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91-78 Request for Comments on Member Participation in Partnership Rollups and Listing of Securities Resulting from Rollups on Nasdaq/NMS; Last Date for Comments: February 1, 1992
The NASD requests comments on proposed amendments to Appendix F under Article III, Section 34 of the Rules of Fair Practice and Schedule D to the NASD By-Laws. The amendments would restrict member participation in unfair rollup transactions and prohibit listing on the Nasdaq National Market System of any security resulting from an unfair rollup transaction. The text of the proposed amendments follows this notice.
The NASD has proposed amendments to Appendix F under Article III, Section 34 of the Rules of Fair Practice ("Appendix F") and Schedule D to the NASD By-Laws ("Schedule D") that would limit NASD member participation in unfair rollup transactions and restrict listing of the securities of entities resulting from unfair rollups on the Nasdaq National Market System (Nasdaq/NMS). The amendments respond to the legislative mandate in the proposed Limited Partnership Rollup Reform Act of 1991 (the "Rollup Reform Act"), which would impose on the NASD the responsibility for developing rules to protect limited partners in rollup transactions.
The Rollup Reform Act is the legislative response to abuses that have occurred in recent rollup transactions. The bill requires the Securities and Exchange Commission (SEC) to amend its rules relating to the proxy process and disclosure to include provisions that benefit limited partners subject to a rollup. NASD rules required by the Rollup Reform Act relate to prohibiting members from participating in a rollup as well as prohibiting the surviving entity from listing its securities on Nasdaq/NMS if certain protections are not afforded limited partners. In particular, general partners or sponsors proposing a rollup must provide limited partners, as alternatives to participation in the rollup, with either the right to receive compensation based on an appraisal of partnership assets or the right to receive or retain a security with rights, privileges, and preferences similar to their partnership units. As elaborated on herein, if the NASD makes a finding that it is infeasible to provide these alternatives, then the general partner can propose other comparable rights designed to protect limited partners.
The Rollup Reform Act also requires the NASD to adopt rules to preclude member participation in a rollup transaction and listing on Nasdaq/NMS under certain circumstances. Such action could occur if the terms of the transaction unfairly reduce or abridge the voting rights of investors, if investors are required to bear an unfair portion of the costs of the rollup transaction, or if there are not appropriate restrictions on the conversion of general partner or sponsor compensation resulting from the rollup.
The Rollup Reform Act was approved by the House of Representatives November 5, 1991 and is currently awaiting action by the Senate. Although the bill has not yet become law, the NASD believes that it is appropriate to consider amendments to Appendix F and Schedule D prior to final adoption due to provisions in the bill that will effectively prohibit rollup transactions from occurring until all required rules are finalized. While the Rollup Reform Act provides the NASD with an 18-month period to enact rules, prompt action appears to be necessary so that sponsors and general partners considering rollup transactions will not be precluded from the market as a result of the absence of the rules mandated by the legislation.
The proposed amendments to Appendix F and Schedule D will supplement the NASD's recent action prohibiting the receipt of differential compensation in rollup transactions. While the current amendments are being proposed in the context of the pending Rollup Reform Act, the NASD recognizes that additional regulations that are outside the scope of, but not necessarily inconsistent with, the provisions of the Rollup Reform Act may also be appropriate. Therefore, the NASD requests comments and suggestions for rulemaking on any aspect of a rollup transaction that falls within the scope of the NASD's jurisdiction.
The proposed amendments to Appendix F and Schedule D define the following terms: limited partner, limited partnership, rollup or rollup of a limited partnership, dissenting limited partner, cash flow, cash available for distribution, management fee, and solicitation expenses.
A "limited partner" is a purchaser of an interest in a direct participation program that is a limited partnership. A "limited partnership" is defined as a direct participation program that is a limited partnership, including any entity determined to be a partnership pursuant to Section 14(h)(4)(B) of the Securities Exchange Act of 1934. The term "sponsor," also used in the proposed amendments, is defined in Article III, Section 34 of the Rules of Fair Practice as "a person who directly or indirectly provides management services for a direct participation program whether as a general partner, pursuant to contract or otherwise."
The definition of "rollup or rollup of a limited partnership" is proposed to be modified from the current definition in Appendix F to reflect the definition of a rollup that is utilized in the Rollup Reform Act. The definition encompasses the combination or reorganization of one or more limited partnerships, directly or indirectly, whereby investors in the original partnership(s) receive new securities or securities in another entity in exchange for their partnership interests.
A rollup, under the definition, would not include the combination of publicly traded entities; the combination of all private partnerships into a resulting private entity; the reorganization to corporate, trust, or association form or restructuring of a single partnership if there is no significant, adverse change in the voting rights, term of existence of the entity, management compensation, or investment objectives; a reorganization to corporate, trust, or association form or restructuring of a single partnership if each investor is provided an option to retain a security with substantially the same terms and conditions as the original security; or the reorganization to corporate, trust, or association form or restructuring of a partnership if the entity resulting from such reorganization or restructuring is not intended to be publicly traded following the transaction.
"Dissenting limited partner" is defined as a limited partner who has cast a vote against a rollup transaction. If a partner does not vote "no," such partner will not be considered a dissenter. A dissenting limited partner may also be a person who has filed a dissent from the terms of a proposed exchange or tender offer with the party responsible for tabulating the votes or tenders. The "no" vote or the dissent must be received during the period in which the offer is outstanding.
"Cash flow" is defined as cash provided from operations, including lease payments on net leases from builders and sellers, without deduction for depreciation, but after deducting cash funds used to pay all other expenses, debt payments, capital improvements, and replacements.
"Cash available for distribution" is defined as cash flow less amounts set aside for restoration or creation of reserves.
A "management fee" is a fee paid to a sponsor, general partner, its affiliates, or other persons for management and administration of a limited partnership.
"Solicitation expenses" are defined as direct marketing expenses such as telephone calls, broker/dealer fact sheets, legal and other fees related to the solicitation, and direct solicitation compensation to members.
The proposed rules would prohibit the participation of members and persons associated with members in a rollup transaction unless the transaction includes provisions designed to protect rights of limited partners. The rights of limited partners are presumed to be protected if dissenting limited partners are offered (1) the right to receive compensation for their partnership units based on an independent appraisal of partnership assets, (2) the right to receive or retain a security with substantially the same terms and conditions as the security originally held, or (3) other comparable rights.
The first option, compensation based on appraisal, contemplates an appraisal performed by an independent appraiser unaffiliated with the sponsor or general partner of the program that values the assets as if sold in an orderly manner in a reasonable period of time, plus or minus other balance-sheet items, and less the cost of sale or refinancing. This is to ensure that the appraisal accurately reflects the current value of the assets. The NASD requests specific comment on whether additional standards regarding appraisals or the qualifications of persons performing appraisals should be considered.
Forms of compensation that can be offered to dissenting limited partners are cash, secured debt instruments, unsecured debt instruments, or freely tradeable securities. Debt instruments must provide for a trustee and an indenture, provide the holders with a market rate of interest based on the federal funds rate, may have a term no greater than 10 years, and provide for prepayment with 80 percent of the net proceeds of any sale or refinancing of the assets of the entity. Unsecured debt instruments may be used only when the entity issuing the debt has a limitation on total leverage of 80 percent of the appraised value of its assets.
Freely tradeable securities utilized as compensation must be issued by a company that has been publicly traded prior to the transaction. The number of freely tradeable securities offered in return for partnership interests would be determined by the appraisal of partnership assets in relation to the average last-sale price of the securities in the 20-day period following the transaction.
The second option, to retain a security with substantially the same terms and conditions as the original issue, provides that limited partners must receive or retain a security with substantially the same rights, preferences, and priorities as their current security. There must be no material adverse change as to the business plan or the investment, distribution, and liquidation policies of the partnership.
A general partner or sponsor proposing a rollup may avoid the requirement to offer dissenting limited partners compensation based on an appraisal or the right to retain a similar security only upon a demonstration to the NASD that it is infeasible to provide such protections. To the extent that a general partner or sponsor can make a showing of infeasibility, other comparable rights designed to protect limited partners may be utilized. However, the NASD believes that a clear, convincing, and objective showing of infeasibility must be made. Generalizations, forecasts, or assumptions that cannot be objectively supported will not be acceptable.
Comparable rights may include review of the transaction by an independent committee or other comparable rights as may be proposed by the general partner or sponsor. The comparable rights provisions are intended to provide flexibility for sponsors and general partners to propose other protections for limited partners when the other alternatives are infeasible. If the NASD is unable to determine that the comparable rights offered by sponsors or general partners are sufficient to protect the interests of limited partners, the NASD will require that an independent committee composed of persons not affiliated with the general partner or sponsor be established to review the appropriateness of proposed comparable rights.
The proposed amendments provide that an independent committee will be composed of at least three persons; will, if practicable, contain representation from each entity subject to the rollup, the majority of whom represent the largest equity holders in the partnerships subject to the rollup and the minority of whom may be recommended by the general partner or sponsor; will have the authority to negotiate the proposed transaction with the general partner or sponsor on behalf of the limited partners, but not the authority to approve the transaction on behalf of the limited partners; will be ruled by unanimous decision; will deliberate for a period no longer than 60 days unless unanimously extended; will be compensated by the partnerships subject to the rollup and will have the ability to retain independent counsel and financial advisors; and will be entitled to indemnification to the maximum extent permitted by law from the general partners, sponsors, limited partnerships, and rolled-up entities from claims, causes of action, or lawsuits resulting from their decisions. The NASD requests specific comment on the make-up and functioning of an independent committee.
The premise that underlies many of the objections to rollups is that a simple majority of limited partners voting for a rollup can deprive other limited partners of the business and financial opportunities they bargained for when they originally invested. However, this objection may be obviated to some extent if limited partners owning three-fourths of the partnership interests take affirmative action to approve the rollup transaction. Therefore, another comparable right that may be provided is supermajority approval of the rollup. In situations where the sponsors or general partners reasonably believe that a supermajority of 75 percent of the outstanding units of each of the participating partnerships in a rollup will vote to approve the transaction, the provisions of the proposed rules would not be applicable.
The NASD believes that such an overwhelming approval of the transaction is an accurate indication of the fairness and beneficial nature of the rollup, and that such approval would constitute an "other comparable right" within the terms of the proposed legislation. If the 75 percent supermajority is not ultimately reached, however, the rollup would be considered rejected. Should the sponsor or general partner still wish to pursue the rollup, the proposed transaction would then have to be amended to provide the protections to limited partners provided for in the rules.
The proposed amendments to Appendix F and Schedule D also address elements of rollup transactions that are potentially unfair to limited partners. These elements include the conversion and valuation of general partner interests in a rollup, voting rights, the allocation of transaction costs of a rejected rollup, and the payment of fees in connection with rollup transactions. The proposed rules create a series of presumptions under which these elements are considered unfair if they fail to protect the rights of limited partners.
The proposed amendments establish a presumption that it is unfair and unreasonable for general partners, when determining their interest in the new entity resulting from a rollup, to (1) convert an equity interest in partnerships subject to a rollup into a voting interest in the new entity if consideration had not been paid for such equity interest, (2) fail to follow the valuation methods indicated in the partnership agreements when valuing their partnership interests, or (3) utilize a projected future value of their equity interest rather than the appraised current value of their equity interest when determining their interest in the new entity.
Voting rights will be presumed unfair unless the general partner or sponsor proposes to generally maintain the original voting rights of the partnerships participating in the rollup. However, the NASD recognizes that certain changes to voting rights may be necessary to conform disparate rights that may exist among participating partnerships. Material changes may be effected only if the NASD determines that such changes are not unfair or if an independent committee approves such changes.
The proposed amendments provide that a majority of the interests in an entity resulting from a rollup may vote to amend the limited partnership agreement, articles of incorporation or bylaws, or indenture; dissolve the entity; remove management and elect new management; and approve or disapprove the sale of substantially all the assets of the entity.
The proposed amendments would also require a sponsor or general partner proposing a rollup to clearly delineate the instructions and procedures of voting against or dissenting from a proposed rollup transaction. The general partner or sponsor must utilize an independent third party to receive and tabulate all votes and dissents, and must also undertake to make the tabulation available to the general partner and any limited partner on request at any time during and after voting occurs.
The proposed amendments seek to prevent limited partners from bearing an unfair portion of the transaction costs of a rejected rollup transaction. The allocation of transaction costs in a rejected rollup is presumed fair if the costs are apportioned between general and limited partners according to the final vote on the proposed transaction. The general partner or sponsor would bear costs in proportion to the number of votes to reject the transaction and limited partners would bear costs in proportion to number of votes to approve the transaction. The NASD believes that this allocation of costs is fair to both the general and the limited partners. In the case of a rollup transaction that is approved, the amendments indicate that any partnership(s) that votes not to join the transaction would not have any costs allocated to it.
Finally, the proposed amendments presume that limited partners are not protected if general partners propose to receive or convert unearned management fees discounted to a present value while also proposing to receive new asset-based fees. A similar presumption applies if property management fees and other fees are not appropriate, not reasonable, and not greater than those that would be paid to third parties for performing similar services. Substantial and adverse changes in fees are presumed unreasonable if not submitted to and approved by an independent committee.
REQUEST FOR COMMENTS
The NASD Board of Governors encourages comment from all members and other interested persons. Comments should be forwarded to:
Stephen D. Hickman Office of the Secretary National Association of Securities Dealers, Inc. 1735 K Street, NW Washington, DC 20006-1506.
Comments must be received no later than February 1, 1992. Comments received by this date will be considered by the Direct Participation Programs/Real Estate Committee and the NASD Board of Governors. If the Committee and the Board approve the amendments to Appendix F and Schedule D, they must be filed with and approved by the SEC before becoming effective.
Questions concerning this notice may be directed to Charles L. Bennett, Director, or Richard J. Fortwengler, Associate Director, NASD Corporate Financing Department, at (202) 728-8258.
AMENDMENTS TO APPENDIX F TO ARTICLE III, SECTION 34 OF THE RULES OF FAIR PRACTICE AND SCHEDULE D TO THE BY-LAWS
(Note: Language is in the form of an amendment to Appendix F. Language will be conformed to Part III of Schedule D to the By-Laws. New language is underlined; deleted language is in brackets.)
No member or person associated with a member shall participate in a public offering of a direct participation program or a rollup of a direct participation program that is a limited partnership except in accordance with this Appendix.
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Sec. 6 Participation In Rollup