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90-79 Receipt of Differential Compensation for Soliciting Proxies in Partnership Roll-Ups; Last Date for Comments: January 15, 1991

SUGGESTED ROUTING*

Senior Management
Corporate Finance
Legal & Compliance
Syndicate

*These are suggested departments only. Others may be appropriate for your firm.

REQUEST FOR COMMENTS

EXECUTIVE SUMMARY

The NASD requests comments on a proposed amendment to Appendix F under Article III, Section 34 of the Rules of Fair Practice ("Appendix F") that would prohibit member firms from receiving differential compensation contingent on investor votes in connection with their solicitation of consents in partnership roll-up transactions. The text of the proposed amendment follows this notice. The NASD is also interested in receiving comment on any regulatory alternatives to the proposed amendment.

BACKGROUND

The NASD's Direct Participation Programs/Real Estate Committee, a national standing committee of the Board of Governors, has reviewed certain issues relating to NASD members' activities in connection with the roll-up of existing limited partnerships into new publicly traded limited partnerships, real estate investment trusts, or corporations.

In particular, the Committee reviewed the use of differential compensation plans that provide for NASD members soliciting limited partners in a roll-up to receive a commission only when the investor votes "yes" on the proposed transaction. The NASD is concerned that the payment for "yes" votes raises a conflict of interest, or appearance of a conflict of interest, since such a compensation arrangement may give members an incentive to recommend approval of the transaction.

A typical differential compensation arrangement provides for members to receive a commission, generally around 2 percent, for soliciting "yes" votes from limited partners to approve a roll-up transaction. No payments are made for "no" votes. In addition, members do not receive these commissions if a sufficient number of "yes" votes is not received to consummate the transaction. Members also sometimes receive engagement fees, financial advisory fees, and/or fees for providing fairness opinions in connection with roll-up transactions.

On October 3, 1990, the House Subcommittee on Telecommunications and Finance opened hearings in Washington, D.C., on various investor protection, fairness, and disclosure issues related to the roll-up of limited partnerships.

The subcommittee indicated its intention to convene a series of hearings to determine whether legislative or regulatory action is necessary to curb perceived abuses in the roll-up area.

Such perceived abuses relate to the fees earned by general partners and their affiliates in connection with roll-up transactions, poor after-market performance of entities resulting from a roll-up, the lack of dissenters' rights for limited partners opposed to a roll-up, the accuracy and adequacy of disclosure documents provided to investors considering a roll-up, as well as differential compensation arrangements providing payment to brokers only when soliciting "yes" votes.

The NASD believes that the appropriate legislative or regulatory bodies should address concerns relating to investor protection, aftermarket performance, fairness, and disclosure in connection with roll-ups. The issue of differential compensation, however, presents an immediate issue to the NASD. The Board of Governors is concerned about members' receipt of payment only for "yes" votes when soliciting limited partners considering approval of a roll-up transaction, particularly in light of the above-referenced investor protection, aftermarket performance, fairness, and disclosure concerns relating to these transactions.

The Board questioned whether members should be paid only for soliciting "yes" votes when it is unclear whether such "yes" votes are in the best interests of investors. The Board determined that it may be more appropriate for members to receive a solicitation fee based on delivering any vote, "yes" or "no," as compensation for their solicitation efforts.

Therefore, the Board of Governors accepted the Direct Participation Programs/Real Estate Committee's recommendation to request membership comment on a proposed amendment to Appendix F under Article III, Section 34 of the Rules of Fair Practice. The proposed amendment would prohibit the receipt by a member of differential compensation in a roll-up transaction that is tied to the solicitation of "yes" votes only from limited partners, irrespective of the form of entity resulting from the roll-up (i.e., a partnership, real estate investment trust, or corporation).

REQUEST FOR COMMENT

The NASD is requesting comment on the proposed amendment itself as well as specific comment on several unresolved issues relating to the proposed amendment and roll-ups.

First is the question of whether the 2 percent commission creates a conflict of interest sufficient to sway members to solicit "yes" votes when the member believes the roll-up transaction is inappropriate or disadvantageous to its clients.

Second, if payments for "yes" votes are prohibited, should members be permitted to receive commissions contingent on a sufficient number of "yes" votes being received to approve the transaction? If members know they will be compensated only if the transaction is approved, despite the fact that they can receive compensation for "yes" and "no" votes, there might still exist an incentive to recommend that limited partners vote "yes."

Third, members are requested to comment on whether viable alternatives exist that would address the differential compensation question without adopting a prohibition on its receipt. Commenters are encouraged to propose other methods of regulating this practice. Alternatives include (1) expanding or modifying the disclosure requirements relating to differential compensation and (2) requiring the soliciting broker-dealer to affirmatively inform the limited partner of the potential receipt of differential compensation.

* * * * *

The NASD Board of Governors encourages comment from all members and other interested persons. Comments should be directed to:

Mr. Lynn Nellius, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1506.

Comments must be received no later than January 15, 1991. Comments received by this date will be considered by the NASD's Direct Participation Programs/Real Estate Committee, other appropriate standing committees, and the NASD Board of Governors. If the Board approves the proposed amendment to Appendix F, it must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions concerning this notice may be directed to Richard J. Fortwengler, Associate Director, or Carl R. Sperapani, Assistant Director, Corporate Financing at (202) 728-8258.

PROPOSED AMENDMENT TO APPENDIX F UNDER ARTICLE III, SECTION 34 OF THE NASD RULES OF FAIR PRACTICE

(Note: New language is underlined.)

Appendix F

Sec. 1.



Sec. 6.

Solicitation of Consents

No member shall be permitted to receive differential compensation based upon a limited partner's approval of the transaction in connection with a member's solicitation efforts in a reorganization or roll-up of a direct participation program, irrespective of the form of entity resulting from the roll-up (i.e., a partnership, real estate investment trust or corporation).


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