
cover member reimbursements for payment for order flow and directed
orders.\26\ The other commentator was in favor of the proposed rule,
and further suggested that we eliminate the third exception (i.e.,
permitting reimbursement for certain accountable costs) to the proposed
rule on the ground that it represents an invitation for abuse by
certain market makers.\27\ One commentator opposed the proposed rule on
the grounds that the proposed rule was complex and suggested that the
proposed rule should require disclosure of all such payments and
relationships similar to the requirements on market makers to disclose
payment for order flow arrangements.\28\ One commentator neither
favored nor opposed the proposed rule and offered a suggestion that
small issuers provide the required documentation to the NASD after
issuer's counsel review. Apparently, the issuer's counsel review would
substitute for the member broker-dealer's review.\29\
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\26\ See, comment letter 2.
\27\ See, comment letter 3.
\28\ See, comment letter 4.
\29\ See, comment letter 1.
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Based on the above responses, the NASD does not believe that any
modification to the proposed rule is warranted. The only negative
response supports requiring disclosure of payments and relationships,
rather than prohibiting the conduct with exceptions. The NASD continues
to believe that the inherent conflicts addressed by the proposal
continue to require direct regulatory action, and that disclosure of
such conflicts would not be an adequate substitute. Further, the text
of the proposed rule is consistent with the NASD's longstanding policy.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the publication of this notice in the Federal
Register or within such longer period: (i) As the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding; or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve the proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. The Commission requests particular
comments addressing whether payments by other members to publish a
quotation, act as a market maker, or submitting an application
therewith should be specifically prohibited and what impact such a
prohibition would have on existing payment arrangements between broker-
dealers. Persons making written submissions should file six copies
thereof with the Secretary, Securities and Exchange Commission, 450
Fifth Street, N.W., Washington, D.C. 20549. Copies of the submission,
all subsequent amendments, all written statements with respect to the
proposed rule change that are filed with the Commission, and all
written communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying at the Commission's Public
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such filing will also be available for inspection and copying
at the principal office of the NASD. All submissions should refer to
File No. SR-NASD-97-29 and should be submitted by June 20, 1997.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\30\
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\30\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-14120 Filed 5-29-97; 8:45 am]
BILLING CODE 8010-01-M