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94-96 NASD Requests Comment On Disclosure Of Partnership Valuations On Customer Account Statements

Comment Period Expires January 31, 1995

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Executive Summary

The NASD requests comments on proposed amendments to Article in, Section 45 of the Rules of Fair Practice that would require certain disclosures and reporting of Direct Participation Program (DPP) securities on customer account statements. Units of limited partnership interest are the most common DPP security held in customer accounts. The proposed amendments generally require that DPP securities held by the member or listed on a customer account statement be segregated from other securities. DPP securities may then be listed on the account statement without a price and include a statement that accurate pricing information is not available where no active secondary market exists. If, however, a DPP security is listed on the account statement with a price, the amendments would prohibit the value from being aggregated with the value of other securities held for the customer, or included in any calculation of net worth of the customer's securities. The member would also be required to provide a statement disclosing the method by which the value was obtained or derived, and advise the customer that DPP securities are generally illiquid and thus the value disclosed may not be realized if the customer needs to sell the security in the near future.

Background

The NASD Direct Participation Programs Committee (DPP Committee or Committee) has studied the issues surrounding how DPP security values are reported to investors on customer account statements. The issues addressed by the Committee were also reviewed and endorsed by the NASD Operations Committee. Both Committees recommended to the NASD Board of Governors that amendments to Article III, Section 45 of the Rules of Fair Practice be proposed for member comment.

The DPP Committee recognizes that some members report purchase price as the value of partnership interests on customer account statements, which is usually not equivalent to the current market value. Further, members that list DPP securities at purchase price tend to include that amount in the aggregate total current value of all securities held in the customer's account. The Committee is particularly concerned about this practice because DPP securities are generally illiquid and the purchase price probably has no relationship to current value.

The Committee also reviewed issues that arise when members report partnership securities on customer account statements without a price. This is a growing practice that reflects the difficulty of arriving at a definitive current value for DPP securities because this type of security does not generally have an active secondary market.

The Committee is, however, also aware of both regulatory and practical business considerations that might make it desirable for a member to disclose a value for DPP securities on a customer account statement. For example, when members act as fiduciaries for individual retirement accounts or ERISA plans, the regulations on the Departments of Labor and Treasury require that at least annually, a value be obtained or derived, and reported. Thus, members acting as fiduciaries often report a value for these types of accounts on the customer account statement. The Committee also noted that often the only reliable source of obtaining information on the value of DPP securities is the general partner.

The Committee is also aware that recently some members, general partners, and independent third-party services have begun to utilize sophisticated valuation methodologies to derive a value for DPP securities. These methodologies include the appraisal of the underlying assets, an analysis of income expected to be earned by the partnership, discounted to a current value, or an analysis of recent sales. The Committee believes that because the values obtained or derived through these methodologies could be beneficial if disclosed to investors, the proposed amendments provide for them to appear on the customer account statement.

Explanation Of Provisions

The proposed amendments set forth a general requirement that DPP securities listed on a customer account statement (even if not held by the member) must be segregated into a separate location from other securities on the customer account statement. This can be accomplished by grouping all DPP securities and placing them, for example, below a demarcation line on the statement. This requirement also covers any description of DPP securities listed by the member on an account statement even if the actual security is not held in possession or control of the member. This provision recognizes that often DPP securities were originally sold in uncertificated form and therefore, the member and customer are aware of the investment, even though physical securities do not exist. Thereafter, DPP securities may be listed as priced or unpriced as more specifically described below, so long as there is compliance with the disclosure provisions of the proposed amendments.

If a customer's ownership of DPP securities is listed without a price and there is no active secondary market in the securities, the proposal would require a member to include a narrative statement that explains the difficulty of pricing DPP securities because no active secondary market exists. If a value is disclosed for DPP securities, it must not be aggregated with other non-DPP securities to arrive at a total value of the securities held in the customer account. Further, the methodologies utilized for obtaining or deriving the value of DPP securities must be adequately disclosed and a disclaimer must be included that indicates the value may not be realizable if the customer seeks to liquidate its DPP securities in the near future.

Request For Comments

The NASD encourages all members and other interested parties to comment on the proposed amendments. Comments should be addressed to:

Joan C. Conley
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 January 31, 1995.

Comments received by this date will be reviewed by the Direct Participation Programs and Operations Committees and the NASD Board of Governors. Before becoming effective, the proposed amendments must be filed with and approved by the Securities and Exchange Commission.

Questions concerning this Notice may be directed to Charles L. Bennett, Director, Corporate Financing Department at (301) 208-2736.

Text Of Proposed Rule

(Note: New text is underlined.

Deleted text is bracketed.)

Customer Account Statements

Sec. 45.

(a) Each general securities member shall, with a frequency of not less than once every calendar quarter, send a statement of account containing a description of any securities positions, money balances, or account activity to each customer whose account had a security position, money balance, or account activity during the period since the last such statement was sent to the customer. Where the securities positions or account activity reported to the customer include direct participation program securities (even if not held by the member), the statement of account shall:
(1) segregate the direct participation program securities into a separate location on the customer account statement:
(2) if the direct participation program securities are listed without a price and there is no active secondary market in the securities, include a statement that accurate pricing information is not available because the value of the direct partnership program security is not determinable until the liquidation of the partner ship and no active secondary market exists: and
(3) if the direct participation program securities are listed with a price,
(i) not aggregate the value of direct participation program securities with the value of any other securities:
(ii) not include the value of direct participation program securities in any customer account net worth calculation:
(iii) include a statement of the methodology used for obtaining or deriving the valuation of the direct participation program securities: and
(iv) include a statement that direct participation program securities are generally illiquid securities and the price listed may not be realizable if the customer seeks to liquidate the
(b) For purposes of this section, the term "account activity" shall include, but not be limited to, purchases, sales, interest credits or debits, charges or credits, dividend payments, transfer activity, securities receipts or deliveries, and/or journal entries relating to securities or funds in the possession or control of the member.
(c) For purposes of this section, the term "general securities member" shall refer to any member which conducts a general securities business and is required to calculate its net capital pursuant to the provisions of SEC Rule 15c3-1(a), except for paragraph (a)(2) and (a)(3).

Notwithstanding the foregoing definition, a member which does not carry customer accounts and does not hold customer funds and securities is exempt from the provisions of this section.
(d) The Association, acting through its Operations Committee, may, pursuant to a written request for good cause shown, exempt any member from the provisions of this section.

[Sec. 45 added effective January 31, 1993.]


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